Posted on July 16th, 2012
This quarter’s theme started with the book The Red Circle: My Life in the Navy SEAL Sniper Corps and How I Trained America’s Deadliest Marksmen, written by a friend of mine, Brandon Webb. In an attempt to improve the effectiveness of his sniper students, Brandon brought in Lanny Bassham, an Olympic gold medalist and world champion marksman, to help improve sniper performance and increase graduation rates. Bassham wrote a book, With Winning in Mind: The Mental Management System, and then I came across The Psychology of Wealth: Understand Your Relationship with Money and Achieve Prosperity, a book by Charles Richards.
These authors come from diverse backgrounds and professions, but their emphasis is singular: the mind is the most important aspect of success, whether you’re pushing your body to unbearable limits, hitting the target when everything’s on the line, or making investment decisions with your hard-earned money. Interestingly, all three authors recognize the importance of understanding how the subconscious and conscious minds interact, and how that dynamic often causes us to short-circuit effective decision-making, resulting in bad outcomes.
Most people’s relationship with their money is dysfunctional. That, at least, is Richards’ assertion after interviewing countless investors and financial advisors for his book. He believes our sense of intrinsic worth propels us to achieve goals and is tied to our perceptions and relationship to money. Many of these attitudes toward wealth occur as a result of conditioning and programming when we’re growing up. Often, at the heart of a person’s relationship with money is a strong fear of losing it.
Unfortunately, most of the programming and conditioning investors have is tied to their emotions, which is exactly opposite of what they should be doing to preserve their wealth. Investors believe that more data on economic conditions can allow them to predict investment performance. They think research rating systems, such as Morningstar, are a great predictor of fund performance, recent past performance is a great predictor of future performance, and that they’ll be able to time the market when they feel right about getting in or out. Simply put, they think that they, or someone they hire for advice, has a crystal ball and can predict the future. Academically, all these assertions have been shown to be flawed, yet the search for the perfect predictor continues.
Investment objectives for most individuals and institutions are straightforward. They want to see their wealth grow above inflation, they want to preserve their wealth through volatility, and they often need income as well. My clients don’t want to speculate; they want long-term wealth.
For this “non-speculative” type of investing, there are some essential and academically
sound principles to live by:
- Markets are mostly efficient (Efficient Markets Hypothesis) and provide the best information for pricing
- Global diversification is essential
- Markets should be captured broadly at low cost
- Only three factors have provided a consistent return premium over the riskfree rate:
- Market: Stocks have higher expected returns than fixed income (bonds)
- Size: Small company stocks have higher expected returns than large
- Price: Lower-priced “value” stocks have higher expected returns than
- For fixed income, the best estimate for bond maturity is the current yield curve
- Trading efficiency matter
I bring these points up because recently, a client asked me how he should measure my (Trovena’s) effectiveness. Should we look at recent performance? Should we be looking at how our funds were rated by Morningstar? Should we see how effectively we can time the market?
My answer is, “none of the above.” The best measure of an investment advisor’s effectiveness should be how well he’s capturing and implementing the academically proven investment principles summarized above.
You may not fully understand these principles, but don’t feel bad; most investment advisors don’t understand or implement them well, either. Thankfully, we at Trovena do, and that’s why we feel our clients have a healthier relationship with their investments and our long-term results back that up.
We provide value that’s unique and compelling from an investment perspective. Since we’re wealth managers, our clients have a need for much more than just advice on investment performance. They look to us for leadership and expertise in tax efficiency, taking care of heirs, asset protection, and charitable issues.
I’ll wrap up this discussion with a quote from Larry Swedrow, a well-respected investment professional who was commenting on an issue that fits right in with my message:
“However, having these skills (or working with a financial advisor who does) is only a prerequisite for success. They won’t serve you well if you don’t have the patience and discipline required. As Warren Buffett has noted, ‘The most important quality for an investor is temperament, not intellect.’ ”
Q2 2012 Index Review
Sources: standardandpoors.com, wilshire.com, mscibarra.com, morningstar.com, russell.com, Dimensional Fund Advisor
Equities were down for the quarter, and the domestic market fared better than its international and emerging counterparts. It’s no secret that much of this has to do with the uncertainty with the EU. It doesn’t appear this uncertainty will disappear tomorrow, but as discussed in my previous quarterly review, the markets are indicating that this is a much less volatile scenario than the 2009 global recession so far. High-quality bonds with shorter durations held up well for the quarter.
Many investors got nervous and pulled out of the stock market in early June, only to miss the best June performance for the S&P 500 since 1999. So far, 2012 has been a great year to be an investor, with solid returns across all asset classes.
If recent market performance should have little bearing on decisions with respect to portfolio composition, you might ask why we would even want to look at it. That’s a fair question. It’s a matter of transparency. Many advisors are scared when their bets don’t pay off for clients and they may find it easier to cloud their performance relative to the markets, especially given some of the fees and expenses they’re charging.
Since we make no predictions as to short-term market movements and rely on the academics that have created wealth for investors over time, we have no such concerns and are transparent with regard to our model portfolio performance numbers. You can review them here: http://www.trovenainvestments.com/portfolios/precisionportfolios/.
Looking at recent performance may also provide context. I’ve heard it said that investors have no business being in the stock market unless they have at least a 10-year time horizon. As a matter of policy, we feel the same. While investors with dysfunctional relationships with their investments might look at the second quarter returns and be emotionally compelled to change things, investors with the right temperament and understanding will instead look at whether or not their portfolios are capturing the principles noted above. Looking at 10-year and longer performance will provide better insight into the benefits of principles-based investing.
To conclude, it’s important to be aware of how the unconscious mind may drive our emotions to make bad decisions, resulting in bad outcomes. Many investors use research, data, or “smart” advisors as a proxy and justification to predict near-term events. Successful investors will ensure the “principles to live by” are being implemented with regard to their portfolio. In addition, they should take Warren Buffett’s advice and remember there’s no replacement for temperament, especially during times of volatility.