I recently cleaned out some old files in my home office and pulled out some account statements from 2000.
I recently cleaned out some old files in my home office and pulled out some account statements from 2000. My investing style has changed a bit since then, and I spent some time thinking about how differently I view life and investing today.
As I was thinking about that, I wondered, what will I be thinking in 2020? What will I know then that I wish I knew now? In that vein, I wanted to write now the letter I hope I will be able to send to clients then — about how I really learned and applied the lessons of 2000 and 2009.
Jan. 1, 2020
Dear clients,
As we enter the new decade, I wanted to take a look back at the past 10 years and think about how different things are, and how we have changed our practice — to your benefit — since the tumultuous times at the end of the last decade.
In 2010, we had just come through a terrible crisis. Your accounts had declined significantly, and even though they recovered somewhat, we were all scarred by the experience. We knew we had to change our practice — and we did.
The most important change was to commit to genuine diversification.
That meant moving beyond the stock/bond, domestic/foreign paradigm to seek more representative weightings — more weight to non-U.S. markets of all sorts; more weight to alternative strategies such as managed futures and absolute returns; more weight to real assets such as timber, infrastructure and commodities; and the appropriate use of annuities and insurance.
When new asset classes emerged later in the decade, we moved into those, including student earnings-backed equities, residential appreciation rights, and others. We sought out asset classes that, by history and by design, were non-correlated.
We did not settle for the false diversification that almost sank us in the 2008-2009 period.
STAYING THE COURSE
The next most important change was that we stuck with it. We learned many of the same lessons in 2000-2001, but we forgot them in the next couple of years. Not this time. Rather than do the wrong things again — chase returns, stick with the hot asset classes, get complacent — we committed to re-balancing regularly, selling the winners high and buying the losers low.
As dedicated as we were to what we knew worked, we were not too proud to continue to improve. Besides incorporating new asset classes and products as they developed, we also took advantage of research on valuation levels, helping our risk management by maintaining our broad allocation levels but modifying the allocations within those bands inversely with the valuation levels.
All of these steps were taken to manage the effects of the things we couldn't control. We also took full control of the things we could. We worked to decrease your tax exposure, both through decisions early in the decade on Roth IRA conversions and through continuing decisions to recognize gains and losses at the most advantageous times.
We weren't prescient in knowing tax rates were going to go up — the handwriting was on the wall — but we were quick and thorough about executing steps to minimize the effects.
Managing the transition to a lower-return, higher-tax environment was one of the most effective ways we added value for you.
The other area under our control — where we could and did add value — was expense management. As with taxes, in a lower-return environment, expenses matter and are largely under our control. By rigidly controlling expenses at all levels, we added measurably to your returns.
So what have we learned from 2010-2020 that we didn't already know in 2010? Not much, really, that we didn't already know even as far back as 2000. In both cases, we were coming off serious declines that did severe financial damage to you. The difference in this decade is that we actually incorporated this knowledge into our practice. We did what we knew we should; really diversify, regularly reallocate, manage taxes and expenses, and put systems into place to ensure that we didn't do what we shouldn't — chase returns or sell asset classes due to short-term underperformance.
Because of this, you are well-positioned to pursue your goals, despite the usual market volatility. We look forward to continued long-term success in 2020 and beyond.
Brad McMillan is a vice president and chief investment officer at Commonwealth Financial Network, a registered investment adviser. He can be reached at bmcmillan@commonwealth.com.
