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Since December 2021, our clients investment portfolios have generally fallen in value by 15-20% from their previous highest point as at the time of writing. This is what investors call a 'bear market'.
Many of our clients, especially those with whom we have worked for a long time, have taken this decline in values philosophically, recognising that it is part of the normal ups and downs of investing. That doesn’t mean that they don’t have concerns, or that they like the idea of their investments falling in value. But it does mean that they understand the basic principles of investing (heaven knows, we’ve been banging on about it for 30 years).
But our financial planners have also had some conversations with clients who are on the verge of doing something foolish. To try to support them, I turned to Nick Murray.
Nick wrote an amazing book 15 years ago called Behavioural Investment Counselling. It’s aimed at financial advisers, but it contains a wealth of wisdom for anyone involved in investment markets. You can buy a second-hand copy on Amazon but they’re selling for over £200 each, or you can read it by subscribing to Nick’s website for $350 a year (and no, my copy is not for sale!).
Nick’s book is based on the central premise that it’s investors’ behaviour that is the dominant factor in successful investing. You might think that the important things are which investments you choose, or when you buy and sell them, or the costs of running your portfolio. But all of these things pale into insignificance beside the huge potential losses that investors experience as a result of doing the wrong things at the wrong times. Various studies, including the highly-regarded Dalbar study in the US, suggest that, left to their own devices, investors give up somewhere between 2% and 6% of their potential annual returns as a direct result of their behaviours. And it’s at times like these – bear markets – that this factor really comes to the fore.
Think about that for a moment. Investors have been shown to be giving up 2% to 6% (sometimes even more) of their returns every year on average. Over a 20 or 30 year period that makes the difference between having to scrimp in retirement to enjoying a prosperous and fulfilling life. It’s crucial to get this right.
And one of the biggest killers of return is allowing your emotions to drive your decisions.
Two Monks
In chapter 12 of his book, Nick recites the old Zen parable of two monks, sitting observing a flapping pennant. “The wind is not moving,” opined one monk; “it is the pennant that is moving.” “No,” said the other, “the pennant is not moving; the wind is moving.” The oldest and wisest Zen Master of them all, happening by, heard this and said; “The wind is not moving. The pennant is not moving. Your minds are moving.”
Nick goes on to say; "The most dangerous seasons of an investing lifetime are significant, generalised declines in prices, which we call bear markets. Perversely at such times, people tend to perceive far more long-term risk to their capital than is ever really there.
Thus, bear markets are the true testing times for the client, for the adviser, and most of all for their relationship with each other. How successful you are at sustaining your clients faith, patience and discipline when those qualities are under savage, relentless assault will determine to a very great extent, both the clients lifetime return and….the trajectory of your advisory career.
Bear markets themselves, ironically, are no danger to the long-term investor, because they are so transitory, and because when the permanent uptrend reasserts itself - four years in five, historically - the subsequent gains eventually dwarf the temporary declines. It is therefore not bear markets which do people in. People’s real problem is never what’s going on in the markets: it’s what’s going on in their minds. As the Zen master said, their minds are moving."
An Essential Element
The reality is that, for those people who ‘get it’, bear markets are to be welcomed. They are an essential element in a never ending cycle of human, and therefore economic, activity. They are a regular occurrence (approximately every five years since WW2), and they act as temporary interruptions of a permanent long-term uptrend. You have only to look at our clients’ individual performance charts over the last 20 years to see this in practice.
There are two reasons to welcome bear markets. The first is that they are the reason why investing in equities is so rewarding over time. The market demands a premium return as compensation for bearing that very risk of volatility that we are experiencing now. If bear markets didn’t exist, there would be no equity risk premium and there would be much less point investing in shares in the first place. The paradox that you need to get into your bones is that you need to embrace this volatility as the very reason why patient equity investors (like me, and hopefully you) can become and remain financially secure.
The second reason why bear markets are to be welcomed is that they present a massive opportunity to stock up on the quality equity portfolios which will sustain your lifestyle in retirement and become your legacy to your children. Don’t think of it as a bear market, think of it as a massive sale. This is your opportunity to purchase a high quality investment portfolio at prices that you may never see again.
When you buy an investment portfolio, you are buying a future stream of income in the form of interest, property rents and dividends from successful businesses. The lower share prices fall, the more income you get for your money. Some of the investments in our recommended portfolios are yielding over 10% income at the time of writing. When prices recover, you will be paying a lot more for the same level of income. If you are in a position to buy, and it makes sense for you to own this type of portfolio, you should do so now and not wait for a recovery.
Rattled
Given these advantages, why is it that people get so rattled at times like these?
Firstly, it’s because they haven’t truly understood the nature of successful investing. They think that the way to become wealthy is to buy and sell in anticipation of market ups and downs, to focus on individual holdings and weed out the underperformers, exchanging them for investments that they forlornly hope will do better, or capitulating altogether and putting the money back in the bank where it can earn a rate of interest that is well below the rate of inflation and is likely to fall next year in any case (and when interest rates do fall, that will be a trigger for share prices to rise and your bear market opportunity will start to disappear).
Secondly, it’s because seeing your wealth decline in value is a scary thing. We get that. Of course it’s scary. And like anything scary, it gets your mind moving. How much worse will it get? What can I do to stem the flow? It’s down x% and (enter name of bear market pundit of choice) says it’s going much lower because of (enter reason for apocalypse: government debt, oil prices, war in Ukraine, Israel, covid, climate change, price of biscuits, etc, etc.). Somebody do something!
This stuff can be hard to resist, it’s like a narcotic.
Thirdly, a stock-market sale is always accompanied by bad economic and financial news. Journalists will seize on whatever bad news there is, and spin it out into a scenario that sounds like the end of the world is nigh. Reporting will always be hysterically overblown, and important sounding commentators will tell you why we are about to experience Armageddon, why our economy is going down the drain, and how much poorer we are going to be by this time next year. Surely they know what they are talking about? Don’t they?
So, we will say it again and we will keep on saying it. The route to financial security and independence is to; a) make sure that you have enough cash to cover your foreseeable spending plans, b) invest in a high-quality portfolio of well diversified assets, c) assume that your investment timescale is the rest of your natural life (at least), d) relax and ignore the doomsayers.
If it was that easy we’d all be doing it. That’s why you need to listen to your financial planner, the cost of whom is tiny compared to the potential gains you will enjoy by having a plan and sticking to it.
And if you need someone to talk to, give us a call. We know what works, and we have a plan.
And so do/will you.
Andy Jervis, Certified Financial Planner
October 2023
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