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Leverage, often referred to in investing as a ‘double-edged sword’, is another word for borrowing money to own more of an asset. Much like a mortgage on a house, it enables individuals to own a higher value of an asset they would otherwise be unable to own, but it does run the risk that the value falls such that one ends up owing more than one owns (coined ‘negative equity’ in the housing world). This is never a good place to be.
Students have always been at the centre of activism around the important issues of the time, from the ‘Mai 68’ student riots in Paris, via the pressure put on Barclays and others to divest from apartheid-riven South Africa in the 1980s, to today’s Black Lives Matter movement and the existential threat of climate change. Their enthusiasm and conviction can often act as a powerful catalyst for change. Sometimes, however, a certain naivety accompanies their solutions. Complex problems rarely have simple, binary choices.
As an investor one is always learning. Our perception of investing is guided by our experiences: those old enough to have been investing in the 1970s will retain uncomfortable memories of rampant inflation and the impact that had on cash, bonds, and the general travails of life when prices spiral upwards. Others who lived through the birth of the internet and the boom and subsequent bust of the ‘dot.com’ era of the late 1990s and early 2000s, may also be living through a sense of déjà vu. For most investors, interest rates have been on a steady long-term decline making mortgages cheaper and supporting bond and equity prices. In the past twelve months, we have been reminded of some useful lessons that can – hopefully – make us all better investors.
If we could invest by simply looking at what has done well in the recent past - and by that we mean the past few years, not just months - then life would be so much simpler. Unfortunately, rearview mirror investing is not the best way to build portfolios for the future, which is where our spending and intergenerational transfers will take place
In most industrial settings, health-and-safety rules demand that appropriate protective gear be worn, including the donning of ear defenders in high decibel environments. Yet, when it comes to our investing health and safety, we have little by the way of regulatory guidance except the obligatory phrase ‘Past performance is no guide to future performance’ to protect ourselves from the noise of market outcomes, particularly when investing without the guidance of an advisor.
One of the hardest concepts in investing is trying to understand what ‘risk’ really is and deciding how to deal with it. If you asked a fund manager to explain it to you, they would probably provide a lesson on credit, liquidity, and concentration risk (amongst many others) and the volatility of returns, as measured by the annualised standard deviation of returns!
Humans have a hard time being investors. Normally, we like to purchase things when they are cheap and avoid them when they are expensive, but that is often not the case for equities. We tend to get overly optimistic and enthusiastic when equity markets rise dramatically, as they have done since the Global Financial Crisis a decade ago. Yet when markets fall materially, we feel bruised and cautious, seeking to hang onto our stable bonds and even selling equities to avoid further falls in portfolio value. That’s rarely a good idea, especially if you do not need the bulk of your capital in the foreseeable future.
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