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What do you think is the worst investment mistake you can make in 2024?
There is always the common mistake of not investing based on facts, following your fears and the market's excitement, or gambling in the market when you should focus on your long-term goals. Yes, those are all mistakes. But, they are not specific to 2024. There is one fundamental change in the structure of our economy and capital markets that creates a unique opportunity in the market. Not recognizing opportunity and adjusting your investment based on it is the worst mistake in 2024.
Howard Marks, the co-founder of Oaktree Capital, a $160B asset management firm, is the first person who brought this mistake to my attention, and since then, many top investors have discussed it.
Let's talk about that!
I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.
This post is part of our educational series to help you hone your fundamental investing skills. Catch up with the other post on How to Invest Like Buffett? or how to Find the Highest-Returning Stocks?
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The Market's Structural Change
Before we get to the worst investment mistake you can make in 2024, let's discuss the structural change in the market and our economy that can cause us to stumble and make that mistake.
The most prominent change in our economy and the stock market in the last year or so has been the rapid interest rate hikes by the Fed. We all know that! The interest rate hikes swept the stock market out of cash, created a massive scare, and shifted investors away from risky, high-growth stocks.
But the stock market wasn't the only one that structurally changed. The bond market was also drastically altered due to the interest rate hikes.
The First Part of the Worst Investment Mistake in 2024
As the rates went up, so did the yield on new bonds issued by the government and corporations. For example, the 10-year treasury bond yield rate reached almost 5%. You may have heard that bond prices move in the reverse direction of interest rates and yields. As the interest rates and yields go up, the price of previously issued bonds at lower yields goes down because investors now have the option of buying higher-yield bonds.
That's what happened in 2022 and early 2023, and it is part of the context we need to know to discuss the first part of the worst mistake we can make in 2024, which is ignoring the bond market and staying invested in the stock market only.
Sure, the stock market is more fun, and there is so much to do and learn. But, when you can buy government-issued bonds at 4% to 5%, such a return on investment is comparable to an average return of the stock market, especially if you consider that for the capital gain on your government bonds, you don't have to pay state or local taxes. Even if the bond prices go down, you can hold on to your bonds until their maturity date, and you'd get paid all your money and cash in all your interest checks, too.
Let's continue with the context and discuss the structural changes in the capital market further to get to the second part of the worst investing mistake in 2024.
It's no news that in recent weeks, and after several interest rate hikes, the dust is settling, and things are changing. The new economic data, such as the inflation figure, showed the Fed's efforts to bring down inflation are starting to pay off, and there might be no need for additional rate hikes. The interest rate may stop at its current level and gradually even come down. This means the yield investors expect from future bond issuances can go down, and the current higher-yield bonds will be more in demand and higher in price. We already see early signs of that change. Short to long-term treasury notes and bonds' yields are going down, and the price of already issued and circulating bonds are going up.
Buying bonds now may be a good strategy, assuming that the interest rates hang around at the current rate and then decline gradually. You get paid a higher yield, and the value of your bond can go up because the demand for your relatively higher-yield bond can go up. Ignoring the bond market, especially not investing in some high-yield treasury bonds with 4.5% to 5% yield now and in early 2024, can be a terrible mistake you can make.
The Second Part of the Worst Investment Mistake in 2024
But that's not all! There is even another part to the worst investing mistake.
If you take investors' overall sentiment about the Fed's future actions and the broad consensus that the Fed stops to hike rates now and combine it with the fact that the stock market has had a relatively great year, with the Nasdaq being up by more than 30% YTD in 2023, you could assume that the effect of high-interest rates on the market has already been felt. Things are going to be great from here. However, it is very unlikely that the Fed will return to zero interest rate anytime soon. This means the cost of borrowing money for individuals and corporations will stay high compared to the last decade. Despite popular opinions, the effect of higher interest rates on individuals and, more importantly for investors, the impact on corporations' borrowing costs is only starting to appear in the market now. It will be even more prominent in 2024.
There lies the context for the worst investment mistake you and I can make in 2024.
There is a highly insightful podcast episode on Oaktree Capital's website in which Howard Marks, co-founder of Oaktree, and his Head of Performing Credit, Armen Panossian, discuss this topic. I leave a link here, and I highly recommend you listen to it. But let me break down what I've learned from that episode and my other research on this topic.
While the bond and stock prices immediately saw the impact of higher interest rates in the form of lower prices and a "risk-off" period in 2022, the effect of the higher cost of borrowing capital will only show itself at company levels starting from now. Howard Marks argues that when interest rates hit zero during the low-interest period, especially during COVID-19, companies borrowed many short-term loans to finance their long-term projects at an attractive low-interest rate. As those short-term, low-cost funds dry, companies will look for new financing or refinancing their existing loans. Only then will we see the widespread impact of higher interest rates on companies, corporate bond rates, and companies in distress who cannot afford to pay their loan interests.
There are many companies with solid market demand and long-term positive outlooks that will have to borrow money at higher yields due to short-term financing gaps. These companies tend to get lower credit ratings and have to pay much higher yields, and are commonly called corporate junk bonds. According to Howard Marks, the credit market (bonds) will generate stock market-like returns at a 10% annual return rate or higher in the coming years. This high expected return from the bond market is thanks to long-lasting higher interest rates and the massive expected need for refinancing commercial loans by companies in the new higher-interest rate environment.
Therefore, the worst investing mistake you can make during 2024 is assuming that the impact of high interest rates is broadly over and forgetting about high-yield interest rate opportunities in the bonds.
How To Find ETFs to Avoid the Mistake
Of course, buying individual bonds may not be as convenient for many of us retail investors. Still, you can easily find a few high-yield corporate bond ETFs or even focus on a broad bond market index ETF and enjoy a better return in your portfolio.
If the worst investing mistake in 2024 is ignoring the bond market, and especially not considering any high-yield corporate bonds. You and I need to figure out how to find high-yield corporate bonds to invest in. Generally, investing in individual corporate bonds requires a significant amount of capital. They are rarely available at small denominators for you and me to buy them directly from our brokerage. But luckily, there is an ETF for that.
Some ETFs exclusively focus on high-yield corporate bonds.
I'll show you how if you go to your Stock Card account now. Under the tools, pull up the ETF Screener, and under the general filters, look for the Fund Manager's strategy. You can see we have grouped ETFs into corporate bonds and high-yield corporate bonds. Use this filter, and add a few other ones that make sense to you. For example, I always look for ETFs with more than 1 year of investment history and more than $50M in assets under management to filter out new and operationally unstable ETFs.
There are other good filters to play with, too. For example, pick low-fee ETFs or filter out high-risk ones. Those are ETFs that borrow a lot of money to boost their return or have a high turnover of assets
You should try it for yourself and find your own High-Yield Corporate Bond ETFs to invest in. I saved this one I just created and here's the link so you can have a starting point for your research.
Now, let's wrap up today's episode.
The most important lesson we have to learn from this episode is that the market cycles bring new opportunities, but we must educate ourselves. What worked for our portfolios in the last decade may not work in the next decade.
Talking about our portfolios and higher returns reminded me of another post in which I talked about Rule 72 and how you can use it to double your portfolio faster. That's a good post to read next and continue your investment education. I'll leave a link to it here.
I'll see you next time!