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In previous posts, I have referenced the philosophies and strategies of investment gurus like John Templeton and Warren Buffett. I want to explore further why the wealth management advice FIM provides is rooted in the best practices of these investing legends.
Thesis
The superior performance of proven private investors like Buffett and Templeton – and economic scholars like Benjamin Graham and Larry Ellison – can be distilled into a single, disciplined approach that captures the essence of their investment strategies. This approach is fortified by best practices that attempt to sustainably do one thing – maximize benefits by using the following investment tools:
- Diversification and concentration
- Conscientious security analysis
- A “price matters” orientation to capture excess returns
Money doesn’t manage itself. Asset allocation, diversification, security analysis and capturing excess returns don’t just happen. These tools require the “hands-on” management of a skilled, talented manager who can implement them with consistency and discipline, unencumbered by the four psychological poisons that can reduce investors’ returns.
Four Poisons
- Recency effect
- Endowment behavior
- Fear and inertia
- Narrow investment universe
These four poisons can create a “sell low and buy high” market pressure that compels undisciplined investors to deviate from their long-term strategies, thereby reducing their returns by a significant percentage (see FIM Group March and December 2008 newsletters – www.fimg.net).
Investing Without Borders
The next element of successful best-practice investing seems so empirically logical and rational, but nonetheless it should be mentioned. Simply, one should invest without arbitrary restrictions. Long-term success depends on the flexibility of an unencumbered investment approach that completely avoids, for example, a country bias, region bias, asset class bias, market cap bias, etc. The root of such restrictions is an attempt to simplify a complex universe of investment options for the sake of making the management process “easier.” I equate it to the modern approach of “dumbing down” investing – aka laziness.
Money Must Be Managed
Many approach investment management as a static system of indexing or passivity, but money doesn’t manage itself. Countries, companies, societies, consumers and all the elements that drive financial markets are dynamic and ever-changing. Consider, for example, the historic opportunities to preserve and create wealth – like in the U.S. in the 1930s, the early 1970s, 1999-2002 and 2008, and other worldwide events, like emerging Asia, emerging Europe, renewable energy trends and the technology revolution. Such periods have led to asset class booms and busts in real estate, oil, metals, currencies, bonds, interest rates, etc. The wild swings in prices, leading to opportunities as well as risks, are proof that passivity is a guaranteed way to lose, at worst, and have inferior results, at best.
Volatility Is Reality
Winter turns into spring, and spring turns into summer. Recessions lay the seeds of recovery. Booms will go bust, and busts will become booms. No one can “time” the markets, and successful long-term investing has one constant side effect: volatility. Understanding that volatility exists and is part of the successful investing landscape actually helps long-term performance; however, volatility can be uncomfortable, especially during manias resulting in market peaks and bottoms. A best-practice system sees opportunity in busts, bear markets, panics and other investor psychological extremes to apply careful security analysis, a price matters discipline and other sustainability and values-driven tools (e.g., patience, forward-looking analysis) to achieve favorable long-term investment returns. This approach will cause investors to invest “too early,” as no one can time a market’s recovery perfectly. As Warren Buffett said, “The Stock Market is designed to transfer money from the Active to the Patient.”
Risk Management
Attempting to time a market is a risky and wasted effort. When a market, asset class or investment is priced to imply a high expected return, it should be considered. Any historical market analysis concludes that it is better to be early than late. The S&P is the one asset index that has the most data available to test investment history. Using this resource, Jennison-Dryden, a division of Prudential, researched this “be early” sustainability idea. Their results are illustrated below:
Wealth Management Advice from FIM
Why is financial planning important? This chart tells the story.
More volatile markets tend to come out of bear markets with returns substantially in excess of those of the S&P 500. For example, the S&P Asia 50 index, which measures the four major markets in Asia, had returns from its bear market bottom on September 4, 1998, through September 3, 1999, of 123% in its first year of recovery. Missing the bottom and waiting three months to have invested in this index reduced the 12-month return by 43 percentage points to 80% for the period of December 4, 1998, to December 3, 1999.
Risk Management II
Risk management is embedded in best practices. It is not about volatility management alone, but rather about objectively looking at investments as tools. Portfolio management is about achieving goals, minimizing risks and maximizing potential. It is not about panic selling, going to cash or CDs when there is volatility, or trying to time the market. I have yet to find any research, book or study that champions CDs, money market investments or fixed annuities as anything other than meeting shortterm needs for cash. Nor can I find any credible evidence of a strategy emphasizing 100% cash or CDs as a portfolio strategy. Yet statistics show that today’s investors – despite the fact that the best valuations and the greatest opportunities in a generation are available – have more money allocated to CDs and cash than ever before in history. Again, the irrationality of investors’ behavior is driven by the four poisons.
Summary
2009 marks my 25th year of managing portfolios. 2008 was for sure our most challenging and disappointing year. We were obviously early, but I believe our disciplined approach is rational, appropriate and based on proven time-tested best practices. We have a history of success despite having basically matched the markets last year. However, we have not set aside our disciplines or thrown out history. Based on the irrational level of prices of the securities, I believe 2009 has the potential to be our best year ever–so far, so good. In year-end letters to clients, I have often chatted about “another good year.” I believe that 2008 will be looked back upon as laying the groundwork for many subsequent incredible years. I sincerely believe that future year-end letters will again end and begin with “another good year,” and quite possibly next year’s will begin with, “2009 was an incredible year”
To learn more please visit www.FIMG.net of call 800-632-5528.
