The SHAKE WEIGHT Financial Plan
Honestly, did you forward a YouTube link of the Shake Weight commercial to your immature friends? Did you find the Saturday Night Live Shake Weight skit to be hilarious? Unfortunately gimmicks like the Shake Weight are regularly sold to folks believing in a magic bullet or quick fix. People approach markets similarly — seeking the Shake Weight financial equivalent.
The financial Shake Weight may initially be less obvious, but once unearthed you begin recognizing the gimmicks are omnipresent. “Stocks to buy and hold for the next 50 years” was the talking point on CNBC January 2nd. A Google news search of “2016 stock forecast” yielded greater than nine million articles. These crystal ball forecasts are your Shake Weight financial equivalent.
Understand what you watch on CNBC (and other financial broadcasts) is entertainment. Furthermore, as a general rule, anytime you see, or hear, the word ‘forecast’ replace it with ‘guess’. This act alone should help clarify the charlatans.
Thinking you’ll buy and hold for 50 years is a joke. Believing the next 50 years will offer similar financial returns to the last 50, or the underlying assumptions nearly all financial models have, is not a plan.
Q: Who is the most iconic buy and hold investor?
A: Warren Buffett
Using Mr. Buffett as an example, I took Berkshire stock and looked at a rolling 12-month return starting from March 1980 to present. During that period Mr. Buffett had portfolio drawdowns of 20% (August ‘82), 40% (October ‘90), 61% (March ’00) and 62% (March ‘09). Were you aware of this, or did you believe his portfolio only increased?
When the media parades Mr. Buffett’s accomplishments they rarely mention his fortitude to stay the course during drawdowns nor his steady stream of insurance premiums to reinvest on a continual basis. I already know what you will do. In the absence of a plan, you will sell near cycle lows and buy near cycle highs.
The folks interested in selling you their financial services pitch a narrative of diversification, re-balancing at designated periods and participating in the market over a long period of time. To support this, they provide data that the stock market returns 7–10% per year over the long term. Two reasons why you will not earn these returns:
First, the 7–10% returns advertised are in fact a reasonable estimate over a long period of time based on how this return is calculated. However, the difference between how this calculation is widely figured and your human nature does not afford you these returns. When markets are rallying you will likely buy stock in greater amounts because the recent past performance tricks you into believing the future is less risky. In reality, the opposite risk assessment is largely more probable.
Oppositely, as markets come under selling pressure you will buy less, and eventually you will stop buying, as recent performance and attention grabbing headlines make you believe the world is ending. Recent negative performance tricks you into believing the future is more risky WHEN IN REALITY RISK IS BEING REDUCED. Precisely the best buying opportunity.
In short, you will add more to your portfolio as the bull cycle matures and you will add less, or none, as markets contract. Resultingly, your weighted average buy will be much higher than what the 7–10% long term average assumes.
Secondly, diversification is a term taught in business school and espoused by financial analysts and advisers. Have you considered this may be their hedge for being wrong? Diversification ensures mediocre returns. Roughly 80% of your gains will come from 20% of your positions. If you buy and sit, you do not see enough looks to capture the best performers. You need a system that recognizes when the money is dead, cuts poor performers and attempts to isolate and maintain exposure to the best performers. In this scenario, even if your win percentage falls, the amount you win increases disproportionately.
Left to your own devices without a plan, I suspect your returns are nearer 0% than the 10% posited by market cheerleaders. How can you change this? Begin by asking yourself — “What will tell me I am wrong?” In my experience, having tight risk controls (exit plan) is materially more important to long term investing success than knowingwhat and when to buy. Read that again. You’ve likely been programmed differently. Think about it, nearly every financial source you consume discusses what stocks to buy wrapped in a sexy can’t miss narrative. Who discusses the exit plan and appropriate risk sizing?
Taking the advice of a suit pretending his/her Ouija board sees 50 years in the future is a non-starter.
Let’s grow our financial education. Stay nimble.
