In uncertain times, it might be reassuring to rely on well-known investment and trading sayings. However, what about the ones that may steer you in the wrong direction? Our Head of Investment Advisory, Diego Wuergler, breaks down what to look out for as an investor.
Navigating the investment world can be tricky. In turbulent times, sound investment wisdom is even harder to come by. Common adages can be helpful, but also misleading. In this Markets Explained article, we take a closer look at how time-tested investment mottos hold up.
Investment motto #1: “Let’s make a quick trade.”
The running joke on Wall Street is that “every long-term investment is a short-term trade that went wrong…”
Short-term trading depends on luck alone and your probabilities of winning are roughly the same as playing at a casino (50%). On average, the stock market rewards us (around 8% p.a. in the US) for our patience.
My view: The key is to have a time-horizon that is long enough.
Investment motto #2: “Sell in May, and go away.”
“Sell in May, and go away,” meaning to sell in May and get back to the market in November, is not a useful guideline, seen from both a statistical and theoretical view.
Statistically, if it is true that the May-October period underperforms the November-April one, the absolute performance remains positive, but this does not work systemically, and is certainly not working in 2020.
Theoretically, it is even worse. If selling in May really makes sense, smart investors should anticipate the May selling pressure and start at selling in April, so that the saying would become “Sell in April and go away.” You would continue, by extension, to always sell a bit earlier.
My view: Make sure you avoid irrational decisions by not following this motto.
Investment motto #3: “Let’s hedge a portfolio for the short-term.”
Implicitly, this means timing the market for a correction which is, in essence, impossible to do.
When hedging, you generally have two alternatives:
- Selling futures is easy to implement, and it incurs no extra costs. However, you give up any potential upsides.
- When buying put options your upside potential remains unlimited, but you pay a premium.
Two major problems arise:
- Most hedges will be imperfect. If you sell S&P500 futures, you perfectly hedge your portfolio only if you own the S&P500 in terms of assets, and there aren’t many investors in such a situation. This may yield unwelcome outcomes, where your assets may go down but the S&P500 goes up. You lose on both sides.
- You need your timing to be perfect, not only when initiating the hedge, but also when closing it. However, closing it at the bottom of the market, when everyone panics and news flow gets horrible, is the most difficult thing to do.
My view: short-term hedging is more entertaining than effective, with the only exception being FX hedging given that this is an important aspect of risk management. Furthermore, it might make more sense to leave futures hedging to institutional investors (as they may not be able to reduce their equity allocation). On the option side, the most appealing strategy appears to be selling puts to enter a stock or selling calls to take the profits. Simple and effective!
In today’s world, it’s hard to filter out all the noise. Pitchy investment proverbs prevail, and they may seem to serve as a guiding force. However, it’s always better to think twice about whether these mottos still ring true.