Strategy for Stock Investing
Is It Time to Take Less Financial Risk?
"When you have eliminated all which is impossible, then whatever remains, however improbable, must be the truth."—Sherlock Holmes
In answer to Adam's question, Mean Markets suggests that none of the big three investment alternatives—buy stock, bonds, and real estate—is likely to provide great returns. Based on macroeconomic analysis these traditional investments range from fairly valued to expensive. Importantly, none of them appear to be cheap.
While none of these investment alternatives looks cheap, standard economic analysis doesn't find any of them to be wildly overpriced, either. Therefore, one might conclude that we will see a relatively benign investment world.
The science of irrationality, however, reaches more pessimistic conclusions. We are built to do that which has worked, and we have just lived through an extraordinary period that rewarded financial risk. Furthermore, the single best guide to future performance is to bet on that which is unloved. Wall Street, Main Street , and both neoclassical (the "rational" school) and behavioral economists (the "irrational" school) are betting that risk will be rewarded.
In The Adventure of the Silver Blaze, Sherlock Holmes solves the case in an unusual manner. Holmes's colleague, Inspector Gregory, asks, "Is there any other point to which you would wish to draw my attention?" Holmes responds, "To the curious incident of the dog in the night-time." Inspector Gregory protests, "The dog did nothing in the night-time." To which Holmes concludes, "That was the curious incident."
Sherlock Holmes solved the case because of the "dog that didn't bark." Similarly, the Mean Markets conclusion is that the best financial approach today might be to reduce risk. This is the opposite of the conventional wisdom. The very core of the efficient stock market hypothesis is that investors who want high returns must accept high risk.
The "investment that doesn't pay today" may solve the current financial dilemma. Because markets are sometimes wildly irrational, the "reward only for taking risk" equation can be reversed. The analysis of this book suggests that now is one such time. Low-risk investments, even those that pay close to nothing today, may be the long-term road to wealth.
Financial success might require hunkering down in a low risk posture until markets become irrationally cheap. When the financial world is filled with pessimism and others are selling their risky assets, those savvy investors who are prepared will be able to scoop up bargains.
Thus, the Mean Markets and Lizard Brains answer to Adam's question is that each of us should reduce our financial risk to a level far below where we feel comfortable. Our lizard brains have been fooled by the last 20 years of unsustainable gains. Thus, it is likely that we are all walking around with overly optimistic views of the world. We are taking more financial risk than we think we are, and most of us are taking more risk than we would want if our lizard brains allowed us to see the world clearly.
For those who want to take the Mean Markets and Lizard Brains advice to reduce financial risk, here are eight steps that can be taken immediately.
Risk Reducer #1: Allocate More Money to Lower-Risk Assets
Sell some stocks. Shift some money from trade stocks to value stocks. Increase holdings of cash and short-term securities.
Risk Reducer #2: Buy Some Inflation and Deflation Protection
Buy inflation-protected bonds in the form of Treasury Inflation Protected Securities (TIPS) or Series I U.S. Savings bonds. Buy the stocks of companies that make the products that might go up in price (e.g., drug companies, oil companies).
Risk Reducer #3: Buy Short-Term Bonds
Buy bonds that mature soon, sell longer-term bonds.
Risk Reducer #4: Live in a Smaller House
Own a house that is less valuable than the one you plan to live in five years from now.
Risk Reducer #5: Have a Fixed Rate Mortgage
Variable-rate mortgages are risky.
Risk Reducer #6: Invest in Other Currencies
Buy bonds that pay European euros or Japanese yen. Buy stock in companies that make a lot of money outside the United States .
Risk Reducer #7: Pay Off Your Debts
Rewards go to those with strong financial structures able to withstand (and profit from) adversity. Reduce your debts to build a strong hand.
Risk Reducer #8: Seek a Secure Paycheck
Now might not be the best time to leave a boring but safe job in order to start a restaurant or work for a start-up company.
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