J.P. Morgan, Goldman Sachs and Morgan Stanley are all forecasting a US GDP growth of around 8% this year. That would make the year 2021 the best year for the economy since the 50s. But is this extreme positive outlook already factored in share prices? It is important to recognize that things can and will go wrong. Who was seeing the stock market crash of 1987 coming? Or Hussein’s invasion of Kuwait in 1990, the collapse of Long-Term Capital Management, 9/11, the collapse of Lehman Brothers, or the COVID-19 pandemic? Few to none! So, don’t be complacent just because of a terrific economic outlook. Same for the downside arguments, such as inflation, reckless money printing and outrages debts among all worldwide central banks and governments. What is already factored in and what is not? The sophisticated investor realizes that the outlook is always blur and is always prepared for the rainy days ahead.
However, long-term investors and short-term traders must handle things differently. The most important consideration for long-term investors is asset allocation, so how you divide your portfolio up among various, correlated and un-correlated assets, like stocks, bonds, real estate, precious metals, commodities and cryptos among many others. Studies consistently show that 90% of investors’ long-term returns are due to their asset allocation. The remainder is due to security selection, investment costs and taxes.
It does not matter if you are a fantastic stock picker if you had only 20% of your portfolio in stocks, with the rest in bonds and cash. Another investor with, 60% in a plain-vanilla S&P 500 index fund would have 3 times as much equity exposure, and therefore earn a lot more in the long run.
The key for long-term investors is not to guess the market, which cannot be known but to have a sensible asset allocation?
Nothing outperforms a diversified portfolio of stocks. Every dip, bigger correction and longer term bear market turned out to be a massive buying opportunity. That means long-term investors can make investing very simple. You need only asset allocate properly, minimize your investment costs and tax-manage your portfolio. The only additional work that remains is to rebalance your portfolio once a quarter or even year to bring your asset allocation back into alignment.
But some are short-term investors. Or even both!
Short-term traders should focus on the outlook for individual companies. Company’s earnings often dependent on the strength of the economy and their share prices on the short-term trend in the market. But as mentioned, we cannot know these in advance.
So how do short term traders control risk then?
a) Stick to high-quality securities that have plenty of upside potential and hold up best in a correction or bear market.
b) Diversify across various countries, industries and sectors. Not all stock markets move in the same direction at the same time. Some industries – like healthcare, defence, food and utilities are largely recession-proof.
c) Run trailing stops behind each position. You do not know when stocks you own will peak. Trailing stops protect your profits during good times and your principal during bad. They give you unlimited upside potential with limited downside risk.
Experienced investors recognize that the future is not predictable. So, a majority believes they have to guess then what the market will do next. But there is an outright: No! Simply, do not do it!
The primary goal of intelligent risk management is to guess as little as possible. Accept that uncertainty will forever be your inseparable companion. Instead spent you time using proven principles of wealth management.
If you follow these guidelines, then you are already ahead of 95% of investors.
Sven Franssen