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?
Or
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.
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.
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.
(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.
With that kind of 12-month return – let alone the average bull market run of 4.5 years – you can expect to easily recoup losses in the vast majority of situations, and pull ahead.
4) Raise your expectations, not lower them
In a nutshell, with this knowledge - a client who has a long time horizon should take more risk, not less. And you should expect higher returns.
It is never easy to stomach volatility. But if you see it coming, much like a horror movie where you know the ending after having watched it a couple of times - you won't have such a drastic reaction.
Not only that, but positive volatility occurs far more than negative volatility. Your portfolio should jump up far more violently, and often than negative drops.
In reference to the table above, abnormally large returns occurred 37.6% of the time, while abnormally large losses were only about 7%. So for every huge drop you see, you can expect at least 5 different occasions where it should rise by the same proportion.
5) High Risk, High Return
Ultimately, the data shows what I've been trying to say from the beginning - high risk, high return.
To be specific, the probability of achieving high returns from taking said risk is exponentially higher than not taking risk.
Despite the risks and drawdowns, with a long enough time horizon - the V Bounces allow you to get returns that are far beyond a balanced portfolio or a safe, guaranteed portfolio.
This includes your CPF, which you can use to invest in such funds.
Most Equity Funds have a similar kind of volatility.
Conclusion
Ultimately, the data shows that high risks have far higher returns over long time horizons, despite serious crashes, crisis's, etc. If you have a long time horizon, especially if you're young, it makes financial sense.
As an investment professional, I have access to a wide range of funds.
We know that tracking a market is cheap and effective, but it’s not foolproof. In fact, if its highly tradable, you can consider it worse. That comes under the most common investor mistakes from people who DIY, such as switching out my liquid funds when its bothering them.
When the average fund is held for a mere 3.27 years, its daring to assume you'll be able to go decades without compromising your returns.
On my end, I intentionally don’t choose markets for my clients where fund manager performance has a low probability of strong performance compared to mimicking a market index (such as the US, where 80 - 95% of funds benchmarked against the SNP500 lose), and I don’t keep my assets liquid so I don't get tempted.
Historically speaking, I should outperform the SNP500 by 2.5 – 3 percentage points for my semi-retirement portfolio and 5 - 10 percentage points for my full-retirement portfolio, net of fees*. My breakeven returns across 20 years are lower than a self bought fund on any given brokerage.***
The 5 year return for the STI ETF is 3.49% with all dividends reinvested, while 2 funds I'm personally invested in currently have 5 year returns of 15.4% and 17.3% respectively, net of all fees with an equivalent recorded Standard Deviation.
In other words, I am historically on track to make at least triple of what the STI ETF makes.
My clients typically experience higher returns, lower volatility, a higher return-risk ratio and a higher Sharpe ratio.*
The catch? If this kind of investing were for everyone, they would do it successfully. For starters, I prep my clients mentally for the long journey ahead, such as with this article.
If you enjoyed the article or have some thoughts or comments on how you can start developing your streams of income, do like - comment and subscribe!
Money Maverick
Investments above are available using CPF (Ordinary Account), SRS (Supplementary Retirement Scheme) and Cash.
Special Notes:
All data presented is at time of writing.
*This combination of funds has historically outperformed the Nasdaq QQQ Index net of fees by over 2 percentage points across 3- and 5-year periods. It also has a higher Sharpe Ratio and lower Beta.
QQQ has performed 19.07% (3 year period) and 17.05% (5 year period), gross of fees. Refer to point below for potential fees or factors.
I also used Timeline to verify this (the market and asset allocation choice) to some degree (since they don't have mutual funds).
**The Table Returns recorded above for the SNP500/QQQ do not account for the following
1) Dividend Withholding Tax
2) Forex Risk
3) Management Fees/Account Fees/Transaction Fees ***Please consult me on how this is achievable. It is very tricky and very conditional. (prospects only)
Credits:
1) Dalbar – Quantitative Analysis of Investor Behavior, Dalbar Inc (March 2011)
-Funds are not held longer than an average of 3.27 years
2) Global Financial Data Inc, SNP500 price level returns
-Tables, etc
3) Markets Never Forget - Don Fisher
-Information
4) Chart of the Day
-SNP500
5) SPDR STI ETF
Disclaimer: All returns and statistics posted on this article are not to be taken as investment advice. Any formal advice from my end can only be conveyed to you during a professional consultation.