Warren Buffett has two rules for investing. The first is: Don't lose money. The second is: See rule number one. Investors are beginning to live by the same rules as they recover from some of the worst losses in decades from the stock market. They've seen portfolios that took a lifetime to build wither in a matter of months, watched huge gains turn into losses almost overnight.
And they were following the old rules, mainly the one about buy and hold. While that still has a place in most portfolios, many investors are looking for different ways to invest. And not to maximize their returns. But to simply preserve capital. In other words, to not lose money.
To exacerbate the losses in the stock market, housing also tumbled. In some markets, it crashed, sending values down 50% and more. Again, homeowners saw years of potential profits vanish. Some thought their homes would be their retirement wealth, looking to cash in on the housing bubble as prices went ever higher. But the best case scenario didn't happen. Instead, many are living in homes that have a mortgage larger than the value of the house, wondering if they should just abandon the property, take their loss, and move on.
When all of this trauma hit, individuals began to see the world in a different light, certainly the investing world. The old tried and true truisms didn't work anymore. Buying and holding stocks, for the most part, was a recipe for quick losses and long, slow gains, if any. Real estate didn't always go up, even if they weren't making any more of it.
Investors are now looking for other strategies to lower their stress and keep what assets they have. The first tactic is simple. Stop using leverage. Leverage only works when assets increase but kills when they're going down. That means larger down payments on smaller homes. Keeping mortgage payments to a minimum also cushions the blow if you find a pink slip with your company newsletter.
As for stocks, they're too narrow a category now, at least just U.S. stocks. Owning U.S. stocks was a sure way to lose large amounts over the last four years. There were some winners, but they were few. And in March of 2009, owning them was like having the flu, a broken rib, a migraine, and convulsions, simultaneously. Investors didn't like the feeling.
An old approach that is getting more attention is to understand and use diversification. In a recent study by Broadridge, a company that consults to financial institutions, found that there are almost 50,000 stocks in world markets and that less than 10% of them are on U.S. exchanges. It also showed that developed and emerging market indexes outperformed U.S. indexes in the past several years. Furthermore, The Wall Street Journal reported a few weeks ago that Hong Kong was the world's leading exchange for IPO's (initial public offerings) for the last 3 years.
Another trend they found: active investors and high-net worth individuals are investing in foreign stocks on their local stock exchanges in the country's own currency. In other words, they're going direct, eschewing ETF's and ADR's, two other ways of investing in foreign stocks but tend to offer mostly large-cap stocks.
Investors need to re-think their approach to investing, to keep up with some of the trends already started. Buy and hold can work for part of the portfolio but not all. Frequent trading isn't ideal but taking some profits as they're made is much wiser than simply riding out the volatility that is part of investing. (Over the last 10 years, with all the ups and downs, investors are at a break even point if they just owned U.S. stocks.)
Investigating and knowing foreign markets, particularly emerging ones, is where some new money is flowing. The best way to start learning this area of the market is to buy ETF's (Exchange Traded Funds) and ADR's (American Depository Receipts). As you become more familiar with them, you can start to buy stocks directly in foreign countries.
Knowing and using other asset classes is also essential. Owning more than stocks, bonds and real estate is almost mandatory. Gold, foreign stocks, foreign real estate, commodities are just a few of the alternatives that can be part of a well-diversified portfolio. Again, ETF's and ADR's are a great place to initially invest in these.
Investing is changing. Investors want to hold on to what they have. Trying to maximize returns through leverage or risky stocks no longer is where the smart money is. Keeping in mind Mr. Buffett's 2 rules of investing, sharp investors focus more on the downside potential than the upside. And plan their portfolios accordingly.
- Ted Allrich
January 31, 2012