If you feel like investment has got a whole lot more difficult in recent years there may be a good reason for that.
The long bull market from the early 1980s until the top of the dot.com bubble in 2000 really was a golden age for stock market investing.
You didn’t need to do anything particularly clever in those years to enjoy remarkable (and history has shown, unsustainable) returns. Just turning up was enough. No wonder investors started to believe that time in the market not timing the market was all that mattered. No wonder, too, that passive funds should have grown in popularity. If tracking the market, at low cost, is so profitable why go to the trouble, or expense, of trying to beat the index?
Just as old generals fight the last war, I wonder whether this passive, buy and hold approach can still cut it for investors in today’s low-growth, low-returns world.
Credit Suisse recently made a convincing case that the strong returns enjoyed in the bounce back from a financial crisis tend to mutate into an extended period of much less exciting returns.
A recent note from Goldman Sachs described the outlook for the market from here as “fat and flat” – in other words volatile and disappointing. A colleague this week described his vision of a trading range capped by high-ish valuations and unimpressive earnings growth but underpinned by central-bank largesse and an absence of alternatives to equity investment.
Problems for disengaged investors
If these market watchers are right, this environment poses a problem for disengaged investors without the interest or inclination to roll their sleeves up and really manage their portfolio.
Madness, as they say, is continuing to do the same thing and expecting a different outcome, so perhaps now is the time to think about how to thrive in a sideways-moving and volatile market.
If successful investing is about something more than just taking part, what strategies might a risk-averse investor adopt?
The first approach is to tilt the overall angle of your returns upwards by picking winners and avoiding losers. By definition, active investment does not always get it right. It may even be a zero-sum game with as many losers as winners. But if the alternative is to travel sideways, I would suggest that we don’t have any alternative. The annual compounding of even a relatively small performance gain over the market as a whole makes a whole lot of difference over an investing lifetime.
Second, be a contrarian. Equity investment as a whole may deliver unexciting returns but at any one time certain markets are in or out of favour. History shows that rummaging through the metaphorical investment dustbin pays off in the long run. Banks, supermarkets, miners – there are plenty of sectors that are widely disliked and consequently cheap. If you get it wrong and they don’t bounce, you won’t lose much because the bad news is in the price. But if the market has over-cooked the pessimism, the potential gains are significant.
A bit of market timing
Third (and I’m whispering this because I’ve said the opposite many times) a bit of market timing may just be necessary now. You won’t catch the top or the bottom but reining back your exposure when sentiment is optimistic and becoming more gung-ho when the headlines are grim is a shared characteristic of all successful investors.
Fourth, remember that the best way of tilting the trajectory of market returns upwards is to re-invest your dividends. Do that religiously and even a flat market starts to feel rewarding.
Finally, focus on quality. Companies which enjoy significant barriers to entry, strong brands and pricing power have the ability to earn higher returns on the capital they employ – sustainably, year after year.
If you can find this kind of investment opportunity you don’t need to worry about market timing or being a contrarian. Time and the magical power of compounding will do the work for you.
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