Purchasing long-term investment assets requires trust. Doing so involves handing over a valuable possession – that is, money – with no guarantee that the sum will be returned in full as expressed in real terms, except for certain inflation-protected securities. Investing is an act of faith.
Today, 30-year Treasury bonds yield 2.9%. Their prices will sink if interest rates rise only moderately by historic standards, to 5%, even if that increase doesn't occur for 15 years. There is no escaping the fact: interest rates must remain low by post-World War II standards for high-quality bonds to succeed.
Unlike bonds, which unambiguously suffer from higher rates, companies sometimes benefit from higher rates – if they receive more income from their investments and/or loans. In addition, companies can adjust what their businesses do, while bond payments, of course, are fixed.
Still, the point stands: confidence that interest rates will remain low underlies current security prices. In addition – this part usually remains unsaid, but it should be surfaced – neither asset class will withstand major wars. Finally, high-quality bonds would tolerate a Great Global Depression, equities would not.
In other words, economic optimists expect the world to stay the course. It will continue to behave as it has since the 1980s, the best 35-year investment period in history.
Or, maybe, reality will intrude.
Fortunately, catastrophes rarely happen overnight. The interest rate hikes that devastated the financial markets from the 1960s until the early 1980s took 20 years to run their course. More recently, savvy participants foresaw 2008's financial crisis 18 months in advance. One could have been notably late to that prediction party and nonetheless exited before Lehman Brothers' September 2008 collapse.
Hindsight is Dangerous
The catch being that hindsight makes the choices unrealistically clear. During the events, the decisions are not so simple. For example, Black Monday in 1987 looked to be an evil omen, leading many investors to jettison their portfolios and some business owners to cut staffers, anticipating a recession. Conversely, during their 2000-02 crash, technology stocks had many false positives before they finally did recover.
As the saying goes, economists have identified 10 of the past two recessions.
The first faith is economically inspired: the reason to own long-term investment assets is because they thrive when the world does. The second is personal. Most investors will fare badly when the financial markets head south, but those who are unusually astute and observant can avoid much of the damage. The third is numeric. Its believers do not profess to know the economy's future, nor the wisdom to time markets. What they do know is that, over several decades, equities always win, and bonds (albeit less reliably) beat cash.
This could be called the Church of Bogle, but it could just as well be called the Church of All Money-Management Organisations, because in this case Bogle's message matched not only that of other fund companies, but also of institutional investors, consultants, and financial advisors. Almost every investment professional preaches the virtues of time diversification while citing historical asset-class returns.
This belief, at heart, is agnostic. The adherent does not claim to comprehend how the sun rises each morning. What they do claim is that just as it rose yesterday, it will rise today, and it will rise again tomorrow. The past is indeed a reliable guide for the future.
Faith-Based Investing
Of course the most common reason that investors place trust their portfolios: somebody told them that they should.
That somebody might be a financial adviser, who assures clients that, although they have not studied investment theory and have not considered the market's various possibilities, he can fill the gap. He knows what they do not. Or it might be a fund manager, trained in the skill of allocating assets.
Or, most recently, it might be the investor's employer. Typically, plan participants are only vaguely aware of what funds they hold – if indeed they realise that they possess investments. But they are comforted by the conviction that if the funds were not good, their company would have not have selected them for the plan.
When I started this column, I believed that my primary faith was investment mathematics. Those reassuring patterns, indicating that for as long as anybody can remember, US stocks turned a profit – or just missed doing so, very briefly – over 20-year stretches, and usually a very handsome profit at that. I was wrong. Investment mathematics is comforting but ultimately misleading. Its numbers are the effects, rather than the causes.
Describe me instead as a hopeless economic optimist. Being heavily invested in long-term investment assets, in particular stocks, comes from somewhat buried conviction that the past 35 years have not been an anomaly. They are instead an indication of what is to come. That is the assumption against which my beliefs should be tested.
