Vaccinate Your Portfolio

Faith in institutions is near all-time lows. Americans don’t trust the mass media. We certainly don’t trust politicians. The internet allows each of us to construct a comfortable cocoon of congenial opinions. It appears we are each allowed to select our preferred set of “alternative facts.” Absent trusted sources of data, confirmation bias runs rampant.

Yet there remains an objective reality out there. In many disciplines there are recognized best practices that define how well-informed and prudent individuals and institutions should act; failure to follow those best practices risks adverse consequences.

Consider vaccination.

My wife is an epidemiologist trained at Johns Hopkins School of Public Health. Some of my closest friends, and many of my clients, are physicians. None of them have any doubt whatsoever that vaccination is safe and effective. All recognize the absolutely central role of vaccines in improving public health.

We no longer have thousands of children and adults confined to iron lungs because of polio. I don’t know anyone whose brother, sister, son, or daughter died of measles, mumps or whooping cough as a child. Unless the Iranians or Russians have retained live smallpox cultures, a disease that has killed millions over the centuries is gone from Planet Earth.

All because of vaccinations. Yet vaccination has become controversial because of misinformation spread on the internet. Even intelligent people, when struggling with a personal tragedy, can be led astray into believing in the non-existent dangers of vaccination.

Vaccination remains a sensible, indeed essential, best practice for the protection of something precious–the lives and health of people we love. Bad information about vaccination puts unvaccinated individuals at risk, but it also harms all of society as we lose the important protection of “herd immunity.”

A recognized best practice also exists in investment management. Diversification is the proven, sensible, documented best practice for managing investment portfolios. All professional investors, charged with managing entire portfolios for individuals or institutions with long-term goals, diversify.

Period. Hard stop. No capable investment professional ever fails to diversify, regardless of the temptations of today’s “hot” speculative opportunity. No sensibly-run college endowment ever puts all its money in one asset class. No foundation decides to bet it all on a single hot stock, fund or manager. No pension plan abandons diversification to go entirely into cash, stocks, venture capital, pork belly futures or Bitcoins.

All of these professional investors recognize that diversification is the key strategy to manage risk and deal with the intrinsic uncertainty of the financial markets. The intellectual foundations for diversification are simply too robust, well-documented, and mathematically compelling to be ignored.

That doesn’t mean institutions never make mistakes. As behavioral finance demonstrates, we humans are all potentially subject to information-processing and decision-making errors. At market extremes, many tend to over-weight the best-performing asset classes, confusing recent price trends with long-term economic advantages. (For a great summary of the thought process that leads investment committees astray, here is a recent piece from the smart folks at GMO, one of the world’s premier asset-allocation firms.)

Despite the abundant evidence in favor of diversification, we’ve recently observed a small number of investors choosing more focused portfolios. They believe they have identified the specific assets that will perform best in the near future–as at prior market highs, usually those assets that have performed best in the recent past. Right now, some smart people are inclined toward investing all of their money in U.S. large-cap stocks, believing that the “Trump trade” will continue to drive domestic stock markets to new highs.

I doubt that any of these folks would consider not vaccinating their children. But they may be in danger of making a tactical blunder with important consequences for the health of their portfolios. We’d hate to see that result.

Be smart. Vaccinate your portfolio. Stay diversified.

J

 

Mad Libs for Investors

The emotions are really starting to heat up. During most of the typical stock market cycle, most investors are able to keep their emotions well in check. That is particularly true of our clients, who tend to be a patient, mature, and generally cerebral bunch.

But during certain parts of the cycle, the mass of investors, including even our cohort of unusually smart and even-tempered clients, begin to behave less as individuals and more as a herd. As emotions take over, reasoning ability becomes compromised. Vision narrows, blood pressure elevates, time horizons shorten, and calculation gives way to expectation; what is happening right now becomes all important, while what is likely to happen longer-term appears entirely unimportant. The chance for profits seems both immediate and certain, while the danger of loss appears theoretical and distant.

With the market making new highs day after day, we are beginning to get those phone calls, and have those conversations. The content of these discussions sound something like this:

“Everyone is getting rich! Why do I still have cash?”

“We need to buy now!”

“I’m tired of underperforming when the markets are going straight up. I need a better strategy.”

At market extremes, whether the market is making exciting new highs or scary lows, the emotions of the crowd are a deadly danger to our long-term financial interests. At those market inflection points, our job as financial advisors is to refuse to validate our clients’ emotions as a basis for action.

That sounds really harsh. I still remember, more than twenty years later, one of my favorite clients, a retired woman of unusual grace and poise, telling me in a profoundly wounded tone, “You don’t want me to have any feelings!”

I was trying to explain to her, at the depth of the 2000-2003 market decline, that she should not sell out at the market low, amid all the bad news, as she had done in the three prior bear markets.

When my kids were younger, they loved Mad Libs, and filling out those forms prompted great hilarity during long car rides. “I need a noun! Now a verb! An animal!”

So here is a very simple Mad Libs style exercise about the current exciting market. I’ll provide four phrases with blanks, and a choice of words to fill them in.

Active investors are advantaged if they ______ low and ______ high.

Right now, the market is at an all-time ______. The mass of investors are _______ing. We should be _______ing.

The four words to use to complete our Investor Mad Libs are:

Buy

Sell

High

Low

(One hint. You will need to use only three of the four words.)

Please let me know if this exercise makes sense to you, and if it changes your current thinking in any way.