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Certainty - Misunderstood & Overvalued

Oct 4, 2017
4 min read















Almost 10 years have passed since the Financial Crisis of 2007-2009, yet its effect on people's thinking is still visible. Take for example the Foundation for Vested Pension Benefits and the Voluntary Retirement plans in Switzerland which together hold mostly long-term locked-up capital of 150 billion Swiss francs. A recent survey revealed that more than 75% of these savings are held in interest accounts earning record-low returns [1]. Another striking example is the lack of civil outrage and the level of satisfaction expressed by pension fund managers and their customers even though Swiss pension funds produced paltry average annual returns of 2% between 2008 and 2015 [2]. When I talk to family, colleagues, friends and listen to media, the arguments are always the same. People seek certainty and are afraid of losing money.


The desire for certainty is understandable but unfortunately most individual and professional investors confuse volatility with risk and believe low volatility provides more certainty. This misunderstanding is unfortunate because it results in a tremendous loss of purchasing power in the long-term. For instance, investors regard cash or short-term government bonds as safe and mid- to long-term government bonds as safer than stocks. Yet, $1’000 invested in 1977 in short- or mid-term government bonds, would have turned to $6'092 and $15'573, respectively, 40 years later. This compares to $64'062 if the same amount had been invested in a broadly diversified stock index (e.g. S&P 500) [3]. So, the real risk is not volatility but rather the loss of purchasing power over the investment period. What may appear certain can indeed be very risky. This has likely never been as true as it is today.


Figure 1: Asset Class Returns, 1997-2016
Figure 1: Asset Class Returns, 1997-2016

Given today’s record-low interest rates, cash, cash-like investments and presumably “safe” bonds are terrible investments. 10-year U.S. government bonds yield approx. 2%, which means they sell for approx. 50 times earnings. Cash, short-term bonds, and most European government bonds yield even less and are therefore more expensive. But it gets even worse. Their earnings (yields) cannot increase while western central banks are committed to achieving more inflation.

At best, these types of investments will produce unattractive returns in the mid- and long-term. More likely, they will fare far worse than they did between 1977-2016 and cause significant losses in purchasing power. The “risk-free returns” of the past, have turned into “return-free risks” today. By relating low volatility to certainty, we risk fooling ourselves. Even worse, we pay a dearly high price for a false sense and understanding of certainty.


In contrast, the companies in the S&P 500 Index, the STOXX 600 Index, and the MSCI Emerging Markets Index sell for approx. 24, 18 and 16 times earnings respectively [4]. Their earnings are virtually certain to increase over time as explained further below. Thus, owning a broadly diversified group of businesses in form of broad stock index funds is highly certain to produce superior returns over the long-term. Among these indices, there are even some very strong businesses with enduring competitive advantages available at more attractive prices. Investors who can understand and value businesses will, therefore, invest selectively in such stocks. In doing so, they will minimize risk further and generate even better returns than those available from broad stock index funds.


Tragically, individuals still hold excessive amounts of cash, and pension funds, insurance companies as well as investment managers continue to invest a substantial portion of the assets entrusted to them in bonds. For instance, pension funds in Canada, Japan, Netherlands, Switzerland, and the UK on average had approx. 44% of their assets invested in bonds in 2016 [5].


Don’t get me wrong. I am not predicting what markets will do short-term. The next crisis may be around the corner. Since the last crisis was 10 years ago, many argue that the next one is near. That may or may not prove to be true, no one knows. There is no natural law dictating a crisis at least once a decade. More importantly, the history of stock markets shows, long-term investors need not be worried about short-term market fluctuations:


In the 20th century, people experienced the Global Depression in the 30s with massive unemployment, two World Wars, the use of atomic bombs, numerous regional wars, epidemics, the Oil Crisis in the 80s, the Asian Crisis in the 90s and the Dow Jones Index went from 68 to 11'497 during the 20th century, even without counting or reinvesting dividends.


And for those who cannot wait a century: Since 2000, we have experienced the Internet Bubble burst (Dow Jones Index fell approx. 40%) and the Financial Crisis, the most severe crisis since World War II (Dow Jones Index fell more than 50%) and the Dow Jones Index went from 11'497 to 19'762 at the end of 2016, again without counting or reinvesting dividends.


Businesses are productive assets run by people who want a better future for themselves. This makes businesses as a group resilient over time despite all challenges that will inevitably come. As a whole, they earn attractive returns and reinvest on investors' behalf for ever-increasing returns.


A rational investor, who invests a fixed amount regularly needs not be worried about unpredictable crises and stock market crashes. On the contrary, the rational investor benefits from such crises by automatically purchasing more stocks when prices are low and fewer stocks when prices are high.


The next time, we feel the urge for certainty, let us ask ourselves:

  • “What do we want to be certain about? Short-term stability or protecting our purchasing power?”

  • “How certain do we really need to be?”

  • “What price are we willing to pay for certainty?”


Bahram Assadollahzadeh, CFA



[1] "Säule-3a-Sparer setzen nur selten auf Wertschriften", Neue Zürcher Zeitung, May 17, 2017

[2] Pension Fund Study 2016, PPC Metrics, “Säule 2016: Analyse der Geschäftsberichte von Pensionskassen”, http://www.ppcmetrics.ch/de/themen/ppcmetrics-studie-2-saeule-analyse-geschaeftsberichte-von-pensionskassen/2016/

[4] Index Fund factsheets as of 08/31/2017 for S&P 500 Index and MSCI EM Index, and as of 07/31/2017 for STOXX 600 Index.

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