What Does 20,000 Mean?

We all saw the headlines! “The Dow reaches 20,000!” But what significance does this have is to the average investor? Studies show, not much. For the media it means headlines and talking points. For traders and speculators, it may be an excuse to make some trade based on expected short-term outcomes. I believe that for investors, it means nothing except for its potential to distract you from what really matters.

It’s nice that stock market indices are increasing, but what does it really matter that the Dow hit 20,000? Sure, it’s a nice round number with lots of zeros. But there is really no difference between the Dow hitting 20,000; 20,126; or even 19,944.

Your financial goals are unaffected by an arbitrary index hitting some round number, even if that number is “psychologically important”. Your financial goals are affected to a much greater degree by the investment choices you make, and your willingness to stay disciplined with your investment and financial planning strategy.

Does Dow 20,000 influence you to predict where the market is heading? Afterall, that’s what the experts are doing right now. Perhaps you are thinking “Wow, that is expensive, maybe I should lighten up on stocks and wait until the market dips down a bit.” Or maybe you are thinking, “This has real momentum. Let’s back up the truck and buy more US stocks!”

Both may be prudent options, but either way, your investment decisions should not be made based on some arbitrary index figure. If there is anything we have learned throughout the history of the market, it is that the market goes a lot lower than we expect during bad times, and a lot higher than we expect during good times. And decades of market history have shown that the most consistent and costly investor errors come from speculating on the market’s direction.

That is the why I encourage my clients to remain focused on their financial plans. Your plan is customized to reflect your needs and values. It isn’t influenced by the headlines of the day nor the whims of the market. It is the constant in an otherwise unpredictable and volatile market.

Disclosure

The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and non-utility) goods and services. The Dow Jones industrial averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors, and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore, their component weightings are affected only by changes in the stocks’ prices. It is not possible to invest directly in an index.

Basic content material compiled by Jay Mooreland from the Emotional Investor; but edited by Kerri Patrick for my audience and blog.

Following the Smart Money

August 16, 2016

What assets should investors buy to enhance their returns and reach their goals? This is a question for every investor and financial advisor. You have your financial goals, now you need to select assets that will help you reach them. Which assets (and combination of assets) will be best for you? Can you identify a few “home runs” – which may allow you to reach your goals a few years ahead of plan? We all love an early arrival (whether that is a plane arriving ahead of schedule, a meeting that gets out early), but wouldn’t it be great to arrive at our financial goals ahead of schedule?

What is Smart Money?

The term “smart money” usually refers to institutions and money managers with a great track record of performance. These individuals are usually very well known in the financial industry, and are often quoted and interviewed by the financial media. They may even be household names. They are very well educated, highly intelligent and manage billions of dollars. Access to them directly is usually reserved for only the super rich, and some of them may be completely inaccessible. Much of the “smart money” runs endowment funds, hedge funds and/or mutual funds.

Most investors can’t get access to their expertise directly through their fund, but since they are known through the media, you may be able to simply invest in what they are investing in (mimic their portfolio). It is not uncommon for their holdings to be made public as investors share the contents of the fund’s report online, or the media reports on when they take large stakes or “bets” in a company. And if a super smart and successful manager takes a large stake, they must have significant conviction.  We may conclude, “I’ve got to get me some of that.”  After all, if they are taking that large a position, it’s got to go up, right? Well, not always.

A Can’t Miss, Misses

Recently two respected and successful money managers invested in the same public company. These managers individually, and as a whole, represent the “smart money”. So not only do you have an individual manager investing in a company, but you have two different smart money managers taking significant stakes in the same company. This may appear to be a “can’t miss” strategy.

Bill Ackman of Pershing Square (hedge fund) has amassed a solid track record of outperforming major stock indices over many periods of time. Until recently. A few years ago he lost substantial money in JC Penney, and more recently he invested/bet a significant amount of money in Valeant.  Sequoia, a mutual fund that runs itself like a hedge fund, also took a large position in Valeant – over 30% of the portfolio. Now that’s conviction! With this type of investment from the “smart money”, any investor may be influenced to buy the stock. An investor might say, “If these guys think it’s a home run, it probably will be. So I should buy some – it may help me reach my goals early or take out some money and have a fantastic vacation.” Sounds reasonable. The problem is the smart money in this case wasn’t very smart.

Valeant lost over 80% in one year. This is the kind of loss that is very hard to recover from, and more often than not, delays an investor’s retirement date and/or impairs the desired lifestyle. It may seem smart to follow the “smart money”, but that is seldom the case. The “smart money” can earn very high returns because they take significant positions in a few companies that happened to work out over a period of time. But no one is consistently correct. It’s not just Ackman and Sequoia who make costly mistakes; you can also ask John Paulson (Paulson Advantage Trust) and Bill Miller (Legg Mason Value Trust). When a big investment (or bet) goes right, it looks like they can do no wrong. But let’s remember that everyone makes mistakes at some time, and those mistakes can be devastating.

Which is more important to you, achieving your financial goals or risking your goals to try to arrive a bit earlier? Investing is like a marathon – sometimes we need just need to pace ourselves even as others pass us.

Where It Could Make Sense

You could certainly make a case for holding concentrated positions to increase wealth. Bill Gates didn’t become filthy rich because he held a diversified portfolio. Workers at Facebook and Google do not get filthy rich through their earned income. Significant wealth is often created through concentrated stock positions. But we don’t hear about all the stock grants and options – all the concentrated positions – that went bust. But they happen, and they occur more frequently than the grand slams. So if you are inclined to try for the fences, you may want to consider doing it in a separate “Mad Money” account where if you lost it all, it wouldn’t have a material affect on your ability to reach your goals.

It’s important to note that the views expressed are not necessarily the opinion of SagePoint Financial, Inc. and should not be construed directly or indirectly, as an offer to buy or sell any securities mentioned herein. Individual circumstances vary. Investing is subject to risks including loss or principal invested.

Simple, yet Difficult

Warren Buffett said, “Investing is simple, but not easy.” You would think that if something were simple that it would be easy. However, in real life simplicity has little correlation with ease. Take losing weight. Very simple. Burn more calories than you take in. To be a successful investor all you have to do is buy low and sell at a higher price. Easy, right?

The Conflict

While it may be easy to define a future goal, the pathway to that goal is often one filled with conflicting shorter-term desires. For example, with a diet we want to lose weight and become more fit. But in order to do that, the path requires that we (1) exercise instead of relax (2) not eat that chocolate cake. The short-term distractions are often more powerful than the long-term goal because they are the today, the now. The goal is so long term that we lose the tangibility of it. But the current desire is now; we can literally feel it and taste it.

For most investors, goals are long term in nature…just like dieting. And just like dieting there are temptations in the short term that can lead investors astray. Those investment temptations include listening to (and heeding) expert forecasts, trading on the news of the day and micromanaging the portfolio based on short-term outcomes.

Investing may be harder than dieting. While we may choose to give up a day of exercise or give in to that dessert, we know that those slow down (or even reverse) our progress toward the goal of losing weight. Yet with investing, costly decisions that thwart our progress are often made in an attempt to achieve our goals even sooner. We sometimes make decisions that we believe will increase the probability of reaching our goals, but actually reduce it by delivering lower returns.

The Natural Response

When the market becomes volatile and we begin to see losses accrue, the natural reaction is to protect ourselves from further harm. This makes complete sense. If we have a physical harm or are experiencing pain, we respond by reducing the pain and doing whatever we can to avoid it. That response is essential in our daily living, but can be quite costly when it comes to investing.

Just about every investor goal requires increased asset values. When asset values go down two things happen: (1) we experience hurt/pain and (2) we are further from our goal than we were yesterday. Those two combined can influence investors to “stop the bleeding” and get to safety, especially when experiencing severe losses. The instinct is natural, but costly.

The Cost of Following Instinct

Wouldn’t it be great to be invested just on the big up days and be in cash for all the big down days? That may be very difficult because the big up days often occur very close to the big down days.

sheep-redorbitJP Morgan reports1 that over the past 20 years, six of the 10 best days occurred within 2 weeks of the 10 worst days. If the worst days have you moving to safer places, you may not be able to enjoy the best days the market has to offer. And missing just a few of the best days in the market takes a hefty toll on long-term returns…and reduces the probability of achieving your goals.

The following data demonstrates the significant drag missing a few of the best days can be. Data is from Jan 1, 1996 through Dec 31, 2015 for the S&P 500.

 

Fully Invested Entire Time             8.2%

Missed 10 Best Days                         4.5%

Missed 20 Best Days                         2.1%

Missed 30 Best Days                      -0.1%

 

You may argue that we wouldn’t need a best day if we could avoid the worst days. That may be true if anyone could actually predict the market consistently. The realities of the market differ from what we may wish it did. Since we don’t know when worst days will occur, when a worst day will be followed by a best day or what the market will do in the future, it is best to overrule our natural instinct with deliberate thought and focus on our plan. That’s the simplicity and difficulty of investing.