Often said, this entry looks at how to hold on to precious earnings with a focus on the sharp rise in the stock market in the last 10 months. The market is up 11.6% year to date at the time of writing this piece.
Before we grapple with ways of holding onto the gains, have you noticed the tone and message of investment advertizing? They used to promise to beat the market. Fund managers strove mightily to create an edge. Even a fraction of a percent would build credibility. Now the hypothesis is to pick a trusted advisor. Trust is fine; profits are better! The Myth Buster intends to investigate a few well-known and obvious ideas about how to hold onto the bird in the hand.
Investors are skeptical by nature; let’s agree that the gains are real by affirming long-standing investment truths. In November, 2016 the Dow stood at approximately 18,800 (Nov. 10). As of August 29, it stood at 21,865, a 16.3% rise. (Even that has been surpassed!)
Low Risk, Low Return?
Let’s begin with the Big Blip Theory: hold the profit by avoiding the volatility and problems of stocks and the companies and currencies involved. Scrape off earnings in the sometimes shaky stock market and place them in safer, slower moving investments. That used to mean bonds. For those who love a little risk along with its associated return, a bond portfolio spiced with munis and junk provides more return than pure Treasuries and more safety than the stocks that brought on the big blip.
The first alternative is not bad – secure and proven and it will hold onto recent gains. However, long term, the stock market performs less erratically than its critics fear. Over a stretch of years, a sound stock portfolio outdoes bonds. As obvious as this appears, a reminder helps. A review of the highs and lows of large funds will alternately thrill and depress. Keep in mind the wide array of specialty funds – all gold, no stocks; all emerging markets, no blue chips; all oil and gas, no manufacturing; and so on. By their very nature, these portfolios are not balanced. Investing a portion of the portfolio in each of five or ten funds will balance the return. Over a stretch of years, a balanced portfolio outperforms a safer bond portfolio.
The second alternative would leave the funds in the current, successful, stock-based portfolio. Here is the rationale: the market tends to follow short-term upward spurts. After the happy leap, it tends to settle down to lower long-term returns. Even the lower return is likely to outperform a bond portfolio. Removing funds from a stock-based portfolio while it is in an upward trajectory may cause the investor to lose out on the full effect of the spurt. A true spurt may prove as rare as last summer’s solar eclipse.
Don’t be sidelined by temporary drops. Since 2010, which takes in the recession, the Dow Jones has risen from 13,403 (September, 2007) to 21,784 (September, 2017). This represents a 62.5% increase or 6.3% per year. Note that the low point in 2009 was about 6,626. The market lost 50% in less than two years. But, it re-gained the loss and rose well above its previous high.
Alternatives one and two are sound. Scraping off the earnings ensures safety, but locks the investor into modest returns. Investing is best considered from a long-term perspective, which favors leaving the portfolio in place.
Consider a few examples. The Fidelity Intermediate Treasury Bond Index Fund – Premium Class (FIBAX) averaged 4.81% over the last ten years according to Fidelity. The fund is almost entirely US Treasuries and holds more than $1.6 billion. Bonds carry less risk than stocks, but these figures demonstrate that over time, stocks outperform bonds. Unless the investor is locked into selling off the portfolio when it reaches its low point, holding on proves a better strategy. So, shifting from stocks to bonds works, except when you consider long term benefits.
A Bird – in the Hedge?
In one of the Myth Buster’s favorite topics (myths?), many investors prefer to shift to gold when they fear volatility or losses. After all, gold is the ultimate hedge. Fidelity Select Gold Portfolio (FSAGX) shows 10 year performance of -1.44%. According to its website, in addition to gold bullion and coins, it invests in exploration, mining and processing companies as well as silver, platinum, diamonds, or other precious metals and minerals. (With all that platinum, it must be ready for a Grammy.) According to JM Bullion, at the end of 2016, the price of gold was $1189. Ten years earlier it was $632. That makes an 88% increase or 8.8% a year. However, gold does not go straight up. It goes up and down based on stocks and bonds and the gold itself does not produce dividends. So, the investor would have to pick the right time to unload the gold and move from the protection of the favored hedge. Gold does not produce little gold bars either. If an investor bought gold in 2009 ($1088) and sold in 2015 ($1060), the result would be no gold, no profit, no bird! Only an empty hand.
Indeed, a bird in the hand is worth more than two in the bush, but shows itself as elusive as the Orange-Bellied Parrot if investors lose sight of how the market doles out rewards. If only we could figure out how to keep those profits. Bulls, bears and bird watchers beware; in the next piece, we will move to Part II of this insightful myth.
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Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.
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