While the death toll from the current crisis is frightening, all that is asked of most of us is that we physically distance from one another. I am disheartened when I see that some individuals are unwilling to sacrifice so little for the greater good. On the other hand, I am proud to see the selfless behavior of the “essential personnel” that are allowing us to live our lives during this crisis. The medical professionals, as well as people working at grocery stores and pharmacies, are allowing us to weather this storm
As a part of my series about “Investing During The Pandemic”, I had the pleasure of interviewing Robert R. Johnson, Ph.D., CFA, CAIA.
Robert R. Johnson, PhD, CFA, CAIA, is a Professor of Finance in the Heider College of Business at Creighton University. He is also Chair and CEO of Economic Index Associates, a NYC-based firm that develops investable indices based upon Federal Reserve monetary policy. He is the co-author of several books including Strategic Value Investing, Invest With the Fed, Investment Banking for Dummies, and The Tools and Techniques of Investment Planning.
Thank you for doing this with us! Before we dig in, our readers would like to learn a bit more about you. Can you tell us the “backstory” about what brought you to the finance industry?
I had the good fortune of being born and raised in Omaha, Nebraska. While that might not seem to be the hotbed of the investment profession, it is the home of Warren Buffett. I became aware of Mr. Buffett very early in my life, as his son Peter was in my graduating class at Omaha Central High School. Studying Mr. Buffett has shaped the way I approach investments, and has certainly influenced the way I invest for myself and advise others.
Can you share with our readers the most interesting or amusing story that occurred to you in your career so far? Can you share the lesson or take away you took out of that story?
The pinnacle of my career was when I learned that Mr. Buffett chose my book, Strategic Value Investing, for his Berkshire Hathaway Annual Meeting Reading List (the book has appeared on the list for each of the last four years). It has been an honor to participate in annual book signings at the Berkshire Hathaway annual meetings. But, one particular book buyer stands out. I played tennis in college and have always been an avid tennis fan. I became interested in tennis at the time of the “Battle of the Sexes” between Bobby Riggs and Billie Jean King. Ms. King was always one of my sports heroes. I was shocked when at the 2017 Berkshire Meeting, I looked up and saw Ms. King asking me to sign a book for her. In life, it is wonderful when your heroes don’t disappoint. Ms. King and Mr. Buffett are examples of individuals that not only meet your expectations, but exceed them. They make the world a better place.
Are you working on any exciting new projects now? How do you think that will help people?
My academic career has been focused on investigating the relationship between Federal Reserve monetary policy and capital market returns. For nearly thirty years, I have researched and documented the influence of monetary conditions on investment returns and have discovered that Fed policy overwhelms most observed market anomalies. For example, the small cap effect, stock price overreaction, and the cash effect, among others, are largely explained by shifts in the monetary environment. I am very excited to be launching a new business, Economic Index Associates. Our firm develops and licenses active index strategies that are designed to be rules-based, replicable, investable, and transparent.
My colleagues Luis Garcia-Feijoo, Gerald Jensen, and I have designed an investment strategy that allocates security weights such that the selected portfolio is always optimally exposed to the prevailing monetary environment. A shift in monetary conditions results in selecting a portfolio of securities with characteristics that align best with the new environment. The funds should be available to both institutional and individual investors later this year.
None of us are able to achieve success without some help along the way. Is there a particular person who you are grateful towards who helped get you to where you are? Can you share a story about that?
Anyone who believes that their success is simply due to their own hard work is mistaken. Both luck and being exposed to wonderful people play a major role in any success one is able to achieve. Any success that I have experienced is largely attributed to the wonderful people that have shaped my life and career. I noted earlier that I was a tennis player in college. I had the good fortune to have a teammate, Bob Slezak, who helped me chart my professional course. As a freshman and a first-generation college student, I was having difficulty determining what field to study. I was enrolled in the College of Arts and Sciences and was tentatively planning on declaring a history major, but was truly rudderless. After talking to Bob, I decided to investigate the College of Business, and ultimately became a finance major. Bob and I remain lifelong friends, and he went on to achieve tremendous success in the business world as the Chief Financial Officer of TD Ameritrade. We share a love of sports and investments and frequently share ideas. One of the things I have learned is that if you surround yourself with intelligent and inquisitive individuals, you get a lot luckier. I am very fortunate to have Bob Slezak in my life.
Let’s shift a bit to what is happening today in the broader world. Many people have become anxious from the dramatic jolts of the news cycle. The fears related to the coronavirus pandemic have understandably heightened a sense of uncertainty and loneliness. From your experience, what are a few ideas that we can use to effectively offer support to our families and loved ones who are feeling anxious? Can you explain?
My biggest takeaway from the coronavirus pandemic is to focus on what really matters. The factors that swamp any other considerations are family and health. I also believe that occasionally, it is a good idea to get a healthy dose of perspective. While the current coronavirus pandemic is certainly unusual, I believe it necessary for those who believe that other generations haven’t faced this type of challenging circumstances to reflect on history. I recently read an article bemoaning the fact that millennials are facing their second significant crisis, the first being the financial crisis that started in 2007. The article implied that other generations haven’t faced such dramatic circumstances in such a short period of time. My parent’s generation — The Greatest Generation — faced two unprecedented crises in a span of a few short years. The Great Depression and World War Two were both challenges that their generation faced with grace and dignity. While the death toll from the current crisis is frightening, all that is asked of most of us is that we physically distance from one another. I am disheartened when I see that some individuals are unwilling to sacrifice so little for the greater good. On the other hand, I am proud to see the selfless behavior of the “essential personnel” that are allowing us to live our lives during this crisis. The medical professionals, as well as people working at grocery stores and pharmacies, are allowing us to weather this storm, and all most of us are being asked to do is, in the words of Jerry Seinfeld, truly nothing. I am reminded of Bill Gates’ quote, “Life is not fair; get used to it.”
Ok. Thanks for all that. Let’s now jump to the main core of our interview. As you know the stock market and the economy in general have become extremely volatile and uncertain. Many people “dollar cost average” and put aside a monthly sum into a long-term savings plan for retirement, college, or a home purchase. If a loved one or a client came to you and said, “I have been saving and investing $500 every month in an S&P 500 index fund. Over the next few months until the dust settles, should I be doing something else with my money?”, what would you say to them?
The wonderful thing about investing in a bear market is that stocks are selling at prices below previous highs. Warren Buffett famously said, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is market down. The bad thing about investing in a bear market is that it can be psychologically debilitating if the bear market is long in duration. That is, one doesn’t get positive feedback in a prolonged bear market and one wonders if a bull market will ever return. When investing in a bear market one should remember Warren Buffett’s words when he said, “be greedy when others are fearful and fearful when others are greedy.” If you have a long time horizon, now is the time to get greedy.
Eventually the economy will recover and rebound. Certain sectors, like travel and hospitality, might be hurting for a while. But other sectors, like technology and healthcare, might do very well. If someone wanted to prepare today to take advantage of the future recovery, what would you suggest they do?
In short, for most investors, nothing different should be done in a bear market, bull market, or flat market. All investors should establish what is called an Investment Policy Statement (IPS) and follow it. Investors should not concern themselves with broad market moves or the crisis de jour. An IPS is a written document that clearly sets out a investor’s return objectives and risk tolerance over that investor’s relevant time horizon, along with applicable constraints such as liquidity needs and tax circumstances. An IPS sets out the ground rules of the investment process — it is the document that guides the investment plan. Included in that IPS is a target asset allocation. The IPS should include a glide path for target asset allocation changes as the individual ages. All investors should have an IPS. And, it is best to develop an IPS in a rather calm market. Developing an IPS in a volatile market or during major stories is problematic. The whole point on an IPS is to guide you through changing market conditions. It should not be changed as a result of market fluctuations. It only needs to be revised when your individual circumstances change — perhaps a divorce or other unanticipated life change. It shouldn’t be adjusted as a result of the crisis de jour, which now is the Coronavirus.
At the 2000 Berkshire Hathaway Annual Meeting, Vice Chairman Charlie Munger explained buy-and-hold investing this way, “You have value, and growth investing, but now we also have “sit on your ass investing”, which is better. By this, Munger means simply identifying good companies, buying them and holding them for the long term. This requires that the investor tune out the latest crisis de jour, whether it be an escalating trade war with China, Brexit, the Greek debt crisis, the latest presidential tweet, or coronavirus.
Are there sectors that provide exciting and lucrative investment opportunities today, specifically because of the volatility and uncertainty?
High-quality stocks with strong balance sheets are typically the best investments in bear markets as there is a flight to quality when investor sentiment turns negative or when economic conditions weaken. For instance, currently, securities like Apple, Berkshire Hathaway, Coca-Cola, and McDonalds are popular with investors because of their strong balance sheets and franchise value.
I would avoid investing in stocks that you believe will benefit in the short-term from the coronavirus pandemic. Blue Apron is an example of such a firm. Since it became a publicly-traded company less than three years ago, it has been a financial failure. It is not profitable and any clear path to profitability is difficult to see. Blue Apron is a very speculative company and buyers would be betting solely on a short-term surge in demand for the type of service (delivering ingredients along with recipes for meals) the firm offers. While it makes intuitive sense that in the short-term demand will increase for Blue Apron, will there be a fundamental shift to demand this service once the coronavirus pandemic has subsided? Additionally, there is no economic moat to providing this service. Other home delivery services are being offered (including Purple Carrot, Plated, and Home Chef). That is, if in the long run this service will increase in demand, other firms will enter the space and compress operating margins, making the business less attractive. Firms have already entered and exited this crowded market. The message is to buy long-term, sustainable businesses that have business models that will flourish over decades, not weeks or months.
Are there alternative investments that you think more people should look more deeply at?
Although I am a Chartered Alternative Investment Analyst (CAIA) charter holder, for the vast majority of investors I am not a big fan of alternative investments. During times of market turmoil one always hears talking heads espousing the benefits of investing in gold. Simply put, one shouldn’t consider investing in gold. If you have a long time horizon you should not invest in precious metals, as the long-term returns are far below those of equities. At the end of 1925, the price of an ounce of gold was $20.63. At the end of 2019, an ounce of gold sold for $1519.50. Over that 94-year period, the precious metal returned 4.68% compounded annually. Over that same time period, according to Ibbotson Associates, the compound annual rate of return of a diversified portfolio of large stocks (the S&P 500) was 10.2%. That same $20.63 invested in gold at the end of 1925 would have grown to $190,702 if invested in the S&P 500. Investing in a diversified basket of small stocks provides even greater returns. The compound annual rate of return of a basket of small stocks over that 94-year period according to Ibbotson Associates was 11.9%. That same $20.63 would have grown to $812,428 at the end of 2018. The overall return to gold was less than 1% of the return to a diversified basket of common stocks.
While having a small position in precious metals may dampen portfolio volatility in the short-run, the tradeoff between slightly dampened volatility and the lost long-term return is certainly not a prudent one. Gold and silver are speculative investments, based on the Greater Fool Theory. The price of gold is not determined by its intrinsic value but simply by its expected selling price to someone in the future. But, don’t listen to me, listen to Warren Buffett who in 2011 when meeting with students at the CFA Institute Research Challenge explained his rationale concerning gold as an investment as follows: “The world’s gold stock is about 170,000 metric tons, which if melded together could create a cube of about 68 feet per side; the cube would be worth about $9.6 trillion. For that much money, one could buy all the cropland in the United States, purchase 16 Exxon Mobils, and have about $1 trillion of walking-around money left over.” He asked the students, which one they would rather have. He also noted, “You can fondle the cube, but it will not respond.”
I would be remiss if I didn’t mention cryptocurrencies. I believe the quickest way for investors to self-destruct is by investing in bitcoin. In my opinion, it is the biggest investment fad I have seen in my lifetime. The entire cryptocurrency market is a bubble, and it won’t end well for “investors.” I put “investors” in quotation marks because investors aren’t making capital commitments to cryptocurrencies; speculators are doing so. There is nothing to support the valuations of bitcoin or any of the other so-called cryptocurrencies, as they don’t have any cash flows associated with them. Like gold, they don’t pay dividends or have earnings. But, at least gold has some industrial and other uses and some real, not virtual, limits on supply. My favorite quip about cryptocurrencies is from the late T. Boone Pickens who said “At 89, anything with the word “crypt” in it is a real turnoff for me.”
If a person in their thirties and forties came to you today and said that they have $10,000 that they want to put away today for a long term investment what would you advise them to do with it? First, I would counsel that person not to overcomplicate the investment process. But don’t take my word for it. Listen to Warren Buffett, who said that for building retirement savings, “Consistently buy an S&P 500 low-cost index fund. I think it’s the thing that makes the most sense practically all of the time.” In his 2014 letter to Berkshire Hathaway shareholders, Mr. Buffett said that when he passes away, the instructions for the trustee for his wife will be as follows: “My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors.”
A second recommendation are the shares of Berkshire Hathaway. While most people believe that Berkshire Hathaway is synonymous with Warren Buffett, “the Oracle of Omaha,” it is much more than that. Buffett and Vice Chairman Charlie Munger have assembled a terrific executive team, and enduring culture, that ensures Berkshire’s success well beyond their lifetimes. Berkshire is attractively positioned to provide solid returns in the future because it is so well-diversified, and is largely concentrated in recession-proof, staid industries such as consumer products. The firm is also attractively priced after the recent pullback, trading at levels that Buffett and Munger have indicated they may employ Berkshire’s huge cash hoard and increase share buybacks. This effectively helps put a floor on the price of the stock.
Ok, thank you! Here is a more general finance question. You are a “finance insider”. If you had to advise your adult child about 5 non intuitive essentials for smart investing what would you say? Can you please give a story or an example for each?
First, investors simply can’t afford to make oversized bets on individual securities. And, often that is what happens to beginning investors who buy the stock of the company they work for or the stock of a product they like. History shows that when investors experience failure, they withdraw from the equity markets. Investing in a broadly diversified basket of securities is a prudent strategy. An interesting study done by University of Arizona professor Hendrick Bessembinder shows that only four percent of common stocks have provided a higher return than Treasury bills. In other words, the returns on the market have been driven by a small percentage of big winners. Trying to pick winners, for most, is a loser’s game. The solution is to invest in diversified funds and you don’t need to pick those winners. Investing in the stock of a company you work for concentrates one’s total portfolio (both human capital and invested capital). When a company one works for struggles or even fails, if one has invested their defined contribution plan in own company stock, they stand to lose both their job and suffer significant losses in their retirement plan. One need to look no further than Enron to see the dangers of investing in own company stock. At the time the infamous firm failed, more than 60 percent of pension assets were in worthless Enron stock.
Second, one of the biggest pitfalls is that many people who decide to invest, invest too conservatively. Over the long run, holding significant amounts of cash ensures that one will suffer significant opportunity losses. When it comes to building wealth, one can either sleep well or eat well. Investing conservatively allows one to sleep well, as there isn’t much volatility. But, it doesn’t allow you to eat well in the long run because your account won’t grow much. According to data compiled by Ibbotson Associates, large capitalization stocks (think S&P 500) returned 10.2% compounded annually from 1926–2019. Over that same time period, long-term government bonds returned 5.5% annually and t-bills returned 3.3% annually. To put it in perspective, $1.00 invested in the S&P 500 at the start of 1926 would have grown to $9,243 (with all dividends reinvested). That same dollar invested in t-bills would have grown to $21.62.
The surest way to build wealth over long time horizons is to invest in a diversified portfolio of common stocks. Someone with a long time horizon should not have exposure to money market instruments, yet many investors do because they fear the volatility of the stock market.
Third, attempting to time the market is “fools gold.” The late Jack Bogle, founder and CEO of the Vanguard Group is quoted on market timing: “After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know of anybody who knows anybody who has done it successfully and consistently.” JP Morgan Asset Management’s 2019 Retirement Guide provides some data on the effect of market timing. Looking back over the 20-year period from Jan. 1, 1999, to Dec. 31, 2018, if you missed the top 10 best days in the stock market, your overall return was cut in half. Fully invested in the S&P 500 for that 20-year time period, the return was 5.62%. If you missed the ten best days the return was 2.01%. Miss the 20 best days and the return was negative. Many people have been preparing for a recession for years and have exited the stock market. The opportunity cost of such a strategy is quite high. These folks have foregone strong gains in the market for the past few years while they have held cash. There is an old Wall Street adage that states “no one rings a bell at the top or the bottom of the market.” Some pundits are boasting that they called this market correction. The problem is that many of them have been calling for it for several years and if you’d have listened to them you would have had a big opportunity loss. Remember, if you want to time the market you have to make a series of good decisions — when to get into the market, when to get out of the market, and when to get back in. Time in the market is more important than timing the market.
Fourth, one’s risk tolerance is function of both ability and willingness to bear risk. For example, young people have the ability to bear risk because they have a long time horizon. But, they may not have a willingness to bear risk. That is, the potential of losses may cause them to lose sleep. Your investment strategy must be consistent with your personality. Some of us are much more willing to bear risk than others. You must be honest with yourself in determining what kind of an investor you are. If you are consistently losing sleep over your investments, then you likely don’t have the requisite willingness to bear risk and will find a more conservative investment approach is right for you. I am not a believer in cookie cutter or algorithmic approaches to investing. We are all unique human beings and two individuals may be identical in many respects (that is, the ability to bear risk), but may differ dramatically in willingness to bear risk.
Fifth, in most cases, the best course of action with respect to your investments, is to do nothing. One of the worst activities for an investor is to listen to all the pundits on CNBC who suggest that one needs to make constant portfolio changes in reaction to global events. Much of success in investing is simply a result of playing the game and being patient. One of my favorite Warren Buffett quotes is “The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient.” As painful as it is watching the markets fall, remember the words of the late John Bogle, the founder and CEO of the Vanguard Group, who said: “Don’t do something, just stand there!” In the world of coronavirus, the best advice is to not touch your face or your 401k.
Can you please give us your favorite “Life Lesson Quote”? Can you share how that was relevant to you in your life?
I believe that EQ is more important than IQ in determining success in life. By EQ I mean an individual’s ability to emotionally judge situations and to fit into groups by managing personal interactions. With few exceptions, achievements are the result of group efforts. The ability to thrive when working with people not only allows one to achieve more, but it makes savoring those achievements that much better.
One can draw a sharp contrast between the EQ and IQ exhibited by two high profile and financially successful individuals — Elon Musk and Warren Buffett. The lack of emotional intelligence by Mr. Musk concerns me. From his “pedo guy” tweet to his tweets taunting the Securities and Exchange Commission that resulted in his removal as Chairman of the Tesla board, the brilliant entrepreneur consistently exhibits a lack of emotional intelligence. The contrast with Musk and the leadership at Berkshire Hathaway — a company with a tremendous culture — is stark. Warren Buffett and Charlie Munger make it a point to emphasize that while they are the face and voice of Berkshire Hathaway, it isn’t all about them. Before last year’s Berkshire Hathaway Annual Meeting started, a parody of the song “My Favorite Things” played in which the Berkshire operating managers were praised and thanked for their achievements while their photos crossed the screen. During the meeting, Buffett lauded portfolio managers Ted Weschler and Todd Combs for “their intellect and record” but also because “they are exceptional human beings.” Publicly praising employees engenders tremendous loyalty and creates the best kind of culture. It seems that the only time a Tesla Executive is in the news is when it is announced they are leaving the company.
You are a person of enormous influence. If you could inspire a movement that would bring the most amount of good to the greatest amount of people, what would that be? You never know what your idea can trigger. :-)
Our society needs a focus on financial literacy. Two of the biggest financial crises confronted by Americans in the past dozen years have been caused at their core by a lack of financial literacy. Both the financial crisis of 2008–09 and the burgeoning student loan crisis were the result of a lack of financial literacy.
The financial crisis of 2008–09 was precipitated by a lack of understanding of how variable rate mortgage debt worked. People were taking out mortgages with low teaser rates on large homes. When rates rose, many borrowers didn’t have sufficient cash flow to make those rising mortgage payments.
Today’s student loan crisis, at its core, is caused by a simple misunderstanding of how burdensome debt can be. Too many borrowers are funding expensive educations that do not provide the borrower with sufficient earning power to pay off the loans.
Teaching financial literacy in college is simply too late. By that time, many students have sealed their long-term fate by incurring burdensome student loans. I am an advocate of preparing students for the real world by teaching financial literacy in high schools. And, this education need not be extensive. Budgeting, taxes, and debt (including mortgage debt and student loan debt) are the major topics that need to be covered.
Students should be taught that debt extinguishment should be a priority. To quote Albert Einstein “Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.” People can put their investment house in order by reducing debt and acquiring assets that grow in value over time. The fastest way to change one’s net worth for the positive is to obtain more assets that earn compound in value (like stocks or CDs) and reduce one’s debts and lower interest payments.
Thank you for the interview. We wish you only continued success!