2022 was a challenging year for investors. Unless you were entirely invested in energy stocks last year, the chances are your portfolio took a hit. Mine certainly did.
After a period of poor performance, I like to step back and analyse what went wrong, and think about how I could do things differently in the future. With that in mind, here are three investing lessons from 2022.
Valuation always matters
One of the biggest takeaways from 2022, in my view, was that valuations always matter in the end.
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In the years prior to 2022, when interest rates were low and central banks were pumping billions into the financial system, valuations were a bit of an afterthought for a lot of investors. Many (myself included) owned growth stocks with high valuations.
Now these kinds of stocks did generate strong returns in the years before 2022. However, as soon as central banks began to raise interest rates, their valuations came into focus and they started to underperform.
Tesla, which had a sky-high valuation going into 2022, is a good example here. It lost nearly 70% of its value last year.
Now, I do pay attention to valuation. However, I was still burnt in 2022 by owning too many expensive growth stocks.
So, going forward, I will focus more on stocks’ valuations and look for companies that offer growth at a reasonable price.
No investment approach works forever
Another key lesson from 2022 was that no investment style works all of the time. In the years before 2022, there were a few different styles that had worked really well.
Growth investing (Tesla, Amazon, etc), quality investing (Apple, Microsoft, etc), and thematic investing (renewable energy stocks, online shopping stocks, etc) are a few examples of investment approaches that had generated strong returns for investors.
In 2022, the financial landscape changed dramatically however. And all of a sudden, these approaches to investing didn’t work. Instead, it was value and dividend approaches that worked well.
The takeaway here is that it can pay to have exposure to a few different styles of investing within a portfolio. By allocating capital to different styles can potentially lower overall portfolio risk and smooth out returns.
It’s crucial to right-size positions
Finally, 2022 highlighted the importance of ‘right-sizing’ stock positions within a portfolio. We often hear about the importance of diversification when building an investment portfolio. This is one of the most fundamental components of risk management.
But what’s also important from a risk management perspective is to ensure that position sizes within a portfolio are set according to their risk levels. If a stock is extremely risky, it’s sensible to keep the position very small (less than 2% of the overall portfolio). That way, if it tanks (like Tesla did), the impact on the overall portfolio is small.
This is another portfolio management concept I will be focusing more on in 2023. By right-sizing my stock positions and keeping my exposure to higher-risk stocks small, I can, hopefully, avoid big losses in the future.
