Investors should be careful about lessons taken from the incredible and, in all likelihood, unique market downturn of 2008-09. Between November 2007 and March 2009, the stock market fell by more than 50 per cent. Lazy minds seek out the easiest rather than most valuable lesson, a case of preparing for the last war rather than a sober assessment of future risks.
The results of lazy thinking are everywhere: former property trust investors have sworn off all listed property (instead of that which is overpriced and overleveraged). Instead, they are heavily invested in mining and bank stocks.
Growth investors are seeking more dividends and value investors question whether "buy and hold is dead". Overseas, Americans are still fleeing the stock market in droves.
Now money is ploughing into government bonds earning just a few per cent or less. These aren't just easy lessons, they're the wrong lessons altogether.
So here's what I learnt in the crisis.
First, I wasn't sufficiently diversified. Now I'm working harder on having adequate, and thoughtfully uncorrelated, diversification.
Second, I have a greater appreciation of the value of cash.
Before the crisis, I was a Peter Lynch "get caught with my pants up" investor. Markets go up over time so, I thought, better to be 100 per cent invested in my 10 to 15 favourite opportunities at the time.
In my grubstake days, I even avoided frivolities such as breakfast and a full tank of petrol, just so I could have a few dollars more to put into my favourite new stock idea.
I've since ditched Lynch's strategy, which works great in bull markets, for Seth Klarman, who says: "in the absence of bargains, I hold cash".
Including unlisted investments in my overall portfolio, today I'm about 25 per cent in cash. This is what I've learnt from the experience:
More discipline when it comes time to sell. Although I have a commitment to keeping a portfolio of underpriced securities, in reality I was giving leeway to fairly priced and even slightly overpriced securities, if there were no alternative bargains to buy. Now, I sell fairly valued securities from my portfolio and happily sit on cash instead. I'm more concerned with real losses than the fear of missing out.
Willingness to hold cash. It improves discipline when it comes to buying. Just because a stock might be the best opportunity I can find right now doesn't mean it's a great opportunity. Reserving the right to hold cash allows me to consider tomorrow's opportunity set as a valid alternative.
Take advantage of genuine bargains. I don't have to "sell cheap to buy cheaper" as I did in 2008-09. Panics and bargains tend to emerge at least every few years, although we're unlikely to see a period like that for a very long time. But I picked up a raft of cheap stocks in August 2011 and I'll be ready when I get a similar opportunity. In the meantime, I prefer cash over cheapish securities. My money might not be "working" all the time but market downturns now create more wealth today than they did in the past. Conservative investors have to be more active in the current environment than they have been before.
Sell overpriced stocks. Overpriced markets create more wealth through the ability to cash out. This is the reverse of the previous point. When stock prices are expensive, I get the chance to sell out at attractive prices and wait once again for the bargains.
No longer do I have 100 per cent of my wealth invested in growth assets all the time. Instead, the 75 per cent to 80 per cent I tend to have invested is, on average, in a cheaper and better-constructed portfolio (the sell discipline in particular helps in this regard).
The arguments in favour of holding cash mount up when you add
the benefits to overall returns of being able to take bigger swings when bargains emerge and the tendency to be less invested
It may well be a different matter in the face of a mindless, 20-year bull market but right now, that possibility looks a long way off.
I was once someone who wanted their money "working" all the time. Experience has taught me smart money is the type that works hard when the risk-reward equation is compelling, and when it isn't, the best place for a portion of your money is where I spent much of my short-lived professional AFL football career, on the bench.