Bad for Your Wealth
Amen of the Week
“Driving back to Portland I’d puzzle over my sudden success at selling. I’d been unable to sell encyclopedias, and I’d despised it to boot. I’d been slightly better at selling mutual funds, but I’d felt dead inside. So why was selling shoes so different? Because, I realized, it wasn’t selling. I believed in running. I believed that if people got out and ran a few miles every day, the world would be a better place, and I believed these shoes were better to run in. People, sensing my belief, wanted some of that belief for themselves. Belief, I decided. Belief is irresistible.”
– Phil Knight, founder of Nike (Shoe Dog by Phil Knight, 2016)
Bad for Your Wealth
It’s a different world. No doubt. Nevertheless, many advisers will advise “staying the course”. For most, that means maintaining the “market portfolio,” a broadly diversified “pie chart” of all asset classes. This agnostic “own a bit of everything” strategy has been smart since the early 1980’s. But now is the time to become VERY skeptical of what has worked well the past few decades.
Three decades of falling interest rates created double-digit returns in stocks and high single-digit returns in bonds. Owning a broad mix of many equity and fixed income “asset classes” has thus enabled an investor to earn high-single-digit returns well in excess of inflation. A not-insignificant portion of this return was generated from bond prices generating positive real returns as interest rates fell. But looking forward, if interest rates rise toward historically normalized levels, long-term bonds could generate negative real returns. For this reason, pie chart portfolios with heavy allocations to bonds could erode investors’ real wealth going forward.
What’s a better alternative? Warren Buffett’s advice makes the most sense to me. You’ll never hear him recommend an “own-a-bit-of-everything” pie chart portfolio. In Berkshire’s 2014 annual letter (back when equities were near today’s lofty valuation levels), Buffett wrote,
“Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions…
It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors … whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits…
For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities… (They can assure) themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).”
In other words, Buffett is saying that you should have as much stock as your circumstances allow. (Note his emphasis of “purchase over time“. You’re better off dollar-cost averaging into stocks rather than jumping in all at once). For those of you who need to draw an income from your portfolio, you may need to set aside a reasonable amount in fixed income. How much exactly? That depends on your specific circumstances, and it’s where a fee-only fiduciary adviser like Fielder can add legitimate value. Another way we can add value is in suggesting optimal ways to index. Some methods are smarter, cheaper, safer, and/or more efficient than others.
As always, please let me know if I can help you or anyone you care about navigate the path ahead.
Yours in the Field,
Frank Byrd, CFA
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