It’s a crazy time to be an investor.
COVID-19 and tense global politics have given new meaning to investors’ least favorite word: uncertainty.
While we’ve all been focusing our attention on the pandemic and the election, there are other big, hairy threats to the economy lurking.
For example, the current economic cycle was growing mature when the pandemic arrived. Meanwhile, interest rates are at record lows.
The pandemic might be the tip of an iceberg facing investors over the next decade.
What factors will matter to you, as an investor, over the next 10 years? What could stock and bond returns look like between now and 2030? And what, if anything, should you do differently?
Short-term market forces
Personally, when I use the word “investing,” I’m talking about assets you will own for many years, if not many decades. I have a small brokerage account where I trade a handful of stocks for fun. But the bulk of my wealth is invested in a tactical portfolio comprised of index funds. This is how I recommend you invest, too.
If you follow financial news, every day you hear “the stock market went up because of this” or “down because of that.”
A host of other factors move stock markets all the time: unemployment numbers, inflation numbers, monetary policy (interest rates going up or down), corporate earnings and on and on.
In 2020, these were some of the unique factors that caused market volatility.
Of course, the coronavirus pandemic has wreaked havoc on the global economy and – at least initially — the stock market. But, to many people’s surprise, the stock market recovered from its 2020 losses within months even though the economic damage from COVID-19 continues to mount.
We can watch many people speculate, but we simply can’t know for sure the largest forces responsible for the market’s quick recovery.
But one important piece of the puzzle is this: the stock market is forward-looking.
A company’s stock price doesn’t so much reflect what the market thinks it’s worth today, rather what the stock should be worth tomorrow given our best guess of where the economy will be six months from now.
This is why stocks plummeted after stay-at-home orders went into effect but then recovered. At first, the market believed we were entering a deep recession. After just a month or two, it began to believe “maybe this isn’t as bad as we thought (economically speaking).”
Donald Trump likes to take credit for a booming stock market during his presidency. The truth is that markets performed just as well during Obama’s eight years in office.
As much as politicians like to believe their policies bend the will of the markets; long-term performance has more to do with market cycles and long-run monetary policy that transcends presidential terms.
That’s not to say a presidential tweet can’t move the market. They can, and have, moved the markets both up and down. In Trump’s case, the more he tweeted on a given day, the poorer the S&P 500 fared.
But, either way, the effects are short-lived. The same goes for presidential elections.
Like other short-term influences, history shows that presidential elections don’t matter as much as we think they do for the stock market. We can tell is that the market tends to perform better when the incumbent party wins than when the incumbent party loses.
Fiscal stimulus and monetary policy
The government has two big levers it can pull to try to prop-up an ailing economy: fiscal stimulus and monetary policy.
Fiscal stimulus involves increasing government spending or cutting taxes. Sometimes, the government gives direct stimulus to businesses and taxpayers, as it did earlier in 2020.
The goal of stimulus is to increase demand in the economy. The government gives people money (or lowers their taxes) in the hope they will go out and spend this money.
The stock market loves stimulus because it increases the demand for the products all the various public companies make. This is why stock markets rally when the government adds stimulus (or even talks about doing so in the future).
Monetary policy is controlled by the Federal Reserve Bank and refers to raising or lowering interest rates.
In general, the market prefers lower interest rates. Like government stimulus, lower rates encourage spending. That said, this is a gross oversimplification. The actual relationship between the stock market and interest rates is quite complex.
The stock market moves anytime the Fed makes an interest rate announcement. But these short-term moves have more to do with whether the Fed’s decision was expected or surprising.
In the next section, I explain the long-term importance of interest rates on investment performance.
What about Black Lives Matter?
The Black Lives Matter movement and corresponding rallying cries for racial justice were another significant event in 2020.
What effect did these have on the stock market? Not much of one.
It’s just another example of how removed Wall Street is from Main Street’s reality.
Does any of it matter to long-term investors?
In fact, no. Today’s headlines only matter if you’re trading. They matter if you’re researching an options contract.
If you’re investing money that you don’t plan on using for a decade or more, NEWS is nothing but NOISE.
Of course, most of us end up listening to the noise for other reasons. We just shouldn’t allow it to influence our investing.
If you’re a true long-term investor, one day you will look back at all of 2020 and the entire pandemic and think “look at that crazy blip on the chart”.
So, what should you be worried about?
Long-term market forces
The things that really matter to the stock market and investors’ long-term performance move slowly. These are things like:
- Monetary policy trends (rising or falling interest rates over time).
- Policy change.
- Geopolitical change.
Together, these factors determine how asset classes (not individual stocks) perform over many years.
For example, if inflation is high, the Fed will usually respond by raising interest rates. Bond prices fall when interest rates go up. If this trend of high inflation and rising rates continues for several quarters in a row, bonds as an asset class will underperform. Bonds and stocks tend to (though not always) have an inverse relationship. As such, it’s conceivable stocks will perform well during the same period.
For the record, we are not in this situation in 2020. If anything, we’re in the opposite situation.
And that should concern you as an investor.
I do not suggest you abandon your buy-and-hold plan and try to predict market cycles.
What am I going to do, personally? I will adjust my asset allocation (subtly) to account for what I believe will be likely economic conditions in the 2020s. If you’re comfortable, you may want to do the same.
More on that in a minute. First, what’s going on?
The following factors could all play roles in market performance over the next decade.
Low interest rates
Interest rates in the United States are at historic lows. Just look at this graph of the effective federal funds rate over the past 65 years.
Low interest rates are both good and bad. They’re good when you can get a low rate on a 30-year mortgage. Low interest rates are bad when you want to earn interest from a savings account or bond.2 There’s no fee for the Chime Savings Account. Cash withdrawal and Third-party fees may apply to Chime Checking Accounts. You must have a Chime Checking Account to open a Chime Savings Account.
This could be a big problem for investors.
Most investors have at least some exposure to bonds in their portfolios. If you’re young, bonds might only make up 10 or 20% of your investments. If you’re in retirement, however, bonds make up likely more than 50% of your portfolio.
- Bond prices are less volatile than stocks and often remain stable or rise when stocks lag.
- Bonds provide yield (interest income) every year.
If you are a retiree living off your investment income, bonds are essential because they are supposed to provide somewhat predictable income with low volatility. In the 1980s and 90s. bond yields averaged around 6%. One could have conceivably retired with a 100% bond portfolio and lived on just the interest.
Not so today.
The yield on many treasuries (the safest kind of bond) is near 0%. That means that in real terms (adjusted for inflation) these bonds earn negative interest.
A real (adjusted for inflation) interest rate can be negative even when the nominal interest rate is positive. If you hold a bond earn 2% interest but inflation is running at 3%, your interest rate – and your rate of return – is -1%.
All of this is to say that if you own these treasury bonds today at near zero interest rates, you are paying the government to hold their debt.
If you want extra credit, read this explanation of negative interest rates.
Otherwise, let’s move on. We’ll come back to interest rates in a moment.
I mentioned earlier that the effects of presidential elections on the stock market are short-lived. But government policies can affect markets in more enduring ways. Unfortunately, it’s difficult to predict if a certain policy will move markets and, if so, by how much.
The fiscal stimulus policies we discussed earlier are like shots of adrenaline; they give a quick boost to the market for a while, but the effects fade in time. The stimulus money gets spent.
Tax policy, on the other hand, may impact the market longer-term in complicated ways. It makes sense that tax policies affect incentives for both corporations and investors. This, in turn, could affect the stock market’s overall growth rate.
The surprising truth is that past tax increases have less impact on markets than we would expect. The biggest reason is that tax hikes are often accompanied by government spending (stimulus).
Many individuals might think it’s obvious that we should raise taxes on fat-pocketed corporations. Meanwhile, others cry out that raising corporate taxes will have downstream impacts: less growth, a smaller dividend, higher prices to customers and employee layoffs.
The same goes for capital gains taxes. The thinking goes that low capital gains tax rates encourage investment, which leads to economic growth. In reality, I think few investors would be dissuaded by higher taxes on their gains. If they want to grow their money at a rate faster than inflation, where else are they going to put their funds.
It all comes down to this: nobody knows for sure But I think there is widespread sentiment among investors that tax increases are coming for Americans. Regardless of whether Democrats or Republicans control Washington, D.C., there are a host of big issues on the table that will require spending to solve: pandemic recovery, healthcare, climate change, crumbling infrastructure and an aging population, to name a few.
Will such tax increases create a headwind for the market? Some analyses of historic tax hikes suggest not. Personally, I’m going to be prepared either way.
The United States is changing. Our population is growing. It’s becoming more racially diverse. And, notably, it’s growing older.
This chart shows the percentage of the U.S. population ages 65 and older between 1960 and 2019. It has climbed from 9% to more than 16%. According to the Census Bureau, the percentage of Americans ages 65 and older will grow to 24% by 2060.
The fact that we’re getting older, as a country, means lots of things.
Social Security and Medicare will get more expensive for the government. Nest eggs will need to last longer. And demand in various verticals will change (financial advice and healthcare stand to gain).
As I write this, the inflation rate hovers around 2% — that’s fairly low. And inflation has been low for a while (hence low interest rates).
Since the 1990s, central banks have become quite good at managing inflation. This is why we haven’t seen double-digit inflation since 1980.
If inflation falls further, that could be a problem. If inflation doubles (which it could, despite Fed policy), it will create a different set of issues for investors. Both scenarios are possible.
The risk of the lost decade
What’s worse for an investor: a stock market crash of 40% followed by a slow two-year recovery? Or an entire decade with an average annual return of only 2%?
Assuming you didn’t need your money in those two years following the crash, the decade of low returns is far worse.
As long-term investors, we count on our money compounding. We recognize that we will not have gains every year. But we look at history and expect 1) the good years will outnumber the bad and 2) some good years will be really good and more than make up for bad years.
But what if we don’t have those really good years? What if valuations more or less stay the same?
Some investors are worried that the 2020s could be a lost decade. It could be “lost” if your money fails to grow faster than inflation or grows at a very small rate.
Why might it be lost?
Some or all of the factors discussed above may create significant enough resistance to economic growth. In addition:
Despite the current recession, the stock market hovers near its all-time highs and shows no signs of slowing again. It’s logical to expect another (larger) correction in the coming years.
It’s not impossible to imagine a scenario in which $1 invested on January 1, 2021 becomes $0.65 after a crash in 2022 and just barely gets back to $1 by 2030. After all, this is what happened to investors between 2000 and 2010.
If you invested in the S&P 500 in January 2000 and sold your stake in January 2010, you would’ve lost about 0.5% of your money. Adjusted for inflation, your return would’ve been about -3%. Ouch. (And this takes dividends into account, by the way!)
Ordinarily, this is a good example of the role bonds serve in a portfolio. Holding some percentage of bonds over the same period would’ve at least preserved your purchasing power, if not eked out again.
But as we look ahead, remember where bonds are. They’re priced high and yielding close to nothing. If you buy bonds now, you stand to earn very little income and your bonds stand to lose value whenever interest rates start going up.
Enough with the doom and gloom. What should we do about all this?
How to invest for the 2020s
My investing strategy for the next decade is simple: be more aggressive and expect to live with some more volatility.
We design our investment portfolios based upon our needs and our comfort with risk. If you’re a younger investor and would be tempted to sell your stocks after a 20% market decline, you have low risk tolerance. You might invest in a balanced portfolio of no more than 50% stocks.
If you’re a retiree drawing income and would also get spooked by a 20% pullback in the market, your plan might be even more conservative.
If you want to learn more about determining your risk tolerance and designing your perfect portfolio, subscribe to my free 9-lesson course: Advanced Money School.
But, with all of the things working against stocks over the next decade (and bonds, too) I think we all need to become more comfortable with volatility. This might mean going from a 60/40 stock/bond allocation to an 80/20 stock-bond allocation. It might mean putting 10% of your money into an alternative like gold or REITs.
It doesn’t mean shying away from a solid passive investing strategy. It doesn’t mean trying to start picking “quality stocks” that will outperform the rest. It simply means being smart about your asset allocation as we start the decade in a rather unique economic position.
Reduce bond exposure
The bottom line is that I’m worried about bonds being a good place to invest for the coming decade. There may be some value in holding some bonds for safety, but honestly, I might prefer cash if you absolutely need to preserve principal.
If you share my concern with bonds, I wouldn’t hesitate to trim some from your portfolio. You can always buy back in when rates have risen (and bond prices have fallen) a bit.
Add international equities (especially emerging markets)
Stocks are a wildcard, but they’re the best shot you’ve got at a winning decade. The key with stocks in the 2020s, I think, is global diversification.
Stock valuations on U.S. companies are high. It’s also reasonable to assume the U.S. economy is going to have a tough time getting back on its feet after the COVID-19 situation. It might even have further to fall. (Remember that, even before the pandemic, economists were predicting the economy was nearing the end of its market cycle and due for a recession.)
Meanwhile, emerging markets like China (I know, it’s funny that the second-largest economy in the world is considered “emerging”) have a lot of runway ahead of them. Investing in emerging markets is riskier than U.S. stocks or even international equities from developed counties. But, if you have a long horizon, they offer growth potential you’re simply not going to find elsewhere.
Even if you consider emerging markets too risky, consider increasing your foreign stock positions.
Consider alternative investments
I still believe in the stock market. I will continue to keep most of my money invested for the next decade and beyond. But if there were ever a time to consider diversifying into some alternative investments, this might be it.
Unlike bonds or dividend stocks, gold provides no cash flow. But history has shown that gold can perform well in both inflationary and deflationary economic environments.
Gold is known as a safe-haven investment. When things are bad elsewhere (like the U.S. dollar, for example), money flows into gold. I consider this point in history a good time to have some money in a safe haven investment.
I don’t know what inflation will do over the next decade. But on an expectancy basis, there is a significant enough inflation that we cannot ignore it. Gold will be a good thing to have.
If you want to avoid gold, treasury inflation-protected securities (TIPS) are another option. These are treasury bonds that are adjusted for inflation, guaranteeing purchasing power and the prospect of a tiny amount of income.
It’s a good time to get into real estate investing if you can find a market that isn’t overpriced. That’s a big if. Homes are selling so fast where I live, I wouldn’t dream about buying in until things cool off.
But if you find the right market, why not take advantage of low mortgage rates?
If you’re not ready to buy a rental property of your own, real estate crowdfunding could be a solution. These platforms pool investor money to invest in commercial real estate deals.
Any number of real estate investment trust (REIT) ETFs can provide similar exposure to commercial real estate.
These investments are risky. With hotels, shopping malls, and office buildings vacant these days due to COVID-19, commercial real estate is having a rough year. Of course, it could be the perfect opportunity to get in and ride the wave back up.
I’m not a crypto bug, but I do think Bitcoin is here to stay. The jury’s still out on other cryptocurrencies. I consider them speculative still.
But could you put some money into Bitcoin as an investment? Sure, some. As with any investment, just be smart about how much you allocate to it.
Would I put 1% of my assets into Bitcoin? Sure. 5%? Maybe. 10%? Probably not.
Here’s the TL;DR.
As ever, investing in a long game.
Headlines about COVID-19, protests, and politics may shake up the markets in the short-run. But just a few years from now, they will be insignificant.
What will matter for your investments over the next decade is economic growth, inflation, monetary policy, government spending, tax changes, and demographic shifts.
For the above reasons, the 2020s could be a rough decade for investors – even a so-called “lost decade”.
We can hope not, but we can also be prepared.
There’s nothing wrong with sticking to your evergreen investment plan and riding it out. But if you want to be tactical, consider shifting to a more aggressive asset allocation. That means trading bonds for stocks and increasing exposure to foreign stocks and alternative investments such as gold and real estate.
Whichever path you choose, be prepared for more volatility ahead and stay the course.