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Today’s post is an expansion to a brilliant question from one of the social media groups that I subscribe to.
Is it Dangerous To Be In Equities?
To paraphrase, the original poster queries the majority of people in the FIRE community who have an asset allocation consisting of 100% in equities, a majority of which sits in index funds (ETFs).
It seems like the narrative is “Buy equities, passively, at any price, indefinitely, and hold virtually no other assets, it’s all good coz you can’t beat the market, oh and lowest fees possible”. Occasionally with “use margin or other leverage to speed it up”.
With equity markets dislocated from economic reality, and equity valuations one of the highest in history… is this the right way forward? And what ramifications of this are there?
My Initial (Mega) Response Is:
“I don’t know whether the overall market is going to go up or not, but can say that as more capital piles into passive investing, the counter-argument is that there is potentially more alpha to be made via active investing as a contrarian approach.
Whether the market continues to rise in the short-term is a complete unknown, but a historian would argue the market does rise in the long-term (the risk is of course, that the long-term exceeds your retirement age).
Many people bring up that market history can and does repeat itself (GFC, Great Depression etc).
However I would argue that the playbook for crises has been formulated, at least for the medium term, in the form of govt and centralized intervention – imagine the sitting govt not acting whilst an economy goes to sh1t, they would be castrated by the mainstream.
We saw these intervention and stimulus measures in March/April and I believe is Plan A for crises going forward, in short – to chuck money (and quick) at the problem.
What this does do, is create a floor for markets. There is no “invisible hand” at work no more.
At the risk of being controversial, COVID was one of the best opportunities to reset valuations based on a free market approach.
However as seen with the GFC and GD, the social turmoil is enormous and certainly not advocated.
Another point to be made is that it is not you nor I which move markets, it is the big instos, super, mutual and pension funds who are mandated to bring a benchmark return to their shareholders/investors.
As rates are so ridiculously low right now, there’s really nowhere else to put their capital. Bond yields are so low, and you can forget about cash.
I think the big macro trends at play in recent years, have been the lowering of rates coupled with the huge stimulus measures from govts and central banks to create a marketplace where we are now.
Unsure whether it will continue, and certainly not discounting a Black Swan to knock it off it’s perch.
End of the day I try and find an asset class that I’m comfortable with, and try to manage risk as best as I can!”
To Expand…
I had wanted to expand on this point further because I felt it is such a pertinent question in relation to how the markets are behaving right now.
To me, it does seem a little naive that there are segments of the investing community who believe equities, and ETFs in particular – is all you need for FIRE.
We saw the effects of how quickly markets can turn during the crazy days of March, and I think it is fiscally irresponsible to think that equities only move in one direction.
But what are the alternatives?
I think this is the million dollar question.
What are the alternative asset classes which you can put your money into in this current environment?
- Real Estate: Yes for sure, but the entry costs to property investing are prohibitive for many people.
- Bonds: Bond yields are so low right now as a reflection of low interest rates.
- Cash: Well… you could… for a paltry ~1% in some cases.
- Crypto? I don’t know enough of this sector to really comment bar the usual DYOR and high risk/risk return paradigm. Although it has moved… A LOT (just check out the price of Bitcoin recently).
- Perhaps we need to start a business? Or another side hustle?
This question really nailed it on the head for many people right now.
Equities are flying, and have been for the past few years (a COVID-induced pause notwithstanding), mainly because there really is a lack of return from anything else.
However.
I would say that the aim of investing, is to aim for the highest possible returns, risk-adjusted.
The last part is key, because a fundamental pillar of making money is factoring in the risk per unit of money invested.
I’m not talking about the risks of a company going bankrupt, or the risk of losing your property tenant.
Or even if the market drops 35% in the space of 3 weeks.
No, the key here in my eyes – is the risk of you not being able to recover from a market hit because you went all or nothing.
Long term investing is not about making the most money.
Long term investing is about survival.
Going all or nothing, is counter-intuitive to surviving. Because you only have one bullet – use it or lose it.
That point is what I think many people are missing right now – thinking that good times always last, and to tilt their asset allocation as gung-ho as possible.
No one knows what the future will bring, but I am always reminded that the higher an asset rises, the more inherent risk is in that underlying asset.
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