The Four Most Prosperous Words in Investing

Nathan Geraci is President of The ETF Store, Inc. and host of the weekly radio show The ETF Store Show“.

Legendary investor Sir John Templeton once said, “The four most dangerous words in investing are this time it’s different”. Over the past decade and a half, we have witnessed two vivid examples where investors would have been wise to heed Mr. Templeton’s advice: the dot-com bubble culminating in a spectacular stock market crash in 2000 and, more recently, a housing bubble that precipitated the 2008 financial crisis. In both instances, vast swaths of individuals threw caution to the wind and joined the masses in either loading-up on risky tech stocks and/or operating a household budget on the assumption their home would only increase in value.

The crux of what Mr. Templeton was getting at is anytime you hear or think “this time it’s different”, you should ignore the temptation to act differently and instead, invest or operate your finances in the same manner you always have. Although, there are new and advanced ways such as investing from your phone. If investors in 1999 remained diversified and resisted the urge to buy stocks of dot-com companies with no real revenue or earnings, surely they would have minimized losses when the NASDAQ cratered nearly 80%. Individuals who simply bought a house within the constraints of their family budget and left the growing equity alone as values surged in the middle part of the 2000s, were certainly in much better position to weather the impending implosion in home prices and subsequent Great Recession.

So why mention this now? There are two very important – albeit different – reasons, both of which serve as cautionary notes moving forward: 1) The “this time it’s different” mentality can wreak just as much havoc in down markets as in up markets – a fact that continues to paralyze some investors today even though we are five years removed from a stock market bottom, and 2) As stocks continue to advance, investors must be wary not to forget the lessons of the dot-com bubble and financial crisis and begin to believe “this time it’s different”. While these two reasons sit on opposite sides of the investing spectrum, there is a way to be mindful of both in your investment portfolio.

First, while you will typically hear the four most dangerous words in investing uttered during times when stocks are racing ahead, they can be just as commonplace during times when stocks are down. Think back to early 2009, when many investors exited the stock market and doomsday scenarios of nationalizing banks and stocks declining another 40% were running rampant. At that time, many investors believed “this time it’s different” and instead of the usual economic recovery following a recession, investors believed the country was on the verge of economic Armageddon. The “this time it’s different” mentality caused investors to quickly forget even relatively recent history, such as the stock market crash of 1987 (where after falling nearly 30%, stocks proceeded to race ahead close to 100% over the next five years). Or, after the previously mentioned dot-com crash, which was followed a year later by the 9/11 terrorist attacks, stocks proceeded to rebound over 40% within five years of the attacks. As you can see from the below chart courtesy of Morningstar, Inc., similar scenarios have played out many times over the past 100 years:


Yet, even as the economy began picking itself up off the mat in 2009, many investors still continued to believe “this time it’s different” and avoided investing in stocks. Since March of 2009, the S&P 500 is up close to 190% and the five-year old bull market continues to grind higher. Data shows many investors have failed to participate in this impressive bull market run, instead preferring to keep their cash on the sidelines. The dot-com bubble and financial crisis left deep psychological scars and caused otherwise moderate and aggressive investors to invest much more conservatively than normal. The takeaway from all of this is that altering your investment approach because you think “this time it’s different” can be just as detrimental in down markets as in advancing markets – which brings us to reason number two.

Now that stocks have indeed advanced some 190%, the sentiment is changing and some are questioning whether investors are beginning to take a “this time it’s different” approach by ignoring signs of a stock market bubble. If you are unsure, you can go to Stocktrades to find out more on investing on the Canadian Stock Exchange. Moreover, have the Federal Reserve’s unprecedented accommodative actions fueled a stock market rally that is not congruent with what is happening in the real economy? Are record corporate profit margins sustainable? Have the labor markets (see real wage growth) and housing really recovered? Anecdotal evidence and real data do suggest the economy is continuing to recover, but enough to justify current stock market valuations?

You can see the cruel paradox here. On one hand, investors who took the “this time it’s different” mentality in early 2009 have missed the enormous run-up in stocks. On the other hand, there is a very real possibility that investors are now using the exact same mentality and ignoring potential warning signs of an overdone market. So what are prudent investors to do?

Two of the most important concepts of successful investing are discipline and diversification. The aforementioned Sir John Templeton was well-known for preaching an investment approach of not following the crowd. Simply put, do not buy and sell investments when everyone else is doing the same. This takes a tremendous amount of discipline, but for longer-term investors, the rewards are plentiful. Given today’s current market environment, with the Fed’s extraordinary influence, geopolitical strife in Iraq and Ukraine, political gridlock in D.C., and so on, it is difficult to say whether buying stocks would be considered following the crowd, sensible investing, or simply a poor decision. Economic data suggest the economy is heading in the right direction, but is that already reflected in stock prices? At the end of the day, no investor has a crystal ball, but enacting discipline by rebalancing stock positions back to targeted allocations and reallocating proceeds to investment opportunities where valuations are perhaps more favorable seems logical. Furthermore, a disciplined approach would entail not chasing returns by keeping long-term target allocations intact.

Another famous quote from Sir John Templeton was, “Diversify. In stocks and bonds, as in much else, there is safety in numbers”. This, perhaps, is the most important lesson of all. After all, you cannot properly rebalance your portfolio if it is inadequately diversified. More importantly, when the inevitable U.S. stock market downturn arrives – and it will arrive at some point – your portfolio can weather the storm and, as an ancillary benefit, you will react in a much more disciplined manner. Diversification breeds discipline and discipline prevents you from acting on a belief that “this time it’s different”.

At The ETF Store, discipline and diversification are core tenets of our investment philosophy. We constantly monitor the global investment landscape, looking for opportunities to further diversify our portfolios which drives returns and minimizes risk. We keep a steady hand on the wheel at all times. Combined with low cost Exchange Traded Funds, we believe this approach offers the best chance at long-term investing success. If the four most dangerous words in investing are “this time it’s different”, we would argue the four most prosperous words in investing are “discipline, diversification, & low cost”.