Now that 2022 is underway, I’ve put together a ‘2021 Year in Review’ where I’ll show returns of some major global asset classes from the last year.
I’m also going to demonstrate why this information doesn’t usually tell us anything about the future, and highlight a common trap investors commonly fall prey to when looking at past returns.
Finally, I’ll share a few key ideas that might help one better position themselves (and their money) for higher future expected returns.
Why The Past Isn’t Always A Good Predictor Of The Future…
Let’s look at how some major Global Asset Classes performed in 2021 in Canadian Dollars:
Source: Dimensional Fund Advisors.
Unfortunately, the numbers from 2021 don’t tell us much about 2022 or the next 5 to 10 years. To illustrate this point, below is a table showing the Global Stock Returns per country over the last 20 years. Each square is a country, each vertical column is a year, and each horizontal row is the rank of each country each year.
Source: Dimensional Fund Advisors.
Look random to you? I agree. And that is exactly my point: country stock returns year to year are largely random.
Looking Forward, Not Backwards, 2022 and Beyond
Investors are humans, and humans constantly suffer from “resulting”, a term that describes judging our past decision making as good or bad based on the outcome, not the decision making process.
For example, if you invested only in an S&P 500 index fund for the past 10 years and you received 15% annualized returns, was your decision to invest exclusively in that index a good one?
What if you did the same thing in the year 2000 until 2009 and your returns were -1% annualized for a decade?
Did you make the wrong investment decision?
We know absolutely nothing about the decision making process, only the outcome.
This is dangerous because we can make poor decisions and get good results from luck and visa versa.
This can reinforce our decision and lead us to make another poor decision that will eventually be more likely to lead to bad results.
As behavioural animals, human’s have a tendency to think they are being proactive by looking for forecasts and extrapolating near term results (think large tech stocks, crypto etc).
They think they’re being proactive but they’re just defaulting to knee jerk reactions.
Ideas (Not Forecasts) for 2022
There is compelling evidence for including international stock diversification in portfolios (despite its 10+ year underperformance to US stocks), as well as tilting towards value stocks over growth stocks.
Reasons include but are not limited to the fact that US stocks are much more expensive relative to international stocks, and stocks with growth characteristics have valuation spreads as wide as they have ever been relative to value stocks. If you want to look at a bunch of awesome charts to illustrate these points, I have included them at the bottom of this blog post.
Long-term peer reviewed research supports the idea that if one were to look for opportunities for higher expected returns over decades, they would tilt more towards value stocks.
The Best Idea for 2022: Discipline
We can attempt to squeeze out excess returns and implement clever efficient portfolios using academic research and current valuation spreads. But in terms of reaching your goals, the best thing you can do is build and follow the right habits.
It’s not sexy, or an easy shortcut, but staying disciplined means thinking about your investment goals in terms of 10 years or more and ignoring short term noise. Markets are constantly re-adjusting to new information or new perspectives.
If you’re mid-career and accumulating assets, the biggest variable affecting your long term wealth building is your ability to maintain habitual savings into risk assets regardless of short term narratives.
If you are near or in retirement, your best chance at a good outcome is disciplined rebalancing, diversification, tax awareness, and staying the course. Ignore the schizophrenic Mr. Market in the short-term.
“Investors are always searching for good ideas, when what they need are good habits. Only procedures that you repeat and follow until they become automatic will enable you to invest steadily over the long run.” – Jason Zweig, WSJ
Happy investing – all the best for 2022 and beyond.
Marc Berger
Want to dig deeper into my investment ideas for 2022 and beyond?
Check out the charts below for 2 key takeaways, value vs growth spreads are sounding alarms. International diversification for those with US heavy stock portfolios are also ringing alarms.
- Value vs. Growth: within the US stock market, there are major price differences. Small Value stocks are trading near their historic price levels. Large Growth stocks are well above. If the price you pay for a stock has an impact on future returns, and historically over long periods it has, this chart is screaming for the relative cheapness of value stocks vs. growth stocks as a style.
- More on value vs growth: this chart on the left shows the relative price between US value stocks and US growth stocks. The last time this big of a delta was present was the dot-com bubble. History doesn’t repeat, but it rhymes.
- This chart is basically showing that given the current P/E level of the S&P 500, when it has historically been at this level, 5 year forward returns are not great. Doesn’t mean it will happen this time, but how much do you want to tempt the probability of this outcome?
So US stocks look like they might be expensive. What do we do?
- As seen above, we can tilt portfolio’s away from market cap weightings to overweight stocks that have value, small and high profitability characteristics.
- We can make sure we are diversified internationally.
- Explore alternate sources of returns.
- The US equity market has been on an unusually long run of outperformance. This may continue, but for how long? It helps to be aware of falling victim to recency bias, or assuming the current trend will continue forever.
- Another way to look at US vs ex-US valuations. Foreign Stocks are at a price-to earnings discount of 32.7% and dividend yields are 1.6% higher.
More on Yields…
- Diversification means you will never only own the best asset class. But it also means never having to say you’re sorry. In other words, when investing large sums, it’s better to be broadly correct than exactly wrong. Just ask anyone who was only invested in commodities the past decade. (The following chart represents a balanced portfolio as described in the fine print and returns in USD)
- Time is your friend. Like my recent post “Is the stock market just the casino?” This chart gives some good perspective on risk and returns over 1, 3, and 5 years. The figures within the bars show the highest and lowest returns that were experienced over each period since 1950.
- Lastly, this chart reminds me why having an advisor is so important, not just for financial planning and asset allocation, but for help staying the course. The average investor is in and out of strategies to their detriment.
Disclaimer: Past performance is no guarantee of future results. This blog post is meant for general information and not to be taken as specific investment advice.