10 Jul 2020 Let’s Get Tactical, Shall We?
The hardest question I ever get asked is this: Which is better, Eastern North Carolina barbecue or Western (really, Lexington) North Carolina barbecue? The question isn’t hard to answer because I don’t know what I think about it (Eastern is 100% the best, though both are way better than whatever sort of beef-based product they’re serving in Texas and Oklahoma). No, it’s hard to answer because it’s a question that can’t be answered without doing so emotionally. I grew up on Eastern! I genuinely believe it to be superior! I will gladly raise my voice expressing so! But I also know some of that opinion is clouded by time spent in particular places where I have particular memories with particular people. So perhaps I shouldn’t raise my voice…
Well, in the last two months I’ve experienced a steep increase in the number of other hard-to-answer questions falling into two broad camps: 1) “Should I reduce my equity exposure significantly or completely, since we’re likely to experience a ‘second wave’ in the fall?” Or 2) “I’d like to put additional money to work in the market in this particular stock, what do you think?” I’ll call these questions “tactical allocation” questions, and I’d ask you to notice that both types are coming at the same time, from smart people looking at the same data, and reaching diametrically opposed conclusions as to what to do with it.
I have strong opinions on nearly everything, so of course I have strong opinions on these tactical allocation questions, but before I get to that, I do think it’s important to recognize why these questions may be coming with increasing frequency in the first place. My hunch is that the reasons are twofold: 1) This existential fear of a “second wave” is very unusual as it relates to investing, because it feels like a free and unassailable market forecast that is tradable now. And 2) People are tired of being stuck inside and find themselves wanting to actively do something with their portfolio. Those are two perfectly good reasons to be asking tactical allocation questions!
Now to my answer. Like the barbecue question, this is not something that can be done simply, with cool rationality and smugly constructed spreadsheets. Obviously we have way more data at our disposal when answering it than when we fervently declare Eastern NC barbecue best, but still, there is a tremendous level of emotional mechanics at play here. I want to be sure to express that up front, both as a way to recognize the legitimacy of the questions, and to make sure my answer is not misconstrued as “correct.”
At Beacon, we hold to a pretty strong version of what’s called the Efficient Markets Hypothesis, which is a convoluted way of saying, we believe that generally speaking the participants in the public stock market in the aggregate do significantly better at pricing securities in the long run than individual participants themselves. Some people hold to stronger versions than we do, but we certainly are on the side of the spectrum which believes that stringently. It’s the foundation (based on a great deal of evidence) that leads us to use broad-based, passive index funds, and to let a robust planning process be the governor of our investment decisions at all times, but especially hard times.
So when it comes to tactical allocation questions, we believe that most of the time they don’t fit most investors, both for reasons of market data and human behavior. In the case of the first set of questions I referenced above–“Should I reduce my equity exposure in anticipation of a second wave”–these are tactical decisions based on time. And what makes tactical timing decisions immensely difficult is not the getting out (though getting that right is hard enough), but the getting back in. And the second set of questions, related to the opposite conclusion of putting more money into not just equities as an asset class, but particular stocks that carry significantly more risk, these are tactical questions based on (generally) sentiment. These tactical sentiment decisions are tough because there’s a sample size of one, and we know from data that the overwhelming majority of stocks underperform the stock market as a whole.
There you have our general stance, then. We don’t believe market data or human behavior generally support making tactical decisions, maybe especially when it already feels like the world is falling apart. As we like to say, being in a portfolio that you can stomach in good times and bad, which is systematically rebalanced as allocations get out of whack—that’s going to be the best all around answer for most people, almost all the time.
But, for the folks that love Western NC barbecue tactical allocation decisions, here’s a possible framework to use in the scenarios where it could be appropriate:
Timing Decisions. If convinced you want to make timing decisions by significantly reducing equity exposure (same is true in the other direction, but for now let’s assume pulling risk off the table), here’s how I would think through doing so wisely:
- First of all, consider whether you are simply holding too much risk in your portfolio. If you feel a great deal of worry, then it may not be a temporary thing you’re dealing with, but a more long-term change. In which case, your financial planner (hopefully us!) should help you find a better fit risk-wise and show you the impact of such a move on your financial plan.
- Assuming this is truly just a timing play to temporarily pull risk off the table, the most important thing is to define ahead of time when you will get back in. There probably should be a time component (I.e., no matter what, I’m getting back in in three months), and possibly a price component (I.e., no matter what I’m getting back in when the market hits X price) on top of that. The reason the time period is so important is because the longer you’re out, the harder it is to get back in without getting entrenched in your position. And it should be noted that even with a specific date and/or some other tactical plan in place, it’s very likely that the moment you need to get back in will be the moment it’s hardest to do so psychologically. It’s for that reason the damage done waiting too long to get back in is often significantly greater than the damage avoided by getting out.
Sentiment Decisions. Whether a hot stock, a stock that seems likely to “win” from Coronavirus treatment, or even an IPO, here’s how I would think about doing so wisely:
- First of all, are you doing everything else you need to do to reach your goals? Saving the required amounts to meet goals, taking care of tax planning opportunities, etc.? If not, then I would strongly advise against investing in any particular stock until those are done.
- Assuming you are taking care of all the “have-tos,” I have seen people make these tactical decisions well by doing two things: 1) Do it in a “play” account. Keep these bets separate from the rest of your portfolio, both so you can track it more efficiently, and so that you can keep your emotions on that bet from “contaminating” the rest of your portfolio. 2) Do it in small dollar amounts relative to your overall portfolio. There’s no magic number here, but I wouldn’t go above 5% and would ideally keep it down closer to 2%. The reason for capping these investments is because they are exponentially more volatile than the rest of your portfolio, and the last thing you need is for a side bet to meaningfully derail your family’s goals.
We live in a culture that lauds those who “hit winners,” in tennis parlance. Avoiding unforced errors doesn’t have nearly as much cachet. And yet, for the overwhelming majority of investors, it’s the avoidance of unforced errors which truly helps people win, or reach their goals. And it’s our job to help folks keep the ball in play. In a world that loves hitting winners, that can be a hard role to fulfill. Just seven months ago, on January 10th, I wrote a blog about Tesla and the dangers in investing in “what you know,” and the stock is up 190% since then! But if I had to write that blog over again, I don’t think I’d say anything different. And what about the second wave? I truly do not know. But I’m very hesitant to make a tactical decision on the most publicly available information in existence right now. Whatever happens, my guess is those who stick with their plan and focus on their broader sanity and mental health will end up in a better spot—emotionally and financially!–whenever we get to the other side of this thing.
Of course, I could be wrong. I’ve been wrong before, and I’ll certainly be wrong again soon, and I’m not raising my voice. But let’s manage our misses in ways that don’t hurt us in the long run.
