long term investing

Make Believe

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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

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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.

Icky-Tasting Medicine

© Can Stock Photo / dolgachov

If you believe that living with ups and downs is an integral feature of long term investing, some aspects of customary investment practices seem rather curious.

The idea that volatility is risk is the root of the trouble, in our view. We believe volatility is simply the normal ups and downs, not a good measure of risk. A widely followed concept, Modern Portfolio Theory or MPT, adopts the approach that volatility is literally, mathematically, risk.

This approach attempts to work out “risk tolerance,” by which they mean willingness to endure volatility. If one is averse to volatility, then portfolios are designed with volatility reduction in mind.

Unfortunately, volatility reduction may result in performance reduction. But investments which do not fluctuate are not truly investments. Your bank account does not fluctuate, but it is not an investment.

We think beginning the conversation with an attempt to tease out willingness to endure volatility is a lot like a doctor working with a child to determine tolerance for icky-tasting medicine before making a prescription.

Our strategy is to impart what we believe about investing. We work with people to understand what part of their wealth might be invested for the long term, and whether they are comfortable with ups and downs on that fraction of it.

This necessarily involves learning about near and intermediate cash needs and income requirements, as well as talking about what it takes to live with the ups and downs. We invest a lot of time and energy into providing context and perspective so people might be better able to invest effectively. This process begins at the very beginning of our discussions with potential clients.

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


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

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

The Trouble with Zig and Zag Theory

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The idea behind massive diversification, owing a bit of everything, is that some things zig when others zag, keeping the whole bucket steadier. Great theory.

The problem is that things do not zig and zag ALL the time. When the big downturn comes, they all go down together. Oh, some things do not go down – but those things also tend to never go up, either.

The mathematical basis for massive diversification is Modern Portfolio Theory. It depends on different types of assets behaving more or less independently of one another – zigging and zagging. The lack of correlation is what drives the hypothetical usefulness of the theory.

In the big downturns, however, the correlations may converge. In plain language, in times of market stress, even independent investments may act as though they are related. The theory may not work due to systematic risks.

This is a real problem, because it is a theory that sometimes has the potential to drive investors to diversify into sectors and asset classes which may hold unknown risks, in the interest of avoiding market volatility.

This only makes sense if one defines volatility as risk, something to always be minimized and avoided. We think it makes more sense to understand volatility as an integral and necessary part of long term investing, a feature to be tolerated (or embraced) as the price of pursuing market returns over the long haul.

Investing in fluctuating markets with confidence requires us to know where our needed cash will come from – only long term money should be invested for the long term.

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.

Up And Down Really Means Up And Down

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As long term investors we talk a lot about the need to weather short-term volatility in pursuit of long-term results. Our notion is that volatility is not risk, but an inherent feature of investing.

As years go by, many think of the market as having good years and bad years. This is based on the outcome for calendar years. The astonishing thing is how much movement there is during the course of the typical year.

“At least one year in four, roughly, the market declines.” We’ve said that about a billion times, to reiterate that our accounts are likely to also have good years and bad years, if one judges on annual returns. The object is to make a decent return over the whole course of the economic cycle, year by year and decade by decade.

But in those other three years out of four, the market also experiences declines during the course of the year. In an average year you may see a decline of 10 to 15% at some point during the year.

Our object is to leave long term money to work through the ups and downs, without selling out at a bad time. Three things help us do that:

1. A sense that everything will work out eventually, a mindset of optimism.

2. Awareness that downturns tend to be temporary, ultimately yielding to long term growth in the economy.

3. Knowing where our needed cash will come from, based on a sound cash flow plan.

Bottom line, even years that end up well can give us a rough ride. Knowing this can make it easier to deal with.

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.

Stock investing involves risk including loss of principal.

All performance referenced is historical and is no guarantee of future results.

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.

 

The Rip Van Winkle Effect

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Rip Van Winkle is a character in a Washington Irving short story written nearly two centuries ago. You might know the story: Rip sleeps for twenty years up in the mountains, eventually returning home to find that much had changed.

One of the most dynamic companies in the world emerged on the scene a little over twenty years ago. An investor who purchased it on its first day of trading would have made several hundred times his original investment, had they held all the way through.

In spite of the incredible long-term result, it would have been very difficult to achieve even if one had bought in early. If you carefully looked every day to see how it was doing, as of November 12th this is what you would have experienced:

• On 1,346 of the days of ownership, the value would have been less than 50% of its previous peak. This is nearly one day in four, out of the 5,410 trading days in question1.
• On 494 of the days, the value would have been down 80% from the prior peak.
• The worst drop from a prior peak would have been 94%.

It isn’t always easy to hold an investment that has declined in value. We strive to own bargains, even when they become better bargains. (Once upon a time, a client asked me “What kind of moron would watch a stock go down from $11 to $7, dropping day after day, and do nothing?” Of course, I am that kind of moron.)

We have noticed that a certain few of our clients use the Rip Van Winkle effect, to their benefit. In the example above, they would have accepted in advance they would be under water at times, and just held for the long term. They enjoy the long-term result, without the day to day anguish of fluctuating values—they did not need to look every day.

We work diligently to understand what we should own, and why. Sometimes we change our opinion and sell at a loss. But often the Rip Van Winkle effect would help us. Clients, if you would like to talk about this or anything else, please call.

Notes & References

1. Standard & Poor’s 500 Index, S&P Dow Jones Indices. Retrieved November 12th, 2018.


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.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

Stock investing involves risk including loss of principal.

The Three Investment Strategies

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Great thinker Morgan Housel recently wrote that there are only three legal investment strategies.

1. Be smarter than others.
2. Be luckier than others.
3. Be more patient than others.

Does one of these jump out at you as being a lot more accessible than the others?

Luck falls where it may. We do not control the luck we have. Smarts? We do what we can to improve our odds. Reading, studying, analyzing, thinking…we do our best to understand what we can. But there will probably always be somebody smarter, somewhere.

The edge that anyone may choose is patience. We talk endlessly about the long view, about waiting out the downturns, about hanging in there when times seem rough. Anyone may choose patience, but it is not always easy!

After decades, we have yet to see a fool-proof indicator that will tell you which way the market is going to go in the short run. Nor have we seen evidence that any person can reliably predict the direction of the market. But we do know a couple key things:

• In the past, the broad market has tended to go up about three years out of four, and down about one year out of four.1
• Over extended periods, these ups and downs have potential gains for those who are patient.

Past performance is no guarantee of future returns, of course, so it takes some courage to exercise patience. We appreciate that in you.

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

Notes & References

1. Standard & Poor’s 500 Index, S&P Dow Jones Indices. Retrieved November 26th, 2018.


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

Every Share Sold is Bought

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We talk a lot about cycles, but there’s one truth to them that we could come right out and say more often: there are no ups without downs, no downs without ups. Night and day. Yin and yang. Buy and sell.

People sometimes lose sight of this reality, especially when talking about the waves of selling that engulf the markets from time to time, cratering prices. They might say, “Long term investing is all well and good, until the financial crisis comes and wipes out half your account—that happened to me.”

In the last crisis (2007–2009), the markets recovered and went on to post gains for many years. When I inquire whether their accounts have bounced back since then, some reply, “Of course not! Everybody had to sell out to save what was left!”

Life is too short for most arguments, isn’t it? We move on to other topics. But the fact remains: even on the worst days in the depths of the crisis, when the market was suffering large percentage losses, we believe every share sold was also bought. There are two sides to every transaction, a buyer and a seller. Not everybody “had” to sell out.

In the fall before the market bottom in March 2009, noted investor Warren Buffett wrote in The New York Times that the economy was likely to be larger—and company profits higher—ten and twenty years in the future.1 Therefore, he was buying.

We felt the same way.

But it may feel as if everybody is selling. In the crisis, one of you told us it was no longer possible to talk about the economy or markets at coffee in the mornings, because every single person there called you a fool for staying in or told you all your money would be lost. Another said the same thing about the Friday night dinner crowd—you felt lonely. But you persisted.

It is popular lore among financial advisors to presume that people are really not capable of investing effectively, pointing to behavioral economic studies. You know we have worked hard to find you, the exceptions: people who either have the native good sense to invest effectively or who can learn how to do it.

We believe that every share sold is also bought. We have a choice, which side of those transactions to be on. Clients, if you would like to talk about this or anything else, please email us or call.

Notes and References

1. Warren Buffett “Buy American,” The New York Times: https://www.nytimes.com/2008/10/17/opinion/17buffett.html. Accessed: September 24, 2018.


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