High Risk, High Return - No Risk, No Return.
Here’s a fun dilemma for you that I face every other week -
1) Do I adhere to what kind of investment the client wants, with some additional adviser value?
2) Do I convince them not to go for what they want because it is not optimal, at severe risk of losing the client entirely for not being able to follow a simple instruction?
Yes, I use CKA, as is mandated. But I'm not an order taker. Most people don't know how investing works. How then, would they decide their risk profile?
Does that make sense to you? If you are a doctor and someone comes in wanting Panadol but your diagnosis suggests they need a Heart Surgery, do you just shut up and give the patient what they want? Or are you a professional?
Of course, you can never force anyone to do what you recommend. But there are times where I make an especially strong recommendation, especially in the circumstance where I believe very strongly due to the fact-based fundamentals of investing – that is ultimately:
1) Buy Low, Sell High
2) Time in the Market is better than Timing the market
3) High Risk, High Return
The rules above are not easy to follow. If they were, I wouldn’t spend a considerable amount of my time fixing portfolios for new clients over the last two years.
I have to continue promoting investing aggressively, especially when you’re young, because there’s so much opportunity cost if you’re under 40 and you’re not investing aggressively. I think that its important that people are prepared.
As a result, I thought I’d address (3) a little bit – since let’s face it, out of the three that’s probably the easiest. Why should you take on high risk? How do you take on high risk? How do you know you will get a high return? Can something help you understand all of that, and get why that as a young person, you should invest aggressively? (and likely as aggressively as possible)
...It’s the V Bounce.
The V Bounce is an investment occurrence marked by high growth following a depression or a recession.
In an aggressive portfolio that comprises of mostly equities, you WILL typically experience this a few times in your investment lifetime. There are several advanced variants as well as different forms of growth post-recession, but we’re only covering basics today.
What this means in English for investors is simple – after a recession is over, the market tends to swing upwards in a drastic manner.
And I mean really drastic.
Here’s an illustration of what a V-Bounce looks like.
As you can see, a humongous drop is quickly followed by unprecedented (or precedented, which I'll cover some other time) growth that exceeds the previous high point by a humongous margin.
One implication is of course, that despite severe losses in the short term you'll ultimately make money.
...A lot of money.
There are several definitions out there, but I'll define it simply by these two characteristics: 1) The beginning of the V hits a extremely low point, typically the worst of a recession
2) Followed by the second end of the V, which should be much higher than the beginning of the first end
V Bounces are recorded throughout most of stock history, so its not an uncommon event. In every chart and fund that I run through with my client, there's at least one - if not several, V-Bounces.
That's meant to be reassuring, not discouraging.
What you can learn from the V Bounce
1) Markets do not fundamentally change. This has been going on for centuries (well more than 1, at any rate).
Using the US as an easy illustration, the same market which cynics say that past performance does not equate to future performance has gone through the following.
Wall Street Crash: -86%
Great Depression: -60%
Oil Price Rise (1973): -48%
Black Monday (1987): -34%
Dot Com Bubble (2000): -49%
Financial Crisis (2007): -57%
And over half a dozen more of such events from 1929 till now.
Despite ALL of that, the annualized returns for the SNP500 are 9.07% (25 year annualized return from 2018, gross of all fees).
A $100,000 investment from the start of 1993 would be worth over $876,250 in 2018.
And I can get you an even better return.
As it turns out, fluctuations included - time in the market is really much more valuable than timing the market. Past performance is future performance the overwhelming majority of the time. Investing twice in 25 years while holding onto cash gives you a far lower result.
2) There is nothing average about serious equity market returns.
They are not normal.
Getting an 'average', or annualized return of 10% means nothing to the chart itself: the volatility is so extreme that the bear market of 1980 to 1982 was -27% (-16.7% annualized), followed by a bull market following that was 229%, or 26.6% annualized for 5 whole years.
Its hard to imagine that a 10% annualized return came out of all that, but it did. The average means nothing.
The second part of the V is always higher. Much higher. This is reflected in almost basically every geography – India, China, Japan, etc.
Unless you’re the STI ETF, which hasn't even recovered from its 2007 high yet.
(Its more like an L.)
3) Really NOTHING average.
Experienced investors know that when their portfolio falls 25%, rising 25% doesn’t get them up to breakeven – it has to rise 33%.
To recoup a 40% drop, their portfolio must rise 67%. Harsh.
If we calculate this based on annual or annualized return, it looks like a serious uphill task.
Someone who looks at it from face value - for the 40% drop – if you have a 10% annualized return, it’s still going to take more than 6 years just to break even.
But the math is incorrect on this because that’s not how stocks work. If you keep staying invested or invest further, it pays off in a big way. In fact, it pays off far more during initial recovery – as you can see in the table below.