The past year has been a mixed blessing for many investors. Those who persevered and focused their portfolios on US equities did quite well; those who panicked and sold and focused their portfolios on US bonds did poorly and may even have lost capital.
Investment mistakes like this are quite common; we are all subject to it. These errors mainly focus on misunderstanding the nature of investing and the risk of investing, and the difference between short-term and long-term investing. In any case, they are always detrimental to the financial health of the investor.
Investing in stocks is by nature investing for the long term. This means dealing with occasional bouts of volatility and major short-term portfolio losses. This month of January is a notable example. The reason stocks generally offer higher long-term returns than bonds is because of the uncertainty of their short-term returns. Investors don’t know when or if they will see returns or how much they will be. The trade-off for the certainty of returns is the certainty of small returns, as investors now see in CDs.
Thus, it is always a mistake to panic and sell stocks during a downturn. Downturns are ubiquitous, a short-term phenomenon, and may occur more than once in 2022. It is a mistake for investors to make long-term investment decisions due to long-term behavior. short term. This reaction is caused by a misunderstanding of the risk. The risk is not short-term volatility; it is a permanent loss of capital, for example, due to bankruptcy.
Believing that asset allocation is a panacea is another mistake to avoid in 2022. This mistake is due to a lack of understanding of the significant long-term impact of asset allocation. With the usual strategy of having a large portion of a portfolio in bonds, the swaps have increased peace of mind for lower returns. This is true because equities almost always significantly outperform long-term bonds; for example, in about 70% of all 10-year periods. However, they can underperform bonds over shorter periods, and sometimes bond prices can rise when stocks fall. This means that, for example, a 60/40 equity versus bond strategy may have less volatility than an 100% equity portfolio, but significantly lower long-term returns, especially now with rising interest rates.
Thus, it is generally, and especially in 2022, a mistake for portfolios focused on the long term to be dominated by bonds, especially long bonds. Long-term bond investors have seen strong returns over the past 35 years as interest rates have moved from low teenage percent to very low single digits. In general, the longer the maturity of the bond, the better off they are. However, now that interest rates are rising, the opposite behavior could devastate the value of longer-term bonds.
This will reduce the usefulness of these bonds as a diversifier for an equity portfolio. Given that in a rising interest rate environment, bond yields will not compensate for short-term equity losses. Thus, it would be a mistake in 2022 to buy bonds with maturities longer than a few years. With shorter-term bonds, investors can, when they mature, quickly reinvest the principal at the new, higher interest rates.
All data and forecasts are provided for informational purposes only and do not constitute advice to buy or sell any security. Past performance does not represent future results. If you have a financial concern that you would like to see addressed in this column or if you have any other comments or questions, Robert Stepleman can be contacted c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at [email protected] tampabay. rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated with Dow Wealth Management, LLC.