long term investing

Teaching an Old Stock New Tricks

© Can Stock Photo / alexskopje

Consolidated Edison Company of New York (Con Ed) was listed on the New York Stock Exchange back in 1824. Known then as New York Gas Light, it holds the record for the longest listing on the exchange.

For every single day of those nearly two centuries, every share of its stock was owned by somebody. Through financial panics, recessions, wars, the Depression – through everything – every share of its stock was owned by someone.

It seems curious to us that some investment advisors advocate the belief that the vast majority of investors are incapable of owning shares of stock through the inevitable downturns. (Stocks do go up and down, as we often note.) Yet somebody has to own every share, every day.

These advisors with low expectations of you usually rely on one of two basic approaches.

1. Keep 40 to 60% of your long term assets in bonds or other forms of fixed income. This strikes us as an exceptionally poor idea for many long term investors, because of historically low interest rates, and potential losses from inflation and rising interest rates.

2. Expect to be able to sell out before big declines, and reinvest before big rises. This unlikely outcome is usually sold as a “tactical” strategy. It is a great one, too, but only on paper. Nobody to our knowledge has ever demonstrated a sustainable long term ability to reduce risk while maintaining market returns with in and out trading.

Our experience tells us that many people understand long term investing, and living with the inevitable ups and downs. Many more can be trained to become effective investors. We think you can handle the truth: real investments go up and down.

The thought of forfeiting a significant fraction of potential future wealth by pandering to fear of short-term volatility hits us wrong. We won’t do it here at 228 Main, nor would we pretend we our crystal ball works well enough for in and out trading.

Of course, our approach is not right for everyone. Clients must be able to live with their chosen approach, and not everyone can live with ours. We can handle the 60/40 or 40/60 mix for clients who want less volatility. But the fraction in the market is going to experience market volatility, a pre-requisite to obtaining market returns.

We mean no disrespect to advisors with different approaches. After all, they lack the main advantage we enjoy: working with the best clients in the whole world.

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 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. 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.

 

Letters To Our Children #8: Keep Your Eye on the Horizon

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We wrote before about your three investment buckets, each with a different time horizon. Here is why that is so crucial.

Business founder Jeff Bezos highlighted the key thing about time horizons.
“If everything you do needs to work on a three-year time horizon, then you are competing with a lot of people. But if you’re willing to invest on a seven-year time horizon, you are now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”

The investment parallel is clear: just by lengthening the time horizon, you can live with the short term volatility that is inherent in the pursuit of long term investment results.

Those with a short time horizon—an insistence that market values be stable day to day or month to month—can generally expect meager returns. Stable values and liquidity both cost a premium, and if you want both you’re not left with much room for returns. This is good for your short-term bucket, but may hamper you anywhere else.

Behavioral economists have a theory that the preference for stability is very strong, part of human nature. If the demand for stability is high, then the price of stability may be high—and the rewards for enduring volatility may prove to be large since fewer are willing to do it. This is based on our opinion, no guarantees!

Bottom line: we believe in investing for the long term with your long term money, and leaving short term strategies to your short term bucket. It pays to understand volatility, and its role in your investment returns. No matter what, you should be able to live with your chosen strategy, even when (especially when?) it is uncomfortable.

Clients, if you have questions 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.

Every Share of Stock is Owned Every Day

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Every share of stock in existence is owned every single day by somebody. But the market news often refers to “all the selling on Wall Street” on a down day, or “the buying on Wall Street” on an up day. In reality, every share sold was also bought.

This came to mind when we recently read the words of a supposed expert: “investors need to be protected from themselves.” Since “you can’t change people” then the right prescription is a 60/40 or 40/60 mix of stocks and bonds, because otherwise people would sell out at a bad time – in a down market. But every share sold gets bought! So we cannot all be selling at the same time.

The idea that nearly everyone should give up the potential returns of long term stock ownership on a large fraction of their wealth because they won’t behave properly seems wrong-headed to to us. Our actual experience with you over the years says that many people are either born with good investing instincts, or can be trained to invest effectively.

We believe you can handle the truth. Long term investing requires living with volatility, the ups and downs. This is not appropriate for your short term needs, of course, for which you need stability.

In these times when bonds pay so little, insistence on a significant allocation to a sector where returns are likely to be historically poor for many years seems short-sighted. Particularly when used to shield true long term money from normal stock market action.

Let’s be clear: our philosophy is not for everyone. History suggests that about one year in four, broad stock market averages are likely to go down. If you can’t stand that with some fraction of your wealth, our approach is not the right one for you.

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 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.

The Hidden Trade-off: “Risk-adjusted Returns”

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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.

More Lessons from Moneyball

© Can Stock Photo / findog822

Michael Lewis’s book Moneyball turned 16 over the summer. In 2015, we wrote about the contrarian lessons we noticed in the Moneyball movement. The Oakland A’s won by using data to make roster decisions, favoring things like on-base percentage over batting average. Then, after the rest of the league adopted the A’s process, the 2015 World Series champion Royals won by bucking the trend and not following along.

We’ve found another lesson within Moneyball that applies to us—and you. Oakland A’s general manager Billy Beane rarely watched the product he helped put on the field to see how it performed. This may seem unusual (who wouldn’t want to watch baseball as part of their job?), but Beane had his reasons.

In a 2014 interview for the Men in Blazers podcast, Beane explained that he didn’t watch games because he did not want to do something about it in the heat of the moment. “When I watch a game, I get a visceral reaction to something that happens—which is probably not a good idea when you’re the boss, when you can actually pick up the phone and do something.”

Beane continued by saying doing something “probably isn’t logical and rational based on some temporary experience you just felt in a game.” This has meaning to us.

We all know that the market goes up and down, and we don’t find watching the ticker each second of the day to be helpful. Like Beane, we’ve strategically built our portfolios for performance over the long term (no guarantees), and we’re willing to ignore a hiccup from a star on occasion.

Like Beane, we can remove ourselves and our initial emotions from the equation. Then we can focus on only the moves to better our “team” and its goals in the big picture.

Clients, if you’d 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 Anti-Buffett

© Can Stock Photo / Leaf

We had back-to-back conversations recently with clients who are big fans of Warren Buffett. Oddly, they seem to dislike the application of his principles to their portfolios. It is a good illustration of why Buffett’s success has endured, in our opinion. His ideas are easy to understand, hard to do.

Consider these quotations, investor first, then Buffett in bold.

“This stock has done nothing but go down since I bought it. I want to sell.”
I love it when stocks I like go down, then I can buy more at a better price.

“That company is in the news all the time with problems. I don’t think we should buy it.”
The troubles everyone knows about are already in the stock price.

“Everyone I know is afraid of this market, so I’m thinking of getting out.”
Be greedy when others are fearful.

“This stock is doing great, it’s gone up a lot since we bought it.”
Watch the company, not the stock.

These conversations are noteworthy because they are rare. The tagline on our digital archives, ‘for the best clients in the whole world,’ reflects our high esteem for you.

Clients, if you would like to talk to us 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.

Make Believe

© Can Stock Photo / nameinfame

It’s good fun to watch small children at play, using their imagination – they might be pirates or princesses, or serving imaginary meals, or having conversations with stuffed animals.

What is not good fun are financial types who pretend that so-called “market-linked” products actually provide exposure to real investment market returns. Often, a formula used to determine returns pays only a fraction of percentage gains, puts a maximum limit on returns, and ignores the effect of dividends. That’s investing only in the same sense that talking to a teddy bear is actual conversation*.

There is another common form of make-believe in the investment world. Some pretend that one might sharply limit the ups-and-downs in an account, yet still reap stock market returns, through some special strategy or tactic. Our view is that this is pandering. Long term investing is about willingness to accept a certain amount of risk in pursuit of getting paid.

Both of these fantasies play on the natural human desire for stability. But lower volatility may come at a cost of lower returns or higher costs. By the time the investor figures out there is either less stability than expected, or lower returns, a lot of freight may have been paid. Skip the make-believe, keep it real.

Clients, not everyone agrees with us – we hold contrarian views. 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.

Building a Faster Horse

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There is a quotation often attributed to Henry Ford: “If I had asked people what they wanted, they would have said faster horses.”

Biographers and historians have never managed to find any evidence that Ford ever uttered this statement, so it remains apocryphal. But the sentiment remains true to Ford’s reputation as a stubborn visionary.

For investors as well as consumers, sometimes there is a difference between what we need and what we want. We all want stability in our portfolios: why not? But stability often comes at a cost of lower income or growth potential. If you are sure you have all the money you will ever need, it makes sense to invest for stability. If you need your money to work for you, though, you may have to hold your nose and accept volatility.

If you really want stability, you can bury your money in a hole in the backyard. It will never grow, but you know that if you dig it back up you will still have what you put in.

The same is not true if you invest in volatile holdings. The value of your portfolio can and certainly will go down sometimes. As painful as that is, if you can afford to wait there is a possibility that it may recover over the long run.

If you just buried your cash in the backyard, there is no chance that it will suddenly produce more wealth. A long time horizon can smooth out the risks of a higher volatility portfolio, but it will not produce more gains from a more stable portfolio.

If we asked new prospects what they wanted, many would probably say they wanted stability. But that is not what we are selling. Not everyone has the same risk tolerance, and different amounts of volatility are appropriate depending on financial circumstances. We still generally think that learning to tolerate volatility may be more useful than seeking stability at all costs.

Clients, if you have anything to discuss, please 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.

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

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.

And Now, the Weather

© Can Stock Photo / ifeelstock

When you watch the news and the weather forecaster tells you there is an 80% chance of rain tomorrow, what exactly does that mean?

It might rain tomorrow, or it might not. It says rain is more likely than not. So if there is no rain after all, does that mean that the forecast was wrong?

Forecasting is often a fuzzy subject. No one can see the future with 100% certainty, so predictions are often spoken of in terms of probabilities. But we as humans are generally not good at thinking in terms of probability. An 80% chance is far from a sure thing, but when someone tells us something is 80% likely to happen, it can sometimes feel like one.

This is particularly true when it comes to trying to predict one-time events. If you flip a coin and it comes up tails, you can keep flipping it and see that it will still come up heads about half the time. If the weather forecast says there is an 80% chance of rain next Tuesday, there is only one next Tuesday. If Tuesday comes and goes without any rain, it sure feels like the forecaster blew it.

Economic and financial forecasting runs into the same problem. First, a forecast is only as good as its model. Economic projections may include assumptions that prove to be unfounded. But even a good forecast is limited to predicting a range of probabilities. If an analyst tells you they think there is an 80% chance that the market will go up this quarter, all they are really saying is that it might go up and it might go down. You probably did not need an analyst with a fancy model to tell you that.

We put little faith in short term market predictions. Even if they are accurate, you can probably not afford to bet the farm on them. We prefer to take a longer-term view. We cannot be sure how an investment will perform over the next month or next year, and do not believe in speculating on short term results. We feel much more comfortable in the trend over the long run.

Clients, if you have any thoughts or questions, please 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.

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