Investment Decisions in Haste – Is a Waste of Time
Recently in an Investment Committee discussion we reviewed a client portfolio with the wealth advisor who manages the relationship and verbalized a set of statements that had elevated itself to his direct interaction.
- We’ve been going along for almost two years now and I’ve made no money in my portfolio.
- My returns have been basically zero. Something must be wrong.
- Shouldn’t you change something?
- How long do I have to take this?
The Real Issue
Those four statements summarize a common feeling of fatigue that many investors encounter in their portfolio management journey. The question is especially relevant at the moment since we are in such a period. Most importantly, these questions bring into focus an important behavioral management risk – allowing short-term difficulties or setbacks to undermine what is actually a sound long-term game plan for a family’s wealth. Our desire as humans is to see steady and constant reinforcement of our efforts to reach longer term goals. This is how we are wired. However, our desire for steady affirmation is frequently in conflict with what experience and history teach us about investing and therefore where our attention should actually be focused.
The Long-term Plan
Most of our clients have multiple financial goals, but there is one common thread that touches almost every family relationship we have without exception. Most families share a goal of maintaining wealth to support them at a point in time they are without a paycheck from working. It takes two forms.
- This might be a very current goal, because the time for this retirement has already arrived and the family is indeed living off their capital. The principal motivation for the client in this situation is to ensure that they do not outlive their money.
- Or the goal might be somewhat distant. This is the case for the working family that is currently earning sufficient income from working to support themselves, but also are saving for their future. They desire to accumulate sufficient capital by a certain age to be in a position to give up the paycheck without fear of subsequently running short of money.
Two orientations to the same goal, but either way, the family is defining a long-term goal that involves investing over many years and generally multiple decades.
For this reason, most clients engage in a discussion about portfolio sustainability and necessary returns to meet these goals. In many cases, we’ve prepared cash flow projections and tested them with some form of Monte Carlo testing to form a more educated judgment about the probabilities of success in attaining those goals. This testing does two things.
- It allows us to formulate a well-reasoned recommendation for an investment policy that has a high likelihood of attaining the long-run goal. We can then design a combination of investments in the financial markets that have historically provided very acceptable returns.
- It addresses a reality: investing in the financial markets (stocks and bonds) involves committing capital to markets that fluctuate. While these markets have historically provided very attractive returns, those returns are not constant and certainly not uniform year-to-year. In some years and for even extended periods of time, in fact, the returns are likely to be negative.
A simple analogy will illustrate. One can think of this like embarking on a long car trip for a two week vacation. You might have a list of places you desire to visit (the goals), but you likely begin the process by consulting the navigation program to ascertain if it is realistic within your time limits to complete your desired trip. With modern navigation programs, you will likely receive notice warnings about certain hazards along the way — construction delays, detours, road-closings, etc. These will create inevitable obstacles along the planned route, but your navigation program has allowed for them and calculated the time it will take to hit all your planned stops, even considering these detours and delays that will be encountered.
If you leave your navigation program at home and embark on the trip using only your memory about the route, you will very likely forget about some of the inevitable slow-downs and hazards and might be tempted to start “winging it” in some ad hoc fashion. If you do this, there’s a good chance you will end up lost, and you may run short of time, not reaching all the destinations on your schedule. (We have all probably experienced the regret of exiting from the freeway during a traffic back-up, attempting to use side streets to avoid the delay. More often than not, when we return to the main freeway route, we conclude we would have been better off staying on the original plan and simply exercising patience during the back-up.) In summary, it is a good idea to maintain focus on the planned route, including even its allowance for obstacles along the way.
The application of the analogy to portfolio management should be readily apparent. If you’ve properly planned your investment policy to attain the desired long-term objective, remember that your planning, if done right, has already taken into account, the likely delays and obstacles which will be presented as part of normal financial market behavior. Unless your core objectives and goals have changed, it will almost always be a mistake to begin deviating from your game plan in the interest of the short-term desire to “do something” in response to the market.
Doing Well Over Time versus Doing Well at Every Point in Time
Warren Buffet’s annual Chairman’s Letter in the Berkshire Hathaway annual report has become widely read, perhaps more so than that of written by any other CEO. At the end of 2013, he wrote the following to shareholders:
“Over the stock market cycle between year ends 2007 and 2013, we out-performed the S&P. Through full cycles in future years, we expect to do that again. If we fail to do so, we will not have earned our pay. After all, you could always own an index fund and be assured of S&P results.”
What Mr. Buffet did not point out in his statement is that in 4 of those 7 calendar years, Berkshire Hathaway’s performance was short of the return provided by the S&P 500. Nonetheless, the tally for the full seven years ended comfortably ahead of his benchmark.
This little anecdote from one of the world’s best known and respected stewards of financial capital reminds us that the long-term result matters, and in fact typically requires patience through short term periods that prove distinctly unsatisfying.
This truth applies to more than just shares of Berkshire Hathaway. Here are some simple mathematical facts regarding investing in stocks, from 1937 to 2015, a period of almost 80 years:
- Using the first day of every calendar month as a possible starting point, during this 78-year period, there are 829 distinct 10-year periods where you could have invested in the 500 companies making up the S&P 500 Stock Index.
- Of those 829 possible periods, there are only 24 possible starting points (about 3 percent of the time) which turned out to be a 10-year period where you would have failed to make money. So, the odds were heavily in your favor to have a positive result; in fact, you had to be pretty unlucky to pick one of the losing periods as the starting point.
- On average, your annual return during those 829 possible 10-year periods was about 11.2 percent.
- That data confirms the truth in the premise that if you are investing with a goal that spans a decade or more, stocks should almost certainly be a meaningful part of your strategy.
- However, before we get carried away with the attraction of that double-digit return, let’s notice that our market “navigation” program revealed some other important information.
- Within that same 78-year span, there were actually 181 times that you would have endured a 2-year period with a return of 0 percent or less.
- Returning to our travel analogy, therefore, you can look at it this way. The planned route was 97% likely to accomplish the goal you set on day one. Nonetheless, about 20 percent of the “trip” was characterized by stalled traffic, construction delays, or outright detours which caused you to double back and cover the same ground twice.
The Bottom Line
What is the important take-away from this? We believe two things…
First, do not allow short-term pain or fatigue with the “traffic” in the financial markets to challenge your patience and force you off the planned route. Succumbing to fatigue is likely to prevent you from arriving on time at your planned financial destination.
Second, keep perspective about your own likelihood to attain long-term success through frequent short-term changes in strategy. If Warren Buffet does not choose to make short-term trades, the rest of us financial “mortals” should probably muster sufficient humility to admit that we are unlikely to outsmart the Sage of Omaha.
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Linscomb & Williams does not provide legal, tax or accounting advice. The information, analysis, and opinions expressed herein are for general and educational purposes only. This presentation may contain forward looking statements that may or may not occur. Nothing contained in this presentation is intended to constitute legal, tax, accounting, financial, or investment advice. Always consult with your independent attorney, tax advisor, and other professional advisors before changing or implementing any financial, tax or estate planning strategy.
Information expressed herein is based upon opinions and views of Linscomb & Williams and information obtained from third-party sources that Linscomb & Williams believes to be reliable, but Linscomb & Williams makes no representation or warranty with respect to the accuracy or completeness of such information. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.
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