Part 1: Some basic investment principles to be reminded of in these uncertain and frothy-looking times

There is so much talk about investing nowadays. This is not surprising at all, given that in most of the world today, governments and policy makers are doing everything they can to generate growth and inflation. This includes printing unprecedented amounts of money, going on massive fiscal spending sprees (relief packages, infrastructure programs, etc.), and issuing debt and printing even more money to fund all that spend/deficit. As part of all this, what policy makers are effectively doing is making cash and cash-like assets (such as US treasuries and short-term government bonds) increasingly unattractive.

The result is a world at large that is awash with liquidity and searching for yield and returns, which is in turn lifting up most, if not all, asset prices. US equities have surged over 80% from the lows struck in the depths of the Covid crisis, the strongest rebound rally since 1936. And as is classically the case in the late stages of economic cycles, retail investors are increasingly taking notice and coming late to the party. 

In the context of an environment like this, it is easy for novice investors to get carried away with all the optimism around. Many resort to investing out of FOMO (Fear Of Missing Out) instead of giving proper weight to the fear of losing money. This is manifested through signs that have traditionally indicated complacency and excess, from the volatile price action we’ve seen in bitcoin and other cryptocurrencies, to the speculative social-fueled buying of “meme” stocks, to the craze about NFTs (Non Fungible Tokens) and the Buffet Indicator (ratio of total equity market capitalisation to GDP) crossing its historical highs. Also, with the ‘Robinhood effect’ making it easier than ever for anyone with a bit of change to invest in pretty much anything online, investors who were previously out of (or underinvested) in financial markets are now piling in.

Before proceeding, let me first be clear that I am by no means bearish on the current economic climate. On the contrary, I believe that, with the rapid progress in vaccination in the US and China, as well as the unprecedented amount of government stimulus being injected into developed economies, it is quite hard not to be optimistic about the post-Covid global economic recovery. And as life will slowly return to normalcy across the world, consumer spending is poised to come back full throttle, unleashed by $5.4tn in global excess savings stockpiled by households from a combination of holding back on spending during the pandemic and stimulus checks.

With the above backdrop, I wanted to take a step back and highlight what I think are important basic principles that less experienced, perhaps first-time investors should be cognisant of before looking at investing their hard-earned savings in any one single investment or asset class over another.

Principle 1 – Consider return in the context of risk

When you evaluate any financial investment, the most essential consideration should be to look at two measures:

A-   What is the expected return.

B-   What is the expected risk, as typically measured by the asset’s volatility (i.e. how big and fast the changes in price have historically been).

These two things can vary a lot from one individual investment to another, from one asset class to another, and so on.

Principle 2 – Consider your circumstances/criteria and competing opportunities

So how does one judge that a particular investment is good or bad? Well, firstly the right question to ask is, is the investment good or bad FOR YOU. That means you need to put the expected return and risk in the context of 2 other things: a) your objectives and risk tolerance (i.e. how much in terms of possible paper losses you can stomach at any time) and b) the universe of investments that are accessible to you as an investor. For example, if I want passive income and have a low risk tolerance, is a dividend yielding stock better for me than buying a fixed income bond or investing in real estate? Asking yourself these questions before making each investment decision helps you increase your chances to meet your objective more effectively.

Principle 3 – Diversify

If you are looking to make consistent positive returns and grow your wealth over the long term, diversifying well is the single most important rule to not forget. By diversifying well, you can lower your risk without lowering your expected returns. What I mean by diversifying well is to design a portfolio with a mix of assets that are uncorrelated (i.e. they do not move in tandem with each other). The best professional and institutional investors capitalize on this most important technique. Ray Dalio calls it the holy grail of investing. Typically we think of diversifying across asset classes (i.e. stocks, bonds, alternative assets such as RE and Private Equity, gold and other commodities, even bitcoin), but one should also consider diversifying across countries and currencies to have a truly balanced portfolio.

Principle 4 – Be aware of your emotions

Lastly, an important aspect of investing is to know that it can be an emotional affair. This topic is vast – the psychology of investing – and perhaps warrants a separate piece but at a surface level, investing awakens your emotional and less rational side of the brain (Ray Dalio calls it the ‘lower level you’) because: i) money is obviously super important (think Maslow’s hierarchy of needs), ii) so we associate a lot of personal things with it (security/safety, self-esteem, etc.) and iii) investing in anything essentially involves making a bet that your investment will perform better than other available investments, so it is always in comparison to something else and so by definition, a competitive endeavor.

If allowed to become emotional in investing, one can lose sight of the fundamentals and this can lead to bad outcomes. An example of this could be investing in what appears to be the best deal because the returns look high, such that you end up disregarding the risks or even worse, going “all in” on that wrong investment, or equally, not knowing how to react and surrendering to fear by selling all your holdings when market sell offs happen and panic settles in. Those types of decisions could be detrimental and are often why first time investors tend to get burned in investing, because of a combination of a) they fail to keep their emotions in check, and b) they picked the wrong investment (for them).

That’s why when it comes to investing, it is important to stay objective, rational and to harness your behavior.

In the next two articles of this three-part series, I will share a primer on what I believe are the basic characteristics of Real Estate, why this asset class merits being a cornerstone holding in your portfolio and why investing in Real Estate matters more than ever today. Stay tuned.