Every year, the market gifts us invaluable lessons on investment strategies. While each year is different, many of these lessons are reinforced or repeated year after year; that’s why one of my favorite sayings is that there’s nothing new in investing, only investment history you don’t know. Before you read the 10 lessons 2021 taught us, I want you to remember one important takeaway: When investing, imitate the lowly postage stamp. This small object does one thing but does it well – sticking to its letter until it reaches its destination. My greatest hope is that you stick to a plan until you have reached your financial goals! Now to my top 10 lessons learned in 2021….
Lesson 1: Valuations cannot be used to time markets.
While higher valuations do forecast lower future expected returns, that doesn’t mean you can use that information to time markets. They are best used to provide estimates of returns so you can determine how much equity risk you need to take in your portfolio to achieve your financial goals.
Lesson 2: Active management is a loser’s game.
Despite an overwhelming amount of academic research demonstrating that passive investing is more likely to help you achieve your financial goals, many individual investor assets are still held in active funds. Yet, in 2021 a large majority of active funds underperformed the markets, as they do each and every year.
Lesson 3: Don’t make the mistake of recency; last year’s winners are just as likely to be this year’s dogs.
The historical evidence demonstrates that individual investors are performance chasers. They buy yesterday’s winners (after the great performance) and sell yesterday’s losers (after the loss has already been incurred). Unfortunately, a return in a past year doesn’t necessarily predict the same return the next year. In fact, great returns often lower future expected returns, and below-average returns raise future expected returns.
Lesson 4: Gold is not an inflation hedge over your investment horizon.
Because gold has performed extremely well in the past few years, some investors believe buying this shiny security is a great way to avoid inflation. History has shown that over a long period of time – and by that, I mean a century – buying gold has effectively hedged inflation However, the markets have shown it’s too volatile to hedge inflation over periods even as long as 20 years.
Lesson 5: The investment world isn’t flat, and the diversification of risky assets is as important as ever.
The financial crisis of 2008 led to the rumor of the untimely death of diversification. Many people believe that because the world is now flat (meaning interconnected), diversification no longer works. However, diversification benefits come not just from correlations, but from the dispersion of returns as well. And a wide dispersion of returns in almost every year since 2000 demonstrates there are still large diversification benefits.
Lesson 6: Hedge funds are not investment vehicles; they are compensation schemes.
Hedge funds entered 2021 coming off their 12th straight year of trailing U.S. stocks (as measured by the S&P 500 Index). The market has persistently taught investors that the only objective hedge funds have achieved is transferring assets from investors to the fund sponsors.
Lesson 7: The correlation of returns of stocks and bonds is time varying.
The market has shown us again and again that when stock returns vary from their historical average, bond returns are just as likely to be higher or lower than their historical average. However, without a crystal ball, not even the best investor is able to predict future correlations.
Lesson 8: Don’t let your political views influence your investment decisions.
Over my 25 years as an advisor I have repeatedly seen investors buy and sell based on their political views. The reason is that individuals become more optimistic and perceive the markets to be less risky and more undervalued when their preferred party is in power, with the reverse being true when the opposition party is in power. To avoid this, it’s important to become aware of how our views impact our choices.
Lesson 9: Diversification is always working; sometimes you like the results and sometimes you don’t.
Diversification has been called the only free lunch in investing. When done properly, it reduces risk without reducing expected returns. However, once you diversify beyond a popular index, such as the S&P 500, you must accept the fact that you will almost certainly be faced with (sometimes long) periods when a common benchmark index outperforms your more diversified portfolio.
Lesson 10: The strategy to sell in May and go away is a myth.
A basic tenet of finance is that there’s a positive relationship between risk and expected return. To believe that stocks should produce lower returns than Treasury bills from May through October, you would also have to believe that stocks are less risky during those months – a nonsensical argument.
Summary
Smart people make mistakes. What differentiates them from fools is that they don’t repeat the same mistakes and expect different outcomes. By utilizing the 10 lessons 2021 taught us, you can avoid making common investment errors. It’s also important to know your financial history and have a well-thought-out investment plan. If you don’t have a strategy, start by reading my book, “Investment Mistakes Even Smart Investors Make and How to Avoid Them.”
Looking for more details on these lessons? Learn more!
And remember – it is usually in your best interest, if you have a well-strategized financial plan, to stick to your plan like a postage stamp sticks to a letter. Happy investing!
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