Many investors are more financially sophisticated than they were decades ago thanks in part to the availability of information on personal finance and investing. But there is also a large portion of the investing public that has a tendency to get whipsawed—over and over. They have a recency bias that can contribute to performance chasing; they give up too soon when an investment disappoints; they are overconfident in their ability to make sense of investment markets and specific investments; and they are susceptible to the grass is always greener way of thinking triggered by the onslaught of opinion presented by the financial media and perpetual financial marketing. They bounce around like a pinball from strategy to strategy and from fund to fund. The end result can be too much buying high and selling low—a practice that cuts into returns and is inconsistent with achieving long-term financial goals. The behavior also results in frictional costs through transactions and taxes.
To guard against these very common human tendencies, we believe investors must do two things:
First, they must find an investment philosophy that resonates strongly and is grounded in sound investment theory. As an investment manager we have a philosophy and a set of values that we stick with through thick and thin (our philosophy is briefly discussed below). We may tweak our investment process from time to time based on new insight or significant developments in the investment environment, but we are always grounded in our fundamental investment beliefs and philosophy. We believe this philosophy is particularly valuable for our clients.
Second, investors must embrace the reality that they will be investors for the rest of their lives—decades in most cases. The concept of being a lifetime investor may seem straightforward, and sometimes things that are simple may seem unimportant. But in our view, executing this concept is hugely important and is a strong facilitator of success in meeting an investor’s long-term investment goals.
A very long time horizon provides a needed perspective that should inform how investors think about their broad investment strategy, their portfolio, and how they evaluate their portfolio’s performance. Here are just a few examples based on what we’ve experienced in the over 25 years we’ve managed money for clients.
The patience that comes with a lifetime perspective also may make it easier to accept that periods of subpar performance will not necessarily carry into the future. This does not mean that strategies, managers, or positions should never be jettisoned from a portfolio. What it does mean to us is that there should be sound reasons for doing so that go beyond raw performance numbers.
We believe being a lifetime investor facilitates accepting certain investment realities, including the very real cycles of over- and underperformance that managers and consequently portfolios experience. An investor might be able to accept that over a lifetime (decades), a prudent investment approach will likely disappoint at times, occasionally for a few years, but over the very long-term, common sense discipline is likely to win. In our opinion, these periods of underwhelming performance are likely not material to investment returns over decades. Understanding this may help protect an investor from giving up on something that will likely work well over the long run just because it has been out of sync.
What this all gets at is being disciplined about building and sticking with an investment program. It’s easy to say but surprisingly difficult to do.
Once an investment philosophy is identified, there are a few principles and disciplines that can facilitate developing the steady hand at the tiller that is the ultimate benefit from thinking like a lifetime investor.
One’s investment philosophy and values, long-term investment goals, and risk tolerance should be regularly reviewed. The purpose of the review is to reinforce and internalize them so that investment decisions are always thought of in this context. Without this regular review process the philosophy may become something that was once discussed but fades from consciousness over time.
Developing some historical context is also helpful. Specifically, there are characteristics of investment markets that are eternal. Perhaps the most important is that investment markets are cyclical and there are many types of cycles. There is the economic cycle and the accompanying investment cycle. There are longer-term “secular” cycles such as the long decline in interest rates we’ve experienced since 1982. Sometimes a market or a sector experiences a cycle that becomes a mania. Some investors fully buy into the underlying stories, which may be based on “new era” thinking. “Experts” tout the underlying rationale. The result can be a cult-like belief in the stories (and the financial industry is expert at feeding these stories to investors), and this leads investors to make costly mistakes by buying and owning overpriced assets and avoiding underpriced and unloved opportunities. We believe, understanding how cycles work can help investors resist this temptation.
An obvious example of a mania was the tech bubble of the late 1990s, when anything tech and, specifically, Internet-related surged in price over several years. Companies with questionable business models, no profits, and sometimes no revenues had multibillion-dollar valuations. The tech mania ended and the technology sector saw prices drop dramatically. And while technology was and is a game changer, it has taken time, and many tech and Internet companies have not succeeded in a very competitive and rapidly changing environment. Another recent example was the belief that house prices would never decline. And going back some years, Japan in the 1980s was widely viewed as an economic powerhouse that was going to dominate the 21st century. The stock market reflected that belief and it generated a much higher return than the U.S. market in the 1980s. But the belief turned into a mania and Japanese stocks became grossly overvalued. As it turned out, Japan was not an economic powerhouse and has floundered during the 25 years since. The Japanese stock market has lost enormous value over that time, while the U.S. stock market has generated positive returns. Manias often last much longer than one would think, and the challenge this presents for investors (and investment managers) is sticking to rational analysis when it seems misplaced, sometimes for as long as several years.
Another facilitator of a very long-term investment perspective has to do with evaluating the investment portfolio in the context of one’s long-term investment philosophy and goals. That is, looking at performance numbers as a means to an end (the investment goals). This can be a challenge given the shorter-term, benchmark-related performance reporting common in the investment industry, which can be inconsistent with a longer-term, goal-oriented focus. In a world where performance data may be available daily and is surely provided at least quarterly, context and perspective are especially important. No investment philosophy, approach, or manager is going to generate strong returns all the time—whether measured in absolute terms or relative to a benchmark. This is an inconvenient truth. Investors would like to have an investment strategy or manager that is a champion all the time, but this is not realistic.
So with respect to performance, investors face a conundrum. On the one hand, they understandably want to know how their portfolio is doing on an absolute and relative basis. And how it is doing can provide important insights into the portfolio’s characteristics and level of risk. On the other hand, in most instances, investment returns and volatility are not very useful to assess the success of an investment approach or the skill level of a manager until there are many years of data. Performance over one, three, or even five years can be impacted by a multitude of factors. It is only over much longer periods that legitimate insights can be formed. So, we believe reporting is most useful as an opening to discuss portfolio structure, and in understanding what is driving investment performance and what that means going forward. This is not as easy as looking at a set of numbers; however, in our opinion, a good advisor (or mutual fund manager) should offer commentary and details that can assist in this process.
This article has so far outlined the theoretical benefits of a lifetime investment perspective, including the increased ability to stick with an investment program in rough waters or when temptations come knocking. In looking at today’s investment environment, we can highlight a number of temptations.
The U.S. equity market has had a very strong run over the past few years and by most valuation measures is stretched. After six years of generally rising stock prices, investors may be complacent about the potential risk. Those risks may or may not be imminent, but there are signs that suggest potential returns in coming years could be quite low (likely driven by a bear market along the way).
U.S. and foreign stocks have a habit of going through multiyear periods in which one outperforms the other, followed by a reversal. For example, in the late 1990s/early 2000s, U.S. stocks enjoyed a streak of outperformance over international stocks; however, from 2002 to 2007, international stocks trumped U.S. stocks by a wide margin. Over the last few years, U.S. stocks have charged ahead. Because markets move in cycles, there will always be periods where global diversification doesn’t appear to “work” and investors will begin to question their allocations. However, we believe the reversal of this current cycle may not be long in coming given the relative attractiveness of foreign stock market valuations (stock prices) and the potential for foreign company earnings to improve from currently depressed levels.
The financial services industry is masterful at developing and marketing new compelling investment products. Unfortunately, their benefits are often oversold. These days there is an onslaught of “alternative” investments. Some are compelling and we use some of these. However, most are not, and many charge exorbitant fees in exchange for questionable value. Careful research is essential when wading into new, hot investment offerings.
Passive index funds and ETFs continue to take market share. They provide low fee access to markets and this can be appealing (indeed we use them at times in our portfolios and we also run some index-oriented portfolios). Index investing makes a lot of sense and so does active investing in the right hands. Litman Gregory does both but we believe that over the very long run, for a lifetime investor, active can add value over an index by taking advantage of market excesses (we’ve achieved this goal over the life of our firm). The tech bubble period was a great example, when tech stocks’ surging share prices drove their S&P 500 weighting to over 30%. When the tech bubble burst, active managers, on average, performed quite well relative to the index because they were able to underweight their exposure to tech (this was also a very strong period for Litman Gregory’s relative performance). The index, on the other hand, had its highest all-time exposure to tech stocks right before the tech sector collapsed.
While overall indexes can be hard to beat because of their low fees, there are managers that beat them. But in some periods a smaller percentage of managers beat their index benchmarks while in other periods a higher percentage of managers come out ahead. When it comes to building a portfolio, a lifetime investor concept is useful in getting beyond the sway of recent index-versus-active performance trends to think more strategically about if (and where) it makes sense to follow an index-approach based on a variety of factors, the primary one being whether the investor has a robust and ongoing process for selecting and monitoring active managers.
The long-term perspective of a lifetime investor should facilitate discipline and steady decision-making across every scenario leading to a sense of confidence in achieving long-term outcomes and less worry along the way.
Our Thoughts on the Silicon Valley Bank Failure
Recent problems in the banking industry have increased uncertainty in the financial markets. On behalf of our clients, we have taken a close look at the situation and assessed the potential consequences. In this post we summarize the circumstances at Silicon Valley Bank that led to its failure, describe the broader implications, and review what we see as minimal impact for our clients and their portfolios.
Insight Newsletter—Winter 2023
Our Insight Newsletter is now available. Included in this edition: Investment Commentary Research Update: Trend Following with Managed Futures Tax Planning Opportunities from
Research Update: Trend Following with Managed Futures
The evidence of the long-term value that trend-following managed futures bring to a balanced portfolio is compelling, even though there are shorter periods where sharp see-saw patterns can lead to disappointing returns. However, in a year like 2022 that saw significant declines for both stocks and bonds, managed futures experienced large positive gains and were one of the only asset classes to provide meaningful downside protection. This research update serves to address many of the questions that we receive about this interesting investment strategy.