Thursday, June 25, 2015
Cycling vs. Investing
You might be thinking what these two things can possibly have in common. Let me explain.
Here in Vancouver, we're becoming obsessed with biking. There are over 400 kilometers of bike lanes in the area and half of all trips now consist of walking, biking, or transit.
I got sucked into this culture. It's been about three months that I've been proudly biking to work every day. However, I’m very ashamed to admit that for the first little while, I kept my bike fixed in high gear.
This city has a lot of hills. I loved the high gear as I went downhill or on a flat road. But going up-hill in this gear was painful. I used to always pedal standing up and was completely out of breath by the time I reached the top. Everyone else seemed to be riding the same hill seated with ease and so I wondered why I could be having such trouble.
After some research, I found the answer. Whenever I was going downhill or on flat road, I kept in my regular high gear. But when I was going uphill, I downshifted to a low gear. Magic. What a painless ride.
The same concept applies to investing. You can’t be holding the same fixed portfolio allocation in both boom times and in recessions. You need to occasionally shift gears between stocks and bonds depending on the prevailing environment. And just like with cycling, the method to switch gears should be very simple and systematic.
However, the common mantra in the financial industry is that you must hold a fixed allocation to stocks and bonds regardless of the market environment. Most advisers and fund managers love to hug the benchmark indices. Finance textbooks told them that the market is efficient and they should not try to beat it. In addition, they want to minimize their “career risk.” This is the risk of their customers abandoning them if the fund has a period of under-performing the benchmark.
Then every so often, a recession hits and these "experts" and their unaware clients get tortured through it. Just like I suffered biking uphill in fixed gear, but worse. Thankfully, it doesn't have to be this way.