volatility

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.

Building a Faster Horse

canstockphoto15211

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

canstockphoto13131965 (1).jpg

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.

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

© Can Stock Photo / chokniti

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.

Choose Your Risks Wisely

© Can Stock Photo / alphaspirit

When you think about your finances over the course of a lifetime, it is easier to see that risks may only be selected, not avoided.

Our first understanding of risk often relates to fluctuations in value. If you put in a dollar, and the value soon drops to 80 cents or 60 cents, it seems like a clear (and vivid!) loss.

Money buried in a can would never have that kind of risk, yet its purchasing power—what you could buy with it—declines year by year if there is any inflation at all. This kind of damage reminds us of termites, which chew away behind the scenes, causing damage that is not obvious.

Longer term fixed income investments, like bonds, offer interest that may offset inflation in whole or in part. But the value of a bond may change with interest rates. A 3% bond is probably not going to be worth its face amount in a 6% world.

The interesting thing about all these different kinds of risks is that they cannot be entirely avoided, but they may be balanced against each other.

• The things that fluctuate in value may provide growth over the long term to offset inflation.
• Having money in hand when needed may enable us to live with fluctuating values in other parts of our holdings.
• Reliable income helps us avoid excess amounts of money laying around.

We think one of the most valuable lessons about risk is that, on our long term investments, volatility is not risk. If we aren’t retiring for many years, ups and downs in our retirement accounts may not be all that pertinent.

The stock market, measured by either the Dow Jones Average or the S&P 500 Index, has risen three years out of four. There is no guarantee that this general pattern continues, or how results will work out over future periods. But someone that invested ten, twenty or forty years ago may have seen a lot of growth overall, in spite of fluctuations ever year—and some years that were negative.

Clients, if you would like to talk about the balance of risks in your situation 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.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

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.

Pain Fades Away

© Can Stock Photo / pressmaster

Some pundits calculate the current run-up in the stock market as the longest bull market in history. It seems many have forgotten how tumultuous and uncertain things have felt at times during the rise.

Before the rise began, a punishing drop in the market (and investment account balances) happened, from mid-2007 to spring 2009.

Then, just a couple years into the recovery, we had one of the most turbulent periods ever. In August 2011, after dropping more than 5% the week before, the Dow Jones Average dropped another 5% on Monday, August 8. This 634-point drop was partially offset by a sharp rebound on Tuesday, a 429-point gain. Wednesday reversed again, with a drop of 519 points. Thursday’s gain of 423 points ended a string of daily moves greater than 400 points, down-up-down-up.1

Since the market was much lower then, an equivalent 4% move today would be about 1,000 Dow points! Imagine that four days in a row. We lived through it.

Why did this happen? Developments developed, happenings happened, and pundits spewed punditry. It would spoil our story to detail the details. As it turns out, they don’t matter.

We’ve been asking people whether they remember this episode. Few do. Thus our conclusion: the pain is temporary.

If you do a little math with our story, you’ll note the Dow dropped more than 10% in six days1. This was alarming to those who were paying close attention. Yet from the longer-term perspective, it probably would have been a mistake to sell at any point in there.

After all, this turmoil happened during the longest bull market in history!

The next round of turmoil is always out there. When we counsel patience, it is with the long term—and a knowledge of history—in mind. Clients, if you would like to talk about this or anything else, please email us or call.

Notes & References

1Standard & Poor’s 500 index, S&P Dow Jones Indices: https://us.spindices.com/indices/equity/sp-500. Accessed September 4th, 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 involves risk including loss of principal. No strategy assures success or protects against loss.

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Portfolio Hiccups

© Can Stock Photo / NicoletaIonescu

We have all had the experience of getting interrupted by a hiccup. Do they serve any useful purpose? A momentary dislocation, each spasm passes quickly.

Over the course of our lives as investors, we similarly experience a spasm through our portfolios from time to time. We feel this way about the year so far. Unlike hiccups, which sometimes feel like they come out of nowhere, in this case we can clearly spot some of the causes:

• Your portfolios are generally overweight in select natural resource holdings, a sector that may do better or worse than the major market averages in the short run. So far this year? They haven’t been great.

• We began adding overseas equity exposure a while back, as we saw better bargains emerging after a decade of underperformance. These bargains have become even better bargains, which is another way of saying they haven’t been great either.

• In recent years, cyclical holdings have found a home in our shop. Many of these have been affected by trade war talk and tariffs.

At the start of the year, we were focused on the years and decades ahead, as always. We prefer up years to down years, of course. But the best time frame for effective investing is one measured over many years. That is why we see this year so far as a hiccup—in the grand scheme of things, a momentary dislocation that will pass.

Paradoxically, those things that hold us back in the short run are often the things that provide above-average results in following periods. It has happened before; it will happen again. We counsel patience with our current holdings.

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. 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.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

 

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.

 

Building a Retirement Fund: Two Simple Things

© Can Stock Photo / tashka

As a rookie in business, I impressed myself with how much knowledge the work required. It was complicated! It did not take long to figure out that many people believe the same thing about their work.

The point was driven home when I made the mistake of suggesting that working in the ice cream factory must be pretty simple—to a fellow who worked on the production line. “Are you kidding me? You got all your different flavors, plus the ones with nuts or candy mixed in… it’s complicated!”

Like any field of endeavor, retirement planning has those who seek to impress with how complicated it is. But if you get just two simple things right, you can put yourself on the road to progress.

Your Savings Rate. The money you put away is the raw material of your future retirement. The first thing is to set aside money every payday. 401(k) plans make it easy, but you can do it with or without one. It seems like many people starting out cannot save 10% or 15% of their earnings—one needs to buy groceries and electricity, too.

But wherever you start, even at 1% or 4%, you can increase that 1% per year until you get to 15%. Or put half of any raise into the plan—if you get a 4% raise, add 2% to your contribution rate.

Your Long Term Strategy. Put your long term money into long term investments. Various investments offer short term stability or long term returns—but not all of both. If your retirement is decades away, investments that promise a stable value tomorrow or next year do nothing for you in your real life. You might aim for higher returns instead.

(Some people are unable to live with the ups and downs of long term investing. We aren’t suggesting that living with volatility is right for everyone. But if you require stability, you will probably need to save more in order to reach your goals.)

Clients, if you figured these things out long ago, you might pass this along to younger folks. To talk about these ideas or anything else, 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.

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