15 Jan How to cope with what 2021 bringsRead Time: 4 minutes
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As you will have noticed, 2020 was a difficult one for the forecasters. While what was to become the coronavirus pandemic had started, nowhere was it apparently recognised that within months it would spread around the world and result in significant economic impact, quite apart from the human tragedy. As a result, it would be unfair to pick on individuals and to highlight their particular predictive failings.
With the UK now in a further lockdown period which is due to last for at least several weeks, one difference from the usual January is that gymnasia will not be deluged by suddenly enthusiastic exercisers desperate to show that they are doing something to work off excess weight. Still, at least they have the excuse of being ordered by the government to stay at home.
It is probably reasonable to expect most forecasts for 2021 to have at least some aspect related to coronavirus. Since almost none of the 2020 forecasts did, this illustrates well how our view of the future is influenced by our experience of the past. I remember attending a conference once at which one of the speakers from an investment company outlined its approach to portfolio construction. It started with a list of all the possible economic scenarios for the coming year and then assigned each one a probability. This was then fed into a model which used the data to produce an optimal set of portfolios to accommodate the most likely scenario. While this sounded great in theory, what seemed to me an obvious flaw was that first, nobody really knew what the possible scenarios were and second, nobody knew what the likelihood of each of them was either. This attempt to provide solutions to an inherently uncertain future had superficial attractions for anyone who were themselves was uncertain about what would happen but the reality was that the manager’s predictions need not be any better than those of its customers. That company is no longer operating in the UK, so maybe it models were not quite as good as it thought we would all be using them.
However, 2020 was not all about coronavirus. At the start of the year, there was much concern about fires in Australia. We then had protests at the death of a previously unknown man at the hands of police in Minneapolis, the withdrawal from public life of the sixth in succession to the British throne, the shooting down of a Ukrainian airliner over Iran and the explosion of several thousand tons of ammonium nitrate in a Beirut warehouse which killed over 200 people. And in case you missed it, we were advised to inject bleach and sunlight as protection against coronavirus (seriously, do not try this at home or indeed anywhere else). Was any of these events predicted in the 2020 forecasts that you read? Not in mine either.
Prediction is easy, accurate prediction less so. Therefore trying to organise your own life, or your finances, on the basis of what you expect to happen in the world or the economy is probably going to lead to disappointment. Better to focus instead on positive actions that you can take yourself which will be effective regardless of external events.
In that context, here are some suggested resolutions which should allow you to whether whatever 2021 has to offer:
- Focus on your process. This is the only thing that you can control and it covers how you allocate your cash, which investments you buy and when you decide to sell them. The market does not know how much you need to achieve your goals and it does not care either.
- Whichever strategy you decide to follow, make sure that you can stick with it through thick and thin. Your optimal strategy is not the one with the highest recent returns as sooner or later, it will be the one with the lowest recent returns. You might try looking at the decisions that you made last year when the market plummeted in the first quarter – did you sit tight or did you sell everything? If you did sit tight, how did you feel and did you regret not selling when the market went lower?
- When you decide to buy something, write down the reasons. It is when those reasons no longer apply that it is appropriate to dispose of it.
- Similarly, write down the reasons why you would settle the investments that you currently own. This is an exercise also worth carrying out before buying so that you have a framework for making future disposal decisions.
- Review the composition of your portfolio on a consistent basis. If you own full funds such as unit trusts, do not look at them more frequently than quarterly and ideally, annually. The more frequently you trade, the more costs you will accumulate and costs are the enemy of the long term investor.
- When you do review it, only rebalance back to your target composition if the portfolio has diverged materially from that target. What constitutes ‘materially’ is affected by both the amount of time that you have to manage the portfolio and the costs of transactions. The main purpose is to control the risk to which you are exposed and allowing individual portfolio components to move at least 10-20% before rebalancing them is likely to be sufficient in most cases.
- Review the costs that you are paying. Every pound that you pay to somebody else is one that is not available to meet your own goals. Higher costs may be worthwhile (for example if they pay for things which you either cannot or do not wish to do yourself and which you value) but equally, they may not.
- Write down a set of instructions for what should happen to your portfolio if you are unable to manage it. Ensure that someone you trust knows where these instructions can be found. You may also need to put in place a lasting power of attorney to provide the legal framework for them to act on your behalf.
- Don’t keep your approach yourself. If you have gone to the trouble of coming up with a coherent process for managing your portfolio, share this with members of your family so that they understand why you are investing in the way that you are. They may even have suggestions to make which can improve things and it is never too early to educate them about the principles of how investing works. At some point they will need to do it themselves and you may not be around to help them at that time.