The value of your investment and any income from it can go down as well as up and as a result your capital may be at risk.
The best investment advice doesn’t grow old. When former Baillie Gifford Partner Edward Hocknell wrote ‘How to Invest in Equities and Stay Sane’ back in 2012, ‘global pandemic’ was just one on a list of scenarios for business continuity managers and civil servants to plan for.
Now that this risk is upon us in the shape of the coronavirus (Covid-19), we thought Edward’s paper, a reflection on the Great Financial Crisis, was well worth retrieving from the vaults. His point is not that great upheavals such as this are “irrelevant” to investors, but that however overwhelming the influence and buffetings of the news, they should not obscure the opportunities presented by the “benign adaptations which help us to survive”. These “gradual and quiet” advances continue to make life better. Their progress can even be accelerated by a crisis.
Life is more secure now than it has ever been. Uncertainty has been reduced to levels which previous generations would find incredible. Their lives were plagued (literally) with disease, famine, war, floods, religious manias and social upheavals. No wonder the ancients erected massive temples and performed endless sacrifices. It was all an effort to reduce the terrifying uncertainty of life.
We are lucky – on the whole. In the modern world, risk has been squashed and repressed wherever it appears. The big exception is in our savings, which for many people is now the riskiest part of their lives. When we try to preserve our wealth we immediately become medieval peasants, helpless victims of an implacable fate. Two hundred years ago, Nathan Mayer Rothschild, the greatest banker of his day, said that it was ten times harder to preserve wealth than it was to make it in the first place. Not much has changed.
Unfortunately, we have to take risks. We have no choice, because the cost of not doing so has become immense. The entry fee to safe havens is prohibitive. Bond markets are behaving like an insurance salesman who wants to charge you more to insure your house than it would cost to rebuild. Safety guarantees loss.
If we want a reasonable prospect of real returns, we have to invest in equities; and that means having to cope with uncertainty. As John Maynard Keynes, the great economist put it in the 1930s: ‘The modern holder of quoted equities requires much more nerve, patience and fortitude than the holder of wealth in other forms’. The purpose of this piece is to instil in you, Dear Reader, that Nerve, Patience and Fortitude. The evidence is clear: it is worth it – and anyway we have no choice.
It seems to us that the greatest enemy of successful investment is ‘Events’. We are all participants in an endless parade of happenings, which, being human, we continuously try to integrate into our world view. There are too many events for us to treat them critically, or test them for relevance. With our wealth at stake, we adopt a semi-conscious policy of worrying about as much as possible, and discounting as little as we can – especially if it sounds alarming. There is plenty of academic evidence for this. It is best summarised in Daniel Kahneman’s excellent book ‘Thinking, Fast and Slow’. He shows how we instinctively default to the most recent or striking piece of evidence, and that our urge to leap to conclusions overwhelms our better, rational selves.
Modern media make the problem much worse, of course. ‘News’ is crafted to grab our attention; it is not created spontaneously by the world. It is said that in 1936 a BBC announcer solemnly announced over the wireless: ‘Good evening. It is six o’clock. There has been no news today’. Those days are long gone.
So, if news and events are our enemies, how do we cope with them? The first step is to regard them with the suspicion they deserve, and to be more discriminating in how we react. From the investor’s point of view, most events can be put into one of three categories: a large proportion is simply irrelevant, even though it may look vital and pressing; some is misleading, sending us haring off in the wrong direction; but some is boring, underreported – and very helpful.
The rest of this paper will concentrate on giving examples of all three types of events in the hope that it will help fellow investors make some money and ignore the siren calls enticing them onto the rocks. It may also help them sleep better at night.
Image: Glasgow Street. © Hulton Archive/Getty Images.
Most news is irrelevant and can be safely ignored. Especially pointless are the frequent predictions of things which cannot be predicted. The forecasting records of even the best economists are very poor. We know this but we still listen to them. We are like ancient Romans, who peered at chickens’ livers before every battle to see who would win. We would be better off assuming that the economy does OK most of the time. Experiments show that in complicated matters mean reversion is a better tool for prediction than listening to experts.
Similarly, the huge amount of effort devoted to interpreting short-term market movements is largely pointless. The market is not a person; it does not have reasons or intentions. Its wanderings are the residual of countless opposing forces. It is not ‘Trying to tell us something’. Its meanderings may well provide us with opportunities to buy or sell, but it is much easier to behave rationally if we do not believe that a fall in prices betrays some hidden horror. Similarly, a rise in prices does not mean that Santa Claus is on his way.
A great deal of political, social and global reportage is irrelevant to us too. We are trying to be good investors, not emperors. We are not responsible for the big picture; we only have to buy what we really like. Very often a story will draw us in. We become ‘experts’ on matters such as Greek public finance, which held no charms for us before, but which assume a disproportionate importance in our minds because we keep hearing about it. We are unwilling to write off this tediously won knowledge, so we think it must be important.
The point is not that everything is irrelevant, but that most investors are too exposed to random buffetings by forces that have no more influence on their portfolios than the gale outside their windows (this is written in Scotland). They should wrap up.