26 Jul 2013 Persistence
One of the great secrets of success in investing is that of persistence; defined as “firm or obstinate continuance on a course of action in spite of difficulty or opposition.” In this age of information overload, particularly in the area of investing, persistence has become considerably more difficult than it was 10 or 20 years ago. Throw into the mix an ever-expanding supply of ‘financial advisors’ backed by sophisticated marketing machines designing products to address today’s ‘opportunities’ and its easy to see why staying the course is more difficult than ever.
We believe that the capital markets produce ample returns if harnessed intelligently and efficiently by long term investors. We believe a persistent low turnover strategy produces greater wealth over the long run than short- or intermediate-term trading strategies designed to take advantage of current trends.
It stands to reason that a portfolio that efficiently captures capital market returns, in essence one that does not leak wealth to high expenses, excessive taxes, and persistent under-performance will eventually exceed the more active ones – by significant amounts. Actively managed portfolios may provide greater returns for a time, but they will drain more of your wealth in taxes, expenses, and underperformance. A substantial majority of actively managed funds persistently underperform the capital markets. What’s more, there is little correlation between previous winners (the basis on which you must choose) and those that will outperform next year.
For the efficient investor, one of the most difficult challenges he or she faces is persistence; especially when short term forces seem aligned against them. When they see declines for a time, they may lose sight of the fact that their efficient portfolios are designed with the proper weighting of stocks and bonds to meet their goals with a minimum of risk as viewed over long market cycles.
Consider a beautiful painting. The closer you stand the more able you are to see the brush strokes, the imperfections, and details that might distract and confuse you. But as you back away to gain perspective, you begin to grasp the fullness of the story the painting is meant to convey. Similarly, as investors we can easily become confused by short-term market swings and maybe even convinced we are on the wrong path when the swings persists longer than our ability to ignore their impact.
Let’s back away from the brush strokes and view the art of the capital markets, specifically an efficient allocation of the markets. The chart below is an index representation of our most conservative Risk Averse portfolio. The indexes are allocated in precisely the same blend as the exchange traded funds (which efficiently capture the indexes) we have been using for the past seven years in our client portfolios.
Notice that in the last 40 years the Risk Averse portfolio has had four and now five periods of extended declines. These declines have ranged from a year to a year and a half. But notice the art, the persistence of the steady periods of appreciation. These steady growth periods range from about four years most recently to as much as 13 years between 1994 and 2007.
The current decline for our conservative investors is due to the abnormal pressures that have been exerted on US Treasuries by the Federal Reserve as it attempts to revitalize the economy. Markets are coming to grips with when the Fed will begin slowing and eventually stop buying Treasuries, to allow their prices to approach true market levels. It can be argued that they have already done so.
The Risk Averse portfolio has generated 8.84% for the past 40 years and 6.7% for the past 10 (as of 12/31/2012). These returns are not much lower than the all-stock S&P 500’s returns of 10.2% and 7.1% over the same periods respectively. The difference is that the S&P has seen considerably greater downs in the past 40 years with the granddaddy in 2008-9 of 38%. These downs make it even tougher for folks to persist. But even with an all stock portfolio, those who persist are rewarded with greater wealth than those who allow their emotions to intercede.
When you are on the right path, persist and you will be rewarded.
Have a great weekend.