Against the Wind

“Do you want to know how to get rich in the market? Come closer. Close the door. Be greedy when others are fearful. Be fearful when others are greedy.“

                                                                                                     Warren Buffett

I’ve written a few times lately about optimism and pessimism, and passed along the observation of one long-term client that the tone of my recent postings has been too negative, so much so that he no longer passes along our material to potential referrals.

I’d like to share a few data points, offer a bit of mild pushback against the accusations of inappropriate pessimism, and then ruminate a bit on one of the paradoxes of investment management.

First data point: The last month saw a reversal of the public’s recent stock buying, with huge flows from stocks to bonds. It is a cliché, no less true for being so-oft repeated, that individual investors always get it wrong, especially at inflection points. After almost five years of market recovery, with the S&P up more than 175% from the March 2009 low, investors began to buy stocks in late 2013. (In other words, they missed a bull market that more than doubled the price of equities.)

The sharp downdraft in January destroyed that emerging confidence, and individual investors stampeded from stocks back into bonds. But they did not exit at the S&P 500’s intra-day market high of 1847 on January 21. They jumped out in time to catch the intra-day low on February 5, when the market was down almost exactly 6%. And thus missed last week’s rally, during which the market gained 3.4%, erasing most of the prior loss.

Second data point: Investors are fleeing emerging markets stocks in droves. As this article makes clear, the last time the investing public turned similarly bearish on EM stocks, in 2002, the next five years saw annual returns on emerging markets of over 30%.

Which gets back to our recent pessimism. The mass of individual investors are at the mercy of their own dysfunctional psychology, getting in and out of the markets at precisely the wrong times. As stewards of our clients’ portfolios, we have two principal jobs:

1) Make, and implement, good investment decisions.

2) Keep our clients from harming themselves by over-reacting to market events.

If we are doing those jobs as well as we possibly can, we will assist our clients in maintaining an even strain, by letting some steam out of the psychological balloon when the markets are over-priced (during bubbles and late in bull markets), and pumping them up with optimism when they are under-priced (during panics and bear markets). Hence our cautious stance over the last year or so.

Here is the paradox. The way for clients to get rich is to behave against the crowd, as Buffett has often observed. Yet the way for an adviser to best attract new clients is to validate their emotions, not to challenge them, especially when those emotions are most excited.

Paradoxically, by doing what is right for existing clients (counseling prudence at market tops, maintaining optimism at market bottoms), we make it harder for our firm to attract new clients. The answer to the perpetual question, “If you’re so smart, why ain’t you rich?” is that being smart makes us periodically unpopular. My own experience is that challenging a client’s emotions can make me persona non grata. I’ve had a few clients over the years whom I kept from selling out in bad markets, and who never forgave me. They ignored the thousands, tens of thousands, hundreds of thousands, even millions of extra dollars they earned by owning stocks during the recovery, but held onto their bitter resentment over my failure to take counsel from their fears. (As one client said, “You just don’t want me to have any feelings.”)

So here is a statement about what sets TGS Financial Advisors apart from most of our peers in the retail advisory space: We are more committed to your long-term financial security than we are to your short-term psychological comfort.

And if you are a friend of the firm, and don’t think we are telling our story very well to prospective clients, consider saying this to the friend, relative or colleague you’d like to send our way:

“My advisor really beat me up to stay invested during the panic back in 2008-2009. I’ve made a lot of money in the market since then. Now he’s telling me to be careful. Did your advisor keep you invested back then? Is he watching out for you now? Maybe you need a second opinion.”