Stability is no bargain. A lump sum invested for 25 or 30 years in a less wiggly portfolio might only grow to half as much as a more effective portfolio that embraces that longer time horizon. The longer we can tolerate volatility, the better off we may be.
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Clients, the markets are at a low point. It’s a prime time to revisit our holdings! Let’s take a second look.
To be clear, portfolio reviews are part and parcel of our regular business. But these times of churn and change are a great opportunity to look more closely—and try to make sense of everything given the context.
Conversations with some of you lately have inspired some changes. Could it be time to garner tax losses and take a different approach with some of your resources going forward?
Our goal at 228 Main is to grow your buckets. We believe the better off you are, probably the better off we will be down the road. That’s enough for us to review and comment on your plans and planning, as well as your investment holdings and accounts.
While it’s Second Look Season for us in the shop, could it be Second Opinion Season for anyone in your life? It could be you know folks who are paying fees for investment management when their investments don’t seem to be managed at all. Does anyone in your life have long-term investments stuck in stagnant short-term holdings?
I often say I’m in business to talk all day. If you have questions about your holdings, I might as well be talking to you and your loved ones! And clients, please know that we have nothing to lose by your seeking a second opinion of your own. All the power to you: you are the boss of what you do with your wealth. (We seem to get all the business we deserve, and none that we don’t.)
No matter where our resources land, remember that the markets go up and down. We won’t tell fairy tales about “minimizing risk” or getting market returns without enduring the inevitable fluctuations. We will not ignore that the price of so-called “safety” is often the loss of potential future gains.
But we do believe in striving for long-term total returns. So we live with volatility. No waves, no voyage. No rain, no flowers.
Clients, when you have questions about your situation, please write or call. If you know someone who would like to chat with us, let them know Second Opinion Season is in full swing, now through year-end!
Thank you all, for everything.
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Author F. Scott Fitzgerald wrote, “the test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.”
What if I told you—the best clients in the world—that you (yes, each and every one of you) have that first-rate intelligence?
See, there’s something in our work together that tests this idea, just about on a daily basis. When you join us, you learn to live with the volatility in the market: it goes up and down, and we accept this as a feature of the ride.
Very often, it goes down faster and deeper than it goes up. We may expect a 5% drop around three times a year: we might see a 10% drop around every two years. Meanwhile, gains of 10% are few(er) and far(ther) between: we’ve only seen it twice in the S&P 500 this century and only four times in the whole of the last century. And those gains have usually come shortly after one of the big drops.
But we wouldn’t be in this business if, in the long run, the market went down more than it went up.
So what gives? There are two seemingly opposing ideas about the market:
Clients know the secret: the first idea is all about daily events, and the second idea is about the long haul. No guarantees, of course, but it is possible that these things can both be true. We just care less about the former.
Therefore, if you consider yourself a member of the best client base in the world, then I consider you to be of first-rate intelligence.
We’ve grown a community of geniuses here at 228 Main. Want to talk more about what this means for you? Write or call, anytime.
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 indices are unmapped and my not be invested into directly.
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Understanding the risks involved is an important part of decision-making. Most would agree, I think, because how can we make informed decisions without weighing the consequences?
What makes it tough, however, is that a lot of financial planning literature uses the word “risk” when they’re actually talking about volatility. It’s about as helpful as the local news personality letting us know that weather is ahead: “There’s a risk of weather today! Heads up, everyone.”
How would that possibly help us make informed decisions?
Instead of railing against the presence of weather—or gravity, or any other to-be-expected force!—we like to spend our energy paying attention to risks that can actually affect our long-term goals.
Recall that in our shop, risk assessment takes place with a long time horizon in mind. We believe that you should have the money you’ll require for the next 3–5 years invested outside of the market. (Short-term volatility is a risk during the short term.) If you’re parking your money with us for a longer time horizon (3+ years), here are some risks you can expect we will factor into our strategy:
How much risk a portfolio might endure depends on a number of factors—your investing time horizon being just about the biggest one. There are other types of course, but these are some of the main examples of the risks we’re attuned to.
Volatility isn’t one of them. We don’t “mitigate” weather by hiding in a burrow forever; we don’t react to short-term swings by pulling out. As if we could spell it out any plainer, here’s our periodic reminder: we live with volatility in the pursuit of long-term gains.
Clients, when you want to talk risks, time horizons, and goals, email or call.
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We love working with you, the best clients in the world, because you’ve accomplished what some find impossible. You have recognized that long-term investors get paid to endure volatility. Some of you came to us this way. Others have learned across our many interactions. A few of you are still learning.
Up to this point, we have mostly defined risk by what it isn’t, as in “volatility is not the same as risk.” It might be useful to be more explicit about what types of risk we do consider.
Recall that our risk assessment takes place with a long time horizon in mind. We believe that you should have the money you’ll require for the next 3–5 years invested outside of the market. (Short-term volatility is a risk during the short term.)
If you’re parking your money with us for a longer time horizon (3+ years), here are some risks we do factor into our strategy:
How much risk a portfolio might endure depends a number of factors—your investing time horizon being just about the biggest one. And of course, there are other types of risk in the mix, but the topic is important enough to offer you more information from time to time.
Clients, if you want to talk about your risk exposure, email or call.
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We’re contrarians. We are not satisfied with conventional thinking that portfolio management requires plugging in the right numbers and then following the formula.
It’s not that simple—and it can actually lead investors astray.
Here’s the deal. Modern portfolio theory—one version of the conventional wisdom—uses rigorous statistical models that attempt to quantify volatility and risk in their many forms. The idea is that if you can measure and predict volatility then you can construct a portfolio that has only as much volatility as you desire.
We believe there are a lot of problems with this approach. These models all rely on the assumption that the market will continue to behave rationally. So when the market experiences irrational exuberance, statistical models quickly lose their meaning and begin producing nonsense.
For example, one measure of a stock’s volatility is called its “beta.” The more correlated a stock’s movement is to the broader market, the higher the beta. A high beta stock tends to be a big winner or big loser based on what the market is doing, while a low beta stock generally moves less than the market. A stock can even have a negative beta, where it tends to move the opposite way from the rest of the market!
Under normal circumstances, volatile stocks tend to have a high beta. But when a hot stock gets caught up in a speculative bubble, it can take on a life of its own. A stock on a hot streak that goes up even on days when the market is down will show a lower beta than stocks that follow the market but may still be volatile.
In cases like this, investment managers that are chasing “low beta” may end up with some very volatile holdings in a portfolio that claims to prioritize stability and low market correlation. And investors that are looking to avoid the roller coaster of the stock market may find themselves on an even bigger ride without realizing it.
We believe statistical analysis can be useful, but it cannot compete with timeless investment principles. Trying to quantify volatility exposure can lead to ugly surprises when the underlying models break down.
We think there’s another way. Instead of trying to mathematically capture and avoid it, we believe in living with volatility. If you are investing for the long haul and you know where your cash flow is coming from, you do not need to fret about day-to-day price action.
Clients, if you have questions about this or anything else, please give us a 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.
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.
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.
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