by How should you invest in 2021? With all that’s going on in the world right now: A once-in-a-century pandemic, tangible effects of climate change, business closures, record unemployment, an upcoming election… which investment strategy should you use in 2021?
This post examines the current state of affairs, reviews the blazing tech sector, and provides THE proven strategy on how to maximize your odds of investment success in 2021.
Contents
Current state of affairs in 2020
As I’m writing this article in late 2020, we truly are living in unprecedented times.
Pandemic
We are dealing with the COVID-19 pandemic which has taken over a hundred thousand lives in the U.S. It has affected the way of life for nearly every person on this planet. It has altered how we work, how we attend school, how we eat, how we socialize, and how we visit family, just to name a few.
Wildfire Risk
If that wasn’t enough, we are also dealing with a wildfire crisis in California. Soaring heat, intense winds, and sporadic lightning has causes fires to rage across the state, stretching firefighters to the brink.
Our masks suddenly serve a dual-purpose: to prevent virus spread, AND to minimize the inhalation of smoke. There are days when the Air Quality Index labels the air as “Unhealthy”.
Climate Change
Death Valley just hit 130 degrees Fahrenheit, described as the highest reliable temperature ever recorded on the face of this earth.
Increased energy usage to stay cool during the intense heat has caused utilities to issues warnings of potential rolling blackouts.
Struggling Businesses
From March 1st to July 10th, 2020, Yelp reported 26,160 restaurant closures, with 60% of them being permanent. Over the same period, 26,119 shopping and retail stores closed, with 48% of the closures being permanent. Source: Marketwatch
Many well-known companies filed for bankruptcy at some point during the pandemic. How many of these names do you recognize?
- J. Crew
- Neiman Marcus
- Pier 1 Imports
- Hertz
- 24 Hour Fitness
- GNC
- Lord & Taylor
Unemployment
The unemployment rate during July 2020 was 10.2%, lower than its peak of 14.7% in April, but still higher than at any point during the 2007-2009 Great Recession.
So to get back at the original question:
How should you invest in 2021?
My answer, is to stay the course. Invest mainly in low cost broad market index funds. This is the strategy I implemented in 2020 and it will be the strategy I implement in 2021, and probably 2022 until infinity.
You Can’t Time the Market
Nobody can accurately predict what will happen in the next year or two. I discuss more on why you can’t time the market here.
But you can estimate the probability of positive returns over a specific time frame. Just look at this chart from Teets Investments:
Over 1 day, your probability of a positive return is just a shade better than flipping a coin and guessing tails. But over a 10- year period, your probability of a positive return is 97%! Not only that, but based on history, the average S&P 500 annual return is 10-11% from 1926 to 2018 according to Investopedia.
Honestly, You Really Can’t Time the Market
In early 2020, four senators were investigated for selling a large amount of stock after a coronavirus briefing, and before the markets crashed in March.
Their transactions took place between January 24th and Feb 20th, right before the crash began on Feb 24th.
For the sake of simplicity, let’s assume they all sold their holdings on Feb 19th, at or close to the market peak.
Was it a wise decision?
At the trough of the market, the answer would have been yes.
But the market quickly recovered, and as we see in hindsight the answer is no, they did not any better than an investor who just held their investments.
On Feb 24th, SPY (the S&P 500 ETF) was at 3387.87.
As of this writing in September, the market has recovered completely, and then some, to 3426.
If they had just held on and not sold at all, they would have experienced slightly higher returns.
One caveat is that there is a possibility that they sold on Feb 19th, and bought shares when the market was much lower, between March and April. But knowing how unlikely that even professional fund managers can time the market and beat the market, I would say this possibility is quite small.
Seriously… You Really Can’t Time the Market!
I get it. Everyone is tempted to Buy Low and Sell High.
We get tempted to sell when the stock market is hot. We hear the warnings time and time again. The Dow is at an all-time high. Time to sell!
I’m telling you now to tune out those warnings.
Remember the all-time high in 2007? What if you sold everything then?
Remember the all-time high in 2015?
Or the one in 2018?
How about 2019?
The stock market hits all time highs rather frequently. What happens next tends to be good news, even higher highs!
The average one year return following an S&P 500 all-time high is 10%, after three years 31%, and after five years 54%.
What if a Recession is Coming?
Ah yes, the dreaded R word…
Would it be great if we could predict just before a recession hit, sell all of our stocks, and get back if when stocks are cheap again?
Unfortunately, nobody has a crystal ball and nobody and can predict a recession with an accuracy.
Every year… actually pretty much every month, you might stumble across an article that “predicts” a recession.
Here are just a few examples:
2012:
2014:
2016:
The actual result?
- 2012: No recession
- 2013: No recession
- 2014: No recession
- 2015: No recession
- 2016: No recession
So much for these predictions from so called “experts”. I suppose if you write an article each year about an impending recession, you’re bound to be right eventually.
Here’s what the stock market has looked like through MANY recessions:
Notice how the long term trend of this line is up?
The stock market has recovered from each and every one of the recessions.
In other words, there is not a single recession from which the stock market has not recovered.
Let that sink in for a little bit. The stock market has recovered EACH and EVERY single time.
Let’s Hope for a Recession
As painful as it sounds, a recession does not have to be something to fear. In fact, it is something that should be cherished and embraced.
When a recession hits, stocks hit rock bottom prices.
At the bottom of the 2009 recession, SPY, the S&P 500 ETF was trading at $74.
Today, in September 2020, it’s trading for over $300!
Can you imagine buying an investment that increased in value 4X in just 11 years?
When you’re buying investments consistently, though the market ups and downs, you will tent to do very well. And during recessions, you’ll be picking up stocks are bargain basement prices!
How to invest in 2021
The best investment for 2021 continues to be broad index funds. In 2021, I will continue to implement a dollar cost averaging strategy by purchasing low cost index funds, mostly S&P 500 type index funds, with a small portion in international stock funds, and small cap funds. If I were to buy individual stocks, I would allocate no more than 5-10% on individual stocks.
This has been my strategy for years, and will continue to be my strategy in 2021.
By implementing a dollar cost averaging strategy, I’ll purchase the same value in funds every period. So if the price of stocks drop, I’ll buy more. If the price of stocks goes up, I’ll buy less.
Are index funds really the best?
Warren Buffet instructed the trustee in charge of his estate to invest 90 percent of his money into the S&P 500 after he dies. This is coming from Warren Buffet, a man who has made billions from the stock market. If I was going to heed anybody’s investing advice, it would be Mr. Buffet’s.
Double down on tech stocks?
Why not just throw all your money into tech stocks since they’re doing so well?
Why not just ride the winners?
Clearly, the winners in 2020 so far are tech stocks. So should you invest heavily in tech stocks in 2021?
From Jan 1 to Sep 4, the S&P 500 has returned only 6.94%, while the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) have performed much better: Facebook (38%), Amazon (82%), Apple (63%), Netflix (62%), Google (23%)
With such good results, shouldn’t you put more of your money into tech stocks?
My answer is a cautious maybe, but probably not.
Since 2007, the S&P 500 Information Technology Index (basically tech stocks) outperformed the S&P 500 Index 9 out of 13 years.
Furthermore the tech index has produced an average annual return of 14.43%, while the S&P 500 index has an average annual return of just 8.19%.
So why shouldn’t we invest more in tech stocks?
More Scrutiny
With great returns come greater scrutiny. On July 29, 2020, Facebook’s Mark Zuckerberg, Amazon’s Jeff Bezos, Google’s Sundar Pichai and Apple’s Tim Cook were questioned by House lawmakers about their market dominance and if they unfairly stifled competition.
As their market caps increase, I would not be surprised if Washington decides to take more decisive actions including stricter regulations or increased taxes that could hinder the long term growth prospects of these companies.
Dot-Com Bubble and Bust
Between 1995 and its peak in March 2000, the Nasdaq Composite stock market index (comprised on tech stocks) rose 400%, only to fall 78% from its peak by October 2002, giving up all its gains during the bubble. Source: Wikipedia
The internet only recently became somewhat mainstream in the early 1990s. Wall Street Fat Cats speculated that tech companies were the future. This caused the valuations of many tech companies to reach a level that could no longer be justified.
The names we recognize today are of course Facebook, Google, Apple.
How many of you recognize the major players from the tech boom? Where is Netscape, America Online, and Pets.com today?
Lofty Valuations
As of this writing, early September 2020, here are the Price-to-earnings ratios of the FAANGs.
- Facebook: 34.57
- Amazon: 126.54
- Apple: 36.70
- Netflix: 87.14
- Google: 34.97
Meanwhile the S&P 500 PE Ratio is approximately 29.46.
A stock’s P/E ratio is certainly not the end-all-be-all metric for stock valuation. It is much more complicated than that.
But a PE ratio higher than the S&P 500 PE ratio tells me that there is potential that either:
- Investors expect earnings to grow at a faster rate
- Stock price is overvalued
- Earnings aren’t keeping up with the price
I must reiterate that the PE ratio does not tell a full story, and isn’t always the best indicator of future outcomes. Amazon’s PE ratio has been insanely high for nearly a decade, at one point reaching 3633.14 in 2012!!! And the stock continues to be on a tear.
So it is just MY personal opinion that the high PE ratios of these tech stocks are a cause for CONCERN, and that I certainly wouldn’t dump my life savings into them.
Diversification
The old adage goes, don’t put all of your eggs in one basket.
Netflix wasn’t around 25 years ago. How can you be sure it will be around 25 years into the future?
Imagine if you had put all your money in Blockbuster?
An S&P 500 index fund always tracks the performance of 500 different companies in the index. Companies that aren’t doing so hot actually get removed from the index periodically. Harley-Davidson, Nordstrom Inc., and Alliance Data Systems Corp were recently removed.
In any given year, even if 40% do poorly, you still have a chance that the other 60% do rather well.
Let’s say you put all of your money in Netflix. What if Netflix stock gains 20% every year until 2025 when its competitor, Widgets Inc, creates a device that can plant movies directly into your retina, putting Netflix out of business.
Yeah, you probably should have diversified.
GDP Growth
Over the past 7 decades, GDP growth tends to hover between 0 and 5%. Source: FRED
Q2 2020 experienced a GDP growth rate of -9%. This is because people aren’t spending money.
On the other hand, the savings rate is higher than it has been in recent history.
As lockdowns ease, a vaccine is distributed, and people resume travelling and spending on food and activities, I would imagine that GDP growth will continue in the 2-4% range which will likely be good for the economy and the stock market.
Putting it all together – How to invest in 2021
Given all the craziness in the world, with Pandemic, Wildfire Risk, Soaring Temperatures, Business Struggles, and Unemployment, it’s hard to be optimistic about the future.
So how should you invest in 2021?
If the past is any indicator of the future, stocks will continue to be a good place to put your money.
Utilizing a dollar cost averaging strategy to purchase low-cost index funds, historically, has been a good bet.
According to historical records, the average annual return since its inception in 1926 through 2018 is approximately 10%–11%.
This is even as markets wavered through World War 2, The Cold War, Black Monday, the Dot-Com bubble, and the Great Recession. The stock market has recovered each and every single time.
Even if a recession hits, you’ll be buying MORE stocks at a CHEAPER price. What’s not to like about that?
Let me know your thoughts!
How will you invest in 2021? Will you let current events affect your strategy?
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