In the investment world, every year is unique. This year certainly was. But, in some ways, every year is also the same. The specific events change, but many of the underlying themes—and challenges—don’t change a whole lot. As 2022 winds down, it’s a good time to take a closer look at some of those themes—and the steps investors might take to navigate them when, invariably, they present themselves again in 2023.
Taxes. You may remember George Steinbrenner, the longtime owner of the Yankees. As a billionaire, my guess is that he spent considerable time and effort—and money—developing strategies to minimize the estate tax that would ultimately apply when he passed. But something unusual happened when that day finally came. In the year that Steinbrenner died—2010—a wrinkle in the law resulted in there being no estate tax at all. It was just a fluke. The result, though, was that all of the Steinbrenner family’s planning was, in a sense, totally unnecessary.
The lesson: It’s good to plan, but it’s equally important to recognize that things can, and usually do, change. This applies to all types of financial planning, but especially to estate planning. Because the estate tax is a political football, it’s likely to change multiple times in our lifetimes. And yet, for each of us, it will only matter what the law is in one particular future year. Of course, there’s no way to know which year that will be. For that reason, when it comes to tax planning, I always recommend a light touch. Look for ways to take half-steps, opting for flexibility, where possible, over solutions that might be theoretically optimal under current law.
Shiny objects. One day last fall, outdoor diners at a restaurant in the city of Recife, Brazil became panicked when they saw a group of people running down the sidewalk. It looked like they were running from some danger. As a result, all of the diners got up from their meals and started running too. What was actually happening, though, was much more mundane: The folks running down the street were simply exercising. But all it took was for one person to panic. That triggered others, and soon everyone was running.
The parallel to investment markets is clear. Crowds can often spread panic. But this year revealed that crowds can also do the opposite: They can make everyone feel safe. Cryptocurrency is a case in point. As the prices of bitcoin and other digital tokens rose in recent years, more people began to feel that these digital “assets” were gaining legitimacy and stability. That led more people to buy into the crypto story, further pushing up prices, thus adding further credence to the story. But in reality, cryptocurrency hadn’t become any safer. It was only investors’ perception that changed. The lesson is clear: Always keep your eye on investment fundamentals, such as cash flow, earnings and dividends. If someone tells you that something is the “new thing,” check twice. Then check again.
The recency effect. There’s an old joke about two parents watching their children participating in a marching band. Everyone is marching perfectly in sync, except for one, who is entirely out of step. Seeing this, one parent leans over to the other and comments, “Look at how the whole band is out of step with my son!” It’s funny, but a reminder that many things are a matter of perspective.
Investors, I believe, do try to be rational. And by that, I mean, they look at history and try to make informed decisions based on the data. The trouble, though, is that there’s no single definition of “the data.” Inflation is today’s example. Over the past 20 years, inflation in the United States has been very stable in the range of 2%. But in the 1990s, it was 3%. In the 80s, it averaged nearly 6%. And in the 1970s, of course, it exceeded 10% at times. So how should we look at the inflation we’ve seen this year? Is it an aberration, or were the past 20 years the aberration? Which of these numbers is out of step? Ask five economists, and you’ll likely get five different answers. As an investor, what can you do?
Over the course of this year, I’ve discussed various strategies to protect portfolios from inflation. Here’s the important thing, though: Even if the current bout of inflation does settle down, you’ll still want to maintain some inflation protection in your portfolio. To the extent possible, in fact, investors should try to maintain a portfolio that is diversified in ways that would protect you from as many different types of rainy days as possible.
Expertise. One of my favorite cartoons from The New Yorker features two elderly men sitting side-by-side in easy chairs. Both are reading investment books. Look closely, though, and you’ll see that one of the books is titled The Coming Boom while the other is titled The Coming Bust.
I’ve discussed on several occasions the challenge posed by expertise in economics and finance. Because there are so many variables involved, it’s awfully hard to make accurate predictions. The most notable recent example: Jerome Powell, chairman of the Federal Reserve—perhaps the most informed economist on Earth—was wrong in his assessment of inflation last year.
Powell, like other economists, has taken heat for his inaccurate forecast. But here’s the challenge: As much as we know that predictions are often wrong, we don’t have much alternative. If we ignore experts, then we’re really flying blind. So what should investors do? Author and investor Howard Marks offers one useful solution: Don’t view expert opinion as Gospel. Instead, take it with a grain of salt, just as you might listen to a long-term weather forecast.
More importantly, look at the big picture. In his book Mastering the Market Cycle, Marks acknowledges that it’s difficult to know precisely where the market will go tomorrow or the next day but points out that it is possible to observe, generally, whether the market is very high or very low. And with that information, investors can make reasoned judgments.
Stock-picking. Another topic on which I’ve been a broken record is the difficulty of stock-picking. There’s years of data showing that both professional and individual investors underperform the market, on average. And yet, stock-picking remains alluring. Why is that? The reason, I believe, is because it’s just successful enough—enough of the time—to keep investors interested. Pretty much everyone knows someone who bought Apple or Google or Netflix early on and has happily ridden those gains into bragging rights at family reunions. I call this the brother-in-law effect. How can you combat it? My recommendation: Don’t view the debate over stock-picking in religious terms. Personally, I don’t recommend it, and I don’t do it. But doctors don’t recommend junk food either, and that doesn’t mean you should never, ever touch it. My view: If you want to pick a few stocks—as long as it’s a manageably small slice of your holdings—I wouldn’t worry too much about it. Especially if that helps you better respond to your brother-in-law’s bragging the next time you see him.
Investment frauds. No discussion of 2022 would be complete without a discussion of the defunct crypto exchange FTX and its founder, Sam Bankman-Fried. What can investors learn from this episode? Warren Buffett has this saying: “It’s only when the tide goes out that you discover who isn’t wearing a bathing suit.” In more formal, academic terms, there is an idea in finance called the Kindleberger-Minsky theory. One of the key ideas is that markets go through cycles, and during bull markets, investment frauds tend to thrive. That’s because it’s easier to cover up something like a Ponzi scheme when the market is rising. It’s only when the market drops that fraudsters are exposed—because lower asset prices make it more difficult for them to paper over their theft. That’s why Madoff’s fraud only came to light at the end of 2008, when the market dropped. And that’s why the scheme at FTX only came to light this year, after bitcoin had dropped 70%. The lesson: As an individual investor, you should always be wary of things that are new and untested. But you should be especially careful when the market is strong, and everything looks perfect. Counterintuitively, that’s when risk levels are highest.
