What does it mean to invest for the long run in a post-crisis world?
For many years leading up to the economic crisis investors have been told that equities were the asset of choice to provide for a comfortable retirement. Earlier this year Rob Arnott at Index Universe noted the many “false investing dogmas” the economic crisis and ensuing bear market helped puncture. Not least of which was the notion that equities provide a notable and consistent return premium over bonds.
Indeed one finance professor Jeremy Siegel rose to prominence on the back of a book entitled Stocks for the Long Run. In that book he presents research showing the performance of stocks over the some 200 years. Not surprisingly that data showed stocks besting bonds over the long run. This line of research has been adopted wholeheartedly by the financial planning industry to justify a tilt towards equities.
It is interesting to note that recently there have been some skeptics of the Siegel data. Jason Zweig at WSJ had a piece up contending that the early stock data is particularly flawed. One can also find a criticism of the Siegel data over at Ticker Sense.
Some analysts go beyond issues with the data and call into question the notion of an equity risk premium. Eric Falkenstein who blogs over at Falkenblog has written extensively on the theoretical and practical aspects with equity risk and returns.
A believer in the Siegel data would likely presume that a long-term buy and hold approach works best. However the past decade has put the issues with this data in stark relief. Less so the technical aspects, but more about what it implies for investor behavior.
One can see where this has lead. Time Magazine recently had a piece on the sorry state of 401(k) plans. Doug Short and Roger Nusbaum both discuss the circumstances that have lead many employees to be disappointed with the results of their 401(k) plans. Undoubtedly having an equity-centric, or even worse company stock-focused approach has lead to lower than expected returns.
In that we have discussing the topic of buy and hold investing of late it makes sense to think a little bit more about this issue. To put it bluntly a dedicated buy and hold, equity-centric investor was decimated this past decade. Two huge bear markets have shown this approach to be a tough one to follow. Few investors likely maintained this type of strategy through thick and thin so as to enjoy whatever rally we have experienced year-to-date.
Perhaps investors are better off thinking about the long run as a series of short runs. That does not necessarily imply a short-term investment approach, but it does recognize the need to manage the risks inherent in one’s portfolio over a reasonable time frame.
We were prompted to this discussion by a couple recent articles. John Keefe and Charles Wallace at the Macro View blog note how your long run is likely very different than that in academia. They write:
You don’t have “the long run.” You have one run, over your working years. Be sure you understand what that means, and don’t let a book title, even a professor’s, determine your investment policy.
The aforementioned Jason Zweig again at WSJ takes issue with notion that sufficient time will eventually smooth out the returns from equities. He writes:
The belief that extending your holding period can eliminate the risk of stocks is simply bogus. Time might be your ally. But it also might turn out to be your enemy. While a longer horizon gives you more opportunities to recover from crashes, it also gives you more opportunities to experience them.
So if holding (and hoping) for the long run is an untenable approach for many what is an investor to do? We are of course leaving aside the always-sensible advice of living below your means, saving, and working hard etc.
One approach is diversification. While their advice varies Arnott, Zweig, Nusbaum and James Picerno at the Capital Spectator all note how a broader approach to investing will help stem some of this equity-centric thinking. Picerno notes how a true market portfolio outperformed equities over this decade. Arnott focuses on a broad array of assets, Nusbaum notes the need for international diversification and Zweig even goes back to Ben Graham to extol the benefits of bonds in a portfolio.
Some analysts go even farther to the side of bonds. One prominent voice on the subject is Zvi Bodie who believes that bonds, specifically TIPs should be the core of any retirement portfolio.
On the other hand some, like Veryan Allen at the Hedge Fund blog, think investors should be focused on strategy diversification as opposed to asset allocation. The point being that only alpha-centric strategies can generate consistent returns. Asset classes have demonstrated they cannot.
No matter the approach investors can’t get too hung up on their particular approach. What investors likely need over the long run is flexibility. Carl Richards at behavior gap maybe puts it best by noting our need to “course correct” over time.
We place way too much weight in plans; in fact, most plans are little more than guesses.
The next ten years may very well be a good time to be in the equity markets. However planning on that is a very different thing. A more prudent approach would recognize our inherent limits in forecasting future returns.
So no matter how well you plan, the future isn’t guaranteed to any one. The capital markets are going to do what they are going to do whether you participate or not. All an investor can hope to do is try maintain a flexible approach and stay in the game. Only those investors who stay in the game will be able to capture some gains along the way. Nobody said investing is easy. Nothing worth doing ever is.