“Chasing an arbitrary index that is 100% invested in the equity market requires your clients to take on far more risk than they likely want or can endure.” – Lance Roberts
Every year DALBAR Inc produces a study of investor behavior which highlights the difference between investment and investor returns. History has shown that investors as a whole tend to lag the performance of the investments they hold by a significant margin because of their fickle behavior (something we call the cost of being human).
Gil Weinreich, editor at Seeking Alpha, produces a daily email called the Financial Advisors’ Daily Digest where he comments on some of his favorite, curated articles on Seeking Alpha. In today’s email, he commented on a recent post by Lance Roberts who was writing about the most recent DALBAR study and why humans are their own worst enemy when it comes to investing. The single most important issue that Gil drilled down into was the tendency for investors to chase returns rather than “focus on capital preservation.” Gil went on to share a real life story about his neighbor, which we’ve copied below. Given our emphasis on this “most important issue,” we thought it appropriate to share Gil’s story and then sum up this week’s post with our own takeaway from his story.
My most vivid recollection of engagement on this issue comes in the form of a neighbor who, on learning of my profession, would frequently inquire as to my views of the stock market. He wanted to know how long the bull market might last (answer: “I have no clue.”) He wanted to know what I thought of Apple stock. I was similarly uninformative. This sort of questioning, and my responses, must have surely left him wondering how I could make it in this business, but the questions persisted whenever he caught sight of me on the block, and it became apparent to me that despite his friendly smile and seeming calm, he was very worried about his portfolio. A DYI investor, he relayed that he felt that he chose his portfolio wisely and felt he could manage it on his own, but his obsessiveness and anxiety said otherwise. The fellow, probably about 60 to 62 years old at the time, knew his and his wife’s retirement rested heavily on that portfolio, and I don’t think he was sleeping well at night because it became evident to me that he was checking his stocks all day. He was much better informed than I was on the market’s daily performance.
The neighbor frequently asked about the relative merits of hiring a financial advisor. I thought that would probably be a good move for him – strictly on the basis of his personality. I put him in touch with an advisor I thought could help him. I’m pleased that that advisor is still on friendly terms with me, because the guy kept him at his house for six hours discussing every jot and tittle of his plan. In the end, the neighbor simply could not hire the advisor. He didn’t want to dilute his performance with the fees he’d pay the advisor and thought he could continue to manage the stocks on his own.
I no longer live in that neighborhood and don’t know what became of this fellow and his portfolio. But in my mind, he’s the sort of person who will do poorly in the next market crisis. (I hope I’m wrong about that; he’s a good guy.) I think that because, just as he viewed hiring an advisor as a dilution of his performance, so too would he view a stable-value holding such as cash as a drag on his returns.
We’re on an amazing train ride and we hesitate to get off, because it’s been spectacular. The view from the window of ever dizzying peaks –not of snow-capped mountains, but of mountain-high investment returns –makes us reluctant to change course.
My former neighbor has had an incredible train ride. But the Alpine scenery is essentially a pretty postcard because it is all on paper. To enjoy it when he will want it requires a capital preservation strategy in advance of a major market decline.
The story of Gil and his neighbor is one that we have seen play out over and over again. We can’t even tell you how many times we’ve been asked what direction XYZ stock or “the market” was going to go, only to respond in a very similar manner as Gil. Unfortunately, many people misconstrue our lack of conviction about an uncertain future with a lack of expertise in our field, but nothing could be further from the truth. In fact, we would argue that the opposite is true. If you run into someone with a high degree conviction on where “the market” is going to be next month, year, decade, etc., our advice would be to politely smile and nod and then run the other way when he/she asks you to hand over your hard earned money.
Since we can’t predict the future with any level of confidence, we chose to take a more humble approach to investing which spreads risk across as many different, non-correlated investments as possible as well as using trend following techniques to provide additional downside protection from large shifts in investor sentiment. The foundation of our approach to investing is what Gil considers to be the “most important issue” for investors (especially those approaching retirement)…capital preservation. Any investment discipline built on the foundation of capital preservation will lag an arbitrary equity index during a bull market, but it should increase the odds that the investor will meet their retirement goals and allow them to sleep well at night.
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
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