Quarter 1 - 2018Preparation, Predictions, Grocery Shopping and Perfume
“Spectacular achievement is always preceded by unspectacular preparation” – Robert H. Schuller
“Preparing to be successful is only as good as how successfully we prepare.” – lou pelz
This is the time of year when we hear countless numbers of so called experts speak about the future. We will hear examples from people trying to extrapolate short term social and economic trends into the coming year with the hopes you will follow their advice. These experts will be strategically placed by their publicist in prime-time locations and moments in both print and TV media. This in effort to make the audiences believe they are knowledgeable and reputable. It has been my experience most predictions are made with author knowing tomorrow why the things they predicted yesterday did not happen today. Predication may have lady luck on his or her side in the short run, the long run will reward those who are prepared for all outcomes. This preparation is centered on two primary beliefs. Analyzing a large database of historical information gathered from reputable and verifiable sources and ignoring the subjective and intuitive arguments made by those appealing to our emotional biases. Fred Schweb, a Wall Street wit, declared that difference between investment and speculation could be separated because the first aim of investment was the preservation of capital while the primary aim of speculation was the enhancement of fortune. The goal of this letter is to help the reader recognize the difference between speculation and investment.
This morning as I was walking through my local grocery store it reminded me of a quote from Benjamin Graham in his book The Intelligent Investor, “most people buy stocks like a woman purchasing perfume when they should be investing in stocks like a person shopping for groceries.” Examples of this powerful insight are revealed almost daily. How often do we see a celebrity endorse a product with the hopes of consumers projecting the popularity of the celebrity to their product? The marketing companies are hoping consumers will make a popular emotional decision and not a rational one. The same holds true for brokers pitching investment ideas. Look at the style of TV commercials for different brokerage houses and mutual funds. They usually have some middle aged attractive man or woman listening intently to a client from a well adorned office while guiding them to a blissful retirement. Hoping you will project yourself into the same image. This is what is commonly referred to as perfume shopping. Successful investing is finding the best value for your dollar. Investing is comparable to finding which grocery store has the best price on eggs, meat, bread and other household items. Common everyday items which consumers have purchased for a long time and will continue to purchase in the future. Items, when purchased in the proper combination, will lead to healthy and joyful home. Sure, there will be stocks which we wished we would have bought. Bitcoins which we wished we owned. There will always be the tendency to want something which is fast, rewarding and easy. We would all like to dream about owning the big lottery ticket. These desires should always be tempered by the big picture along with the emotional stability and discipline to follow the investment principles which have stood the test of time.
Deciding on an investment strategy is as personal as each person’s fingerprint. The difference is, unlike a fingerprint, a person may need to change their strategy as their life may go through either tragedy or good fortune. It has always intrigued me why something as important as a family legacy or a lifetimes worth of savings would be placed in a mutual fund designed for thousands of people. As they would be just as well served buying and index fund and reducing their cost. When choosing a strategy each person should ask if they are ready to accept the unexplainable changes in market prices. The reason the stock market has had a return of above eight percent and U.S. Treasury bills have been approximately three percent is due to these unexplained changes. This is commonly referred to as the risk premium. Deciding how much of this risk premium to take will depend on each person’s emotional and financial situation. Since 1950 we have seen three market downturns of 40 percent or more, thirteen corrections of 25 percent and 83 corrections of 10 percent*. Corrections will come. Deciding what percentage of the downside risk to take is the first part of establishing your investment strategy. The second part is to ask how your investment managers style will give you the best return for market risk you are willing to take. The third part is to ask how that investment style has performed over a long time series of data. The fourth part is to have a transparent method for making sure the investment manager has the discipline to maintain the agreed upon style through different market cycles. We have had an inordinate length of time since our last correction. Corrections do provide opportunity. When stocks prices are driven to irrationally low prices due to behavioral biases value can be purchased at very cheap levels. Corrections are welcomed by the intelligent investor. Corrections allow for the intelligent investor to increase their market risk with higher margins of safety. The success lies not in predicting the correction as in the preparation for the correction.
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