By: Dividend Sensei
By Nick Maggiulli
While many of us want to leave 2020 in the past (myself included), it was a year filled with investing lessons that will benefit us for decades to come. Below I have compiled a list of 10 such lessons that you can use to be a better investor in 2021 and beyond. Enjoy!
1. Prices can always go lower
Even when things seem like they can’t get any worse, sometimes they do. Energy traders discovered this truth the hard way when spot oil prices went negative for the first time ever:
I don’t think I ever remember FinTwit being more shocked by a single event. The lesson here is simple: even when you think the bottom is in, prices can always go lower. Sometimes you have to expect the unexpected.
2. The bigger decline, the bigger the potential recovery
If equity markets demonstrated anything this year it was that large price declines have the potential for even larger recoveries. Why? It’s simple math. If a 20% drop in prices requires a 25% recovery to get back to even, then a 33% drop in prices requires a 50% recovery to get back to even, and so forth:
And since 2020 witnessed a 33% decline in the S&P 500 (from peak to trough), this means that the unexpectedly quick recovery was even better for those that got in near the bottom in late March. While no one could have predicted that such a recovery would follow, the fact that a recovery did follow meant huge gains for those who stayed the course.
3. Volatility is alive and well
In case you forgot about volatility, 2020 was your wake up call. Looking at daily Dow returns going back to 1929, this year was one for the record books:
In addition to having two daily declines greater than 10%, March 2020 was also the most volatile month in stock market history. This year was a reminder that the excess expected return of stocks over bonds sometimes comes with a cost.
4. Price is what someone else is willing to pay for something
2020 saw Bitcoin re-reach $20,000 a coin, Tesla exceed $600 Billion in market capitalization and oil drop below $0 a barrel. While none of these prices may make sense to some investors, they made sense to the person who bought them.
As long as markets exist, assets will always be priced based on what someone else is willing to pay for them. This has never been more evident than the recent rise in valuations among non-profitable tech companies. But as long as enough buyers are willing to pay such elevated prices, they will continue.
While such an occurrence may seem like an easy short opportunity, it is anything but. As the famous phrase goes:
The market can remain irrational longer than you can remain solvent.
Try to keep this in mind when investors look like they are losing theirs.
5. Bitcoin doesn’t behave like a safe haven
Despite what Bitcoin evangelists may have claimed in years prior, 2020 definitively proved that Bitcoin doesn’t perform well in chaotic markets. Like many other risk assets, Bitcoin’s price declined rapidly in March 2020:
And while I agree that Bitcoin generally has a lower correlation with other risk assets during good times, this isn’t necessarily true when there is blood in the streets. When the world was in peril, Bitcoin showed its true colors.
And though I have changed my mind about some things related to Bitcoin, it’s proper classification as a risk asset is not one of them.