Why Current Preferences for Passive Investments Won't Work in the World Ahead
When it comes to your investment portfolio, what happens if the next 18 years don’t look like the previous 18 years or 36 years? Are you financially prepared for a generation where returns are very low?
They simply haven’t saved enough, and the passive investment strategy that most people use to invest — buying market capitalization-weighted indexes — may not be the best place to be in a world where the future increasingly looks very different from the past.
From the mid-1970s to today, Jack Bogle and The Vanguard Group popularized the movement towards passive investing, which is essentially buying into the largest companies that have done well and have traditionally been successful. But during certain periods of history, such as the Tech Wreck in the early 2000s or the financial crisis a decade ago, this can be a very painful place to be. When you invest in index funds, you’re abdicating the responsibility of differentiating companies from each other and handing that decision to the market. This works when interest rates are declining. But when we look ahead, it’s clear that America is facing one of two scenarios.
The first scenario is where interest rates will stay low because we’re in a massive debt bog and can’t get out of our own way, so to speak, because of pressure from aggregate debt in the system. This is similar to what Japan is currently facing. But this aggregate debt is weighing down society; it’s like trying to run a 10k when you’re out of shape. It’s possible but tough because your body isn’t optimized for it. This scenario promises high volatility and frustratingly low returns.
The second scenario is that we’re in an inflationary cycle where, like the period of time from 1965 to 1982, interest rates will begin to rise. If this is the case, then stocks could be challenged, and bonds will get crushed. Most Americans won’t have any way to combat this because their investment strategy is passive, so they’re likely to sell everything, which will potentially exacerbate both problems, or they’ll try to ride out the cycle, which could destroy their investments.
Whether the future promises one scenario or the other, get comfortable with the idea of chaos. During the financial crisis, some people were saying, “Why did no one tell me?” Experts were sounding the alarm, people just weren’t tuned into it. Consider this your tuning fork. The appropriate time to be asking the hard questions and examining your portfolio is now.
Consult your investment strategy. If you don’t work with a financial advisor, contact the people who generated the investments that you own and ask,
“How would my portfolio respond in a prolonged period of rising interest rates?"
Most of the current assumptions about the market are based on software that was created in the last 35 years, which was during the present era of declining interest rates. Before that, there weren’t the same sorts of measuring tools. Also, ask yourself what specific risks you’d be willing to accept. Which components of your financial plan are you comfortable with?
Often what blows up portfolios isn’t what you know will happen, it’s what you’re not anticipating that causes issues. What if rates start increasing rapidly? Then, all of a sudden, assets start going up rapidly and many of them will bust.
Most people aren’t thinking about this because they consider their 401k to be “the safe stuff.”
But we’re reaching the end of this era.
It’s easy to just do what others are doing, which often is to hope that financial markets continue to work out in their favor by luck. But if that doesn’t happen, do you have a plan in place where you’ll be okay, even when others who haven’t heeded the warnings aren’t so lucky? It’s wise to approach your portfolio and strategy with a high degree of cynicism.
For example, think about a game of poker. Smart players will place themselves in a position where they’re only going to bet big when there are multiple opportunities to win. If you’re relying on one specific card to make your hand, then the odds should be warning you not to push in more chips. The strategy should be to create scenarios for yourself with many outs. It’s critical to have options and to be prepared for a wider spectrum of outcomes that others aren’t thinking about. Maybe investing everything in a single index has been fine up until now. But based on financial forecasts looking ahead, now is the time to be questioning that assumption.
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Information presented reflects the personal opinions, viewpoints and analyses of the employees of Mirador Capital Partners, LP, an SEC-registered Investment Adviser. The views reflected in the commentary are subject to change at any time without notice. Nothing herein constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mirador Capital Partners, LP manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Visit us at miradorcp.com for more information.