Why Long Term Investors Should Rejoice at a Recession
11 June 2020
“Our favorite holding period is forever.”
— Warren Buffett
While many investors dream of investing like Warren Buffett, few would be able to stomach doing what he does in times of market crisis.
One of the secrets to his success over the years is that he viewed investing as similar to owning a business. Business owners will know that building a stable, profitable business isn’t something that happens overnight. It takes years of hard work, diligence and patience. So, why is it that investors don’t take the same approach to their own portfolios? After all, a portfolio’s underlying assets are also companies and businesses!
One probable reason is that the rise of online trading and numerous finance apps have made investing much more convenient than it used to be. These days, it takes just a tap or a click of a button to buy or sell. Unfortunately, this has encouraged investors to become impatient and impulsive, and created a trading (and gambling) mindset where they consider any investment held for more than a year to be ‘long-term’. It has also resulted in investors being unconcerned about what they are actually holding as long as they think they can sell for a quick profit.
Another reason is the bias inherent in our brains. In their insightful research paper “The Effect of Myopia and Loss Aversion on Risk Taking“, Professors Tversky, Thaler, Kahneman and Schwartz showed that investors who frequently assessed (and accessed) information on their investments were less likely to take risks and thus made less money. In contrast, those who didn’t “check their investments” frequently were more risk tolerant and received a better outcome.
This bias also explains why we tend to make more money from illiquid assets that are hard to trade, such as land and property, while being terrible with daily-traded instruments. Likewise, people tend to experience better outcomes with investments that have long lock-in periods, such as private equity and even insurance products.
Back to the problem at hand: with activity in many industries sharply curtailed due to restrictions aimed at curbing the spread of COVID-19, economists say a recession is inevitable, if one hasn’t already begun.
From a market perspective, we have already experienced a significant drop in stocks as prices have likely incorporated the higher probability of a recession. Investors may thus be tempted to abandon equities and go to cash, but history shows that equities have had a history of positive performance in the two years following the onset of a recession.
Looking back at past crises, we see that investors were rewarded for sticking with stocks.
Total Returns Following a Crisis (SGD)
| Event | 1 Year Later | 3 Years Later | 5 Years Later |
|---|---|---|---|
| 1987 Black Friday | 28% | 11% | 16% |
| 1990 Recession and Savings & Loan Crisis | 15% | 31% | 39% |
| 1997 Asian Financial Crisis | 32% | 28% | 48% |
| 2000 Dotcom Bubble | 27% | 67% | 82% |
| 2008 Great Financial Crisis | 46% | 52% | 83% |
(Returns based on a globally-diversified stock index.)
The prospect of a recession understandably triggers worries about how markets might perform. One could make the case that every recession is different, and that this time “it could be different” for the global economy. However, as the table above illustrates, the historical evidence shows that such times are also among the best times for investors to get into the market or top-up their holdings.
Likewise, the historical evidence shows that acting on recession fears and moving out of stocks in such periods is much more likely to be a big mistake for your investment plan and returns outcome.
Nonetheless, if you have been losing sleep over the past few months and feel that this level of volatility is just too much for you to stomach, we urge you not to do anything just yet. Talk to your adviser and allow the markets to recover first, and then strategise with your adviser on the best way to implement a systematic risk reduction of your portfolio.
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