investment principles

What’s Love Got to Do With It? How to Prep Yourself for a Downturn

Find the bargains. Own the orchard for the fruit crop. Avoid the stampede.

Our three main principles form a pretty clear constellation, guiding our practices here at 228 Main. They are action-oriented, so it’s not hard to tell day to day whether we’re sticking to them.

But what makes us stick with them, especially if we’re bracing for a downturn?

In life, when the going gets tough, our defenses can erode pretty quickly. Our energy flags. Anxiety kicks in. And loss can trick us into believing that good times will never return, that the hurt wins.

Writer and businessperson Arianna Huffington suggests a simple way to get sound decision-making back on track: choose love.

“You’ve got to make your heart bigger than the hole,” she says in her book Thrive. “You just have to make your decisions out of love. And when we make the decisions out of fear, that’s when we have problems.”

Trouble and triumph, set-ups and setbacks—those are constants, and our lives travel the roads back and forth to each. Why should we let fear take the wheel for any part of the journey?

Clients, we know that you’ve felt these truths: it’s part of what makes you the best clients in the whole world, after all. Let this be a reminder, then. We’re with you. We journey together.

When you’d like to talk about this—or anything else—please write or call.

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Rule #3

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Our Fundamental Rule #3 of Investing: own the orchard for the fruit crop. What do we mean?

If the fruit crop is enough to live on, you would not have to care what the neighbor would pay for the orchard – it’s not for sale! Whether the latest bid was higher or lower than the day before makes no difference.

You can think of your long term portfolio the same way. If it produces the cash flow you need, fluctuating values don’t always affect your real life – you buy groceries with the income, not with the statement value. The down years may have no impact on your life or lifestyle. All we need to know is where to find the cash you need, when you need it, to do the things you want and need to do.

This is what we mean when we say “own the orchard for the fruit crop.” It’s important, because enduring volatility is an inherent part of investing for total return.

There are two key points of caution. This approach presumes you keep the faith that downturns in the market end someday, that the economy recovers from whatever ails it—and you do not sell out at low points. Also, it assumes that your short term lump sum cash needs are covered by savings that do not fluctuate.

Clients, this understanding is key to our work. Please call or email us if you would like to talk about it, or anything else.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Rule #2

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We often talk about our three fundamental principles of investing. Rule #2 is “Buy the best bargains.” This is our intent, but we must act on what we know, which is incomplete. Our crystal ball does not actually work; we do not know the future. No guarantees.

The best bargain is likely to be unpopular—or else it might not be a bargain. We often buy into sectors that are down sharply from much higher levels, years before. The crowd is almost never rushing into shares that have declined 50 or 80% over a period of years.

This matches up nicely with our contrarian philosophy, doing our own thinking, going our own way. In fact, we believe that profit potential lives in the gap between the consensus expectation and the unfolding reality. We think there is an edge in finding a lonely, but correct, position.

There are different categories of bargains. The best bargain might be a cyclical investment at the low point in its cycle—homebuilders in recession, for example. Or a wonderful, durable blue chip company available at a temporarily low price because of some short-term issue. Or a deeply discounted bond in a stressed company that we figure is trading below liquidation value. No guarantees, as we said!

Our approach is not the only one. Some believe in buying only when an investment is already in a clear up-trend. Others want to own the things that are on the magazine covers, the ones everyone is talking about. For better or worse, we do our best to stick to our convictions. (And sometimes they are better, and sometimes they are worse.)

The value style, our philosophy, is right for us. Clients, if you would like to talk about this or anything else, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Simply Effective: Avoiding Stampedes

© Can Stock Photo / dgphotography

“Avoiding stampedes” may be the simplest and most straightforward of our three fundamental principles of investing. Let’s talk about what it means.

In our view, a stampede in the markets has two features: large volumes of money changing hands, and irrational pricing. Information, evidence and indications about money flows are readily available. The assessment of pricing is necessarily more subjective.

At the time, many believe that prices make sense—or they would not be where they are. Technology and internet stocks in early 2000, homes in 2007, and commodities in 2011 all fit that pattern. At the peak, some true believers thought there was significant room for further increases. Only with the benefit of hindsight is it obvious that things were out of whack.

These examples are all about stampedes into a sector. Money also stampedes out of things at times, as we know. Stocks during the last financial crisis and high yield energy bonds near the bottom in oil prices in early 2016 are prime examples.

You may recognize a pattern. The habit of avoiding stampedes is a contrarian approach to investing—going against the crowd. If everybody else is doing it, we probably don’t want to.

In fact, if everybody else is doing one thing, we may seek to do the opposite.
Behavioral economics lends support to our practice, in our opinion. Much work in that field purports to show that most people do the wrong thing at the wrong time, thereby hurting their returns. Doing better than average would seem to require doing the opposite of what most people do.

(Of course, no method or system or theory is guaranteed to work, or even to perform the same in the future as it has in the past. And putting a theory into practice may be difficult to do.)

In practice, being a contrarian can be lonely. The crowd at the diner is unlikely to endorse doing what nobody else seems to be doing. We don’t care—we are striving to make investment returns, not please the crowd.

Clients, if you would like to talk about this or anything else, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Don’t Look Down

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Many of you may remember the classic Warner Brothers roadrunner cartoons. Wile E. Coyote continually schemes to catch the roadrunner only for his plans to backfire. Often he winds up sailing haplessly over the edge of a cliff, hovering in midair. Only once his predicament finally dawns on him does he plummet to the canyon floor below.

Sometimes he falls almost immediately. Other times he may remain hanging in the air, oblivious, for an extended time before gravity kicks in. You know as soon as he goes off the cliff that he is in for a fall. You can probably even figure out what will happen as soon as he puts his plan together. But sometimes his physics-defying act winds up dragging things out.

The market, much like the cartoon coyote, does not obey the laws of physics. Sometimes it seems obvious that something may be due for a big market move. A company may seem like it is absolutely set to take off, or due for a fall. But no matter how obvious it seems that a price is unsustainably high (or low), the market can stubbornly defy gravity for a long time before reality finally sets in.

Sometimes a prediction may pan out quickly. Sometimes they may pan out later, or not at all. We have enough experience to come to terms with this and take the long view. We do not believe in trying to time the market: we cannot claim to know what will happen in the market, and we certainly cannot claim to know exactly when.

We think we may be able to make a pretty good guess about what will happen—eventually. But we would rather stick to our core investment principles than try to predict the immediate actions of a market that sometimes seems to have more in common with slapstick cartoons than the real world.

Clients, if you have any questions or concerns, please email or give us a call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Steering the Herd

© Can Stock Photo / carla720

One of our core investment principles is to “avoid the stampede.” If you read this site regularly you have heard us say this over and over again, but we think it bears repeating.

As part of our work we talk to many product representatives who want a slice of our business. There are countless product providers out there competing for our attention, and your money. There are limited amounts of both to go around, so inevitably most of the wholesalers that talk to us are going to be disappointed. However, we still like talking to them as they do us a vital service: they tell us which way the stampede is going.

We are contrarians by nature. When we hear someone tell us that a lot of people are buying something, our instinct is not to line up alongside them. When a lot of people tell us that a lot of people are buying the same thing—our instinct is to run far, far away.

Lately, what we are hearing from the product wholesalers is that everyone is piling into exotic alternative investments. Everyone is looking for exciting new products that are not correlated to stock market returns, and boy, are the product providers ever ready to sell it to them.

We live in uncertain times, and it is understandable to be spooked at some of the troubling headlines we see. We understand the desire to seek safety. But, we believe that safety is not to be found from following the herd. Omaha is famous for its stockyards and slaughterhouses; we know that when the cattle are all getting steered together, it rarely ends well for the cattle.

We know there are always uncertainties with the economy and the markets. But the sales pitches we hear for everything non-correlated to stocks makes us feel a lot more secure in our traditional equity investment philosophy. There may come a time when the herd starts stampeding back towards equities and it will be time for us to look elsewhere. For now, though, our equity focus puts us in lonely company when it comes to wholesalers—and that is just how we like it.

If you want to talk about any market trends or sales pitches you may have noticed, please feel free to call or email us.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Why Not Both?

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We keep reading a curious idea promoted by some in the financial industry. It goes like this: “Managing investor behavior is the key task for advisors, not managing investments.”

That framework assumes there is a choice between one or the other. There are two flaws in the assumption. It does not have to be an either-or deal. And some fraction of people don’t require babysitters for their natural investment behavior, which is effective.

We believe in BOTH of these roles. It may be true that raw human nature is generally counterproductive to sound investing. (Behavioral economists tend to think so.) Our theory and experience says that the attitudes and behavior of individuals can be deliberately shaped to their benefit—and ours.

What may apply as a general principle to all people does not necessarily apply to you as an individual. You have free will. And we believe people can learn.

So we spend a great deal of time and effort talking to you, and communicating about the mindsets and strategies and tactics we believe are effective. But that is only part of the job.

Legendary investor Charlie Munger said, “We wouldn’t be so rich if other people weren’t wrong so often.” By avoiding stampedes in the market, we may sidestep a poor situation that others are getting into. And by seeking the best bargains, we are looking for holdings that others may be wrong about.

In other words, two of our fundamental principles about investment management are founded in a belief that investment selection matters because people are often wrong. We see investor behavior as a creator of opportunities for our clients—not a problem to be managed. Clients, we keep saying you are special: this is why. We believe your investment behavior is exemplary.

Knowing what you own and why you own it, operating in accordance with sound principles and strategy, makes it easier to behave effectively. These things reinforce each other.

Manage behavior, or manage investments? It isn’t either-or—we need to pay attention to both. Clients, if you would like to discuss this at greater length, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Flexible Tactics, Timeless Values

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In business, the things that change draw a lot of energy. New technology, new ways of doing things, and new ideas grab our attention. The new offers the promise of competitive advantage.

Less attention goes to the things that never change. The timeless things can compound over long periods. Successful enterprises may need to harness both the new and the timeless. At 228 Main, we need both to serve you well.

For example, Amazon is one of the most dynamic companies in the world. The growth and evolution of the company has been astonishing. Yet founder Jeff Bezos focuses most closely on the things that never change.

According to Bezos, his customers want low prices, vast selection, and fast delivery. They wanted those things twenty years ago, and they will want those same things twenty years from now. When you invest in meeting unchanging needs, the returns may roll in for many years.

Writer and thinker Morgan Housel wrote that every sustainable business relies on one or more timeless features. We believe the key features you would like us to deliver include close human interaction, confidence and trust, and transparency. (Transparency in this context means ‘what you see is what you get.’)

We have previously noted that 21st century communications allow us to be radically transparent and to connect more closely. When we improve our processes for research and trading and portfolio analysis, we generate more time to work with you one on one. Our sense is that all these things together may increase your confidence in us.

Amazon continuously improves methods and tactics to deliver on its timeless strategy. We seek to do the same. Clients, if you would like to offer your perspective (or discuss anything else), please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Amazon, Leibman Financial Services and LPL Financial are not affiliated.

Our Three Principles

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You’ve heard us talk about conventional investment wisdom, as embodied in Modern Portfolio Theory. No surprise here: we don’t like it. The pie charts, talk of asset classes and correlation… It is all wonderful until it isn’t.

Our alternative approach relies on three fundamental principles. We believe they apply in every season.

Avoid stampedes. Our first principle to avoid stampedes in the markets, and it’s based on our understanding that the stampede is usually going the wrong way. There was a stampede into tech stocks in 1999, which ended badly. There was a stampede into real estate in the early 2000s, which ended badly. There was a stampede into commodities after that, which ended badly. In short, major peaks are usually accompanied by a stampede of money that drives prices to extremes.

Seek the best bargains. Our second principle is to seek the best bargains in the investment universe. This principle lets us sort “the market” into its pieces. The three major asset classes are stocks, bonds, and cash alternatives. Cash and its alternatives currently earn practically zero-point-nothing interest rates; bonds are barely better. Diving one level deeper into stocks, we find that some sectors and industries are expensive and others appear to be bargains.

Own the orchard. Our third principle is to seek to own the orchard for the fruit crop. Portfolio income is an important component of total returns, and those among us who rely on our portfolios to buy groceries surely understand the importance of cash income. As noted above, interest rates remain very close to zero: we do not believe that bonds or cash alternatives are a good way to generate income these days. But we are currently enjoying generous dividends from many companies in the bargain sectors. Other holdings purchased in past years continue to pay regular dividends today.

We must note that, in actual practice, these principles require patience. One should always know where needed cash and necessary income will come from. Please see our other posts for fuller treatment of the three principles in action.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

Behavioral Economics and The Price of Stability

Stone wall with gold letters spelling out STABILITYThe first theory of economists was that human beings act rationally. When they realized they needed a new theory, the field of Behavioral Economics was born.

One of the key findings of Behavioral Economics is that the pain of a loss is twice as great as the pleasure of a corresponding gain. Rationally speaking, if you earn $5 it should feel just as satisfying as if you earned $10 and then lost $5 of that—but we still feel the sting of the loss harder, even though the outcome is the same.

If people weigh these two otherwise identical outcomes differently, when it comes time to invest they will wind up paying more for $5 earned in stable investments than they would for $5 earned in volatile investments. There is no shortage of expensive products designed to pander to this tendency by selling the promise of stability at a premium.

The necessary conclusion we see—the one nobody else seems to—is that if the price of stability is too high, the potential rewards for enduring volatility must be larger than they otherwise should be.

These concepts shape our work, our strategies, and our tactics. “The pain of a loss” is determined by one’s mindset, training, and understanding. Many great investors (and many of our clients) feel no pain over short-term losses. Some are even gleeful at the chance to buy securities at bargain prices. One of our roles is to help you develop more productive and effective attitudes about investing, and we believe that by training yourself out of irrational pain over short-term volatility you can perform better in the long run.

The opinions voiced in this material are for general information only and are not intended to provide specific investment advice or recommendations for any individual.

The illustration is hypothetical and is not representative of any specific investment. Your results may vary.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.