We recently wrote about the 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.
Our first principle, avoid stampedes in the markets, is 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 2000’s, 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.
Our second principle, seek the best bargains, 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.
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, including the oil and natural resource companies. Other holdings purchased in past years continue to pay regular dividends, from pipelines to telecom to auto stocks.
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 post ‘The Fruits of Investment (link)’ for a 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.