A Tale of Today


A TALE OF TODAY

“TODAY IS EVERYDAY”

 

 

In March 2009, I happened to be with a group of strangers when one of them recognized me and asked me what they should do with their money now.  This happens about once a week it seems, and always makes me uncomfortable.  I never know how to answer these questions, especially when I don’t know the individual’s situation or frame of mind.  On this particular day, I tried a different approach to answering the question.  I have tried many approaches over the years, and my objective is always the same.  I want to convey that there is no right answer in general, but there are a number of right answers specifically.  I asked the fellow to try an experiment.  I would ask him a series of questions and he would respond.

My first question was, “How do you think you should invest now?”  He responded typically.  He responded with the situational response reflecting the sentiment or media hype of the times.  In this case, mid-March 2009, public sentiment was long-term bearish but short-term bullish since we were witnessing a strong short-term rally in the stock market after a long and deep drop.  I then asked him a second question.  It was, “OK, I understand how you think you should invest now, but what about now?”  I could tell from the look on his face that he was confused.  I had just asked him the same question just seconds before.  I then asked him a series of rapid-fire questions.  I asked, ”OK, too late.  How about now, how about in 20 minutes, how about tomorrow or the day after tomorrow?”  My message was starting to crystallize.  When it comes to investing, now” is “alwaysandtoday” is “everyday.”

Investing is a continuum of decisions.  Without a decision-making methodology, you will not succeed.  This is why I am so insistent that anyone who invests must develop an investment approach that suits their personality and that they can apply in a disciplined manner.  If you can’t, then you must hire an advisor with a proven approach.  If you can’t develop one or can’t hire an advisor with one, then you must instead simply avoid investing in the stock market.  There is no point in investing in the stock market and trying to get 8–12% per year because you will fail without a successful approach.  It is better to stay conservative and make a consistent but lower return than delve into stocks in a haphazard manner.

There were a few other fellows in the room, and one of them chimed in, “I am a buy-and-hold investor, what do you think of that?”  I told him that there was no such thing as buy and hold.  I explained that even those who preach buy and hold don’t practice what they preach.  I cited the annual portfolio turnover rate, how often a portfolio buys and sells stocks in a given year, for a number of well-known buy and holders.  I even explained that if you examine indices, the theoretical most extreme cases of buy and hold, you observe considerable turnover.  I explained how the Dow Industrial only has 30 stocks in it, that 10 of them weren’t included as of a few years ago and that only General Electric remains from the original Dow.

My point is that even indices have considerable annual turnover, and buy and hold is conceptual, not real.  Even when practiced correctly, it is, at best, a “buy-and-mold” approach to investing and not “buy and hold.”

At this point, a third fellow chimed in.  “OK, so today is every day.”  I get it.  Buy and hold doesn’t exist.  I get it.  The best investors in the world as well as index funds buy and mold their portfolios.  I get it.  But how do I mold my portfolio today?”  This fellow was very clever, and I give him credit for listening, so I gave him my best metaphysical answer.  I said, “You mold your portfolio the same way you always do.”

By this time, I think it was clear that I wasn’t going to give anyone a simple answer.  I could tell them all that, due to my approach; a combination of momentum and long term moving averages, I had the bulk of my investments on the sidelines awaiting a better entry point into the stock market.  I could tell them that I had missed a considerable part of the stock market decline, but that the price I pay for protecting my capital during bad periods is that I forfeit some capital appreciation during good periods.  I could tell them that I was a rules-based investor who invested in the stock market when it met certain criteria and that at other times I am mostly on the sidelines.  I could tell them that buy and hold as practiced by most unsuccessful investors is actually “buy and fold or “buy and pray” when things get bad.  I could have said many things, but chose to say nothing.

There is good news.  What I have learned is that people can develop their own methodologies.  They can develop their own rules that tell them what to do today, tomorrow and every day.  They can invest the time to learn how to invest intelligently or invest the time to hire investment professionals intelligently.

As I was getting ready to leave, a fourth fellow said, “You know, I am a buy-and-hold investor or a buy-and-mold investor as you describe.  I’ve ridden the market down and I will ride it back up.  I do this because my advisor has told me that the proof that buy and hold works is that if you miss the top 10 winning days in any year that your return in stocks drops from 10% per year to almost 0% per year.  Is this true?”

I quickly did the math in my head and concluded that it would drop to much less than 0%.  I had no idea what it would drop to, but I knew it would be far worse than 0% since I know that the top 10 winning days in any year exceed a 1% rate of return per day, so I knew his math was probably off.  I asked the fourth fellow to explore the antithesis of his argument.  I asked him to estimate how much money he would make in any year if he missed the 10 worst trading days in any year.  He quickly understood that the theory behind missing the 10 best trading days as a proof for buy and hold was invalid.  It’s especially invalid when you recognize that losing days in the stock market are larger than winning days and losing days are more volatile than winning days because fear is a stronger emotion than greed.

I was curious, so I went home after my discussion with this group and downloaded the daily price moves for the equivalent to the S&P 500 from 1994 through 2008.  This was a 15-year period, and I used the stock symbol SPY as a proxy for the S&P 500.  The results were interesting.  The return for the 15 years was 4.89% per year if you practiced what people call buy and hold, even though we’ve learned that it is actually buy and mold.  I then calculated the return if you missed the top 10 trading days in each year, and the results were as I expected.  The rate of return dropped from 4.89% per year to a 16.84% loss per year.  Does this prove anything?  Does this prove “you gotta play to win” and “you gotta be in it to win it?”  The evidence looks compelling, but it is only one side of the coin.  Let me explain.  I then calculated what the return would be if you missed the worst 10 days.  In this case, the return increased from 4.89% per year to 36.95% per year.  Once again, right in front of me was proof that you should do everything in your power to avoid the 10 largest drops in any given year.  This presents a conundrum.  What’s better, avoiding losses or capturing gains?

The point of my analysis is not to draw any conclusion.  The point is you need to think about how the market works.  Silly lines such as you can’t miss this or that or the other thing, are worthless.  If you test the opposite statement, you learn that avoiding losses is far more productive than missing gains on an equivalent basis.

Incidentally, this is why my particular approach uses long-term trend-following techniques to tell me what my opinion is.  I don’t have an opinion on the stock market.  I just know how I will react to what is happening, when it happens.  This gives me great comfort and lets me avoid those periods that historically have been the most volatile.

Let me finish this tale by retelling the story of the “Turtles.”  I use the Turtles to illustrate that you must develop your own methodology or hire a successful methodology.  If you don’t, you will be unsuccessful as an investor.

The Turtles were a group of novices hired and trained by two legendary traders, Richard Dennis and William Eckhardt, in the mid-1980s.  The two legends were equally convinced their philosophy about trading was correct.  One believed trading was teachable.  The other believed that trading was a gift or talent that some people had and others did not.  They tested their beliefs by hiring these novices and teaching them their exact techniques.  When I mean they taught them their techniques, I mean they taught them every detail.  They provided them with the exact techniques that they used to trade their own money.  The results were that some Turtles succeeded while others failed.  As is typical of suspicious people, some failed because they believed the legends hadn’t disclosed their full approach to trading.  Others failed because their personality didn’t allow for the level of risk the methodology required.  Still others failed because they were selective in the actual trades they generated based on the trading system.

As a final example of how one must develop an individual trading or investment methodology, let me leave you with something that happened to me.  I attended a trading conference where I had the opportunity to meet Mr. Eckhardt of Turtle fame.  At the time, I was using protective stops in my trading approach and struggling with the idea of whether I should continue or discontinue their use.  For those who don’t know what a protective stop is, it is a sell order placed either below or above the current price of whatever you are trading that automatically gets you out of your position if the price moves in the opposite direction of your position.  I asked Mr. Eckhardt if he used them in his trading and he said, “Only idiots use protective stops.”  A few hours later, I had the opportunity to meet with another legendary trader, and told him about my conversation with Mr. Eckhardt.  I asked him his opinion.  He looked at me quizzically and said, “Did you punch him for calling you an idiot?”  I said, of course not.  To which he replied, “Protective stops, use them, tell your friends about them, don’t leave home without them.”  I had two diametrically opposite answers.  This lesson never left me and so I pass it on today.

To be a successful investor or trader you must develop a methodology that balances your appetite for risk and reward and allows you to execute what your methodology tells you to do.  Like baby turtles struggling for survival, “Many are called, but few are chosen.” 

If you want further information, feel free to contact us at www.financialtales.com.  

Upvote (0)
Comment   |  3 years, 1 month ago