Weekend Reading: Can You Predict A Stock Market Crash Edition

Investors should lower their expectations for future stock returns. I’ve been saying this for a while now, but it bears repeating again now that stocks have gotten off to such a rocky start this year. 

Markets are largely efficient and tend to go up over the long term. But they can certainly overshoot expectations in the short term. Remember that Canadian and US stocks have returned an average of 8-10% over a very long period of time. But the actual annual returns have ranged between -47% and +47% (1929 – 2022).

Investors have short memories. A raging bull market feels like it can last forever and investors become overconfident with their risk tolerance.

Many conversations with readers and clients over the past two years have been about FOMO. Investors with a conservative to moderate appetite for risk suddenly hunger for higher returns and want to dial up their equity exposure or tilt it towards assets with strong recent performance (crypto, tech, clean energy, or simply more US stocks).

That’s understandable when Canadian and US stock markets soared 25% last year. But we can’t expect markets to rise by double digits every single year. Heck, we can’t expect a 60/40 balanced portfolio to deliver double-digit returns like it did in 2020 and 2021.

Indeed, that’s why we shouldn’t be surprised to see a sharp price correction like we’ve seen this past month to bring prices back in line with reasonable valuations and expectations. This is a feature of the stock market, not a bug.

But largely the same investors who were eager to dial up their risk to chase past returns have been even more vocal about January’s poor returns. They want to know why their portfolio isn’t working.

To be blunt, if you don’t know your risk tolerance the stock market will decide it for you.

Behavioural psychology has taught us that the fear of missing out on theoretical gains from holding a less risky portfolio will only feel half as bad as losing actual money when your riskier investments crash.

Worse than increasing the risk profile in your portfolio to chase higher returns would be to completely abandon ship and sell now that markets have fallen. Now you’re locking in those losses for good.

Zoom out. Take a breath. The broader Canadian market is down 2% on the year. That basically takes us back to November 30th price levels. How did you feel about your portfolio then? The S&P 500 is back to mid-October price levels. Again, were you in panic mode back then?

Balanced portfolio investors (represented by VBAL) have seen their holdings dip back to price levels not seen since early October. But if you zoom out one year, a balanced portfolio is up a respectable 3.95%, plus dividends. Zoom out two full years and it’s up nearly 11%, plus dividends.

Predict a Stock Market Crash

With that out of the way I want everyone to watch this excellent video by Preet Banerjee about predicting stock market crashes. You’ll see that the best investing strategy is to pick an asset mix that you can stick to for the long-term and ignore the short-term gyrations of the market.

More than just avoiding the worst mistake (selling everything and going to cash), a big lesson here is to resist the urge to do something based on current market conditions.

As PWL Capital’s Ben Felix says, “your investment strategy shouldn’t change based on market conditions.”

Now I want you to play the stock market timing game that Preet shared in the video and share your results in the comments. In my first attempt I sold out quickly after a 20% gain only to watch the market climb nearly 100% in the three-year period (early 1950s time period). 

I’m sure you’ll find that a buy and hold strategy outperforms all but the luckiest market timers.

This Week’s Recap:

It has been a while since my last weekend reading update. I’ve since shared my net worth update for 2021. I also shared some tips on how to save more this year.

My retirement readiness checklist was a big hit. So was my recap of Vanguard’s 10-year anniversary in the Canadian ETF space.

This week I also busted a myth about working overtime with the next tax bracket myth.

I’m an emotionless robot when it comes to investing and so I stick with my simple one-ticket diversified portfolio (VEQT). But many investors adopt a core and explore approach to their investments and my latest MoneySense article offers some guidance on how to manage the riskier part of your portfolio.

Promo of the Week:

If you’re looking to change up your credit card rewards strategy (or start some light travel hacking) then our friends at Credit Card Genius have you covered with the best credit cards for 2022.

Once again the American Express Cobalt card tops the list of best overall credit card. My wife and I both use the Cobalt card for groceries and dining out.

What about your card – did it make the list?

Weekend Reading:

Economics professor Trevor Tombe offers a great explanation of what’s driving inflation in Canada. Worth a read for those who think the Bank of Canada simply needs to pull a lever to make this go away.

The Canadian Real Estate Association says its house price index was up 26% in 2021, the fastest pace on record.

Morgan Housel explains why it’s hard to distinguish what’s happening from what you think should be happening.

A terrific read on five investment lessons from the latest word craze – Wordle.

Millionaire Teacher Andrew Hallam shares a dumb investment mistake even smart people make:

“Unfortunately, buying last year’s top-performing funds is a bit like peeing in your own bathwater.”

Blair duQuesnay reminds us that we don’t get to choose when markets sell off.

John Robertson takes a deep dive into free investing apps and concludes, “Do not trade on your phone.”

Back to Preet Banerjee with another excellent video, this one examining the phenomenon of crypto FOMO. He looks at whether the early crypto returns can be repeated, and why you may already have exposure through the holdings in your index funds:

Here’s an interesting (and disturbing) look at what you learn from a year of watching bad financial advice on TikTok.

A Wealth of Common Sense blogger Ben Carlson shares his favourite investing performance chart for 2022 – the asset allocation quilt.

Should you invest a lump sum of mooney immediately or dollar cost average in over time? My Own Advisor Mark Seed shares the answer.

Jason Heath answers a reader question about whether you should apply for OAS if you have a high income.

Michael James on Money says now is a good time to decide whether your portfolio is too risky.

CPP benefits are indexed to inflation and that makes the case for deferring your CPP stronger than ever (subscribers).

Finally, remember the Beanie Baby crazy? Here’s what happens when the frenzy ends and the world doesn’t value your valuables.

Have a great weekend, everyone!