Author - Prashant Vaishampayan

Nick Maggiulli writes on his blog about “Winning the Loser’s Game” a book written by Charles Ellis.  In the book, Ellis describes what he calls “winners’ games” and “losers’ games”: In a winner’s game, the outcome is determined by the correct actions of the winner.  In a loser’s game, the outcome is determined by the mistakes made by the loser. Ellis then goes on to explain that investing is a loser’s game because most investors who attempt to beat the market (i.e. those who try to win) typically underperform in the long run.  For example, using excessive leverage or paying high fees for expected outperformance are two common ways in which would-be winners become definite losers.

The better strategy for investors then is not to try and win, but to not lose.  Too many people in the financial community obsess over the “optimal” way to invest when their time would be better spent steering clear of actions that could lead to ruin. Warren Buffett said it best in his 2005 Berkshire Hathaway letter to shareholders: Over the years, a number of very smart people have learned the hard way that a long string of impressive numbers multiplied by a single zero always equals zero.

The warning from Ellis and Buffett alike is crystal clear: avoid the zeros.  Avoid them at all costs. Why?  Because the zeros are those things that can set you back years or decades in an instant.  What are “the zeros” exactly? In the investment world, the zeros are usually things associated with high costs (i.e. fees, taxes, extravagant spending, etc.) or high risks (i.e. leverage, concentration, etc.).  All of these things, if not managed properly, can wreak havoc on your finances.

As the saying goes, “Play stupid games, win stupid prizes.”  So don’t play.  Not even once.

Ben Carlson reminds us on his blog that regardless of the start date, this bull market in US equities has been relentless. Agreeing on the start date may be semantics, but we can all agree that pinpointing when it ends is impossible to do in advance. Until that day comes, here are some reminders about investing during bull markets.

Bull markets make you feel smarter the general direction of the market can toy with emotions by magnifying how we feel about our investing abilities. When stocks are going up it can make you feel like a genius just as when stocks are going down it can make you feel inept. Legendary investor Bernard Baruch offered some advice on this point: “Become more humble as the market goes your way.” Confusing brains with a bull market can be a costly mistake because bear markets don’t care how well you did when markets were going up.

Two things to remember Bull markets can last longer than you imagine. Secondly, even bull markets aren’t easy. They don’t keep going up in one direction. There can be a significant decline in share prices before the bullishness returns testing an investor’s patience and resolve.

Bull markets can lull investors to sleep Bull and bear market volatility in the stock market tends to look very different. You would assume bull markets are overflowing with big up days while bear markets consist of mainly big down days but that’s typically not how it works. Bear markets are full of both big down and big up days as volatility tends to cluster. When markets are going down volatility goes up, but it does so in both directions. Bull markets, on the other hand, are slow and methodical.

The methodical nature of bull markets is one of the biggest reasons we see overreactions during the inevitable bear market to follow. Markets that slowly go up blind investors to the fact that sometimes they also go down. And those overreactions are amplified by the fact that no one knows how long the music will continue to play.

Carlson advises investors to enjoy the bull market while it lasts. Just know it will take a pause at some point and when that happens many investors will sell first and ask questions later.

Jon writes about this on his blog. When? That’s what everyone wants to know. The answers to why a bull market ends come pouring in the second the when is confirmed. But the explanations why are usually complex. They certainly won’t help anyone predict the next turn. They’re often secondary, or scapegoats, to what really happened.

Peter Bernstein offered a simple answer to what triggers the end of all bull markets: What was the secret ingredient that kept investors buying and buying at higher and higher prices? Was it the myths that this market, like all bull markets, created to justify itself? Although the myths helped keep the pot boiling, the basic explanation for the bull market’s longevity and vitality in the face of so much economic difficulty is simpler, more fundamental, and more easily generalized. The same simple, fundamental explanation applies to the bull market’s sorry end as well.

The common thread that runs through all equity bull markets is confident expectations of higher earnings ahead. The common thread that ties the onset of all bear markets together is the loss of those confident expectations of higher earnings ahead. History shows us, over and over, that bull markets can go well beyond rational valuation levels as long as the outlook for future earnings is positive.

Bull markets require economic slack so that companies can grow, and positive trends in real business activity to take advantage of that slack. Remember, stock prices show no consistent relationship with interest rates, exchange rates, inflation rates, budget policy, monetary policy, or any of the other things professionals love to discuss. These forces matter only when they matter to the future movement of corporate earnings. Those same irrational valuations that seem to defy gravity spur the “myths” that get investors into trouble. The big mistakes — overconfidence, trivializing risk, chasing returns — can leave investors under-protected for what inevitably comes next. Overpaying for (optimistic) future earnings never ends well.

Jon concludes that the important thing is to recognize the role confidence has on market prices and the obvious risk of getting caught up in the excitement.

Jeremy Walter writes that perhaps one of the most confusing word we use in finance – and perhaps in life in general – is risk. We are reminded of the different types of risk that investments are subject to market risk, strategy risk, small company risk, turnover risk, limited market risk, concentration risk, interest rate risk. We have risks in life that we commonly insure against. Our homes burning down. Our vehicles being totalled. Our physical ability to earn income. Us or loved ones dying earlier than expected. Healthcare and medical expenses. We have risks that we don’t think about as frequently. Inflation risk. Longevity risk. Income stability risk. Legal liability risk. And these are just the financial types of risk in our lives.

But what is the risk? Oftentimes people define it as the loss of something – which is true but perhaps doesn’t capture all dimensions of it. Walter thinks the risk is simply the chance that something doesn’t go according to plan. And if we accept that, then we need to accept the fact that our plans – financial and non-financial – need to be flexible and need to be able to adapt. In addition, the more complex the situation, the more different, independent risks and variables are involved.

We just acknowledge that risk is the price of admission to anything worthwhile. There are some types of risk that you can insure against. There are other types that you can diversify against. And there are other types you simply can’t do anything about. It’s virtually impossible to eliminate all risk. And that’s ok. As long as we’re aware of it, and we recognize the importance of flexibility. So again – the risk is three things. Risk is (1) a part of life that (2) accounts for things not going according to plan, but (3) is the price of admission for achieving anything worthwhile.

And once we realize it, maybe the risk isn’t as scary – nor as difficult to define – as we think.

Tadas Viskanta writes on his blog that investing is to a large degree a solved problem. We know, by and large, what works and mostly what doesn’t. But that doesn’t mean that everyone should invest exactly alike. Don’t let anyone tell you otherwise.

Why? Because we all have unique situations, differing histories and wildly varying risk tolerances. Constructing an efficient portfolio today is straightforward. Humans are not. Dialling in a portfolio in sync with our risk tolerance is no small feat.

There are as many solutions as there are people. For some people holding more cash than can be reasonable is a way to sleep better at night. This may not jibe with most models but it works for them. For others, 100% equities are perfectly reasonable. For other people kicking the cash habit is really difficult.  So long as the products are low cost, transparent and risk-appropriate for the end-user. Who are we to judge?

The point is there is no perfect way to invest. Just as there is no perfect way to parent. Everyone parent, child and situation are different. Parenting like investing requires consistency and care, not perfection.

Have you made some mistakes getting to where are you are today? Everyone has. Nobody hits on an investment strategy that works for them right out of the gate. Even if they did it would have to change with them over time. As Kristine Hayes at Humble Dollar writes: As with most things in life, there’s no “one size fits all” solution when it comes to finances. Rather than questioning the decisions I’ve made in the past, I’m beginning to appreciate the things I’ve done right.

Tadas Viskanta reminds us to be grateful for how you got here, because something will change. Soon you will be off in a different direction, figuring things out as you go.

“The best strategy is the strategy you can stick with through thick and thin. That will differ for all investors.” – Wes Gray founder Alpha Architect, an asset management firm