stability

Optional Thinking

© Can Stock Photo / lisafx

Readers know we believe there are those financial arrangements that maintain stability and those that may garner long-term investment returns. But anything that promises both stability and high returns is not likely to work out that way.

The uncomfortable truth is, we must live with volatility in order to have a chance at market returns. Short-term market action cannot be reliably forecast, nor profitably traded, in our opinion.

Yet market values can be volatile. Imagine an account of $500,000: a 20% drop would shrink it to $400,000, while a 20% gain would grow it to $600,000. How do people stand it?

First, long-term clients tend to take the long view. If that $500,000 account started as a $200,000 account years ago, the owners remember where they’ve been. That original investment is their anchor: any value above $200,000 represents a gain from that beginning value. (We are talking about the effects of time and compounding, not claiming any unusual investment results.)

Second, the long view helps clients understand that volatility is not risk. Put another way, as we’ve written before, a short-term drop does not necessarily represent a loss. How should we view that $500,000 value dropping to $400,000, in the long view? Relative to the original $200,000, it’s still a gain. Worrying about drops as if they are losses is optional for people who are investing for many years or decades down the road.

Third, even while staying the course over the long haul is important, strategies need to address short-term needs. For those who are living on their capital, knowing where the cash is going to come from is vitally important. With secure cash flow, it is easier to live with the ups and downs in account values. We call this pursuit of opportunity “owning the orchard for the fruit crop.”

This perspective requires a certain confidence that we will stumble through any problems and likely come out of whatever troubles have arisen. Optimism is sound policy, for if we are going back to the Stone Age, it won’t matter what is in your portfolio anyway.

Clients, if you would like to talk about these ideas or any other, 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.

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.

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.

 

No Free Lunch

© Can Stock Photo / 279photo

From time to time, we meet people who are devoted to avoiding the worst selloffs in the market. When there are so many simple statistical tools available to keep track of the trend, they say, it makes no sense to stay in the market when the trend is against you.

For example, by selling out when the major stock market indices dip below their 200 day moving averages, and buying back only when they climb back above, one could have avoided significant damage in the worst downturns.

The problem is, one could also have avoided some really sharp recoveries from low levels. And in any lengthy test of these mechanical rules, generally they would have cost money to implement.

The key question is, what fraction of your total returns would you be willing to give up in order to get a smoother ride along the way? Would it be OK to have 30% less money after twenty years? 20% less? 40% less?

Our point is, there is a cost to the human preference for stability. There is no free lunch. The trend-following systems that save you from damage also tend to water down your results over the long term.

We believe we get paid to endure volatility. Living with the ups and downs when so few are willing to do it…that’s what we do. We seek to understand what fraction of your money can be invested for the long term, without regard to volatility—and invest for you on that basis.

The markets have had volatile spells, but year by year results have been positive since 2009 in the major averages1. We know that sooner or later, unpleasant times are going to come around.

Our principles may hope to offer some cover from overvalued markets. Avoiding stampedes and seeking the best bargains may or may not limit the damage—we have a mixed record, and no guarantees. With the uncertainties of the markets, and the impossibility of knowing the future, it is comforting to have principles by which to operate.

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

1Standard & Poor’s 500 Index, S&P Dow Jones Indices. Retrieved May 21st, 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. All indices are unmanaged and may not be invested into directly.

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.

All investing involves risk including loss of principal.

You Can’t Always Get What You Want

© Can Stock Photo / lucidwaters

Wouldn’t it be great to have an easy job with a big salary? Or a hot sports car that was very low-priced? Or a luscious dessert with no calories?

The financial equivalent: an investment with good returns and stable value. Believe us when we say this is a popular concept.

Nearly five decades ago, the Rolling Stones advised that “You can’t always get what you want.” This is surely true of each of the situations described above. You just cannot get those desirable combinations.

But “if you try sometime, you just might find, you get what you need.” On the investment front, many people need their money to grow over time to meet long term goals. Stability of value along the way would be comforting to have. The true need is growth, and the key measure is how much money you wind up with in the distant future.

The real return on truly stable assets is usually low. Some people with a lot of assets relative to their needs can live with low returns. Most of our clients need their money working harder than that—so necessarily must forego stability along the way. (Or, adjust their goals to reflect more modest circumstances.)

We take pride in telling it like it is. Although many sellers promote the false notion that you CAN get good returns and enjoy stable values, we believe you can handle the truth. Markets go up and down—and that’s OK. Whether you were born with effective investment instincts or we had to train and coach you, many of you have shown the ability to live with volatility and invest effectively anyway.

Go ahead, ask us again about that mythical investment with good returns and stable value. We will help you understand that you can’t always get what you want, but you can get what you need. Call or email us if you wish to discuss your situation.


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

Poking Holes: Find Your Strategy

© Can Stock Photo Inc. / actionsports

“It’s easy to poke holes in every single investment philosophy or strategy. The trick is to find the one with flaws that you’re comfortable with.” –Ben Carlson, Ritholz Wealth Management

This concise statement makes it clear: every investor faces tradeoffs.

Current Income or Long Term Growth? Some strategies focus on growth in capital over time, others focus on current cash flow. Many investors need some of each. A pure growth portfolio probably won’t pay your bills, and a pure income portfolio may not have the growth to stay ahead of inflation.

Stability of market value or long term growth? This is where we live! We have written about the high price of stability. And we have constantly communicated in every way we know how about the link between long term returns and short term volatility. Everybody we know would prefer having both stable values day to day and wonderful long term returns.

You cannot have all of both—the best we can do is some of each. But it helps to resolve this tradeoff if you make sure your income and emergency funds are sufficient for your needs. If you own the orchard for the fruit crop, you don’t need to care what the neighbor would pay you for the orchard today.

Reliability of Income or Stability of market value? This dilemma is not even recognized by most people, and rarely discussed by investment professionals in our experience. Nevertheless it is a vital point. At one extreme, the kinds of investments that assure stable values have delivered wildly varying income over the years. In the early 1980s one could gain interest of 1% a month on money in the bank. More recently, it has been difficult to get 1% per year. So the person that retired on bank deposit interest of 12% saw a lot of volatility—and deterioration—in their income over time. Meanwhile, anything you can own that produces reliable income over extended periods will definitely fluctuate in market value, sometimes sharply.

Putting it all together: As you can see, every investment strategy has flaws. The trick, as Carlson says, is to find the one with flaws that you’re comfortable with. So we need to understand what is required in the way of stability, current income, reliability of income over time, and long term growth. We can build a portfolio that strives to balance those attributes with tradeoffs that are both acceptable and likely to be successful.

Please call if we may be of service in this regard, or to update our understanding of your situation.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss.

Volatility Versus Risk

© Can Stock Photo Inc. / webking

In the investment world, we often speak of the riskiness of an investment in terms of volatility: if an asset’s price changes rapidly and unpredictably, it tends to be spoken of as risky, and if the price tends to stay the same, it is usually regarded as “safe.”

In the short term, this is reasonable. If you have $100 today and you know that you will need $100 a week from today, the only sensible move is to put your money someplace where you know its value won’t change. Investing it in a volatile market means you might make a few extra percent your original money, at the unaffordable risk of coming up short when you actually need your money.

When we start to look at investing for the long term, though, we can start to see the difference between volatility and risk. Suppose you take your money and bury it in a hole in the ground for 30 years: this is about the least volatile “investment” you can possibly make. You can reasonably expect that the value of your buried money will stay nearly constant. Yet, because of the existence of inflation, it is almost a certainty that your money will lose a lot of purchasing power over the course of 30 years. Essentially you have a 100% chance of losing value over the long haul despite having virtually no day to day volatility.

On the other hand, if you took your money and invested it for 30 years, you can afford a lot of up and down movement during those 30 years—as long as the final value is higher than what you started with. If your investment has a daily gain 51% of the time and a corresponding daily loss 49% of the time, you can be fairly confident in your eventual profit—even though you’re watching the value go down several thousand times over the course of those three decades.

None of us know the future: there is no such thing as a guaranteed investment, and every investment incurs some form of risk. But it’s important to understand the difference between an asset’s volatility and its risk. For long-term investors, looking past day to day volatility can help you find bargains that are not as risky as you might think.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the loss of principal.

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.