Looking Back, Looking Forward: Investing Insights For The 21st Century, Part I
As we've seen in high-definition in the past few months--from the natural and man-made disasters in Japan, to the rolling upheavals across North Africa and the Middle East, to the volatile whipsaws in food and energy prices--the factors that must be accounted for while structuring financial affairs are much more complicated than ever before. Plus, the information is coming at us much more quickly, and the potential ramifications for our financial affairs are much more dire than in the "good old days."
The 1980s and 1990s were great times to be an investor. Interest rates were falling dramatically, instigating a huge and lasting bull market in fixed-income investments. Credit became easy to obtain and even our tax policies encouraged consumerism. Investors were pouring into the markets with the advent of 401(k) plans and IRAs. Companies were going public at record rates, resulting in a lot of new and interesting "stuff" to look at for possible investment and creating liquidity for scores of aging Baby Boomers. Regulations for many industries were easing, and the growth of all sorts of investment vehicles (e.g., mutual funds, exchange-traded funds, private equity) was skyrocketing. Globalization took hold, especially after the fall of the Berlin Wall, and capitalism began to more rapidly spread around the world.
According to data from the Investment Company Institute (ICI) and the SEC, the percentage of the population that owned publicly held stocks rose from about 5 percent in 1980 to nearly 50 percent in 2000. Particularly in the latter half of the 1990s, participation was arguably fueled by abnormally high stock market returns. For example, the 5-year annualized rate of increase in the S&P 500 index between 1995 and 2000 was 29 percent!
It was a simpler time at the outset, with fewer investment choices and a slower pace of activity. In 1980, there were a mere 564 mutual funds, and average daily trading volume on the New York Stock Exchange (NYSE) was 45 million shares, according to ICI. Total mutual fund assets amounted to $135 billion. There were no IRA, 401(k), or hedge fund assets. (The former hadn't even been legislated into existence, and the latter were too nascent to count.) Personal computers hadn't been invented, so security analysis took a much simpler form: heavy on the use of pencil, paper, slide rule, reading of SEC filings, and one-on-one conversations with management and suppliers. Moreover, there was no ability to crank out reams of comparative analysis at the push of a button. No email, no Google, no stock screens. Any sort of "quantitative" analysis was an arduous and time-consuming endeavor.
By 2000, there were more than 8,000 mutual funds, and average daily NYSE volume topped a billion shares a day (ICI). Average holding periods dropped from three-plus years to barely a year. As one money manager quipped, people went from "owning stocks to renting them." And now? We have 24/7 access to more investment and financial news than we can possibly absorb--with most of it available for free. The same holds for analytical tools.
Given all the money expended on brilliant people and high-powered technology in the intervening years, I've often wondered why overall returns haven't improved. Perhaps it's because:
- People still pull the "levers," and people are prone to all sorts of behavioral idiosyncrasies--especially when stressed and confronted with unpredictable situations.
- Investors have gotten away from the basics of sound investment policy. Rather than analyzing the merits of specific investments, excessive time often appears to be placed trying to outmaneuver other investors. Many essentially view the investment process as buying lottery tickets rather than pieces of companies.
- The more creative Wall Street gets in "synthetic" products and complicated management structures, the more middle people there are to take a bite out of the potential profit available, if any.
- Nervous investment trigger fingers are exacerbated by 24/7 news flow across multiple channels. Brain scientists have illustrated that when confronted with tons of information, we either shut down and don't want to make any decisions, or we try to respond to all of it by tweaking "this or that" in a knee-jerk fashion. More often than not, the common state is swinging wildly from one extreme to the other, basically reverting through the mean, not to it, on the way to the other extreme.
Today, we are left with a seemingly more complicated world, even if we have the ability to slice and dice its risks into more finely digestible pieces. In addition, there are more market participants influencing daily trading: sovereign wealth funds, governments pursuing self-indulgent policies, emerging trade blocks, more citizens stepping toward democracy, and capital markets. Given the knowledge that the more choices we are confronted with, the more likely we are to do nothing, what's an investor to do? At the risk of sounding overly simplistic, perhaps it's time to re-sync our expectations and revert to some time-tested asset allocation and analysis basics.
Carol M. Clark, CFA, is a partner and investment principal of Lowry Hill, a private asset management firm that provides proprietary investment management and financial services to families, individuals, and foundations with wealth greater than $10 million. The firm manages approximately $5.2 billion in assets for nearly 300 families and 57 foundations from offices in Chicago, Minneapolis, Naples, and Scottsdale. She welcomes questions and comments at email@example.com.
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