Why are time horizons important? Because people have future goals that they want to meet. We typically invest money today because we have some need that we are trying to meet in the future, whether that is college expenses, retirement, or some other less common need. Institutionally, that could be funding a charitable endowment, a pension plan, or the liabilities of a life insurer (or other insurer, but life liabilities are long).
Most retail investment advice is short-term in nature: the analyst has determined that something good or bad will happen in the short-run, so buy or go short now, respectively. In general, such investment advice has not worked out well. Why? For the most part, it is very difficult to time corporate events. It is better to try to gauge longer-term prospects, and invest accordingly — but that means you have to have no need for the assets in the short-run. As is said in many places, you are only investing what you can afford to lose.
Few invest that way, because it is in our nature to be jumpy. We look for short-term gains when we should be patient. Many stocks are like crops that may take years to mature. Yes, if you get the timing right, you can do far better, assuming you have better places to reinvest. Making a clever move is one thing, but a series of clever moves is tough. Investing is easy, but changing horses, and selling and buying to make a big kill is tough.
Now bonds offer more precision on time horizons. Invest today, and barring default, your principal comes back at maturity. With equities, we rely on arguments that over the long run equities don’t lose money. There is nothing structural to support this; ask the Japanese if they agree. (I could comment on equity markets that have gone out of existence for a time, but I refrain.)
At present, the CAPE10 and Q-ratio indicate that stocks are not likely to return a lot over the next 10 years. The same is true of most high-quality bond investments. Also, true of most high-yield investments when expected losses are netted out.
In an over-indebted world, the marginal efficiency of capital is low — we need a certain amount of bad businesses to fail, so that capital can be reallocated to ventures that are more promising. No one likes failure in the short-run, but it yields good results in the long-run — more promising ideas get capital.
We don’t need more houses, banks, autos, etc. The bailouts were a failure because they perpetuated a part of the economy that was in oversupply. Thus we have had a weak recovery.
Back to time horizon. I am not crazy about buying bonds here. The risk-reward is awkward, but the same is true of stocks. That said, the variability on stocks is greater normally, but with rates so low, it may be similar.
If this does not sound optimistic, you understand me well. Perhaps that means that cash, gold, or foreign currency bonds might be better, though I have my doubts on foreign bonds.
I’m going to keep doing what I always do. I buy cheap, well-capitalized stocks, in industries that are out of favor. I manage money with a view to holding stocks for 3-5 years. Though it has not worked well for me recently, it has worked well in the past, and I will pursue my opportunities there.
By David Merkel, CFA of Aleph Blog