Obviously, TV commercials are not reality. On the other hand, investing can get very real because it entails very real risk. Successful investing requires managing risk. That means you must look at what could go wrong, the downside of an investment, as well as the upside. By doing this, you’ll follow the example of the world’s best investor.
There is wide agreement in the financial press that Warren Buffett is the king of current investors. He has produced incredible returns in the stock market over the past 40 years by following a strict value discipline. This means he buys cheap and sells dear. It is all about the steak with him, not the sizzle; fact not emotion.
Buffett owes much of his success to his mentor, Benjamin Graham, who died in 1976 and was a finance professor at Columbia in addition to being an all-world investor. Graham was the greatest investment mind of the 20th century and the author of the best investment book written, “The Intelligent Investor.”
All of which is a preamble for this quote from Graham’s book: “Operations for profit should be based not on optimism but on arithmetic.” Meaning: Arithmetic is easy to quantify. Optimism is not.
An example of optimism: “Stocks always go up in the long run.”
The corresponding arithmetic: Stocks go up in the long run but they also go down. The 1920s Bull Market gained 340%. All of which was then surrendered. The Bull Market that started at the end of World War II and ended in 1966 also gained around 340%. And, all of that was given back.
See the contradictions? If it fits on a bumper sticker, it’s wrong. Dig deeper into the facts.
There were plenty of people that were invested for some or all of those time periods that lost money. It is necessary to define “long run.” It is also necessary to see where we are starting. For example, are equities cheap or expensive? Are interest rates rising or falling? Is the economy contracting or expanding?
According to Graham, “To have a true investment, there must be a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.” Again: Experience or fact can be quantified. Opinion cannot.
An example of opinion: “Stocks do well when our economy does well.”
The experience: From 1966 to 1982, the GDP grew 370%. During that time the return on the S&P 500 was zero; it was unchanged.
So the economy does not dictate return. Except when it does: From 1982 to 1999, the GDP grew 174%. During that time the return on the S&P 500 was 1,200%.
Bottom line — keep it simple: buy cheap, sell dear. It works.
Terry Davies is a portfolio manager at Investment Management & Consulting Group, a registered investment advisor in Portland. IMCG provides comprehensive financial and investment guidance to individuals, families, endowments and businesses. He welcomes your feedback by phone 800-605-6552 or email tdavies@imcgrp.com. The analysis of the financial markets in this column is not meant as investment advice.