Be ready for good times and bad

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This article was published 28/01/2023 (1048 days ago), so information in it may no longer be current.

People are an optimistic lot.

That’s not to say human beings don’t have a propensity for cynicism and anxiety about the present and future, especially when it comes to money and investment.

Yet overall, we’re hopeful better days, or more profitable ones, lay ahead even in the face of adversity.

A new book by a veteran Canadian investment adviser, however, posits that perhaps this bias for optimism — along with other behavioural traits — has many unprepared for what could be a difficult economic path ahead.

If anything, its title captures the imagination: Bullshift — How Unconscious Bias Creates Behaviour That Threatens Your Finances.

“Optimism is widely seen as being the most innocuous bias because most of the time it is the thing that helps us get through,” says John De Goey, the recently published book’s author, and portfolio manager with Wellington-Altus Private Wealth in Toronto.

“We’re happier and live longer, but optimism as it pertains to stock market turbulence can be extremely dangerous.”

De Goey — who has an accompanying podcast, also named Bullshift — argues many investors have recency bias when it comes to the financial market, anchored in the recent past when bear markets and recessions recovered quickly.

The genesis of his book, in fact, was the deepest throes of the pandemic downturn.

“I got to thinking that even some in the industry… had no idea what it would take to get through something truly life altering,” he says.

“But what if we see something we’ve never experienced before? Maybe not as bad as the Great Depression yet nearly as bad and maybe longer?”

Certainly, we could possibly be at the start of that prolonged event given the current ingredients: high inflation, geopolitical instability, rising interest rates and falling consumer confidence.

Of course, a key word in all this is “possibly.”

Market prognostications are not guaranteed. Yet too often, even the industry itself puts far too much focus on optimism.

“Many investors are shifted toward a bullish approach because it’s good for business, and everybody likes to be optimistic — I do too,” he says.

“But if you’re not looking at things as they truly are, and rather choosing to look at things as you wish they would be, you could be exposing yourself to a lot of risk unwittingly.”

What should an investor do, then?

“There is a thing called a ‘premortem’ — like a post-mortem after someone dies — only while things are doing well, you consider what your portfolio would look like if it fell in value by 30 to 50 per cent.”

He notes that includes not just stocks and bonds, but real estate too.

Ask yourself: How would retirement look based on these outcomes?

“If the honest answers are, ‘It would really throw me off,’ ‘I would have to work another five or six years,’ or ‘I don’t know how I am going to put my kids through school,’ then I think it behooves you to contemplate taking steps to proactively mitigate that risk.”

Of course, the next step would be to consider how to address the risk. One way of doing that is rebalancing the portfolio regularly — once or twice a year — to make sure the mix of bonds, stocks and cash remains as set out in your plan. Most people have a balanced portfolio of 60 per cent stocks and 40 per cent bonds. So, if you’re portfolio’s holdings are 67 per cent stocks and 33 per cent bonds today, you may want to restore that 60/40 mix, particularly as bonds, amid higher interest rates, now provide a better return.

De Goey says it may even be worth considering an even more conservative mix of 50 per cent bonds and 50 per cent stocks.

“Last year was probably one of the worst years in history for bonds, and a lot of people have a hate on for them now,” he says. “But they are probably offering the best yield we’ve seen in more than a decade.”

Another important measure is seeking out alternative viewpoints.

“If some talking head says, ‘We’re going to be fine,’ don’t just accept it at face value.”

De Goey notes even asking your friends about their investments can be instructive.

“If the problem is bias, then have a discussion with your buddy while watching the Jets game,” he says. “Try to look for alternative viewpoints and be a contrarian to think about ‘What if I am wrong?’”

That’s not to say: don’t seek help from an adviser. But learning on your own, and from peers are also helpful for a broader understanding.

Considering the different, possible eventualities, especially the nasty ones, results in better preparation for good times and bad, he adds.

After all, it’s likely a new bull market could be underway, or a maybe sideways market.

But maybe we experience a prolonged bear market like Japan after its stock market peaked in 1989?

It has yet to surpass that high.

“If you were a 50-year-old investor in Japan in the late 80s and thought, ‘Not to worry, I am a long-term investor’ … today you would either A) be dead, or B) be waiting to return to your former glory,” he adds. “Either way, that’s not going to cut it.”