FINANCIAL MARKET UPDATE 1.26.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THE TRUE COST OF INVESTING

Long-time readers of the Weekly Market Update may know I am a fan of Morgan Housel, as his blog is frequently among the links in the Hot Reads section. Last year, Morgan published a book titled The Psychology of Money, which I found to be an excellent read as well. One thing that I think sets him apart is his ability to explain abstract financial concepts through stories and metaphors that may be more relatable to people outside of the industry. A chapter of the book covering market volatility really resonated with me. It provided a unique perspective on market swings that, if embraced, can improve your chances for investment success.

Since 1927, the US stock market has returned just over 10% per year on average. At that rate, an investor with a diversified portfolio of stocks would have seen their money double every seven years or so. All you had to do was set it and forget it. Of course, doing so is much easier said than done. Morgan writes:

Like everything else worthwhile, successful investing demands a price, but its currency is not dollars and cents. Its volatility, fear, doubt, uncertainty, and regret. All of which are easy to overlook until you are dealing with them in real-time. The inability to recognize that investing has a price can tempt us to try to get something for nothing, which, like shoplifting, rarely ends well.

The stock market’s 10% average return was much higher than what could have been earned on a risk-free investment. Any investor that hoped to achieve that return had to pay the corresponding price. The period was fraught with wars, natural disasters, market peaks, market crashes, a global pandemic, and many other events that generated substantial volatility and fear. As a result, the price for pursuing that return was quite high, and many were likely unwilling to pay it. Morgan further describes the cost of investing through an analogy of purchasing a car:

Say you want a new car, it costs $30,000. You have three options:

  1. Pay $30,000 for it
  2. Find a cheaper, used one
  3. Steal it

Like the car, you have a few options (when investing). You can pay this price, accepting volatility and upheaval, or you can find an asset with less uncertainty and a lower payout – the equivalent of a used car. Or you can attempt the equivalent of grand theft auto and try to get the return while avoiding the volatility that comes along with it. Many people in investing choose the third option, like a car thief, though well-meaning and law-abiding, they form tricks and strategies to get the return without paying the price. They trade in and out. They attempt to sell before the next recession and buy before the next boom. Most investors with even a little experience know that volatility is real and common. Many then take what seems like the next logical step, trying to avoid it. But the money gods do not look highly on those that seek a reward without paying the price. Some car thieves will get away with it. Many more will get caught. 

The penalty for “getting caught” can be illustrated by the famous analysis conducted by Dalbar Inc. Their study showed that fund investors in aggregate tend to underperform the funds they invest in, a result of performance chasing and failed attempts to time the market.

Risk and return are bound together. Assets with the prospect of a higher return only exist because their payoffs are uncertain. If a risky stock had the same expected return as a risk-free government bond, nobody would buy the stock. Why take risk if you can earn the same return risk-free? In order to attract investors, assets with uncertain payoffs must be priced so that investors may be rewarded for taking the risk. The larger the uncertainty in the potential payoff, the larger the reward that is required to attract investors. This is an especially critical concept for investors to understand in today’s market environment, where interest earned on risk-free investments is effectively zero and negative after inflation. For most people, financial goals require a return that is not only positive but exceeds inflation. To obtain such a return, they must take risk.

I’ll let Morgan close this out with his thoughts on how investors should think about that risk:

The question is, why do so many people, who are willing to pay the price of cars, houses, food, and vacations, try so hard to avoid paying the price of good investment returns. The answer is simple, the price of investing success is not immediately obvious. It’s not a price tag you can see. So, when the bill comes due, it does not feel like a fee for getting something good. It feels like a fine for doing something wrong. While people are generally fine with paying fees, fines are supposed to be avoided. You are supposed to make decisions that preempt and avoid fines. Traffic fines and IRS fines mean you did something wrong and deserved to be punished. The natural response for anyone who watches their wealth decline and views that drop as a fine is to avoid future fines. It sounds trivial, but thinking of market volatility as a fee, rather than a fine, is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.

WEEK IN REVIEW

  • The Federal Reserve’s FOMC began its two-day policy meeting today and will conclude tomorrow afternoon. The end of the meeting will be followed by Chair Powell’s 1 PM CT press conference, which can be streamed on Yahoo Finance. There seems to be a consensus in the market that the Fed will leave its policy rate at the zero bound for an extended period. Early signs of an uptick in inflation, however, are causing some speculation on when quantitative easing (QE) will be wound down. QE refers to the bond buying program the Fed implemented during the height of market volatility last year. Reducing these purchases would likely be one of the first ways the Federal Reserve begins to tighten, and the market will pay close attention to any guidance from Powell on the subject.
  • In the Spring of 2013, the Fed Chair at the time, Ben Bernanke, suggested the Fed may begin to “taper” its financial crisis era QE program. Following those comments, interest rate volatility spiked and long-term yields rose dramatically through the remainder of the year. The event was dubbed the “Taper Tantrum,” a repeat of which Powell will certainly seek to avoid.
  • From an economic data standpoint, look for durable goods orders tomorrow. On Thursday, we will get an update on Jobless claims, the first estimate of Q4 GDP, and the index of leading economic indicators (LEI). Finally, we will get inflation data and a reading on consumer sentiment on Friday.

HOT READS

Markets

  • November Home Prices Rose 9.5%, One of the Highest Gains on Record, Case-Shiller Says (CNBC)
  • GameStop Day Traders Won’t Sack Wall Street (WSJ)
  • Saved Stimulus Checks Expected to Help Spur Economic Recovery (WSJ)

Investing

  • Every Warren Buffett Needs a Charlie Munger (Jason Zweig)
  • A responsible Version of Market-Timing (Morningstar)

Other

  • Why You’re More Creative in Coffee Shops (BBC)
  • The Good Kind of Brain Drain (The Atlantic)
  • Coffee Tied to Lower Risk of Prostate Cancer (NYT)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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