Have we become too optimistic about stocks?

[SINGAPORE] Sometime in the 1990s, a colleague at the brokerage firm where I worked gave a talk about stock investing to the frontline staff of a bank. When he was done, one of them asked what they should say to customers who lost money on a stock.

My colleague told me he responded by shrugging and uttering a glib two-word phrase that would be inappropriate for me to repeat in this column – but which meant that stocks are inherently risky and that occasional losses are unavoidable.

At the time, banks in Malaysia and Singapore were just beginning to get into the business of selling investment products. Their buttoned-down institutional culture seemed so far removed from the brash, freewheeling attitudes in the market that I wondered if they would ever be comfortable operating in this new field.

More than two decades on, almost all my investment activities are now conducted via the platforms of major banks rather than through brokerage firms. The convenience and range of products they offer have proven to be quite appealing.

Indeed, the wealth management businesses of DBS, OCBC and UOB have become so large and robust that they have helped sustain the three banks’ earnings during the recent normalisation of net interest margins.

The narrative about stock investing seems to have evolved too.

In the bad old days, the market was viewed as something of a casino. Brokers would often advise their clients to invest only what they could afford to lose, and to quickly cut their losses to preserve their capital.

These days, the market is viewed as a wealth compounding machine. Investors are told that time in the market is more important than timing the market, and that dollar cost averaging strategies through bull and bear cycles will deliver handsome long-term returns.

Shifting investor attitude

What drove this shift? One factor may have been the secular decline in interest rates since the 1980s.

While 10-year US Treasury bond yields have soared since the Covid-19 pandemic, they are still well below where they were in the mid-1990s.

Another factor that may have fuelled investor enthusiasm for stocks is the wider availability of information about the strong returns that can be had from this asset class.

Warren Buffett – arguably the most influential proponent of long-term stock investing – started becoming famous only in the 1980s, around the time he achieved billionaire status.

Since then, his success has convinced a whole generation of investors that long-term ownership of high-quality companies is a reliable path to fabulous wealth.

The greater access that many financial institutions now provide to major stock markets around the world – directly as well as through fund products – may also have supported this trend. The merits of owning stocks would probably not be quite as compelling if investors were confined to a single, small market in Asia.

What could possibly go wrong?

Lure of higher returns

In a column in The Business Times last month, Providend chief executive Christopher Tan raised concerns about financial adviser representatives encouraging their clients to set aside only the Basic Retirement Sum in their Central Provident Fund (CPF) accounts instead of the Full Retirement Sum (FRS), in order to invest the difference in an investment-linked policy (ILP).

The clients were told that the combined monthly payouts from the ILP and CPF Life would exceed the monthly income from CPF Life alone if the FRS were fulfilled. On top of that, the death benefit of the ILP was presented to the clients as “capital guaranteed upon death”.

Tan pointed out that CPF Life should not be compared to an ILP on a return basis, as the former is a government-backed lifetime annuity while the latter is an investment; and that the overall death benefit of an ILP is subject to market risks.

My colleague Genevieve Cua subsequently weighed in on the matter in her own column, calling out these marketing tactics as cases of mis-selling.

Meanwhile, the Monetary Authority of Singapore and Life Insurance Association issued stern warnings against the use of the term “capital guaranteed” in relation to ILPs.

For me, this story was not just about the misrepresentation and mis-selling of financial products. It was also at least partly about excessive confidence in the market.

In his column, Tan said that prospective clients were shown the strong rates of return of two funds over the past 10 years, to justify investing in an ILP. “These rates appear to have been projected forwards to arrive at an expected future lump sum and income payout,” he noted.

Tan added: “The proposed structure takes a guaranteed, government-backed, longevity-pooled lifetime income and partially replaces it with a market-linked, fee-laden, non-guaranteed product illustrated at optimistic historical returns.”

Excesses building up?

In my view, this incident is a wake-up call for regulators, financial institutions and investors.

The fallout from excessive confidence and mis-selling of financial products often emerges long after the fact. In this instance, however, it was a vigilant industry player who brought an emerging problem to light. It would not surprise me if more trouble is lurking around the corner.

What can be done to address a possible build-up of excesses in the system? One obvious solution is tougher regulation. Another is more education.

More importantly, perhaps, investors should maintain some discipline and clarity of purpose.

Given the market’s impressive run over the past decade, and with the major banks funnelling resources into their wealth franchises, investors could be about to face an avalanche of sales calls from relationship managers keen on promoting some exciting new product.

It is not for me to advise anyone what to do. But my own inclination is to resist the temptation to become significantly more exposed to the market at this point, and to stick with investment products that are not too complicated.

With richly priced initial public offerings of SpaceX, OpenAI and Anthropic about to hit the market, this feels like the moment for some old-school scepticism. Confident as we all might be about owning stocks, it is worth keeping in mind that long-term returns are very much dependent on the valuations at which we get in.