THE Titanic was reputed to be unsinkable. At the first iceberg, we all know what happened.
THE Titanic sank into the North Atlantic 112 years ago this year. This example comes to mind because several investors seem to have discovered a shell of invincibility for some time (and also because we just saw the film as a family, with my 10-year-old son covering his eyes when Kate Winslet dropped her kimono robe).
Let’s say a young investor started investing in early 2023, a year and a half ago, and invested $10,000. Since he has decades ahead of him, he chose a portfolio of index exchange-traded funds (ETFs) that is 80% Canadian, U.S. and international stocks and 20% bonds, such as BlackRock’s XGRO, Vanguard’s VGRO or BMO’s ZGRO.
If he looks at his investments, he will realize that they are up 24%, including dividend reinvestment. His investments are now worth $12,400.
An investor who decided not to buy bonds and instead put all his money into a diversified index portfolio of Canadian, U.S. and international stocks (the XEQT, VEQT or ZEQT funds) would have seen his account grow by 29%. So the portfolio would be at $13,000.
And an investor who had invested only in the S&P 500, the main index of the American stock market, would have seen a rise of 45%. His portfolio would be at $14,500.
Should we conclude that those who took more risks by being all in stocks were right? And that those who chose to be only in American stocks were doubly right?
This is where we can slip and succumb to recency bias.
Recency bias is simply the mistake of believing that what has just happened will continue to happen. In short, of assuming that the future will be a copy and paste of the recent past.
As humans, recency bias has helped us survive. If we saw a tiger appear near a watering hole every day at dawn, we could deduce that it would be there the next morning too. So it’s a good idea for the transmission of our genes to avoid being thirsty at that time.
In investing, however, this bias is the source of a staggering number of errors.
For example, a reader recently wrote to me saying that his portfolio consisted of shares of Tesla, Good Food and Lion Electric, and that it had fallen significantly recently, despite a general rise in the markets.
This investor suffers from a severe case of recency bias. He bought exciting stocks that were getting a lot of attention because they had gone up a lot. But the gains didn’t last.
A “passive” investor who buys an index fund may also be a victim of recency bias.
Today, many readers are convinced that investing 100% in a fund that tracks the S&P 500 is the best thing to do.
Why? They go to Google, look at the S&P 500’s 10-year history, and conclude that it’s the best investment possible. This is forgetting that the United States has already experienced epic periods of underperformance relative to other developed markets.
In the year 2000, the S&P 500 index fell 9%. The following year, in 2001, it fell nearly 12%. The following year, in 2002, it collapsed 22%.
For the decade from 2000 to 2010, the US stock market had a total return of -9%.
A $10,000 investment in U.S. stocks on the 1er January 2000 was worth only $9,100 after 10 long years.
Meanwhile, Canadian stocks grew by 141%. The same amount invested in Canadian stocks was worth more than $24,000 after 10 years.
Would you have bought US stocks in 2002? Or in 2010, after a decade of disaster?
For many people, the answer was no.
The American stock market dominates today. But every period has its winner.
In the 1970s, Japan’s stock market dominated. In the 1980s and 1990s, Sweden’s. From 2000 to 2010, Canada had the best returns in the world. And then, from 2010 to 2020, the United States was at the top, a position it still holds today.
Maybe the US markets will have another incredible decade. Maybe not. Nobody knows.
This is why it is best to be diversified across Canada, the United States and internationally.
Beyond the S&P 500, many readers also want to be 100% in stocks in their portfolio. They note that over the long term, stocks have beaten bonds.
That’s true. But just because stocks are performing well doesn’t mean the investors who own those stocks are performing well too.
According to Morningstar, the larger the percentage of stock funds people have in their portfolio, the more they underperform relative to the funds they own.1.
You read that right: people aren’t getting returns on their funds.
This happens because they stop investing when markets fall. Or because they sell in anticipation of a fall, and buy back in panic when the fall does not occur, etc.
On paper, having bonds in your portfolio reduces your expected long-term returns. In reality, owning bonds can help you get through difficult periods in the stock market without touching your investments. And therefore improve your returns.
This is why the best investors are diversified across Canadian, American and international stocks, in addition to owning bonds.
Make sure whoever is handling your investments sees it this way. If you manage your investments yourself, all-in-one ETFs like those offered by BMO, Blackrock and Vanguard offer international diversification in a single fund.
Being invincible as an investor doesn’t mean that every category in your portfolio is constantly up. Being invincible means that you’re prepared to face whatever the market throws at you – the good and the bad.
And not end up like the Titanic.
1. Read the Morningstar article (in English)