Dear First Mates,
It’s officially 2021! I’m excited for the year ahead and can think of no better time than now to outline our investment first principles. This philosophy was vital to weathering the challenges we saw last year. Despite everything that happened in 2020, the great companies around the world posted positive returns. Unfortunately, many investors jumped ship and never saw those strong gains. So, if these insights prove helpful, please share this newsletter with those you care about.
Before we review them, I’d like to present the foundation on which they stand. To be a good investor, you MUST be optimistic, patient, and disciplined. Optimism is the unshakable belief that our assets will grow with time. For us, optimism is the only realism. The virtue of patience is displayed by riding out investment storms which occur frequently. It can and does take years to see a return on investment. Finally, we are disciplined to stick with our portfolio no matter how bleak things get (and buy more if we can)! Our response to “this time it’s different” is “this too shall pass.”
1. We are buy & hold investors who never time the markets.
We are buy and hold our portfolios, first and foremost, and not investment prognosticators.. Since there are no facts about the future, we fully accept the fact that to capture market upside we must weather the downside. When things get rough, we practice rationality under uncertainty. Furthermore, we never engage in the speculative practice of market timing, i.e., repeatedly getting in and out of the markets. In my experience, this is virtually impossible to do successfully since you must be right twice. In my experience, I’ve found that the more investors change their portfolios (in response to market fears or current fads), the worse their long-term results. Permanent long-term loss in a portfolio is a uniquely human accomplishment since the market historically grows over time.
2. We diversify.
Broad diversification is a display of our humility. We don’t know what will be the best investment year by year – so we buy thousands of global companies instead. This helps ensure we will never get killed by any one idea. And you will fully know you’re diversified if some components of your portfolio are always “underperforming.” The downside is that you won’t make a killing in any idea either and will have to ride out temporary losses from time to time. And we accept that fact wholeheartedly.
3. We are equity investors.
Equities (stocks) represent the ownership of profit-seeking businesses run by professional managers for our benefit. In addition, they fully capture human ingenuity by producing wondrous products and services that make our lives better. In my experience, stock prices tend to be more volatile than the fundamentals of the companies themselves. And that human nature is even more volatile than both.
Large U.S. companies have produced a compound return of 10% per year while bonds have produced about 5%* per year. If the objective is to never run out of retirement money, then stocks are safer than bonds by a wide margin. Especially if you define safety as creating an income that rises ahead of inflation. This is what equities have done for a very lime time, and by my estimation, doesn’t seem likely to change. Yet despite all the data out there, this crucial information is not being promoted as it should be. Don’t believe me? Click here and see for yourself.
4. Goals drive the plan which drives the portfolio.
We are goal-focused, planning driven investors. Not market-focused and current events-driven. We are continuously working on our plan because we understand that the portfolio is the servant of our plan. It’s totally fine to update your investments – if and when the plan calls for it! Planning first investors care about one thing – the risk of not achieving our most cherished life goals. Investing should have the exclusive objective of minimizing this risk. This is why I focus on planning in meetings with the updated planning checklist. Oh, and outperforming a narrow benchmark is largely irrelevant to our financial success.
5. We rebalance at least once per year.
The last thing on earth we’d ever want to do is sell the component that’s already down to chase the one that’s already up. Therefore, we rebalance our portfolios each year in order to return each security to its’ original quota. This means we’ll harvest some of our gains from what has gotten relatively expensive and reinvest them in something that has gotten relatively cheap. Yet this is the exact opposite of what most people do.
These principles are a living, breathing, insurance policy against the terribly destructible impulses that seize all investors from time to time. It is not because we are unwise – but because we’re human and hard-wired to react to problems when we see them. There will come a time when you want to abandon this philosophy, but just know that I’ll always be here to remind you of them. For those that follow these principles, I’m confident in two things: 1) your long-term regret will be minimized and 2) you’ll have much better portfolio outcomes in life. Here’s to a prosperous 2021!
With gratitude,
David Warshaw, CFP®
*Calculations by Craig L. Israelsen, Ph.D. US Large Stock is represented by the S&P 500 Index. US Bonds is represented by the Ibbotson (SBBI) US Intermediate Govt Bond Index from 1926‐1975 and the Barclay’s Capital Aggregate Bond Index from 1976‐present.