Positively Uncertain
Key Takeaways
Investment returns are only possible because of uncertainty — it is the premium paid to us for bearing it and its resultant volatility.
The long term average return of a globally diversified basket of stocks (benchmarked to MSCI World in SGD) is around +7.36% per annum. In reality, what we get each year can be very far from that number (e.g. almost -20% in 2022, or almost +30% in 2019).
Investment portfolios should be based on certain risk metrics, providing a range for possible losses and gains over the long term. With these guideposts for expectations, you won’t be surprised by how your investments respond when the inevitable market downturn happens.
We demand rigidly defined areas of doubt and uncertainty!
— Douglas Adams
The Hitchhiker's Guide to the Galaxy
For many people, uncertainty is something to avoid, or at least try to reduce. New stall at the hawker centre and unsure of whether it is nice? Better to hold back for now, or wait for a long queue to justify trying it out. Shortcut through a dark alleyway? Perhaps it’s better to go the long way around.
We tend to focus on the negative ‘what-ifs’, but what about the positive things that uncertainty can bring? Without it, there would be no surprises, watching sports would be a pointless endeavour, and that +8% average annualised returns on the stock market over the past century (in SGD) wouldn’t exist.
For investing — the returns we receive are the premium paid to us for bearing uncertainty and the resultant volatility. Without unknowns, then returns would be predictable and there would be no difference between putting your money in a savings account and investing it in the stock market. We’ve all lived through years like 2008, 2011, 2015, 2018, and 2022 — when the market went down a lot; we’ve also been through a slew of other positive years, when it went up a lot. The potential risk makes possible the potential reward. So, thank goodness for uncertainty.
People often reflect more on the pains of losses than the pleasure of gains. That’s why Nobel Laureate Daniel Kahneman and his research partner Amos Tversky coined this concept — loss aversion in 1979 when studying utility theory. It basically puts forth the actual human bias describing how a loss feels more painful than a gain of an equal amount.
The start of September has now again brought us into the midst of uncertainty. With a stock market correction ongoing, the pessimists and bearish market commentators have started to re-emerge with calls of an impending recession and subsequent bear market collapse.
Whilst individual countries or stocks can move independently of the rest of the market, looking at the broad global index of stocks provides no indication that we should be running for cover just yet.
Bear markets can come in all shapes and sizes but the key lesson here is that bear markets are short in comparison to bull market trends — so more often than not, there is nothing to fear. However, if you panic during the bear market and get out prematurely (as we’ve previously written about), jumping back in will not only be hard, but costly, as stock prices would have risen; you would be buying what you had sold, albeit at a more expensive level.
The diagram above compares the duration and magnitude of each bull and bear market. Whilst bear markets are fewer and far between, our loss aversion bias captures those painful periods more vividly in our minds, driving us to act emotionally in order to avoid such pain in the future.
Another part of investing which revolves around uncertainty is the question of what type of return we will get after putting our money to work. The long term average return of a globally diversified basket of stocks (benchmarked to MSCI World in SGD) is around +7.36% per annum. Hence, we invest in this basket expecting to receive that return every year.
In reality, what we get can be very far from that number, and with large variances to boot (e.g. almost -20% in 2022, and more than +30% in 2013). As investors, we are bound to get worried when we have no reasonable grasp of an uncertain future. Is monkeypox the next COVID-19? Is Trump going to up-end the global economic order? Is China going to drag the world economy down with it? What if the war in the Middle East spreads?
However, if you are an investor and not a trader, then you can be comforted that there are many more positive years than negative ones. This is one of the reasons why we continue to advocate a long-term approach to investing. When putting your money to work, make sure it is capital that you likely won’t touch for at least a decade or more. In addition, a properly risk managed investment will also help you ride through the bumps and enable you to sleep better at night.
This is also one of the reasons why we endeavour to build investment portfolios based on certain risk metrics — by knowing how much your investment can possibly lose, and how much it can make over the long term, this provides guideposts for expectations. As such, when the inevitable market downturn happens, you won’t be surprised by how your investments react.
This period of uncertainty will certainly not be the last we will experience. The end of the year, and subsequent years, will bring about fresh new worries. But don’t let the inherent uncertainty in the world paralyse you from making better decisions about your money.
When it comes to market responses, some factors (like recession indicators) are arguably more important than geopolitical events (which markets have historically recovered from quite quickly). If you feel concerned about the investing environment, or just want someone to give you a second opinion on whether you are doing the right thing with your assets, we are here to provide a balanced perspective.
