Dear friend and teacher Lance Roberts’ writings get my attention.
Admittedly, his work feeds my confirmation bias as we tend to agree on most topics, especially when it comes to stock market valuations, the macro-economic climate, reversion of averages and most important – the mistake of benchmarking a portfolio to a market index like the S&P 500 or as I call it:
“My brain and ego are both bigger and smarter than the market as a whole.”
Investment managers who claim to consistently beat the market also will boast how they’re above-average drivers, lovers, parents.
It’s this kind of performance-based thinking (or lack of it) that seduces investors to take portfolio actions based primarily on greed. Or fear. Most investors generate above-average returns, didn’t you know?
Until the math is done to prove how well below-average their returns are.
Some compare their lousy returns to a friend’s (embellished) performance and grow frustrated enough to place their risk tolerance aside and create portfolios which are too aggressive for their nature. At the first sign of market pull back I’ve watched these investors sell everything and ostensibly suffer unnecessary losses.
As people we are bigger than life in our own heads.
It’s that kind of myopic ego-based bullshit that can take over the mind of a money manager who then takes on more risk at the wrong time. And if your money manager is getting increasingly aggressive NOW, then this is the WRONG TIME.
And it’s with your money.
Lance’s recent piece 30% Up Years: The Case For “Cashing In” resonates with me.
The writing doesn’t need explanation – it’s perfect as is. It requires an awareness. The messages shouldn’t be minimized even though we are in a favorable market environment which is based in part on seasonal factors along with money managers’ desire to play “catch up” on returns as they close out the year.
In other words, we have moved beyond fundamentals into momentum territory. Just be aware!
It’s ok to participate if you understand what’s driving stock returns. If you believe it’s primarily fundamentals, you should stay out now. Stick with short or ultra-short term bonds and go live your life. Be happy.
Don’t fool yourself.
At this later stage of a cyclical bull market, self-denial, hubris and financial industry media will get you in trouble.
Investors and their financial partners must remain vigilant of risks of markets drunk on unprecedented Federal Reserve policies and publicly-traded corporations who continue to book record profit margins by treating employees like indentured servants.
In case you’ve been under a rock: Corporations survive solely to placate shareholders and buy back shares.
Employees and customers have limited influence on senior management. It’s worse since the financial crisis.
As former U.S. Secretary of Labor Robert Reich lamented recently through social media:
A few decades ago, when American companies were still American and when corporate profits still bore some relationship to the wages of most Americans, the nation fretted over the “competitiveness” of U.S. corporations. But now that the stock market has gone through the roof while most Americans are in the cellar, that old worry seems a bit quaint. For example, Walmart, America’s largest employer, …is highly competitive internationally. Yet it claims it can’t afford to pay its U.S. workers more than the miniscule wages it doles out to them. The claim is dubious. According to data compiled by Bloomberg, Walmart has bought back about $36 billion of its stock over the past four years, and in June announced another $15 billion of stock repurchases. The effect is to bolster the value of the remaining shares of stock.
Corporations will overwork labor and continue to perpetuate wholesome corporate philosophies driven underneath by limited vision, anemic research and development, and an ongoing fear that’s pumped into the brains and hearts of their employees.
The message by middle management remains pervasive: “Be thankful you have a job,” is still heard in meetings (I’ve asked. I know). The words are considered “motivation.”
Unfortunately, many workers are too frightened to leave or are saddled with too much household debt so they continue to languish in their soul-sucking corporate positions.
Perhaps your employer is different.
Hey, as a money manager, I love it!
It’s one of the reasons, even though I’m cautious, that markets can continue to do well through the end of the year and first quarter of next.
At this mature stage of a cyclical bull market, it’s important to avoid allowing your hubris to go haywire. Don’t believe you’re just so damn good, your next goal should be to “beat an index.”
Here are Lance’s rules as to why it’s impossible (along with my commentary); I’ll add three ways to let keep yourself in check as markets eventually revert to a mean:
“While Wall Street wants you to compare your portfolio to the ‘index’ so that you will continue to keep money in motion, which creates fees for Wall Street, the reality is that you can NEVER beat a ‘benchmark index’ over a long period. This is due to the following reasons:
1) The index contains no cash. And you should always have cash. Cash is an asset class, cash is for withdrawals, cash is the ultimate diversification, cash is there to make attractive purchases.
2) It has no life expectancy requirements – but you do. Stocks for the long term? Can you wait 30 years to break even when you purchase at lofty valuations? NO.
3) It does not have to compensate for distributions to meet living requirements – but you do. You also should maintain two years worth of distributions aside for living expenses in retirement.
4) It requires you to take on excess risk (potential for loss) in order to obtain equivalent performance – this is fine on the way up, but not on the way down. Losses are tougher to make up. If you lose 50% you’ll need 100% to get back to even.
5) It has no taxes, costs or other expenses associated with it – but you do. If you invest you’re gonna have fees, commissions. There is no free lunch when it comes to expenses.
6) It has the ability to substitute at no penalty – but you don’t. Commissions, taxes will drag on returns.
7) It benefits from share buybacks – but you don’t. On occasion you benefit from a stock that now has better EPS due to buybacks, however, there’s no consistency to this for you.
In order to win the long term investing game, your portfolio should be built around the things that matter most and beating an index isn’t one of them. It’s great for cocktail party conversation around holiday season, but that’s about it.
Here’s what’s important. Never forget:
* Capital preservation (A lost opportunity is more easily replaced than lost capital).
* A rate of return sufficient to keep pace with the rate of inflation.
* Expectations based on realistic objectives. (The market does not compound at 8%, 6% or 4%. Losses destroy the effects of compounding returns).
* Higher rates of return require an exponential increase in the underlying risk profile. This tends not to work out well.
* You can replace lost capital – but you can’t replace lost time. Time is a precious commodity that you cannot afford to waste.
* Portfolios are time-frame specific. If you have 5-years to retirement, but build a portfolio with a 20-year time horizon (taking on more risk), the results will likely be disastrous.
Three ways to avoid losing your ass, right now:
1). If you must commit capital to stocks 5 years after the financial crisis, go SMALL. Let’s face it: You missed the big ship. Go for the dinghy and be happy. Keep your stock allocations below 50%. Keep the rest in short term fixed income or yes, cash.
2). Work with an advisor who will calculate your required return. To meet a personal benchmark. THEN WORK BACKWARDS into the asset allocation plan. Most financial consultants are there to sell you product, not to calculate your desired return. And remember generating return takes work on your part, too – Increased savings, lower debt-to-income household ratios. working longer. There’s no sexy magic here. If you’re being sold an investment first: WALK.
3). Now is the time to stop listening to friends and family about stocks. The extremes in sentiments will confuse you. Aunt Millie sold out in 2009 and won’t go back. She’s awaiting the “big one,” the crash. Joe went “all in” two years ago and is up a billion percent. There’s a happy medium. Cut the noise. Create rules, work the numbers. Understand where you are behaviorally when it comes to risk. Does your adviser assess you behaviorally or utilize some bullshit risk tolerance questionnaire which tells you nothing about yourself.
Pay the 40 bucks, take the test and bring the results to your advisor. Most likely, you’ll need to do this before you sit with a financial pro.
As Lance writes so perfectly: “The index is a mythical creature, like the Unicorn, and chasing it takes your focus off of what is most important – your money and your specific goals. Investing is not a competition and, as history shows, there are horrid consequences for treating it as such.”
Be thankful for good advice this year.
Know your limitations.
Accept who you are from a risk perspective.
Work with an objective financial partner who listens to you.
And get your ego out of your portfolio.