How to minimize the probability of long term negative investment returns

Some markets produce negative returns for long periods of time, and these are not pleasant for investors. One of these Markets has been Japan.

Japan’s stock market (Nikkei 225) experienced very rapid appreciation from 1983 to 1989, followed by a long-term decline. For example, between 1989 and 2013 Japanese stock market declined 78%. Even to this day (March 2021) Japanese stock market has not exceeded it’s long-term peak reach in 1989. This is 33 years of negative returns. No one can stay invested for this long.

Nikkei 225 (1965-2022)

However, Japanese stock market is not the only asset that has experienced negative returns. Silver, for example, has rapidly appreciated from 1970 to 1980 from under $10 to $120 dollars per ounce. This happened 40 years ago, and silver has not exceeded its historical high up to this day.

Silver (1960-2020)

Source: MacroTrends

Another example of a bubble that has produced a decade of low returns is Nasdaq in 2000. Nasdaq has reached 8000 points in 2000, and then crashed declining 75% from its top. It took 17 years for Nasdaq to recover to reach the previous peak. This is longer than many investing careers.

Nasdaq (1989-2013)

We assume that investors cannot predict, with high degree of accuracy, market tops or market bottoms. If this accuracy were widespread and easy to acquire skill, people would never loose money.

What are some of the defenses investors can implement to protect themselves against long and significant asset declines:

  1. Diversify your portfolio into uncorrelated assets with positive return expectations
  • Diversification brings many benefits, including risk diversification as well as return diversification. In other words, diversification can make a portfolio return to become more stable and consistent
  • For example, while Japanese stock market went down from 1989 to 2013, US Equities produced a consistent positive return
  • Gold also experienced a positive return between 1989 and 2013 (although it did produce zero/negative return for a long-period of time)

SP500 (1989-2013)

SP500 Price Return: 1989 – 2013
SP500 Total Return: 1989-2013
Gold Price: 1989-2013
Gold Return: 1989-2013

2. Rebalance your asset on a periodic basis

As Warren Buffet rightly stated, be greedy when others are fearful, and be fearful when others are greedy. This is the same as rebalancing.

For example, when an investor had a position in Japanese stocks with a target of let’s say 30%, he or she could rebalance the portfolio by selling an appreciating asset on an annual basis and could continue purchasing a depreciating asset (or an asset that has appreciated less than Japanese equities)

In this case, an investor could have sold Japanese stocks and purchased SP500, Gold, or another asset, and could have avoided a long-period of underperformance from a portfolio invested solely in Japanese equities. Same would apply to Nasdaq, Silver, SP500 and other assets.

Final Thoughts and Conclusions:

  • Conclusion 1: Assets can go through long-periods of price appreciation or depreciation for long-periods of time (10-30 years)
  • Conclusion 2: To avoid long-periods of depreciation investors should (1) Diversify their portfolios into different asset classes and (2) Rebalance their portfolios on a regular basis
  • Conclusion 3: Assuming that most investors cannot predict stock-market tops and bottoms, investor’s should not commit to any particular market or asset class to avoid long-periods of underperformance.

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