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.”

2 thoughts on “Against the Wind

  1. I doubt that most clients KNOW when you have made them money or saved them money, or when their other advisers have made them money or lost them money. As smart and rational as I am, even I do not track on these details. It doesn’t matter how many times you tell me, I will forget the details before the next time.

    Perhaps if you came up with some blisteringly simple examples where you actually can say, “in that market bottom we saved our clients 20% of their wealth by helping them stay invested.” If Geico can sell insurance by saying “you might save 15% or more” (when they have no idea if you will save anything), then surely with your performance you have a right to generalize to the point that even your smart clients such as myself can keep track.

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    • It is actually quite hard. First of all, even when the particulars of our strategy matched best with the opportunity set in the market, we’ve never delivered a 10% or higher advantage against the market for a period of five years or more. Nor will we ever, IMHO. Our portfolios are both too diversified and too constrained. (We may begin offering a less-constrained strategy, but that is a matter for another post.)

      Second, what and how we communicate are highly regulated, for good reason. (Not just us, obviously.) Perhaps I might better say, ‘regulated with good intentions.’ Performance information may be disseminated under certain constraints.

      The great problem is that past performance is always what someone else got, not what a new investor will realize in future. Consider hedge fund Titan John Paulson, who made what some consider the greatest trade in history, betting against housing in 2007 and earning more than 350% that year. Huge money flowed in, and he then turned around and lost huge betting on inflation and gold in 2011 and 2012.

      We are considering adding a comparison to the performance results of the average mutual fund investor in our performance reviews, as a proxy for, “Here’s what you might have done on your own.”

      In any case, what to communicate, and how, remains a very difficult question.

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