On Target Newsletter
In this issue:
- Investing myths,
- Saving for early retirement,
- Automatic investment,
- Gold shares a bargain,
- Fund selection.
7 Investing Myths and Realities
Investing may be less complicated than you think, says the financial services giant Fidelity Investments. It argues…
► You don’t always have to take on a lot of risk to hit your financial goals.
► You don’t have to be an expert to invest in the stock market — you don’t even have to manage your own investments. You can get low-cost investment management in several ways.
► Investing is for everyone — no matter how much or how little money you start with.
Could your financial beliefs be holding you back? See if you believe any of these commonly held myths.
Myth #1: Investing in the stock market is too risky
Investors react much more strongly to losses than to gains. The fear that putting money into the stock market could lead to financial ruin keeps many people out of the market. That may keep them from reaching their goals.
The good news is there are things you can do to help manage the amount of risk when investing. For instance, some types of risk can be mitigated by diversification.
If all your money were to be in one stock and the company went out of business, you would have lost your entire investment. But if you own many different stocks, one company probably represents only a small portion of your portfolio. Similarly, adding different types of investments, like bonds and short-term investments, can also reduce the amount of risk in your mix.
When it comes to investments, stock picking is not necessary — or even encouraged. Investing through mutual funds or exchange-traded funds lets you invest in many companies at once, getting professional management and diversification.
Keep in mind that diversification and asset allocation do not ensure a profit or guarantee against loss. That’s why it’s important to build a mix of investments that you can live with — with the potential to hit your goals.
The amount of time you plan to allow your investments to stay in the market makes a difference. With a very long time in the market, history suggests that your chance of permanently losing money in a diversified mix of investments goes down. That’s because stocks have tended to rise over time. And as long as you don’t sell your investments, they may recover from market downturns.
Myth #2: It’s safer to keep money in a savings account
Many people believe cash is safe. But having too much of your money in cash or a low-yielding savings account can mean your purchasing power shrinks due to inflation.
Some people may be more likely to have a lot of cash in savings or current accounts than others. For instance, Fidelity’s research on women and money found that 56 per cent of women who have significant savings outside of their retirement accounts and emergency funds, do not invest those savings in the market.
Since 1985 the average annual inflation rate in America, for example, has been 2.7 per cent. It could go higher in the future, given rising government deficits and stronger economic growth.
Prices on things like housing, food and education tend to go up over time. By investing in assets that offer the potential to earn a return above the rate of inflation, you have the chance to keep up with price increases.
You don’t have to bet the farm looking for double- and triple-digit returns — slow and steady may really win the race.
The key is to find a mix of investments, blending stable investments with those that are more risky that you are comfortable with and could stick with over time.
Average annual rate of return
Accumulated balance after 40 years
This hypothetical illustration assumes that the saver and the investor each make one annual contribution of $15,000 at the beginning of the year and do not draw any capital or income. Taxes and fees are not considered. Investments that have potential for 7 per cent annual rate of return also come with risk of loss.
Myth #3: Investing is too complicated and time-consuming
Investing can be really complicated. But it’s only as complicated as you want to make it. You can build and maintain a diversified investment mix made up of mutual or exchange-traded funds. For many investors it may be easier to turn to a target date fund for retirement goals or an asset allocation fund to handle the investment decisions.
Both types of funds offer a professionally managed, diversified mix of investments based on your goals and financial situation, but target date funds gradually shift to a more conservative mix over time. Asset allocation funds maintain a consistent level of stock investments.
Managed accounts are another way to get professional investment management. Some types of managed accounts offer ongoing advice to help you stay on track with your finances.
Robo advisors are a type of managed account — they generally only manage the investment for you without advice. The benefit is low-cost, hands-off investing. Generally you can get an investment mix that fits your goals and financial situation with rebalancing done for you at regular intervals.
Myth #4: You need a lot of money to start investing
This used to be true. Back when it cost $50 to place a trade and you had to call a stockbroker, investing was out of reach for many people.
But these days competition has driven the cost to invest way down. Investment minimums are non-existent for many mutual funds, and exchange-traded funds (ETFs) offer another way to invest with no minimum fees.
At many financial institutions, it’s possible to start investing with just a few dollars — even with professional investment management if you choose a robo advisor.
Myth #5: I can wait for the best time to get in the market
Timing the market is difficult or even impossible. Rather than waiting for the best time to invest, it can often be a better idea to just get invested. Waiting for the best time can lead to a lot of missed opportunities.
If you’re extremely nervous about investing a lump sum of money, consider dollar cost averaging, or investing a set amount at regular intervals over time. Studies have found that, most of the time, investing a lump sum results in higher returns. But if you need to ease into the market, other research has found that dollar cost averaging may mitigate some risk.
It’s important to understand though that periodic investment plans like dollar cost averaging do not guarantee a profit or protect against loss in a declining market.
At the end of the day, whatever helps you get invested and stay invested may be the best strategy for you. That’s because missing just a couple of the best days in the market can have significant impact on long-term returns.
The hypothetical growth of $10,000 invested in the S&P 500 index from January 1980 and left fully invested till August 2020 would been $952,512. But being out of the market for the five best days in that period would have slashed growth to $590,571; being absent for the ten best would cut growth to $425,369; being out of it for the 30 best days to $154,184.
Myth #6: Investment advisors are just trying to sell products
Some people feel comfortable managing their investments, others are happy to choose diversified, professionally managed funds, while another group may prefer the services offered by financial professionals. But many people don’t know who they can trust in the financial services world and that could keep them from investing.
The good news is that there are several different models for the way financial professionals are paid and the services they provide. Some are paid a commission when they sell certain products or do trades, others may charge an hourly fee or a flat fee, while still others charge a percentage of the money you invest with them. There are even more ways they can be paid as well.
There isn’t one model that is best for everyone and their financial situation. The important thing to understand is that you can and should ask how your advisors are compensated, how much you pay directly, and what it means for their recommendations to you.
Myth #7: Men make better investors
Men and women grow up with constant messages about what men are good at and what women are good at. Those messages can be damaging to your self-esteem and net worth. While women have historically taken a backseat to the men in their lives when it comes to finances, research shows that as a group, they are better investors.
That may be because women investors, on average, tend to trade less frequently and invest in more age-based allocation of investments than their male counterparts.
Because women, on average, live longer than men, it’s really important for them to understand how to manage money. Luckily women are investing nearly as much men: 58 per cent of men say they own shares vs. 52 per cent of women.7
The bottom line…
Investing is for everyone and it can help you reach your financial goals. When investing, you don’t have to have tons of money, trade a lot, or employ sophisticated strategies.
Just doing the “boring” thing of determining an appropriate asset mix, owning well-diversified, professionally managed investments, avoiding the tendency to “tinker,” and sticking with that asset mix over time, may help you reach your goals.
Whether that’s through a managed account, a target date fund, or your own hand-picked mix of mutual funds, using this tried-and-true approach has the potential to lead to excellent results.
The Key to Inflation Is Exploding Demand
The biggest uncertainty now facing investment markets is inflation. Consumer prices are rising everywhere, but in the US, in particular, they’re rising the fastest in almost a quarter-century.
The consensus view is that this doesn’t matter, as it’s a temporary phenomenon described as “transitory”. But what if it isn’t?
Central banks are inhibited from taking the standard anti-inflation action — raising interest rates — because they are worried that the current rise in inflation will be transitory, that the global economic recovery is not self-sustaining, and that any increase in rates would cause undue fiscal stress for governments. That’s a particular risk for the US because of the short duration of national debt (average life of government bonds), and for countries with elevated property prices where floating-rate mortgages proliferate.
The wave of rising prices is mainly blamed on a supply shock caused by a combination of negative factors such as shortages of natural gas, oil, even coal; insufficient supplies of semiconductor chips; not enough ships.
However investment bankers Bridgewater counter-argue that supply of almost everything is at all-time highs. The source of the problem is not supply shortages but a demand shock driven by an explosion of monetary and fiscal stimulus as a response to the pandemic. “There are still large stockpiles of latent spending provided by extremely low real [interest] yields, and more fiscal stimulus is on the way.
“Choking off demand would require central banks globally to move towards restrictive policies quickly, which looks unlikely.
Expect strong spending to be sustained
“Households are wealthy, flush with cash, and ready to spend – setting the stage for a lasting, self-reinforcing surge in demand.” In America retail sales are now running 23 per cent higher than they were just before the outbreak of the pandemic.
There are not enough raw materials, energy resources, productive capacity, inventories, housing, even workers, to meet this explosion in demand. Production of metals such as copper, aluminium and nickel is much higher than in recent years, yet prices are rising and inventories are falling. World supplies of manufactured goods have now recovered to pre-pandemic levels, mainly because China’s output is 20 per cent higher than those levels. There is a sustained housing boom worldwide driving prices higher.
The labour market is “far tighter than anything we’ve seen since 1975,” with half of all businesses in the US unable to fill their positions. Higher savings and strong equity market performance have allowed workers to remain outside the workforce, which explains the labour shortages that are pushing up prices. They are unlikely to come back until their money runs out.
Credit usage is starting to pick up, which suggests more demand financed by credit instead of paying with cash. As that trend accelerates it will encourage more people to take jobs. But they will still demand higher wages and more benefits. These increases “are only the beginning of the next wave of inflationary pressures,” says Bridgewater. “As consumers’ spending behaviours revert toward pre-Covid patterns, thereby increasing spending on labour-intensive services, the ongoing shortage of labour will worsen”.
All of this points to very lumpy inflationary data, says Eoin Treacy. Within the next six to nine months there is going to be a very heated argument about whether interest rate hikes are justifiable. There will be arguments both for and against, with high energy and investment asset prices being the clearest reasons for raising rates. The lack of a straightforward answer is likely to continue to support asset prices.
Eventually Germany will give Russia what it wants and the Nordstream pipeline will open, relieving stress on natural gas prices. In time oil prices will start to ease back if OPEC+ agrees to pump more or US shale plays source the capital to expand drilling. The massive investment in new semiconductor production will bring to an end the shortages, which are already ending in the automotive industry.
However, David Bowers of Absolute Strategy Research says most policymakers have only known a world where demand has been limited yet supply has been elastic. Whatever the demand, China has been ready to meet it as the world’s supplier of last resort.
“The policy response to the pandemic has upset that balance. High levels of savings and government transfers have underwritten a rebound in global demand – but failed to prepare [equivalent] supply… Now it is supply that appears to be constrained and inelastic.”
The longer the crisis in supply chains continues, the more inclined companies will be to re-think their business models. The supply stress is happening at a time when globalization has lost its impetus, countries are seeking to reduce their dependence on China, climate transition policies favour expensive localization policies, and labour markets are exceptionally tight.
If demand continues to grow faster than supply, inflation is likely to stay elevated.
How to Achieve Early Retirement
Retirement has traditionally been reserved for the 60-somethings, but now some young workers are racing to reach financial freedom early and leave their careers as early as their 30s, Jessica Beard writes in The Telegraph.
Growing numbers in the FIRE community (Financial Independence, Retire Early) believe that by living as frugally as possible and maximizing savings in your 20s and 30s, you can become financially free.
Their rule of thumb is that you need to have save capital of 25 times your yearly outgoings. Once you hit that target you are financially independent – able to live off the return of the savings or rental properties without the use of traditional pensions.
For example Kris Vale, a 30-year-old from Pontefract, Yorkshire, says he’s accumulated £600,000 and he’s two-thirds of the way to his retirement target, achieving that on a salary of less than £50,000 a year. “Every single thing we spend goes on a spreadsheet, even down to a tube of toothpaste. But we still live a normal life. I go out once or twice a month and we go to Canada every year to visit my wife’s family.”
For every purchase, he assesses how much it costs in terms of the number of extra hours he would have to work to make up for the expense.
He began to build his savings after he got his first job, setting aside £5,000 a year despite being paid only a minimum wage. He bought his first buy-to-let property at the age of 22 with a £23,000 deposit. He’s since bought two more and receives a monthly income of £2,100 from the three properties. “I keep funds in reserve in case I see something that looks good and is a cracking deal. My dad and I have visited thousands; we really enjoy house hunting.”
Monthly savings are paid into three main pots: an equity account ISA (tax-privileged retirement fund), one for paying off mortgages, and a private pension fund. He takes the £20,000 annual maximum ISA allowance, putting it all into the global market tracker fund Vanguard FTSE All-World.
Vale is a moderator for the Reddit Fire community, whose British subscribers have doubled over the past 12 months.
Years ago the American strategist Harry Browne (who died in 2006) recommended a simple strategy for anyone to follow that would protect any investor “no matter what the future brings.” The investor simply needed to allocate a quarter of his capital to four asset classes… and keep the proportions stable by redeployment once a year.
Such a portfolio would cater, at least in part, for four economic outcomes: prosperity; inflation; tight money or recession; deflation.
Just four types of investments would cover all those bases in what Browne called a Permanent Portfolio:
► Cash. This would be most profitable during a period of tight money.
► Bonds. They should also perform tolerably well during a period of prosperity, but come into their own during a deflation.
► Shares. They thrive during a period of prosperity.
► Gold could be expected to perform well during times of intense inflation.
British adviser Tim Price reports that this approach served investors well. For nearly three decades to December 1998 the portfolio delivered average annual returns of 9.9 per cent… a comfortable 4.5 per cent a year above inflation. It grew through every economic environment.
“The fail-safe portfolio didn’t require any insight into the future. It didn’t require market-timing of any kind; it didn’t require any form of switching investments at all. For over 40 years Harry Browne’s Permanent Portfolio served investors well.” But “unfortunately for the investor of today, the central banks have shot it through the heart.”
In a world of zero or negative interest rates, a portfolio that allocates 50 per cent of its capital to cash and bonds “is no longer fit for the purpose of capital preservation or income.” Of the original four asset classes, only two now make any real sense, in large part because they are themselves real assets – stocks and gold.”
Stocks because there can be no investment rationale for owning the major alternative security, bonds, which frequently trade at yields that are negative in inflation-adjusted terms. Shares offer fractional ownership of real, productive businesses.
Gold because it is the classical defensive asset against inflation. There is “every reason to expect further inflationism and monetary debauchery from the world’s major central banks.”
Gold Mining Shares Now a Bargain
Gold mining shares are now the highest-yielding sector on the planet, says Iain Little of Global Thematic Investors.
“For most of my 40-year career, analysts have mocked poor management in the mining business. The wisdom is that gold mines – perhaps with the exception of royalty or streaming financiers – are low-quality, cyclical investments.”
However, gold miners have finally got the message. Most are now operating with all-in sustainable costs around $1,000 an ounce when the price of the metal is near $1,800. Gold miners are trading on free cash flow yields of 7 per cent, roughly double that of the rest of the market. This is profit that can be paid to investors… and it’s on the increase.
“In a yield-deprived, inflationary age, is this not El Dorado?”
With such a compelling value proposition, why haven’t shares done better? Eoin Treacy says the big challenge for the sector is that there have been no big new discoveries for years. As surface reserves have been exhausted, many of the largest operations have begun to move underground. That is much more capital-intensive, so miners will engage in more acquisitions or will need to spend that free cash flow on capital investment.
Central banks’ nervousness about tightening credit is “creating a very bullish backdrop for gold.”
Lengthy medium-term market corrections like the current one are not unusual in gold. The majority of gains in the first two-thirds of the last big bull market occurred in short sharp bursts. “This suggests gold miners are in a strong position to offer a high-beta play on gold when it next pops on the upside.”
Update on the Pandemic
Do the policies adopted by governments to combat the virus make sense?
For the first time the UK has revealed the cost/benefit analysis it commissioned on the effects of its Plan B programme – lockdowns, vaccine passports, mask mandates, working from home. The cost was put at £800 million a week, adding enormously to the national debt. The likely effect of this on the pandemic was to lower the number of infections reported by no more than 5 per cent.
Does it make sense to vaccinate your children, as American parents are now allowed and encouraged to do? Available evidence is that the risk of anyone younger than 20 dying from the virus is less than the risk of being killed by a lightning strike.
Another interesting development is increasing evidence that vaccination doesn’t protect you against the virus. The British government’s Health Security Agency’s reports show that although a high proportion of the population are now fully vaxxed, they nevertheless accounted for most of those hospitalized and dying between September 27 and October 24.
For the longer period, from December 9 last year to October 20, the agency reports there were 1,738 Covid-19 deaths in the UK and 1.24 million injuries recorded following vaccination.
Fund selection: It’s “an uncomfortable truth” that the main commercial driver of fund management organizations is not to deliver the best returns for investors but to generate fee income, says British commentator Tim Price.
Under conventional ad valorem fee structures the more assets fund managers manage, the more they earn. But a growing library of evidence suggests that the larger fund management businesses become, the less likelihood they have of delivering superior investment returns.
Above a certain level, size is likely to correlate inversely with performance. This is unfortunate for “retail” (smaller) investors “who are most easily won over by the power and marketing heft of well-funded brands.”
Renewables: The biggest problem about the new Carbonista religion isn’t the mind-blowing cost of building the infrastructure required such as the battery farms that will be needed for back-up, but the physical limitations. Where are all the raw materials going to come from? Central banks can “print” unlimited amounts of money, but they can’t print the quantities equivalent to decades of annual production of lithium carbonate, copper, rare earths such as neodymium and samarium, cobalt, high-grade graphite and everything else that would be needed to build the infrastructure of the Carbonista nirvana.
Oil: The fact that the industry is so detested for reasons of political correctness means that its shares are now “stunningly undervalued,” says David Hay of Evergreen Gavekal. “A myriad of US oil and gas producers are trading at free cash flow yields of 10 to 15 per cent, and in some cases as high as 25 per cent.
Some industry analysts forecast a period of prices above $100 a barrel as companies scale back investments in future supplies while global demand continues to rise, at least for most of this decade.
Climate change: During the past 600 million years the Earth has rarely been as cool as it is now, and almost never has it experienced such low carbon dioxide concentrations as the 420 ppm level that climate activists decry, says well-known American commentator David Stockman.
According to the careful reconstructions of earth scientists who have studied ocean sediments, ice cores and the like, there have been only two periods, encompassing only 13 per cent of those 600 million years, when temperatures and CO2 concentrations were as low as at present.
Germany’s electricity: Three more of Germany’s nuclear power stations will be closed down by the end of the year and the last three by the end of next year. They provide 12 per cent of power supplies. At its peak in 2000 Germany had 19 atomic plants generating about 30 per cent of the country’s electricity. Chancellor Angela Merkel decided to shut them down after the Fukushima disaster. Thanks to its headlong drive into renewables, Germany has the most expensive electricity in Europe.
ESG investment: Equity funds that follow environmental, socially responsible or governance strategies have attracted twice as much money this year as funds that don’t. Yet funds operating in the much larger bond market have little interest. According to BBVA Global Markets Research by late last year the stock of green, social and sustainable bonds had yet to reach $1 trillion.
Relying on weather: There has been a great deal of enthusiasm for building wind and solar farms, but building weather-dependent supply when you believe that weather patterns are going to change does not make sense, Eoin Treacy comments in FullerTreacyMoney. “Of course, just because a project has built-in logical inconsistency has never been cause to stop once political decisions have been made.”
Unfit to fight: Less than a third of America’s adult population is considered fit enough to serve in its armed forces. That could be a major issue should the government have to reintroduce conscription and is one reason why its generals favour extending the selective service law to allow for women as well as men being subject to the draft.
Microchips: Electric vehicles are very semiconductor-intensive, David Hay says. With chips already in seriously short supply, this means it’s logical to expect recurring shortages over the next decade for this reason alone – “not to mention the acute need for semis as ‘the internet of things’ moves into prime time.”
Interest rates: They offer investors no defence whatsoever against inflation. In the US, where nominal interest rates are near zero and inflation is running at more than 5 per cent, real rates are around minus 5.3 per cent. Similarly, real rates are roughly minus 3 per cent in the UK and minus 4.6 per cent in Germany.
Immigration: The net cost of immigrants to Denmark from non-Western countries, after deducting taxes received from them, is nearly $5 billion a year, according to details provided by the Ministry of Finance. The figure is based on costs of public services such as welfare, healthcare and education.
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