This week scientists unveiled the first ever picture of a black hole. Black holes are super-massive stars that have so much gravity that even light can't escape them—so as you can imagine, taking a picture of one is a bit of a paradox.

For decades, scientists have been able to 'see' black holes by observing their influence on the galaxy—primarily through 'gravitational lensing' as these massive objects bend light as it comes towards Earth. To get a direct picture, scientists from eight different satellite stations around the globe pointed their instruments at the same infinitesimally tiny patch of the night sky at the same time (about the size of a golf ball on the Moon viewed from Earth). Each satellite gathered so much data that it all needed to be flown on airplanes to a central supercomputer to be combined into a whole picture.

The resulting image still does not show the black hole itself—after all, nothing can escape from its gravitational pull, not even light. But it does show the so-called 'accretion disk' of matter swirling around the black hole's event horizon (the point of no return).

What are the 'black holes' of the investing world?

Investing is far more 'art' than hard science, so it's always difficult to make direct parallels. Even so, there are several areas of the investing world that we can only see indirectly. To name a few:

* Forgone gains. As we discussed in The difference between pain and damage , there's no mathematical difference between losses and forgone gains. So when it comes to risk management, trying to avoid the pain of temporary losses—which are visible and tangible—can create much more invisible (but still real) damage. 100 dollars invested in US large-cap stocks in December 1945 would have grown to over 200,000 in today's dollars, but if invested in a risk-free asset like US government bonds, that same 100 dollars would only be worth about 4,600 dollars today (see Fig. 1).

* After-tax returns. Financial statements and performance reports are always done on a pre-tax basis. Harvesting losses can add significant value over time , and so can using tax-efficient asset classes like municipal bonds and even some taxable bonds . These benefits are only visible indirectly, through a lower tax bill this year and the fact that your "owed taxes" are growing in your account rather than sitting in the IRS's. But just because those benefits are invisible doesn't change the fact that they're hugely beneficial over time.

* The benefit of borrowing. As we noted in our recent white paper, Why borrow if you're already wealthy? , borrowing is often seen as a fourletter word. That's an unproductive taboo. After all, the judicious use of borrowing can help facilitate returns on the asset side of the balance sheet in a number of different ways. In reality, most of the world's wealthiest families owe their success—at least in some part—to the leverage and diversification benefits offered by borrowing. So although liabilities come with directly-observable risks and costs—and its benefits are only viewed indirectly—we believe they're a valuable part of an investor's toolkit. The asset side of the balance sheet doesn't deserve to get all of the credit.

In other words, it's important for us to distinguish between what's visible and what's important. After all, "Not everything that can be counted counts, and not everything that counts can be counted."

Fig. 1: Short-term losses are painful, but forgone gains cause the most damage

Cumulative growth of USD 100 invested in December 1945, various asset allocation mixes (US large-cap stocks and intermediate US gov’t bonds), logarithmic scale

Author:

Justin Waring, Investment Strategist Americas, UBS Financial Services Inc. (UBS FS)

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