Investing Lessons from Warren Buffett

Those saving for retirement should ask two questions:

Is my rate of return meeting my expectations?

If/when the market collapses, what protections do I truly have in place to protect my assets?

Traditional models don’t seem to be working like they used to

Traditional investment models typically employ some version of Modern Portfolio Theory (MPT).  Many still hold to the belief that traditional asset allocation (as defined by MPT) is the ideal way to invest.  I question this type of model in a period of rising interest rates.  As interest rates rise it is hard to fathom how bonds or bond funds give one the protection they did for 35 years during a climate of falling interest rates.

Warren Buffett wrote in his annual report to shareholders, “It is a terrible mistake for investors with long-term horizons — among them, pension funds, college endowments and savings-minded individuals — to measure their investment ‘risk’ by their portfolio’s ratio of bonds to stocks.  Often, high-grade bonds in an investment portfolio increase its risk.”

Famed investor and money manager, Jim Rogers, said, “You will see higher interest rates over the next few years. In fact, interest rates will go much, much higher.  We have certainly seen a top for the bond market. There is no question about that. Bonds will be going lower for many years to come.”

Bonds have been a key part of traditional investment models for the past 35 years as they have been a primary hedge against stock market risk.  Conventional thinking has been tied to some blend of stocks and bonds (equities and fixed income). Those days are behind us if you believe Warren Buffett and Jim Rogers – and I do.

If bonds are not a good hedge against stock market risk, what is?

Again, I go back to Warren Buffett.  Mr. Buffett has done two things in anticipation of a major stock market crash.  One, he has warned his investors that a 50% stock market crash is “inevitable”.  Two, he has accumulated $118 billion in cash in order to weather such a crash and also to take advantage of a crash and be able to buy companies at much lower prices.

If we were to take that down to the level of the average person, I believe it would tell us to put a substantial portion of our money in cash and be ready for this “inevitable” crash.  It would further tell us to be ready to deploy that cash when others are selling stocks – when the intense pain that huge losses can cause is inflicted on investors.  In other words, the Buffett model is to accumulate cash when others are buying and to buy when others are selling.

An alternative approach

I use a version of Warren Buffett’s approach.  My mathematical model “tells” me to sell positions and accumulate cash as prices rise and to be patient so I can deploy that cash when prices drop.  I do not use bonds or bond funds because of the reasons stated above.  My approach is different from Buffett’s, however, in that I use index and sector funds rather than individual stocks.

No single approach is perfect and can avoid all losses in a severe market crash.  I believe that my approach can minimize losses and shorten the duration of those losses.  Investors need to be prepared for the fact that deep losses will occur in the market, have some way to minimize those losses, and have some method to take advantage of real buying opportunities when prices are lower.

Warren Buffett quote

Warren Buffett once said, “ Be fearful when others are greedy and greedy when others are fearful.”

 

Disclosures

Past performance is no guarantee of future results. While active management seeks to produce higher returns than those of passively managed portfolios, historical pricing patterns, which are a component of our mathematical model, may not necessarily be repeated in the future. This type of strategy is not suitable for all investors and there is no guarantee that your investment objective will be met or that you will not incur losses, including loss of principal.

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Davos as Contra-Indicator

Davos as Contra-Indicator

Euphoria at Davos may be a sign that the market melt up may soon begin to cool.

By Scott Minerd, Global CIO

Two years ago, when I last attended the World Economic Forum in Davos, a growing consensus saw the global economy at the brink of recession. The spread between credit securities such as bank loans and high-yield bonds had dramatically increased relative to lower-risk assets like U.S. Treasury securities. Stocks had sold off, and many pundits predicted that we were at the brink of a new bear market. Oil was collapsing toward our earlier established target price of $25 per barrel for West Texas Intermediate. Declining asset prices were offered up as full evidence that the U.S. and probably the entire global economy was at the precipice of recession.

At the time, we argued that correlation was not causality and that oil, stocks, and high-yield bonds were approaching a bottom. In our clients’ accounts we were increasing exposures to high beta asset classes such as mezzanine collateralized loan obligations (CLOs), bank loans, and high-yield bonds. While we stayed the course with our client portfolios, the consensus at Davos led me to conform by allowing for further price erosion when I should have pounded the table that it was time to buy. Fortunately, my words did not exactly match our actions. I remember explaining on a CNBC appearance that no one can time the bottom, and despite any comments to the contrary it was time to start buying on weakness. The good news is our investments performed well as we continued to load up on energy exposures and leveraged credit risk in the form of mezzanine CLO securities.

As things kick off here in Davos, the sentiment could not be more radically different from January 2016. Global growth is accelerating and risk assets are soaring. Sentiment is so positive, it feels like the discussion will focus on “How high is up?” This is occurring in the face of U.S. tariffs on solar panels and washing machines, while CNN and the BBC run documentaries on a rising tide of nationalism, and against a backdrop of discussions on restricting immigration just when healthy Western economies are starting to experience labor shortages in certain key industries.

While I am still a Davos neophyte—it is only my fifth visit to Davos—I am starting to consider that Davos may be a valuable contra-indicator. A few years back the big story here was about the emergence of Africa onto the global scene as an important component of future global growth. While I think that view is ultimately correct, the immediate experience proved very disappointing for investors. Rather than a buying opportunity, investors would have done better to go short for the near term.

While I am hesitant to jump to a conclusion, I am troubled by the euphoria undergirding the gathering here. I will be listening closely and speaking occasionally, most likely asking more questions than providing opinion. I have seen bull market tsunamis before. They can be both rewarding and destructive. The key is to know when to get out.

 

Important Notices and Disclosures

This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

This material contains opinions of the author or speaker, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. No part of this material may be reproduced or referred to in any form, without express written permission of Guggenheim Partners, LLC.

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©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.

 

 

This article was originally published in https://www.guggenheiminvestments.com/perspectives/global-cio-outlook/davos-as-contra-indicator

 

It’s Not Your Fault

Have you heard these statements?

We didn’t see this coming.

You need to be well diversified.

Invest for the long run.

You have lost money, but selling now is unwise.

The stock market goes up and down.  That’s just the way it works.

I thought so.

These types of statements are intended to deflect investors’ attention from the “rollercoaster ride” that so many have been taught to endure.

Many financial professionals will tell investors that the way to invest is to put their money into the stock market.  If that feels too risky, they may advise them to diversify by adding some bond funds to their portfolio in order to “smooth out the ride.” While their counsel may differ slightly, the net result of their investment strategies tends to mirror this advice.

I have seen many people’s brokerage account statements and, currently, the majority are covered in “red ink.”  Many investors have taken significant and unexpected losses.  Many are not young; they are older people who cannot and should not be taking big hits or investing using conventional buy and hold strategies.

Enough’s enough.

I’ve witnessed people’s emotions in response to these losses. They are angry, frustrated, hurt, disgusted, fearful and some are even brought to despair.  I frequently think, “What a crazy industry that so frequently delivers such poor outcomes to trusting people!”  In my opinion, people are not and have not been adequately educated by their financial advisors about what the “investment ride” will entail – at least not in words they can understand or with logical explanations.

Don’t ask.

Some investors are having more success with their investment portfolios than others.  However, the vast majority of the people with whom I have spoken have seen their investments plummet in value this past month. They’re asking the same question I asked myself before I became an Investment Advisor Representative: Why hasn’t someone developed a way to help me protect and grow my money, instead of simply taking me on a financial rollercoaster…again?

I also asked myself other questions. How could advisors more correctly set the expectations of investors, so that when the market collapses, people would still be assured they’ll survive financially?  Why does the way the wealthy invest differ so greatly from how the average retail investors are told to invest?

These types of questions are those which financial professionals dislike hearing, and when they’re asked, it seems that either the questions or questioner are dismissed.  I have experienced this first hand.

It is not your fault.

Perhaps you have been on the “Wall Street merry-go-round” with very few portfolio gains – or only losses to show for the ride.  The financial industry teaches its professionals how to encourage investors to invest in their strategies with a degree of confidence.  However, when losses occur, investors are ill-equipped to handle them.  While this is not always true, far too often it is.

So, what’s the answer?

Ask yourself how much money you’ve made or lost and how much risk you’ve taken to get there. You may have realized at this point that you’re not getting the desired results for the amount of risk you’re taking and that it’s time to move on and find an advisor who will actually protect and grow your investments.

So, how do you make sure that your next advisor won’t deliver the same results as your last three? Here’s a key question to ask a potential advisor, which cuts through all of their claims: Ask to view their track record for 2015 and for YTD 2016 and consider how it compares to the S&P 500. Ask them the tough questions and consider how they respond. Are they making the same claims and statements you’ve heard several times before?

If you’re feeling like you’re ready to get off the rollercoaster, please let me know.  I’d be happy to speak with you and provide a complimentary assessment of your current investments – or just answer any questions you may have.

 

Investing Your Money – When “Conventional Wisdom” Is Not Wise

Conventional wisdom says “buy and hold” investing is superior to other forms of investing.  Sometimes, there can be a case for buy and hold investing. For example, depending on the choices available, 401(k) investing often amounts to buy and hold investing. Also, in taxable accounts, the tax considerations may dictate more of a buy and hold approach.

A younger person who is clearly in the accumulation years of investing can use buy and hold investing as a reasonable approach. However, the older a person becomes, the less tolerant they are of radical swings in the market. The conventional wisdom of, “Just ride it out” or “You can’t time the market” leaves investors of all ages and circumstances feeling they must endure the buy and hold approach and the wild roller coaster that ensues.

The wealthy do not typically use a buy and old investing approach – and that should tell you something.

Why is conventional wisdom not wise?          

In my work as a Seattle conservative investment manager, I have found people follow the conventional wisdom of buy and hold investing because they are told this is just what they have to do, or that they will be making a mistake not to do it. They assume this must be true because so many people are saying it.

In the end, the masses are always wrong.” Don McAlvany 

It is better for one’s reputation to be precisely wrong than approximately correct.”
John Maynard Keynes, British economist

 Buy and hold investing isn’t a question of right or wrong. Rather, it’s about how much stomach do you still have for market ups and downs, and how much time do you have to endure that much pain? In your 20’s and 30’s it is less relevant than it is when you get older. However, the same people often say the same thing regardless of the age of the investor: “Just ride it out”.

Richard Russell has been writing Dow Theory Letters since 1958, and has thousands of loyal followers all over the world.  Russell is an independent thinker and is not beholden to the investing industry. He said recently,

“I’ve never let my subscribers take losses in a primary bear market. I believe we are now in a primary bear market that will go down in history as the worst bear market we have ever experienced. I believe this bear market will touch or break below previous historic lows.”

What Russell means is that when he sees market risks ahead, he tells investors to get out of the way. He has been on the “right” side of predicting market collapses for 57 years. By definition, it means he does not believe in buy and hold investing – and he does not follow “conventional wisdom.”  Right now, Russell sees huge risk right in front of us – and that is being ignored by the “convention wisdom” proponents.

If you get confused and just don’t know who to believe, you are likely to just follow the crowd and get caught in “conventional wisdom.” I understand this dilemma. Many do not have the time or interest to do the research on both sides of the buy and hold debate. 

Tips for investors who want to leave behind “conventional wisdom”:

  1. Question the thinking and advice from anyone whose track record had people endure the last crash and “ride it out”. Find an alternative investment manager who does not solely subscribe to the narrow view that buy and hold is the best way to invest.
  2. Look for bias. Is the person giving the advice to buy and hold benefiting financially while you take the ride up and down in the stock market? This is why I seek information from those who are more independent thinkers and who have largely been successful in avoiding past market crashes. Granted, no one is perfect in this area, so search for multiple sources that are not only independent, but have a fairly consistent track record.
  3. Think for yourself. Visit my website to see articles and interviews from independent experts I follow, and to learn more about risk-averse and an conservative investment management approach.