Low-Debt Investments: The Key to Sound Sleep
- Christopher Devlin, CFA
- Mar 8, 2023
- 3 min read
Updated: Apr 8, 2024
As an investor it's important to balance the risk of higher returns with the importance of being able to sleep soundly at night. For many, high volatility investments can negatively impact personal life by adding stress during market downturns. Market volatility is unavoidable, but if your investment portfolio is constructed with investments that carry low debt, it's possible to rest assured knowing your investments will likely recover.
Key Advantages of Low-debt Investments
Lower risk and volatility: Low-debt investments typically have a lower risk of default or bankruptcy, which translates to lower price volatility and more stable returns over time.
Better performance in downturns: Low-debt investments often perform better during economic downturns because they have a stronger financial position and are better equipped to weather the storm, making them less vulnerable to economic shocks.
Stronger balance sheets: Low-debt investments typically have stronger balance sheets due to lower leverage ratios, which translates to improved financial stability, greater asset coverage, and reduced risk of default.
Lower Risk and Volatility
Investing in low-debt funds and stocks generally reduces the level of risk and volatility in your investment portfolio. Companies with lower debt levels are less likely to face financial difficulties or bankruptcy, as they have fewer obligations to creditors. This stability means that their stock prices tend to be less volatile, providing a smoother investment experience and potentially minimizing losses during market downturns.
The 2008 financial crisis serves as an example that highlights this point. During this period, highly-leveraged financial companies such as Lehman Brothers, Bear Stearns, and AIG suffered significant losses and even bankruptcy due to their high levels of debt. In contrast, companies with lower debt levels, such as healthcare providers and consumer goods companies, were generally more resilient during this period of market volatility. Johnson & Johnson, a company with relatively low debt levels, was able to maintain its dividend payments and performed well relative to its peers, with its stock price declining less than the broader market.
Better Performance in Downturns
Low-debt funds and stocks tend to perform better during economic downturns. In times of financial stress, companies with high debt levels can struggle to service their debt, potentially leading to bankruptcy or other financial difficulties. On the other hand, companies with low debt levels are better positioned to weather economic storms, as they have fewer financial obligations and can more easily adjust their operations to maintain profitability.
Visa Inc. is a global payments technology company that has shown resilience during times of economic uncertainty. During the 2008 financial crisis, Visa's stock price initially declined, but it quickly rebounded and outperformed the broader market. This was due in part to Visa's strong financial position, which enabled it to weather the storm and continue investing in growth opportunities, such as expanding its global network and developing new payment technologies. In the years since the crisis, Visa has continued to perform well, with its stock price increasing by over 800% from its 2009 lows.
Stronger Balance Sheets
Investing in low-debt funds and stocks also means investing in companies with stronger balance sheets. A strong balance sheet is a sign of a healthy company, as it reflects the company's ability to meet its financial obligations and invest in future growth. This financial strength can translate to higher dividends, share buybacks, or other forms of shareholder value creation, making these investments attractive for long-term investors.
Berkshire Hathaway, a multinational conglomerate holding company led by renowned investor Warren Buffett. Berkshire Hathaway has a reputation for investing in companies with strong balance sheets and long-term growth potential. This has such as Apple and Coca-Cola, which both have relatively low debt levels and strong cash positions. This disciplined approach has allowed Berkshire shareholders to experience significant gains without compromising on the core value of stability.
Conclusion
Low-debt investments offer numerous advantages for investors seeking a balance between risk and return. These investments tend to provide lower risk and volatility, better performance during economic downturns, and stronger balance sheets, all of which contribute to a more stable and potentially profitable investment portfolio. By investing in low-debt funds and stocks, investors can build a robust and resilient portfolio that is better equipped to withstand market turbulence, allowing them to sleep soundly at night knowing their investments are well-positioned for long-term growth.
Sources
iShares. (2021). iShares Edge MSCI USA Quality Factor ETF (QUAL). https://www.ishares.com/us/products/239705/ishares-edge-msci-usa-quality-factor-etf
Visa Inc. (2009). Financials. https://investor.visa.com/financial-information/financials/default.aspx