How to invest when markets are expensive and assets fully priced

Investment Perspective – October 2016

“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

Markets are expensive – without doubt. That makes it difficult if we like to invest in good businesses at a favourable price.

Indeed, we need to be careful because the market sets the price not you and I as investors and the market, whilst not always wrong can be highly erratic – subject to that reptilian brain.

Start with the winning investment framework

A good place to start is simply to have in place specific investment purpose (e.g. grow capital, protect the buying power of capital, generate sustainable passive income over a long period of time). We know why we are investing.

Also, investment strategy is critical as it provides us with the framework or structure around how to invest. In other words defensive investors should invest by way of defensive investment portfolios and be happy that the trade off for a smooth ride along the way is that less money will be made, substantially less over the long run. Even 1.5% reduced return is a lot less money and not just a little bit as a percentage like 1.5% can make it sound.

Conservative investors looking for growth will invest in productive assets (good businesses that grow) using Value based methodology (as per WISEplanning!) and being disciplined around the application of that methodology. Add in a reasonable measure of patience when required and we have the makings of investment success, even when markets are expensive, as they are at the moment. We know how to invest.

Mindset matters

Crunching the numbers (investment analysis) is obviously a critical component of investment success whether markets are expensive or not. After all, how do we know one business from another or whether or not a business is available at a fair price without proper analysis?

We do not need to look too far to be able to see that markets and market behaviour are linked and can at times be highly erratic, irrational.

Fear and greed is why markets rise and fall significantly and sharply at times. That is the mindset, the collective behaviour of the markets driving prices. Mindset therefore matters.

At WISEplanning, mindset is about an individual’s lifetime of conditioning, beliefs, habits, attitudes and therefore behaviour. Different people have different experiences, develop different belief systems and adjust to the world they live in differently to others.

If I am an experienced investor I am more likely to look through the market noise, prices declining, media banter and see declining prices as opportunity rather than something to be scared of.

To be clear, the logic of this is obvious to anyone. However, it is my experience that the psychology of declining prices is an entirely different matter. Much less clear, much more complex.

The 37 Reasons …

With the help of my clients, I developed The Money M-A-T-R-I-X Program over 20 years ago. As part of that program we help our clients to first of all realise that real success will only emerge when their behaviour closely matches their big picture long-term goals.

For example, worrying about markets rising and falling is not behaviour consistent with ongoing investment success. Rather, feeling excited about the opportunity when prices decline is behaviour more in line with sustainable investment success.

Anyway, one of the ideas that we came up with many years ago was what we now refer to as “The 37 Reasons”. This relates to all the reasons that people undertake avoidance behaviour, do things that sabotage success or won’t do what they deep down know they should.

So, “The 37 Reasons” became our dictum to highlight the madness of unnecessary worry, buying into what is convenient but what really are excuses for not doing what we know we should.

“37 Reasons to Sell …”

The above chart put together by Motley Fool highlights what appeared to be at the time compelling reasons to sell, to bail out, to run away from the markets. What does the above chart say to you?

Another point… key to investment success

Another important key to investment success is to invest in productive assets, (good businesses that grow).

But what makes a good business anyway? Well, Warren Buffett (I reckon he knows something!) has long been a fan of what he calls the durable competitive advantage. This is something that is not widely available wherever you look. It is difficult to find – and worth it.

Lets talk more about the sustainable competitive advantage next time…

“Men cannot not live by exchanging articles, but producing them. They live by work not trade.“

John Ruskin (1819-1900) English art critic