A Disciplinary Tale





One of my brother’s favorite sayings is, “There’s no sliding in softball.”  Over the years, I have come to appreciate this phrase and use it frequently.  Another way of saying the same thing is to say that there is an appropriate level of intensity one should devote to the task at hand.  No offense to you softball players, but my brother considers softball a purely social and recreational activity that does not merit the potential of injury or appearance of competitiveness.  He would rather be “out” while not sliding and not risking injury, than slide since he knows that he is just playing for fun.  This does not mean he is uncompetitive, it means he chooses his battles wisely.

Investing is about choosing your battles wisely, and this tale is about a person who understands that investing is a long-term battle that requires a game plan and simple rules that lead to financial success.  It is my experience that successful investing is not a game of overreacting.  Successful investors all share the same proclivity to maintain their emotional stability.  The markets and the media are forever telling you to slide.  If you don’t, you’ll be “out.”  However, as long as you recognize you are playing a game of softball and you set the rules on how you play the game, you will avoid the siren call.  If you do, you will maintain your poise when others are losing theirs.  Many investors mistakenly think that the combination of stock market fluctuations and hyped media coverage means they must re-allocate or trade their portfolio based on the latest headlines.  This tale instructs us otherwise.

In the summer of 1985, I provided Jack, a 22-year-old recent college graduate, with a game plan for his financial future.  Jack was embarking on his first professional job in corporate America, he was single and he wanted to be intelligent with his money.  We discussed some simple principles and rules and wrote them down on one piece of yellow legal paper.

I wasn’t as wise as I am today, and I only had five guiding principles for building wealth.  I wrote these principles on the yellow sheet of legal paper and underlined them.  To reiterate, the principles are as follows,

1)    The objective of saving money and investing is to build wealth.

2)    Once wealthy, the objective is to retain your wealth.

3)    Wealth is a personal state of mind and lifestyle, but to ensure you are not off base or living in some woo-woo fantasyland, you must have an objective measure of wealth.

4)    The objective definition of wealth is the ability to earn as much while not working, based on a rate of return of 4% per year on your money, as you can earn while working.

5)    Minimize drawdown.  This means lose as little as possible when losing money.

Naturally, Jack had two questions.  He wanted to know how much to save and how to invest his savings.  These are the two essential questions everyone must ask and answer when they are seeking to build wealth.  Because Jack was not wealthy, he needed a plan to get there.  I gave him my set of investing and saving rules.  We wrote these on a yellow sheet of legal paper as well.  They were as follows:

1)    Save 15% of every paycheck towards wealth building.  Think of this money, not as your money, but picture yourself as a much older man and tell yourself that you are doing it for him.  Save for old man Jack.  Convince yourself that it is his money, not yours.

2)    If your company offers a retirement plan benefit, invest from every paycheck the maximum allowed in the company plan since tax-deferred compounding builds wealth at a faster rate than taxable compounding.  Invest in your company’s tax-deferred plan before you invest in a personal taxable account.

3)    If you want to save more than 15%, that’s fine, but do not do it at the expense of enjoying the things that make you happy.  There is a fine line between over-saving and under-living.

4)    Get a credit card and pay it off in full at the end of every month.  Use it only for emergencies, and try to pay cash as much as possible.

5)    Invest 100% of your savings in stocks.  Stay 100% invested in stocks until you become wealthy, and then re-evaluate.  By the way, I now realize most people don’t have the intestinal fortitude to withstand this level of risk.  However, if it were my brother or son or daughter, this is the advice I would give.

6)    You can invest in individual stocks, and I encourage it at a later point in life, but initially, invest only in the alternatives your retirement plan offers.  They are usually broad asset categories that will provide consistent, but not spectacular, results.

7)    If your company retirement plan offers at least four stock investment options, invest equal parts of every paycheck in no more than four of these choices and rebalance at the end of every year.  Keep it simple.  I find that more than four choices result in confusion.

8)    Buy a house as soon as you have saved enough for a 10% down payment and buy it in a school district that allows you to send your children to a good public school.  This of course assumes you don’t plan on moving.

9)    Hire a good investment advisor.  They are very hard to find, however, since you have no money.  You must educate yourself.

The last thing on this yellow sheet of legal paper was a projection of accumulated assets over Jack’s lifetime.  I explained the rule of 72 to Jack and used it to illustrate the power of compounding over time.  In Jack’s case, he had 43 years to go before he reached the customary retirement age of 65.  If he followed this simple plan, I anticipated he would be wealthy well before he reached retirement age.

Jack started working in 1985 at an income level of $30,000 per year.  I estimated his income would rise at a modest 3% per year and that his retirement plan investments would perform at 8% per year over his 43-year career.  I like to be conservative when making long-term estimates.  I believed both his growth in income and his rate of return would be higher than projected, but I have always found that it is better to plan for the worst.  In addition, I prepared a little chart that demonstrated the power of compounding on a yearly basis over his career.

Jack did hire an investment advisor.  He hired me.  To this day, Jack remains one of my clients.  Over the years, he lived life.  He married, moved from one city to the next, switched jobs numerous times, became a father and purchased several cars and homes.  Jack’s wife, Jill, adopted the idea of saving 15% of every paycheck as well and, in her case; she saves additional money as well from every paycheck.  This was particularly true before they had children.

This tale gets its disciplinary name from the way that both Jack and Jill behaved in late 2002.  Their various taxable and tax-deferred stock portfolios had grown to almost $750,000 at their peak in early 2000, but by late 2002, their portfolios had dipped below the $550,000 level.  The stock market had been declining for almost 30 months, and people were getting nervous and ornery.  The drop in their portfolio was due to the high stock or equity concentration of their portfolio; as was our plan over the last 17 years, they were still 100% invested in equities.  By this time, they owned both individual equities as well as equity mutual funds.  They had suffered a temporary setback over the last two-and-a-half years and called to schedule an appointment to discuss our future strategy.

At our meeting, I once again explained that 25% or more declines in the stock market have happened multiple times and that I expect they will continue to happen as long as stock markets exist.  I further explained that the two-and-a-half-year period that we had experienced and might still be experiencing was an unusually large decline in both duration and percentage drop from the market peak, but it was not outside the boundaries of historical declines, and I advised them to maintain their portfolio allocation.  I also explained that on a relative basis they had performed quite well.

Naturally, I was feeling defensive in late 2002, as most advisors probably were.  I was beginning to question my own advice and convictions, especially since every analyst and commentator that appeared on TV or print espoused the virtues of safety and a diversified stock, bond and cash portfolio.  Short-term safety in the form of bonds and cash was the “in vogue” thing to recommend in late 2002, and we all know that these analysts always possess perfect hindsight.  Please note the sarcasm.  They always see perfectly in the rear view mirror.  In the meantime, Jack and Jill, as well as all my other wealth-building clients, had 100% of their money in the stock market.  We were counting our losses almost every month.  It was a very gut-wrenching period and a very insightful one as well.  Nevertheless, I did not waiver in my recommendation that a couple in their mid to late 30s should maintain their retirement/wealth-building investments in stocks until they are wealthy.  Again, let me say that I have tempered and refined this approach since then.  I no longer have clients where I am 100% invested in the stock market 100% of the time as long as they know it will take longer to achieve their wealth goal. 

I was pleasantly surprised the day after our meeting to receive a fax from Jack.  He had that night pulled out the one-page legal sheet of paper that I had handwritten so many years ago and sent me a copy of it along with a note that said, “Keep up the good work, we are way ahead of the plan.”  I looked at the fax and realized that I had projected that he would have considerably less than the approximately $550,000 he had by 2002.  This made my day.  To this day, I think Jack did this because he could sense the apprehension in my voice as I recommended that he maintain his aggressive all-stock portfolio.  In fact, Jack was well ahead of plan by a considerable margin, despite the large decline.  It was also very evident that the plan was working and that the next stock market move up, or perhaps the one after that, would move this couple closer to their wealth goal.  By late 2006, the equity markets had materially recovered from the lows of October 2002.  They then peaked in October of 2007 and then witnessed another major stock market decline.  Through the decline, Jack and Jill’s portfolio was still aggressively invested although not as aggressively as before.  Neither they nor I could withstand a 100% allocation to stocks.  They had reached some wealth milestones along the way, and I had become a wiser advisor.

What was truly amazing was that here was a plan, devised on very short notice more than 17 years ago, and the client still had the original piece of paper and had stuck to the plan.  The financial plan was good, not great.  But more importantly, it was executed perfectly and with discipline, thus the title of this tale.  I have seen people pay thousands of dollars for financial plans that are elaborate and encompass so much detail that it makes even my head spin.  However, they do not execute the plan, and thus, the plan becomes useless.  This leads to one of my financial maxims, “It’s better to execute a good plan well than to execute a great plan poorly.”

I wanted to make this tale current, so let me leave you with the following.  It’s been 28 years since I met Jack.  Jack and Jill currently have a portfolio worth $1.9 million.  He works and contributes to his retirement plan every paycheck, and Jill is raising their children.  Had his salary increased at 3% per year, had his portfolio performed at 8% per year and had he contributed 15% per year, his portfolio would be worth a lot less.  It would be worth approximately $650,000 today.  So what’s the difference between $1.9 million and $650,000?  The answer is three-fold.

1)    Jack’s salary didn’t increase at only 3% per year.  It increased at 6% per year.

2)    Jack has always worked for Fortune 500 companies.  Large companies like these typically offer their employees a company match, up to a certain percentage, and so Jack was able to contribute more than the 15% due to the company policy.

3)    Assuming a company match of 6%, which increased Jack’s savings rate from 15% to 21%, and assuming the observed 6% annual salary increase, Jack’s rate of return has exceeded the 8% assumption.  My math has it right around 10%.  So, did all this 10% come from investment acumen?  The answer is I don’t know.  The first is Jack must use a portion of his money to buy the stock of his employer.  The second is, together they have saved money beyond Jack’s 15% contribution.

Once again, a good plan but well executed.  I will keep you updated on Jack’s progress in future editions.

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