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May 26, 2020

What Can History Teach Us About Investing?

Is it really possible to build wealth by learning from history?

It’s difficult to say, especially considering that the current COVID-19 panic is nothing like anyone has seen during their lifetime. Things are constantly in flux, even as locations like beaches, some stores, and parks gradually reopen

Despite this, we can find ways to build wealth by learning from history, which includes studying recessions like the one seen in 2008. It’s also possible to learn how to build wealth by analyzing the behavior of successful investors. Yet, history can’t help us predict short term market volatility nor what actions the government will take during this time. 

History can teach us a few lessons in developing the right investing mindset.

What History Can Teach Us:

Develop Investing Habits That Are Resistant to Crisis

It’s possible to invest sensibly during recessions by learning from the past. The markets might have erased all recent era gains (and then some), but history shows us that the stock market always increases over the long term. After the 2008 crisis, the S&P 500 recovered by over 200%

Knowing this is crucial for adopting long term investment strategies and having the right mindset during the chaos. Long term investors keep their funds invested in the markets, knowing that their accounts will grow over time

Having this mentality will reduce anxiety and prevent mistakes like selling at the bottom. Many investors tend to sell their investments when markets heavily decrease, which will result in losses. However, those that stay in the market will benefit from long term appreciation.

These investors acknowledge that economies go through cycles and that bull or bear markets don’t last forever. The four main cycles of an economy are peak, recession, trough, and recovery. Economies start strong during the peak, but then a recession occurs once there have been two consecutive quarters of economic decline. This can include seeing rising unemployment and lower GDP figures.

During the trough stage, economic production reaches its lowest point, before the recovery stage. The recovery occurs when GDP and incomes rise, while unemployment falls for at least two consecutive quarters. 

Avoid thinking from a greed point of view

We can prevent thinking from a greed perspective by learning from history. It’s known that excessive greed can result in investors losing money, especially when they don’t conduct proper due diligence with their investments. 

For instance, many “quality” investments like collateralized debt obligations (CDOs) seemed like sound tools to build wealth. Yet, most investors didn’t realize that these CDOs were backed by subprime loans to people that couldn’t pay their mortgages. Instead, they failed to research what these investments were composed of and this was one of the major causes of the Great Recession of 2008. 

What History Cannot Teach Us:

Pick The Next Hot Stock 

History can’t teach us what the best investments will be or how to select the next “hot stock.” While markets rise over the long term, there is no way to predict which single investment will be profitable in the short run. There are too many variables at play like international relations, ripple effects of certain industries, and complex trading technology.

For example, the Dow Jones rose over 445 points, despite record unemployment in May. Logically, you’d think that the markets would decrease as high unemployment is a sign of a recession. Yet, it had the opposite effect due to factors like relief packages such as the CARES Act and the current low-interest-rate environment.

Understand How Governments Will React Short-Term

It’s also tough to predict how governments will react to crises by just learning from history. Also, it’s hard to predict inflation or future tax rates. Most people want the crisis to be over and get on with their normal lives, especially since COVID-19 cases are decreasing. Despite this, some believe that governments have overstepped boundaries by arresting people for going paddle boarding and preventing businesses from opening.

While this virus has been deadly, it has the strongest impact on the elderly and people with preexisting conditions like diabetes, cancer, and respiratory problems. This has prompted some people, like Elon Musk to safely reopen their businesses despite stay at home orders. 

They’ve taken necessary precautions like sanitizing workspaces, providing personal protection equipment, and promoting social distancing in the workplace. The entrepreneurs acknowledge that this virus can have deadly consequences, but they have an obligation to provide for themselves, their families, and employees. So, they’re trying to keep businesses running in the most responsible and safest manner possible. 

Bottom Line

Learning from history can be very necessary and we can use it to better prepare ourselves for the future. Life might seem scary and uncertain with the COVID-19 pandemic. However, it’s important to look on the bright side as we begin to reopen states and countries. 

While we can’t learn everything about building wealth from the past, we can understand the factors behind recessions and how the wealthy think. Lastly, it won’t teach us how to pick high ROI investments and how governments will react.

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