investment philosophy
The End of the World Portfolio
We live in trying times, a recurring feature of our existence.
Our entire investment philosophy is underwritten by a simple fundamental belief: tomorrow will be better than today. We can’t know that this will be true of every single tomorrow, but we’re pretty sure about the long term trend.
Though they say that “past performance does not guarantee future results,” human civilization has a track record thousands of years long of resilience, rebounding from crisis to do better than before. We expect it will continue. Without this belief the idea of investing for the future is meaningless.
We know that there are troubles in the world, with the news full of the virus, death and disruption. People sometimes feel that the latest bad news signals imminent total catastrophe. This isn’t anything new–people have been predicting the end of civilization for the entire span of human history. Yet somehow we’ve always rebounded all the same.
If the most dire predictions ever do come to pass, it isn’t going to matter what investments you own. Your meanest neighbor will be trying to steal your canned goods. So the ideal portfolio for the end of the world is the one that will serve you best in the event that the end of the world fails to show up—again.
Content in this material is for general information only and 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.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
A Structural Reminder
The ability to adapt to changing conditions is what sets those who thrive apart from those who merely survive.
Our portfolio theory evolves over time as economic and market conditions unfold. The problem with the textbook approach in a changing world is that a textbook, once printed, never changes. Looking at the world as it is and doing our own thinking, we see things in a new way.
Some time ago, we concluded that counterproductive monetary policies have distorted pricing for bonds and other income-producing investments. By crushing interest rates and yields to very low levels, the old investment textbook had been made obsolete.
Therefore the classic advice about the proper balance between stocks and bonds brings new and perhaps unrecognized risks, with corresponding pockets of opportunity elsewhere. Yet the classic advice met a need which still exists: how to accommodate varying needs for liquidity and tolerance of volatility.
Our adaptation to this new world is the portfolio structure you see above. Our classic research-driven portfolio methods live in the Long Term Core. We believe our fundamental principles are timeless, and make sense in all conditions.
But people need the use of their money to live their lives and do what they need to do. So a cash layer may be needed, tailored to individual circumstances.
The layer between is ballast. This refers to holdings that might be expected to fall and rise more slowly than the overall stock market. Ballast serves two purposes. It dampens volatility of the overall portfolio, thereby making it easier to live with. Ballast may serve as a source of funds for buying when the market seems to be low.
The client with higher cash needs or who desires lower volatility may use the same long term core as the one who wants maximum potential returns. One may want a ‘cash-ballast-long term core’ allocation of 10%-25%-65% and the next one 4%-0%-96%. It’s a free country, you can have it your way.
It may be time to review the structure of your portfolio. Clients, if you would like to talk about this or anything else, please email us or call us.
Content in this material is for general information only and 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.
Making Money the Old-Fashioned Way
Years ago, the Wall Street firm of E.F. Hutton advertised “We make money the old-fashioned way. We earn it.” This tag line evoked a world of indepth research into securities and markets, and investment analysis by experienced professionals.
E.F. Hutton disappeared into a series of mergers, and making money the old-fashioned way is increasingly scarce. One popular theory now is that security selection does not matter, only the allocation of money across the different sectors of the market.
Combined with the idea that past patterns of volatility and past returns by sector should dictate what one should own for the future, many modern ‘investment advisors’ pay no attention to individual company stocks or bonds.
It seems to us that owning stock in a failing chain of department stores is a lot different than owning the world’s largest online retailer. A few automakers survived, hundreds did not. Buying a corporate bond for 50 cents on the dollar is a totally different proposition than selling it for 50 cents on the dollar. Owning some of everything is different than being selective.
Our experience says security selection DOES matter.
One of our strategies is to try to find ownership in great companies at decent prices, to buy and hold. Looking for cyclical companies at low points in the cycle is another strategy. And simply seeking bargains anywhere in the investment universe is a third.
This is not easy. Conditions are always uncertain. There are no guarantees. It takes a lot of effort and energy. There is no assurance that the old-fashioned way will make money, as E.F. Hutton claimed.
But we are trying.
Clients, if you would like to talk about this or anything else, please email us or call.
Content in this material is for general information only and 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.
The Hidden Trade-off: “Risk-adjusted Returns”
You surely have noticed this by now: we disagree with conventional ways of doing many things. Modern Portfolio Theory (MPT) forms the theoretical underpinnings of a lot of investment practice today, without adequate understanding of its deep flaws.
MPT defines volatility as risk. We believe, as Warren Buffett does, that volatility is just volatility – the normal ups and downs – for long term investors. So one common practice is to promote the advantages of getting 80% of the market returns with only 50% of the risk (for example). This supposedly is a superior “risk-adjusted return.”
But you could use the same statistical methodology to show that it may cost you about one third of your potential wealth in 25 years to have a 50% smoother ride on the way. For an investor with $100,000 in long term funds, this might be a $250,000 future shortfall. The question might be, “What fraction of your future wealth would you sacrifice in order to have less volatility on the way?”
The idea of sacrificing future wealth is a lot different than the idea of reducing risk. But they are two sides of the same coin. This is the hidden trade-off in superior risk-adjusted returns.
Our experience is that people can learn to understand and live with volatility. We believe investors get paid to endure volatility.
Of course, our philosophy is not right for everyone. Volatility is easier to tolerate for investors with a longer time horizon. But we believe everyone should see both sides of the coin before making a decision to forego significant potential future wealth for a smoother ride, less volatility, along the way.
Clients, if you would like to talk about this or anything else, please email us or call.
Content in this material is for general information only and 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.
Writing the Book on Investing
In the 21st century, it is possible to be more open about every aspect of business than ever before. Digital communications enable us to describe in real time what we are doing, why, how, and for whom with a level of detail that was not possible in the last century.
We have always had a well-defined investment process. We know what we want to own, and why. Since 2015 we have been able to share insights about our views, thinking, philosophies, strategies, and tactics here on the blog at 228Main.com. Those of you who are regular readers have perhaps gained a good sense of what we are about.
It is time to take it to the next level. We are working to comprehensively document our investment management process, from philosophy to research sources to investment selection methods to portfolio structure to tailoring client fit to trading protocols to client and account review process. We will be writing a book.
As great thinker Morgan Housel wrote, “writing crystallizes ideas in ways thinking by itself will never accomplish.” So we expect to come out of this exercise with a tighter, better-defined set of processes and protocols. No guarantees, of course.
This will take time and effort. What are the other advantages in doing it?
• To provide even greater clarity for you.
• To gain a comprehensive business operating manual.
• To help new associates understand what the enterprise is about.
Bottom line, this is a step toward greater sustainability, one of our major objectives for the years ahead. Clients, if you would like to talk about this or anything else, please email us or call.
Hit ’em Where They Ain’t
Investors can learn a lot from Willie Keeler, one of the smallest major league baseball players in history. Wee Willie stood 5’4” and weighed 140 pounds.
Playing from 1892 to 1910, Willie was a prolific hitter, with a batting average of .345 over that long career. He explained his success with words that have become part of baseball lore:
“Keep your eye on the ball, and hit ‘em where they ain’t.”
We believe it makes sense to strive to understand investment opportunities, researching companies, trends, and economic developments to try to gain an edge. This is what it means to “keep your eye on the ball.”
As contrarians, we seek to avoid stampedes. If the crowd is there, we probably want to be somewhere else. As Warren Buffett once said, “be greedy when others are fearful, and fearful when others are greedy.” Isn’t this the investment version of “hit ‘em where they ain’t?”
It would be interesting to know whether Wee Willie Keeler did any investing. Did his investing philosophy match his baseball hitting philosophy?
We cannot know the answer to that. But we do know, our investing philosophy matches up very well. “Keep your eye on the ball, and hit ‘em where they ain’t.”
Clients, if you would like to talk about his 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 investing involves risk including loss of principal. No strategy assures success or protects against loss.
Niche Market of the Mind
In every field of human endeavor, it seems that the best of the best are specialized. From the doctor who specializes in one form of cancer to the CPA who works mainly with trucking companies, specialists rule.
In business, the shorthand term is “niche marketing.” Financial advisors may work with people of a specific religion, those with shared hobbies or interests, people who work in a particular field or for a certain company, or those with some other traits or characteristic.
If you know us, it should not surprise you that we are different. Our niche market encompasses retirees and workers and truck drivers and executives and nurses and engineers and teachers and accountants and married couples and widows and single people. At first glance, this may seem to be a poorly defined client group.
But our clients represent a very well-defined group: it is a niche market of the mind.
We work hard to qualify clients by productive attitudes toward investing—and we are not afraid to try to train clients if the right attitudes don’t come naturally. A tolerance for volatility and a fundamental confidence, as a society, we stumble our way through our problems are two of the elements we need to have.
The rewards for pursuing this niche have been amazing. While other advisors cope with massive defections from informed strategy when the outlook darkens, our clients tend to stay the course. We avoid the curse of “cash on the sidelines,” waiting and waiting for that comfortable moment to get back in the game after selling out. We never promise stability, so we spend less time apologizing for the inevitable volatility.
In short, we can do our best work for people who are in the best position to profit from it over the long haul.
Is it always easy? Is it always fun? Of course not. The market goes up and down, and “up” is a lot more fun than “down.” Pessimism and optimism ebb and flow, and it can be tough to buck the crowd. Any rational person has to scratch their head in the toughest times and wonder whether they are doing the right thing. But together we have tended to make appropriate decisions.
Good information communicated well helps drive effective behavior. Behavior can help determine investment outcomes. Good outcomes can increase account balances. And we get paid on account balances. This is why we are doing what we do.
We don’t care if you engineered the truck, or drive the truck, or own the trucking company… if you have what it takes to invest successfully, we specialize in you. This is why we strive for a niche market of the mind.
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.
Our Three Principles
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.
Weighing the Bad and the Good
If a salesman came up to you on the street and offered you an investment that had only a 54% chance of making money, would you think it was a good bargain? Probably not.
Over the past 65 years the S&P 500 index has had a positive daily return less than 54%. With odds like that, one might think that some skepticism in stock investments was warranted. And yet, over the course of those 65 years, the S&P has risen over 12,000%. Even though it has lost money almost half the time, taking that 54% bet over and over again turned out to be very profitable. At times, market movements feel like they’re going one step forward, one step back—or at times even one step forward, two steps back. But over time, stepping forward 54% of the time is enough to build a great track record.
Past performance is certainly no guarantee of future results. We can only hope that the next 65 years are as good for the market as the past 65. The potential is there, though. And obviously, market volatility does pose obstacles. If you have $10,000 today and you really, really need to make sure you have $10,000 tomorrow, investing in a market that goes down 46% of all trading days is not a very good idea. Investing in volatile markets takes a certain mindset and a longer term investment timeframe. Call or visit us to discuss what investments would be suitable for you.
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 indices are unmanaged and may not be invested into directly.
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