Weekend Reading

Ben Carlson reminds us that there has never been a better time to be an individual investor than right now. And things are only going to get better from here. The problem with having all of these options available at your fingertips is that it’s never been easier to experience Fear of Missing out (FOMO). FOMO brings about a lot of emotions — greed, envy, regret — that make it difficult to make level-headed decisions with your money.

So here are some things Carlson reminds himself when markets go crazy to put things into perspective:

1. There is no such thing as a normal market. Uncertainty is the only constant when investing. Get used to it.
2. The most effective hedge is not necessarily an investment strategy. The best hedge against wild short-term moves in the markets is a long time horizon.
3. Your gains will be incinerated at some point. Investing in risk assets means occasionally seeing your gains evaporate before your eyes. Carlson says he doesn’t know why and he doesn’t know when but at some point a large portion of his portfolio will fall in value. That’s how this works.
4. You still have a lot of time left. Carlson says he is still young(ish) with (hopefully) a number of decades ahead of him to save and invest. That means he is going to experience multiple crashes, recessions, bull markets, manias, panics and everything in-between in the years ahead. The current cycle won’t last forever just like the last one or the next one.
5. Know yourself. One of the biggest mistakes you can make as an investor is confusing your risk profile and time horizon with someone else’s. Understanding how markets generally work is important but understanding yourself is the key to successful investing over the long haul.
6. There’s nothing wrong with using a “dumb” strategy. Buy and hold is one of the dumbest investment strategies ever…that also happens to have the highest probability of success for the vast majority of investors. There’s no shame in keeping things simple.
7. The crowd is usually right. Being contrarian will always make you feel like you’re smarter than everyone else, but the crowd is right more often than its wrong when it comes to the markets. Yes, things can get overcrowded at times but being a contrarian 100% of the time will lead you to be wrong far more often than you’re right.
8. Markets don’t end. For years pundits have been proclaiming I’ve seen this movie before and it ends badly. Well, guess what? Markets don’t end. Yes, some companies fail but most of them keep right on chugging along, selling products and services, making profits and paying dividends. And the stock market isn’t going out of business anytime soon. No one knows how this movie ends because there will always be another sequel.
9. Anchoring is dangerous. Whenever there are huge moves in the market it becomes tempting to play the anchoring game. What if I would have bought at the lows? What if I would have sold at the highs? No one is able to consistently get in at the bottoms and out at the tops. Hindsight makes it look easy but it never is at the moment. Buying when something is falling is hard to act on because it always feels like it’s going lower while selling when something is rising is easy but most of the time you’re wrong.
10. You don’t have to be bullish or bearish at all times. Focusing on your own goals can release you from the need to always have an opinion on the next move higher or lower.
11. You don’t have to invest in everything. Sometimes the stuff you don’t invest in is even more important than the stuff you do invest in. It’s never been more important to have filters in place to guide your actions.
12. Don’t worry about what everyone else is doing. There will always be someone getting richer than you in life and the markets. And with the advent of social media, that means people throwing this fact in your face constantly. This one is not easy but defining what a rich life means to you can help avoid unnecessary envy and regret.

As equity markets around the world reach a new high, investors need to remember a few things about the bull markets. Here are some comments made by famous investors who have seen many bull and bear markets in their careers.

“Bull markets ignore bad news, and any good news is a reason for a further rally.” Michael Platt

“Gresham’s Law says that the bad money [paper] drives the good money [specie] out of circulation; this accurately describes human behaviour when people are confronted with a cost-free choice. I now believe this accurately describes people’s choice of investment philosophies, especially late in a bull market, when the sloppy analysis drives out the disciplined assessment, and when the grab for return overwhelms the desire for capital preservation.” Seth Klarman

“The longer the bull market lasts the more severely investors will be affected with amnesia; after five years or so, many people no longer believe that bear markets are possible.” Benjamin Graham
“In investor behaviour, particularly during the last stages of a great bull market, perception of risk and actual risk are at opposite ends of the spectrum.” Leon Levy

“People tend to forget about the importance of the price they pay as the experience of a bull market just sort of dulls the senses generally.” Charlie Munger

“Once a bull market gets underway, and once you reach the point where everybody has made money no matter what system he or she followed, a crowd is attracted into the game that is responding not to interest rates and profits but simply to the fact that it seems a mistake to be out of stocks. In effect, these people superimpose an I-can’t-miss-the-party factor on top of the fundamental factors that drive the market. Like Pavlov’s dog, these ‘investors’ learn that when the bell rings – in this case, the one that opens the New York Stock Exchange at 9:30 a.m. – they get fed. Through this daily reinforcement, they become convinced that there is a God and that he wants them to get rich.” Warren Buffett

“The further you get away from a bear market, the greater the number of people who have convinced themselves they can handle the downside – until the next time, of course. In the interim, if the indices are performing well, then you can bet that many investors – individuals and professionals, alike – are going to feel pressure to do whatever they can to ride the bull.” Steven Romick

“Never confuse genius with luck and a bull market.” John Bogle

“In a bull market, it is advisable to restrain one’s greed. There is an old wall street saying, ‘The bulls make money, the bears make money. But what happens to the pigs?’. You can’t make 101 per cent. You shouldn’t even strive to make 100 per cent. Your goal should be 66.6% of a big move. Get out and then reinvest in something that has been newly studied.” Roy Neuberger

“It’s just the nature of a rip-roaring bull market. Fundamentals might be good for the first third or first 50 or 60 per cent of a move, but the last third of a great bull market is typically a blow-off, where the mania runs wild and prices go parabolic.” Paul Tudor Jones

“Common stocks should be purchased when their prices are low, not after they have risen to high levels during an upward bull-market spiral. Buy when everyone else is selling and hold on until everyone else is buying — this is more than just a catchy slogan. It is the very essence of a successful investment.” J Paul Getty

“Very early in my career, a veteran investor told me about the three stages of a bull market. Now I’ll share them with you. The first, when a few forward-looking people begin to believe things will get better. The second, when most investors realize improvement is actually taking place. The third, when everyone concludes things will get better forever. Why would anyone waste time trying for a better description? This one says it all. It’s essential that we grasp its significance.” Howard Marks

Source: http://mastersinvest.com/bullmarketquotes

Coined by Carl Richards, “the behaviour gap” refers to the difference between smart financial decisions versus what we actually decide to do. Many people miss out on higher returns because of emotionally driven decisions, creating a gap — “the behaviour gap” — between their lower returns and what they could have earned had they not made an emotional decision.

What Causes the “Behavior Gap”?

#1: Excitement From Good Markets/Good News Many investors may feel tempted to increase their risk or capitalize on rising stocks when stocks are moving higher (aka ‘performance chasing’). This can lead to investors constantly readjusting their portfolios as the market moves higher. An investor who follows such patterns is likely to do the same with declines. This is a clear form of trying to time the market. Trying to consistently nail tops and bottoms in the market is a fool’s game.

#2: Fear From Bad News/Bad Markets As a response to COVID-19 and the market volatility that ensued, we saw a lot of investors flee to safer investments or move out of the market completely. All-in or all-out decisions in the market is hardly ever a good idea and caused investors to miss the subsequent recovery. When stocks are low, a common response may be to sell and effectively miss out on potential long-term gains.

#3: Trying to “Beat the Market” Many investors seek the help of a financial advisor to achieve above-average returns and “beat the market”, otherwise known as “alpha.” However, in this search for “alpha,” our humanness — our emotions and our behaviours — may cause us to do the exact opposite.

#4: Focusing on the Day-to-Day Sometimes it’s hard to focus on the bigger picture when things are running haywire in the short-term. It’s easy to get caught up in “today” and lose sight of “tomorrow”. However, making a rash decision can inhibit the long-term benefit that comes from maintaining a balanced perspective without reactionary behaviour. Your investments will thank you for trying your hardest to keep the end game in mind.

How to Not Fall Victim to the Behavior Gap
The stock market is going to go up. It’s going to go down. For long periods of time, the market will seemingly go nowhere. All of these are okay. In regards to the current crisis of COVID-19, many aspects are out of our control, but one thing we can control right now is how we handle our financial strategy. If you’re experiencing financial anxiety in response to the pandemic or potentially the presidential election, take a breath. Remember the potential for long-term gains. Of course, you can and should always reach out to your advisor for further clarification and reassurance.

Edwin Lefevre is most well-known for his classic book “Reminiscences of Stock Operator”. His talent was turning Wall Street stories and anecdotes he collected over the years into lessons on human nature. He pointed out the errors that plagued investors throughout the market cycle. He covered market history, uncertainty, probability, and he even dabbled in a little value investing. It turns out, Lefevre had a way with words. Below is a collection of his wit and wisdom.
1. All booms are alike. The stage setting varies, but fundamentally they are as drops of water. Customs, like costumes, change from the force of environment and economic conditions, but human nature remains the same.
2. The stock ticker knows more than everybody. It deals with results. It satisfies your cravings for action. It makes life worth living. And when it says that you are an ass, it convinces even you of it.
3. A man who has bought a stock against the advice of a conservative broker, and has doubled his money in a fortnight, finds his suspicions turned into convictions by that impartial judge, the stock ticker.
4. Knowledge, indeed, is the enemy of a speculator during a boom.
5. It is one of the maximums of speculation that stocks never go up, but must be put up.
6. After many years of studying Wall Street’s victors and victims, I must conclude that the American public still insists on losing its savings every time the old hook is baited with the immortal easy-money worm. After every smash, the blame is laid on the hook and not the hunger. In reality, the fault is seldom with the machinery of speculation and is usually with the psychology of speculators.
7. The higher the price goes, the less desirable the investment becomes as an investment.
8. Buying stocks of prosperous concerns may be good business — but only at a certain price. But if you will make sure you know what you are getting for your money, you will be doing what nobody does in a bull market.
9. You know that nine out of ten people who talk about the market talk about their profits. They crave applause for their cleverness.
10. From hardship to comfort, the gap is a million miles wide. From comfort to luxury, the step is only four inches long. Ask any man who has made easy money.
11. It is not the certainty of disaster ahead but the uncertainty of better days to come that keeps the investor from buying.
12. It is only fair to admit that the commonest and most expensive blunder that all exceptionally brilliant businessmen make is being right too soon.
13. Within obvious bounds, the average investor’s most valuable adviser is fear; not the panic variety but the kind you call caution or conservatism, for, after all, prudence is a wise and desirable fear if it smothers greed.
14. Consider investments of every period in history and you will find that a great adverse factor has always been the change, which is something nobody can prevent.
15. “Easy money” means only one thing when it means money that has come easy: It means the money goes even more easily than it came.

Source: www.novelinvestor.com

Portfolio Turnover – Investopedia describes portfolio turnover as a measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by taking either the total amount of new securities purchased or the number of securities sold (whichever is less) over a particular period, divided by the total net asset value (NAV) of the fund. The measurement is usually reported for a 12-month time period.

Ian Cassel writes that he believes there is an over-glorification of buy and hold investing among active managers. With the rise of private equity and venture capital, everyone is trying to invest in public markets with the same permanent capital mantra. The lower the turnover, the more cerebral and thoughtful you appear to be with initial investment decisions. Nothing looks better than being right from the very beginning. More often than not, low turnover is shown as a badge of honour. Many investors feel great pride and joy being a loyal shareholder of a company. It feels good to say you’ve held a company for 5-10-20 years. But in reality, what really matters is performance.

A big part of what made many investors great was spotting when they were wrong quicker. Successful stock picking isn’t just picking winners. It also means picking out the losers in your portfolio. The greatest advantage in public markets is “You can sell”. But you have to know when to sell.

We normally sell a position for three main reasons: Sell when the story changes for the worse; Sell when we find something better; Sell when a company gets very overvalued.

Investors aren’t going to be right all the time. Acknowledging this fact isn’t a justification for not doing upfront due diligence. What we do acknowledge is that we are willing to accept a degree of uncertainty for the sake of speed – getting in early. Often, an opportunity is an opportunity because the conditions aren’t perfect yet. The price of certainty can be expensive as it relates to discovery and valuation. When we find a business that aligns with what we like – speed is more important than certainty.

Our initial due diligence might get us into a position, but it is our maintenance due diligence that will keep us invested and/or save us from big losses. Our future returns are based on our ability to course correct and adapt to new information. We are going to have turnover because turnover is the price of progress.

Sometimes when you sell you have gained and sometimes you have losses. Cassel says he learned a long time ago to not let small losses bother him. A big part of being a successful investor is your ability to admit when you are wrong on a company while not letting it crush your confidence and slow you down.

Michael Batnik writes to debunk something that is probably common in a lot of people’s minds. An advisor cannot beat the market any more than you can. If you find an advisor who happens to deliver higher returns once adjusting for risk, then consider yourself lucky. But if that’s your expectation going into a new relationship, then sooner or later you’re going to be disappointed. So if you can’t beat the market and neither can an advisor, then why even bother? Because an advisor can tell you the most important thing. Am I going to be okay? Can I live the type of life I want to live? That’s it. That’s the job.

If you’re not sure you’re ready to have this question answered, below is an incomplete list of ways to know when the time is right.

When You Made A Big Mistake: You know you need to take your hand off the steering wheel when you can no longer be trusted to get to your destination. Past behaviour is the best indicator of future behaviour. We can learn from mistakes, but you pretty much are who you are. If you panicked last time and convinced yourself you’re going to be fine next time, you’re probably not being honest with yourself.

When you’re worried about your spouse: If you handle the finances in your household and are worried that your spouse would be unprepared to deal them in your absence, it’s probably a good idea to find an advisor. Even if you’re not ready to relinquish control, it makes sense to find somebody that your spouse can turn to in the event of your death.

When you’re tired of it: If you trade stocks long enough, you’ll realize at some point that despite the time, energy, and anxiety of it all, you would have done just as well if not better in an index fund. And if you’re sick and tired of checking prices during the day, of reading headlines at night, and of wondering what the election might mean for your portfolio, then you’re probably ready to hand over the keys.

When you don’t have the time for it: If you work long hours and come home to a family that needs your time and attention, the last thing you want to be doing is stressing out about which fund to buy. Or when is the best time to rebalance? When your life is being pulled in a million different directions, then it might make sense to reach out to a financial advisor.

When the stakes have gotten real: If you’re a young person with an Rs5,000 portfolio, a mistake like panicking in a bear market is something that you can recover from. If you’re older with more money and less time to replenish that lost money, it’s harder to come back from that.

When you feel paralyzed: If you’ve been meaning to sell your underperforming stocks but just can’t pull the trigger, or you’ve been waiting for the right time to put the cash to work, you could probably stand to consult with somebody. If nothing else, taking the emotions out of the equation will force you to finally take action.

When you want to get specific about your goals: If you want to buy a second home in ten years and retire in 20, an advisor can tell you whether or not this is possible. Of course, nobody has a crystal ball, but an advisor’s job is to let you know if it’s possible, or break it to you that you’re not even close.

Jonathan Clements explains that there are many investors, and indeed financial advisers, who are still playing by the old rules. Are you one of them? Do you know those timeless financial principles? Sometimes they don’t age so well. Indeed, if you’re still hewing to the financial wisdom of the 1980s, you’re likely hurting yourself today. Here are three examples:

Goodbye, Star fund Manager: Many investors continued to hunt for the next superstar fund manager. Investors would scour past mutual fund performance, confident that it would be a reliable guide to future results. Today, that confidence has largely evaporated — with good reason: Most fund managers lag behind the market and, among those who don’t, there’s no surefire way to identify the winners ahead of time or distinguish the truly skilful from the merely lucky. Indeed, the proliferation of index funds over the past two decades hasn’t just offered investors an alternative to actively managed funds. It’s also given folks a measuring stick against which to compare those active managers—and, year after year, the managers keep coming up short. What’s amazing isn’t that investors have lost confidence in past performance and their belief in exceptional money managers. Rather, what’s amazing is that it took so long.

Broken Yardsticks: Starting in the 1990s, stock market valuations broke out of their historical range and climbed skyward. Old-timers warned that valuations would soon come crashing back to earth. They’re still waiting. To be sure, rising price-earnings ratios and declining dividend yields can be partly explained by falling interest rates, which have made stocks more attractive relative to the main alternative — bonds. But it seems some enduring financial trends are also driving the rise in stock valuations, including falling investment costs, ever more capital available to invest, a rising appetite for risk, corporations’ growing preference for stock buybacks over dividends, and the move to spend less on plant and equipment and more on research and development. This last change has resulted in lower reported earnings and hence higher price-earnings multiples. The upshot: Today’s stock market valuations are undoubtedly rich by historical standards. But it’s hard to know what to do with that information or whether we should even worry—because it doesn’t tell us anything about short-term returns and it may not be that important to long-run results.

Today’s tiny bond yields: The biggest impact is on retirees. Indeed, the core strategy for many retirees — buying bonds and then paying the household bills with the interest — simply doesn’t work anymore. After all, how many retirees are rich enough to live off a portfolio of high-quality bonds, which today would likely kick off less than 6% in India? It’s time to stop thinking about bonds as a standalone investment. Instead, their sole remaining role is as a complement to stocks. They can provide offsetting gains when the stock market nosedives, a rebalancing partner for stocks, and a way to raise cash if it’s a bad time to sell shares. Clements’ advice for retirees: Forget investing for yield and instead aim to earn a healthy total return by allocating at least half your portfolio to stocks. In buoyant years for the stock market, look to harvest gains. In rough years, get your spending money by selling bonds and cash investments.

In his blog, Jon reminds investors that the stocks of great companies are not immune to a deep decline in the share price. In fact, it’s practically guaranteed to happen more than once. Hendrik Bessembinder followed up on previous research with a deep dive into the greatest companies ever. His first conclusion shouldn’t be too surprising. The most successful company investments in terms of wealth created for shareholders at the decade horizon also involved a very substantial peak-to-trough decline in the share price. Even those investments that are the most successful at long horizons typically involve painful losses over shorter horizons.

Bessembinder looked at the top 100 companies based on shareholder wealth creation by decade since 1950. He then measured the largest decline in share price shareholders faced in that decade. Investors in the greatest companies faced a decline of 32.5%, on average, despite being one of the greatest decades of performance ever. That was just the largest decline, on average. It says nothing of the second, third, and so on a decline during the same decade. AT&T shareholders got off easy, seeing a decline of only 5.9% (over 7 months) in the 1950s. However, Netflix shareholders suffered the worst — a 79.9% drawdown (over 16 months) in the 2010s.

Bessembinder also looked at the decade, prior to the greatest decade of wealth creation, and found shareholders suffered an average decline of 51.6%. Again, that was just the largest decline for the previous decade. The duration of the decline fell in a wide range. They lasted anywhere from a month to three years in the same decade of the company’s greatest wealth creation. In the prior decade (to the greatest decade), in some cases, the decline exceeded eight years!

There are a few important takeaways from this:

First, sometimes great companies stumble. It can take management years to fix the problem (see Microsoft) or come up with a new product/innovation (see Apple) before the company moves in the right direction again. This can create multiple periods of massive wealth creation by the same company as seen in the table above.

Second, sometimes the market gets way ahead of itself in the short term. It gets the growth story right (see Amazon) but the timing is off by a decade. Expectations send the stock price soaring but once instantaneous growth is off the table, the price corrects, sometimes to the opposite extreme.

Third, and not surprising, long term shareholders must endure multiple, and sometimes painfully long decline to reap great rewards. This would confirm that the hardest part of investing is often just holding on.

Fourth, investors have multiple chances to buy great companies at wonderful prices. They usually have ample time too. Now, the usual caveats apply. Neither the buying opportunity nor the greatness of the company is always obvious at the time. But the fact stands. Declines in share price are buying opportunities for patient investors who have done the work and identified great companies in advance.

The broader point is this. It’s up to investors to separate the company from its stock price because declines are inevitable. But a great company’s stock will not only recover but go on to be extremely rewarding.

Drew Dickson points out that there is one way to generate excess stock market returns over the long term, and it isn’t to “own winners at any price.” Sure, in hindsight it was, but that is very convenient. It’s very convenient to now ignore the stocks we thought were winners but weren’t. It’s also very convenient to draw parallels between past winners and newer companies as if it is a foregone conclusion they too will win in a similar fashion. Nor do excess returns come from “owning good companies at any price” or “owning high-quality companies at any price.” The “one way” to outperform is to buy a concentrated portfolio of securities that Mr Market doesn’t own; names which are shunned because Mr Market has become overly pessimistic about the fundamental prospects for businesses that are better than he believes or realizes. That’s it. That’s the formula.
This often isn’t sexy, it often isn’t fashionable, and it often isn’t fun. However, a successful investor outperforming Mr Market over the long term owns companies that, by definition, Mr Market believes are pretty stupid to own.
Instead, Mr Market often thinks growing, glamorous, names are much smarter to own. They definitely are smarter looking. And it is surely more entertaining to own these stocks. It’s also easier to sleep at night. They are obviously more dynamic companies and, in many cases, they indeed are better companies. And there are periods where these growing, good and glamorous names do tremendously, well. During these episodes, it downright sucks to be a fundamentally-driven value investor. Equity markets had one of those periods in 1998-1999, and – in Dickson’s view – they may be having another one of them now. Paraphrasing Thomas Paine, these are the times that try stock-pickers’ souls.
The stock market, at least at the moment, seems most sensitive to whether or not a company is classified as a “good” or “bad” business. And “good” means your stock has already appreciated, is already expensive, and is showing even the slightest degree of business momentum. And no price is high enough for “good”. Because good is good, so why wouldn’t you own it? “Bad” is the opposite. Bad is an already-inexpensive stock that has already sold off, and one that has already exhibited fundamental weakness, even if it’s likely a short-term phenomenon. And no price is low enough for “bad”. Because bad is bad, so why would you own it? As maddening as this behaviour is, it is typical of investor psychology at peaks and troughs; and consequently, the “price” of growth is higher than it has ever been.
Dickson asserts that there is no new era. Stocks are still worth the present value of their future cash flows. While narratives can dominate in the short term, and while the short term is sometimes longer than we like, the fundamentals eventually matter. They have to. We are buying fractions of the equity value of large, liquid, listed, enterprises. The fundamentals “have to matter” because these fractions of equity, these shares, are worth the present value of all future cash flows to that fraction of ownership. We have no idea when “eventually” is going to arrive. Whether or not we are three days or three years away from this growth bubble popping, he doesn’t know. But he is tremendously confident that it isn’t “different this time.”