A Look Back at 2020 - What Went Wrong
I promise this will be the absolute last time I mention 2020! Despite the past year's tragic events, there were oodles of lessons to be learned and applied going forward.
Looking back at the wrongs can guide us in the future. As they say: "those that fail to understand the past are doomed to repeat it."
In a year with a pandemic and economic recession, discipline was necessary to successfully navigate a challenging market. But with all the noise, the crosscurrents of information, investor sentiment swung wildly during the year. Those who broke their discipline in 2020 subjected themselves to potentially disastrous consequences.
Will discipline be necessary for 2021? You bet. It always is.
What we have found is that discipline is an outgrowth of confidence when investing. And when we say "confidence," we are not talking about stubborn opinion about current events. Confidence comes from structuring a portfolio, knowing that markets become volatile for periods of time. It's easier to be disciplined when you are confident your portfolio can weather a challenging market.
That's the key to how we customized portfolios for each of our clients at Nicollet Investment Management.
In looking at what went wrong in 2020, we see that a lack of discipline was front and center of, in our opinion, the biggest mistakes made by investors during the year.
Here are more details on the three wrongs of 2020:
Market Timers Epic Fail
One concept I would like to purge from the investment books is market timing. Perhaps after the events of last year, this futile concept will be abandoned by investors. At least, I hope so.
When the pandemic first hit, it nearly hit without warning. While there may have been a small cadre of investors that saw the destruction that would come with the virus, most were caught off guard.
Once the damage started and the market fell in March, there was a rush to the exits. There was no way the selloff could have been predicted, and once it started, it was too late for "selling" to be a reasoned strategy.
Then, the selloff didn't last very long. In a flash, the losses were mostly erased, and new highs were hit. The windows to time the market in 2020 were so very short-lived that few could have done it effectively.
The disciplined investor weathered the worst of 2020 and realized the rewards of what amounted to a strong year for the market.
I suspect most market-timers took losses or, at best, lagged in their performance for the year.
In my opinion, market timing is always the wrong strategy and even more so when market volatility spikes as it did last year.
Hedge Funds Flailed in 2020
Perhaps more aggravating than market timers are hedge fund managers who often claim to have some sort of magic formula for beating the market. I don't believe there are any "magic formulas."
According to Financial Times, hedge funds had their best year since 2013, in 2019. According to Hedge Fund Research of HFR, hedge funds produced a gain of 8.6% for the year through the end of November.
During the same period, the S&P 500 was up 27.6%, and the U.S. Bond market (as measured by Bloomberg Barclays Index) was up 10.4% in the first 11 months of 2019.
For 2020, according to Bloomberg, hedge funds gained 0.4% through October. HFR's index showed a loss of 4% for the same period. Indeed, the last two months of the year helped the final tally, but those returns still fell far behind the returns generated in the stock and bond markets in 2020.
2020 showed once again that hedge funds are a questionable approach for individual investors.
Oops! Those Bond Funds May Not Be So Safe
We wrote and published several articles on this topic during the last year. Bond Funds have been positioned by the mutual fund industry to be comparable to buying a portfolio of individual bonds. They are not.
The big difference between a portfolio of individual bonds vs. owning a bond fund has to do with the control you can exercise in what is held. A portfolio of individual bonds can be aligned with your cash needs. A bond fund will never be aligned with your specific needs.
Bond funds also suffer because they are a pool of investor funds. What happens when some investors in the fund want to pull out their money? If there weren't enough cash on hand, the bond fund manager would be forced to sell bonds to raise money. If that selling comes at the wrong time, there could be losses for all fund investors – whether they needed to liquidate alongside the other sellers or not.
If a large number of investors pull out simultaneously, it forces the manager to make significant decisions. By contrast, when you own your bonds, only your choices impact the portfolio.
This contrast played out in a significant way in March 2020. Bond funds suffered substantial losses and liquidations spiked, and bond fund investors incurred losses in what is supposed to be their 'safe money' – in some cases to the tune of multiple years' worth of interest payments from the fund. The bond fund volatility in the early part of the year was merely a blip for the buy and hold investor.
If you are interested in learning more from the wrongs of 2020, please give me a call.