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7 investing lessons from 2020
To state the obvious, 2020 has been a pretty crazy year. Due to the pandemic, millions lost their lives and jobs and yet the stock market has been green for the year. Nifty hit an all-time high and if you invested in certain blue Chip stocks in March, you may have doubled or tripled your money by the end of the year. With an incredible amount of uncertainty and volatility, 2020 leaves us with a lot to learn. In this article, I touch on some of the investing and personal finance lessons I took away from this crazy year. Disclaimer - This is my opinion and by no means am I claiming this to be the "only right opinion". This article is not investment advice and merely meant for educational purposes.
1. Predicting is hard
Predicted that the market would fall in 2020? Predicted the virus? Predicted the recovery?
Even if you predicted it did you act on it? Forecasting is hard and 2020 stands as an example of the same. This again brings up the question that should one bother predicting at all. Is investing passively in the market and staying in it forever a good strategy?
2. Passive Vs Active Investing
I don't think I have an answer here. Most people could look at 2020 as a sample and state how staying in the market forever is a good decision. However, if you go back in time there have been periods, where the market did not recover so quickly. For instance, there was a 5 five year bear market which finally ended in 1942. During that period the index value was cut by almost 60%. Hard to average down and keep holding when for 5 years, you have been down by 60%. Now of course an argument can be made the QE is beneficial to the markets and hence staying passively investing forever is smart. While that sounds right, I don't think I have enough evidence to make that claim. I suppose what I am getting at is that markets are hard to predict and we overestimate our ability to remain rational during volatile periods. As an active investor, in my opinion, it all comes down to the conviction one has in picking quality companies and sticking with them(or buying more) during volatile periods. As conviction in one stock dwindles, diversification in different stocks increases.
3. To diversify or not to diversify?
Yes and No. If you are going to end up investing in 30 - 50 different stocks it makes sense if you have a quant strategy. If it is 30- 50 without a quant strategy then there may be a lack of conviction in which case indexing and investing passively may be a wise option.
However uncorrelated diversification, especially into precious metals like Gold is actually a good idea. It has been even before 2020, which is why portfolios such as the Permanent Portfolio by Harry Browne and All-Weather Portfolio by Ray Dalio have always had a place for this.
4. The Black Swan excuse
A black swan event is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight. As soon as Covid hit, people started rationalizing it as a Black Swan. Unfortunately, this is a mistake as Covid is not a Black Swan. Pandemics are not "Black Swans". A Black Swan is said to be unpredictable. Pandemics are very much in the realm of possibilities. Think of all the possible disasters that could occur in this world. Epidemics and pandemics are probably the second or third name on that list. Even Wimbledon was buying pandemic insurance for a reason. The incorrect usage of "Black Swan" leads to a lack of accountability. Richard Branson tried to convince the UK government to give his Virgin Atlantic airline £500m bailouts to help it survive the economic fallout of the lockdown. Reaping the benefits without proper risk management and asking for help when things go South shows the lack of accountability that even billionaires can resort to. We saw something similar in 2008 when the financial crisis was termed as a Black Swan. (incorrectly might I add)
5. Emergency Funds
As touched upon by Nassim Taleb in his book Antifragile, our bodies are naturally made with provisions to a certain degree. We have spare parts and extra capacity in many things like lungs, eyes, neural systems, kidneys, etc. We have reserves. However, our actions are often the opposite of having reserves. We take up huge debts without any emergency funds. We believe that nothing unusual will happen but quite often something unusual does. Having emergency funds as well as emergency food packages and a safety kit stored at home is a no brainer. Uncertainty requires caution and 2020 serves as a great example of the same.
6. Narratives dominate the market
The narrative fallacy addresses our limited ability to look at sequences of facts without weaving an explanation into them. Basically, our innate curiosity leads us to try to explain stuff, and hence if the market falls we rationalize it, and then when it rises we do the same again. Instead of facts, we look at stories and narratives and then jump the gun.
In March, as the market fell we were talking about the great depression, the fall in GDP, and the economic damage this was going to bring out. By September we were talking about how markets are forward-looking.
The problem with this is that instead of looking at data we have a narrative and then look for data that matches our narrative. Confirmation bias coupled with the narrative fallacy is a dangerous combination, that often makes us miss the obvious.
As Arthur Conan Doyle once said “It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts.”
7. Markets may be getting faster
In a four-week period from late-February through late-March, the stock market experienced tanked by 30%. That is an absurd fall in such a short period of time. Five months later it is back at an all-time high. With better and quicker access to information, there could be an argument that markets are getting quicker and so if it's in the news it probably is already too late to act on. Thank you for reading.