HOW HAS YOUR INVESTMENT PERFORMANCE IMPROVED OVER THE LAST 12 MONTHS?
Investment Perspective – December 2018
Peter Flannery CFP AFA
“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business”
Peter Flannery
You might think that I am referring to whether the cash up value of your portfolio has declined or increased and if so, by how much (particularly when we think about the volatility over the last couple of months or so).
I am not.
Even if you have been a client of WISEplanning for five minutes, you will have heard that price and value are not the same thing. You know … the intrinsic value of a business is based on how well it uses capital, as measured by return on equity and return on assets – not whether the trading price has increased, decreased or tracked sideways. Longer term though, the trading price and the intrinsic value move closer together.
When I mention your performance, I am referring to your general understanding about investing and your governance role as an investor, with WISEplanning in the management role.
You see, the governance role allows you effective control over investment direction and the long term outcome (return on investment / how much money you make long term).
You can set the direction and the outcome of your portfolio through your investment risk preferences, which in turn determines Investment Strategy:
- defensive,
- balanced,
- growth,
- toward advanced growth,
- advanced growth now.
Simply, if you are looking for better returns, then a more advanced investing strategy will deliver that to you over time. In the short term though, the cash up value rising and falling offers no indication whatsoever as to the success or otherwise of a more advanced strategy delivering better returns. Hence, watching it closely every other week (everyday !!?) is futile.
That is because … you know … the market determines the return on your portfolio in terms of the rise or fall in the cash up value in the short term – not the performance of each individual business. The market has a different agenda to you and I.
The market “plays the markets” and basically speculates.
This takes place in a variety of ways, most commonly, through share brokers, who adopt the momentum approach (allocating to market sectors, chasing popular stocks), investing in large well-known companies (the so-called “blue chips”). Also, share brokers will tell you quite plainly that they do not recommend many smaller companies because there is limited scrip (limited supply of shares to trade because they are so small), they are not followed by the market and therefore, they as brokers cannot make enough money trading those smaller companies. As I said, the share brokers’ agenda (I am not judging them) is very different to yours and mine – with me?
They have a different way of doing things. For example, they also see profit as a leading indicator whereas, we as Value Investors prefer to consider how well a business uses it’s capital (the return on shareholders’ funds and return on capital). That way we can understand something about both the income statement and the balance sheet (profit, looks only at the income statement, ignores the balance sheet).
A bit like modern portfolio theory, there is a huge industry worldwide, based around share brokers and their activities. So, humans being herd animals, like to “swing with the herd”, so to speak, and therefore, lots of people invest that way. Somehow, for many people, this makes it feel more right (feel more safe?) than other methodologies (like Value Investing) that are less well-known, less well-understood and therefore less prevalent throughout the investing world – strange but true.
Your performance
So, I know some of my clients see their membership of The Wise Asset Management Programme as simply a financial service and effectively default both governance and management to WISEplanning – no problem, we can handle it. However, for those in that category, they might be better to engage just a little bit more and to take ownership of that governance role.
This does not mean that if, for example, you are investing as per a growth strategy, that you are not entirely happy with that (you are allowed to be OK with that). If that is so and you are happy with the outcome that strategy provides long term, then that is fine (or is it?).
My secret mission
Notwithstanding that the portfolio managed for you by WISEplanning is your money, not WISEplanning’s money and certainly not Peter Flannery’s money(!), I have a secret mission to help all investors, who are keen, to advance their investing strategy. The reason is because, I know that they will not regret making the additional tens of thousands or hundreds of thousands of dollars that emerge over time.
Basic school mathematics and compounding tables tell us that even 1.5% additional performance on an investment portfolio of, let’s say, $750,000 equals $225,000 ($260,000 if we compound it) over 20 years.
Unfortunately, some everyday Kiwis cannot think past Christmas or their next holiday, let alone five years into the future, never mind 20 years! That is another story and another obstacle to better investment returns that needs to be resolved, another day (for some).
Also, because of the methodology adopted at WISEplanning, default risk is almost non-existent (or so little, it has minimal impact on our portfolios long term). Really, what we need to contend with mostly is simply pricing volatility.
“The pulse”
Earlier this year, I developed and released ‘The Pulse’ initiative. This was based around two simple questions:
- How far down can you tolerate the cash up value of your investment portfolio declining; and
- For how long?
The answers we received were many and varied. Surprisingly, there are still a number of people who have yet to respond (what gives?).
Anyway, this is a part of my ‘cunning plan’ to help you as an investor to build your investment resilience, confidence and either tolerance or greater understanding around volatility, so that you are better placed to adopt a more advanced investing strategy (and make more money long term).
By the way, if you have yet to respond to ‘The Pulse,’ just search your inbox and (unless you have deleted it) it will be sitting there, waiting for you to complete and return to us. Of course, if you are not interested in the money that you make on your portfolio, then no need to respond, I suppose (?).
SO, about your performance…
Simply, have you adjusted your investing strategy this year up one notch?
No problem if you have not. There is no judgment on this now. In the end though, we will all get to sit in judgment in the fullness of time when we look back – just saying.
If you are happy with the returns you are making over time (remember it is the long term “batting average”, not whether the portfolio cash up value went up or down or by how much over the last two or three years) and if you are happy with the current strategy, of course, in the governance role, that is for you to decide and to mandate for WISEplanning as managers to carry out and deliver.
On the other hand, why settle for less?
Price and value, transactions and performance.
We already know that the intrinsic value of a business is different and separate to the trading price.
“In the short term, the money we make on the share market is closely tied to the “voting machine” (market sentiment, the impact on trading prices and the movement in the cash up value of your portfolio). The longer we invest, the more the “weighing machine” (the underlying fundamentals of the business that you invest in, including the economics of the business and how well it uses capital) determines how much money we make.”
Warren Buffett.
Watching the cash up value of your portfolio rise and fall or assessing the performance of yourself (or WISEplanning) as an investor by the movement in the cash up value of your portfolio, which is simply a reflection of market sentiment, has little to do with your performance as an investor – particularly in the short term.
Remember of course, it is WISEplanning’s role to manage the portfolio, which is why you pay fees and hire us. We will also help you with the governance, however you, ideally, will own that space (if you want to?). You can control the governance, which you can do simply by focusing on your investing strategy, whether you understand volatility or just tolerate it. By the way, would it also help to stop looking at trading prices on the internet / in the newspaper, as though that makes any difference at all?
The novice test
You always know when someone is starting out and is a novice investor. They often focus too much on trading prices and the cash up value of their investment portfolio as a measure of investment success or failure, especially in the short term.
They can also feel anxiety around market and economic events to the point where they become unnecessarily defensive. That can inhibit portfolio positioning, damage long term compounding and easily cost tens of thousands of dollars (money never made that could so easily have been). I mention this because I observe it more regularly than I care for.
The Rule of 5 always applies and it appears to be largely inescapable, even by the world’s richest investors. So, no point in worrying about those investments that do not “perform”.
Some of those investments look like they are not performing but are what Warren Buffett and Charlie Munger used to call ‘work out situations’ and what WISEplanning refer to as ‘special situations.’ These are businesses who are likely out of favour, with their trading price having declined somewhat or significantly, (e.g. Credit Corp back in the day, FSA back in the day, more recently Tasty in the UK and Starbucks out of the US, to name a few).
Starbucks, by way of example, has been out of favour for nearly three years because the same store sales number has been declining. This is a number that the market likes to watch and does certainly have some validity. However WISEplanning have been building our position in this business over that time because the economics of Starbucks the business remain sound and firmly in place.
Anyway, if you feel anxiety or disappointment about trading prices bobbing up and down or declining, then you have a real opportunity to improve your performance.
If you are just tolerating volatility rather than understanding it, again, you have a real opportunity to improve your performance.
So, price and value are not the same thing.
Investment transactions and investment administration are not the same thing as your investment performance. Your governance and your investment portfolio are separate and different things.
Remember, you drive the performance of your portfolio, not the administration around your investments, nor the transactions that we undertake. To be clear, investment strategy determines and drives investment returns – not transactions, administration or the trading prices of your investments bobbing up and down with market sentiment … make sense?
You have the power to control your investment outcome because your role is governance.
Governance controls strategy … strategy controls investment returns. Management (WISEplanning) and investing methodology (investing in sound businesses rather than playing the share market) delivers those returns.
Together, with the methodology at WISEplanning (thank you Charlie Munger and Warren Buffett), you have real certainty around keeping your capital secure, achieving your investment goals and everything that delivers in your life for you and your family.
As this is our final investment perspective for 2018, I thought you might enjoy some light summertime reading
1957 letter
Warren E Buffett
5202 Underwood Ave, Omaha, Nebraska
2nd annual letter to limited partners
“Obviously during any acquisition period, our primary interest is to have the stock do nothing or decline rather than advance. Therefore, at any given time, a fair proportion of our portfolio may be in the sterile stage. This policy, while requiring patience, should maximise long term profits.”