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Still balanced after all these years

This month marks my 20th anniversary as a financial advisor, so I’m in a reflective mood.  As I look back on two decades of working with clients, I’m struck by how much the investing climate has changed since the 1990s.  At the same time, I’m just as shocked by how little investor behaviour has evolved over the same period.

I first came face-to-face with the behavioral obstacles of investing in 1994.  The previous year had been terrific for Canadian resource companies, and in January I received a phone call from a prospective client.  He told me he was going to invest all of his net worth—not some, not the majority, but all of it—into a resource fund that had been the top performer in 1993.  “Thanks for your time and suggestions,” he said, “but I just turned 55 and I have to make up for lost time by finding an investment that is really going to grow this capital.”  In short order, the fund blew up—over the next five years it lost close to 90% of its value.

This investor showed me for the first time—and there would be many more examples in the subsequent 20 years—that few people seem content with a balanced portfolio.  When markets have gone up, they make huge bets on whatever sector, fad, or investing style has recently performed well.  When they’re down, they sell in a panic.  Not surprisingly, the result is disappointment. 

“Everyone I know is getting rich on tech stocks”

During the mid-1990s it was hard not to make money, as the markets delivered several years of double-digit returns.  But by the end of the decade some of my clients were in such a state of euphoria that it clouded their judgment.  Early in 2000, I lost a client who was fed up with my balanced approach. “Everyone I know is getting rich on tech stocks,” he told me before liquidating his portfolio and moving everything into the tech sector in late February.  His timing could not have been worse: just weeks later the tech bubble burst, and by the time it was over the Nasdaq Composite index (a technology bellwether) had declined over 75%.

If that seems like a long time ago, the 2008–09 financial crisis is still fresh in the minds of all investors.  What I remember most about that period was the despair of investors during the dark days.  I recall one prospective client who actually did have a balanced portfolio in late November 2008, yet he still sold everything—not just stocks, but also bonds, redeemable GICs, and structured notes with principal guarantees—and moved everything to cash.  His timing was good in the sense that the markets continued to go down for another three months, but he would have missed the extraordinary recovery that followed.  I’d estimate that his emotional decision has so far cost him more than $2 million, and that loss keeps growing with every year of lost compounding. 

In Search of Balance

As I look back over my career, I cannot recall any period where pessimism has lingered for so long after a crisis. Recent returns have not been nearly as bad as you might infer from all the gloomy headlines, yet I still encounter investors who have thrown in the towel on stocks and bonds.  Now they’re taking big swings at real estate, private businesses, or illiquid alternative investments like private equity funds.  The details have changed since 1994 and 2000, but I doubt the results will be any different.

The markets no longer keep me awake at night, but I still worry about how investors will react to financial news, and how their emotions can sabotage their investment plan.  My advice hasn’t changed: a balanced portfolio works, even if it won’t give you any exciting investment stories to tell at cocktail parties.  It will never make a killing, but it won’t get killed either.  More importantly, it’s the only strategy that will protect investors from making a big mistake during the alternating periods of euphoria and despair we all endure.

It worked over the last 20 years, and I expect it will work in the decades to come as well.