Is This the End of Investments?
As we look back at 2022, it is important to remember that this year likely marked the end of an era for many investments and strategies.
For more than 40 years we have lived with low inflation and declining interest rates, culminating in some of the lowest interest rates in history by 2021.
It was an era of having the Federal Reserve bail out the economy, and by extension investment markets, time after time.
Is This the End of an Era?
Whether it was the S&L and junk bond scandals of the late 80’s and early 90’s, the dotcom bust of the early 2000’s or the great recession of 2007-2009, the Federal Reserve (Fed) and the Federal Government have stepped in to protect investors in stocks and real estate time and again.
These interventions have created a generation of investors and savers who have been led to greater participation in riskier assets.
As a result, there has been a tilt toward risk for investors who felt it was the only way to earn a reasonable rate of return in such a low interest rate environment.
What Difference Does That Make?
Having the backstop we mentioned above, meant that markets would snap back in relatively short order and, with declining interest rates, shifting to bonds when markets dropped meant you were rewarded by more than the interest rate on the bond, but an increase in value as interest rates dropped (the value of a bond moves in the opposite direction of interest rates).
I talked about this in a blog post just before Covid hit. With rising rates, bonds have become much riskier. If we slip into recession this year, some corporate and municipal bonds could be hit very hard.
How Bad Was It?
Looking back at 2022, we saw the tech heavy Nasdaq index down over 30% with many popular stocks down 50% or more.
According to CNBC, the total bond index was down over 13%, the worst year since the 9.2% drop in 1980 and the worst year recorded since the index began in 1972.
So much for bonds protecting you to the downside.
The FTSE All Equity REIT index was down almost 25%! This shows that many different asset classes have been greatly impacted by inflation and increasing interest rates.
“Past Performance Is No Guarantee of Future Results”
We have all heard this disclaimer. I think it may prove to be more true than usual over the next few years. This means that some of the high-flying investments of the last few years may not perform as well going forward and some things that weren’t as “hot” could be the new top investments.
Remember, companies come and go. Today’s hot stock can be tomorrow’s forgotten also ran. Names like Zenith Electronics and American Motors were highly respected companies in the 1950’s and 60’s but are nowhere to be found these days.
3 Things to Keep In Mind
- Would you buy it today? I speak with a lot of people who have stocks and other investments that were purchased many years ago. Often, their value went up and is now back down, but higher than when they bought it, so they tell me they are “waiting for it to come back”.
Even if it comes back eventually, you may want to sell it and buy it back later, especially if there is a loss to take. Those losses can be used against future gains to reduce taxes.
- Are the reasons I bought this still in place? For example, did the growth come because of a lack of competition, but now there are new competitors creating headwinds? Do you remember a company called Netscape?
Their main product, Netscape Navigator, had over 90% of the web browsing marketplace in the mid-1990s. By 2006, their market share was less than 1%.
- Will this make money in a higher interest rate world? I am a big fan of analyzing the profitability of an investment. Buying something that is only marginally profitable like a piece of property or stock in a struggling company dramatically increases risk.
For example, you buy a property that is paying you 3% after expenses. For most folks, this assumes that your tenant pays every month, and nothing breaks on the property. Say you bought it with short term financing at 4%. After a couple of years, you have to refinance that loan but now the interest rate is 8%.There goes your profit margin. So, you try to raise the rent and your tenant moves out. Now you have no positive cash flow at all, and you must go in pocket to protect your investment.
Keep Your Eyes on the Prize
Take advantage of the current state of the markets. Real estate is down in many areas, but still hanging in there. Many former high flying stocks have rallied off their lows, the bond market seems to be pausing recently in hopes the Fed will stop raising rates.
This is a great time to sit down and ask yourself these questions.
Look at what is likely to happen to your holdings if inflation persists, or if interest rates stay where they are.
Then reposition yourself to stay on the path to Retire Happy! I think in the future you will be glad you did.
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.