We don’t know anyone who hasn’t seen the 1983 classic seasonal film,‘A Christmas Story.’It has become a part of the Christmas tradition,as TBS network runs an annual 24-hour marathon of the movie on repeat, beginning on Christmas Eve. In the movie there is a scene in which Scut Farkas, the neighborhood bully, torments Ralphie and his friends. One of the boys (Flick), who did not get away, is tortured into saying “Uncle” which is the equivalent of raising the white flag of surrender.
Similarly, when trying to understand investor risk tolerance, we seek to identify an investor’s point of capitulation, when they would say ‘Uncle,’ and decide to trade their equity investments for the perceived safety of cash or bonds. I bring this up because we don’t define stock market risk as simply falling stock prices. In fact, stock prices fall all the time! Stock market risk occurs when an investor says‘Uncle’ when stock prices fall.It is only when the investor raises the white flag–and liquidates equity holdings in a bear market–that they truly experience risk.You will often hear us reference our favorite investment quote, from Benjamin Graham’s famous book The Intelligent Investor,where he wrote: “The Investor’s chief problem –and even his worst enemy –is likely to be himself.”
Our Philosophy of Investing contains 10 pillars – one of which addresses this risk of bad investor behavior:
It is not easy to keep your composure during market corrections, and the desire to protect your nest egg is intense! Your instincts, and human nature, often overtake rational thoughts. It is natural to feel nervous, and welcome this discussion during volatile times. However, there are tools to help avoid this behavioral risk. For instance, we believe every investor should have a written financial plan in place, AND that if your plan has not changed, then neither should your investment strategy, no matter the market gyrations. We also believe it is beneficial to review your Plan annually to reinforce your commitment to it, in both good times and bad!
Diversification Helps Reduce Bad Behavior
Diversification is another powerful tool that reduces the risk of saying ‘Uncle!’ We take a globally diversified approach to investing, which reduces the possibility of all your assets being down at the same time. For instance, did you know that in one day, this past August, the Argentinean stock market was cut in half? The S&P Merval, which represents Argentina’s stock market, was down 48% in one day, August 12th, 2019. If your portfolio were down this much in one day, would you say ‘Uncle?’
Most people were probably unaware of this major stock market correction in Argentina, because most investors are not invested heavily in Argentina. I present this case as just one example of the benefits of diversification. By maintaining a disciplined approach, and not owning a highly concentrated position in one market, and especially one individual stock, you will be less susceptible to losing 50% of your account value in one day. We seek diversification across countries, sectors, asset classes, etc., which reduces the risk of large dips, which temp capitulation.
We have long been believers that discipline is one of the most valuable traits of a Great Investor. When it comes to investing, our definition of discipline is: “the refusal to react inappropriately to disappointing events, such as times when your portfolio “underperforms” an arbitrary stock market benchmark because it is diversified.” It is both the decision not to do something wrong, as well as the decision to continue doing the right things.
If you are working from a well-defined plan and remain diversified, you will greatly reduce the risk of saying ‘Uncle!’
Investment Market Returns for 3rd Quarter 2019
The Global stock market turned in another flat quarter, up by only 0.1%. The story remained the same as it has for nearly the last decade: US equities outpaced International stocks yet again this quarter. If you’ve been reading our market commentary over the last few years, you will have noticed the trend of Domestic stock markets outperforming International stock markets. This trend remained true in the 3rd quarter as US stocks were up 1.7% while Developed International and Emerging Markets were down (-1.0%) and (-4.2%) respectively. This most recent quarterly performance was a continuation of the longer term return trends. The US bond market had an exceptional quarter as the Barclays US Aggregate Bond Index was up 2.3%, leading all asset classes. While commodities continued its negative trend, down (-1.8%) in the 3rd quarter.
We continue to draw your attention to the positive long-term results for all asset classes. To be a successful investor, you must keep a long-term perspective and accept the intra-year gyrations that come with owning risk assets.
We discussed this US dominance in the equity markets in more depth in our April 2019 Market Commentary. We once again point out that, while U.S. stocks have been dominant “by 1% per year” over the last 70 years, all of that out outperformance has come in the last decade. Up until 2009, domestic and International equities provided similar performance. It hasn’t been until the last decade that the performance shift has been so one-sided.