6 STEPS TO THE 99th PERCENTILE (excerpts Nick Murray)
The great truths of successful investing are immutable and timeless – and therefore never spoken about in the mainstream media, from which nearly all Americans get nearly their entire daily economic and market input. There is, as we have often noted, a sound (if necessarily evil) business reason for this. If the media told the immutable truth, it would end up constantly repeating itself, whereupon people would soon stop reading/watching it, and it would go out of business. It therefore doesn’t cover the truth. It covers the news, and attempts to get people stirred up about the dominant news “event” of any given 24-hour news cycle. (“Is it time to sell Japan? Will oil hit $100 - $200? What six funds went up the most in January?”) It is therefore the function of an excellent advisor to preach truth to the news. And the greatest of all investing truths is that the primary determinant of real-life returns isn’t investment “performance” but investor behavior – that the critical variable isn’t what your funds do. It’s what you do. What are the predominant beliefs and behaviors that will cause a client household to achieve better lifetime returns than virtually all of its peers? What values and strategies will, in time, carry that household to the ninety-ninth percentile of real-life returns? In preparing a talk for a series of meetings I’ll be giving to thousands of advisors at one firm this winter and spring, I had occasion to re-visit these questions. My goal was, as nearly as possible, to denominate this talk in strategies which anyone can execute, without any economic or financial background, and without any particular expenditure of time and effort in following markets and managing their portfolio. Highly successful investing isn’t a no brainier – far from it – but the parts of the brain involved in ninety-ninth percentile success are very different from what the culture suggests they are. I fairly quickly got it down to six variables, three of which I call values, and the other three behaviors. This distinction is, I hope, helpful, but it’s certainly not critical. If you just want to see these six characteristics as the six cylinders you know you have to be firing on all the time, you’ll be fine. The first three variables – the “values” — are as follows:
1. FAITH. This is the first characteristic of all successful long-term investors. It is impossible to invest successfully in a future of which one is fundamentally afraid. Thus, the great enemy of investment success isn't ignorance, but fear. All human experience goes to teach us faith in the future, and especially faith in the American economy and its markets. The problem arises when media suggests that some economic or market setback is new and different; terrible in an unprecedented way, and therefore a disaster you'd better jump clear of. Oddly, the ore inconsequential the disaster (viz. Katrina/Rita), the greater volume of fear mongering. Yet faith in the future is always rewarded in time. The day Rich was born in 1952, the S&P Index closed at $24.00. As of August 22, 2007 it's $1455 - which ignores dividends. When we put together this new website on our office computers, we commanded more computing power than existed on earth in 1950. These are not mere factoids; I'm counting my beads of faith. I cannot be frightened out of my long-term portfolio, and therefore can fail to achieve superior real-life returns.
2. PATIENCE. People are living longer. It's no longer unreasonable to think that at least one member of a couple that retires, both at age 65, will live into their mid - 90's. That's a VERY long investing time-horizon. We are therefore not much interested in what our portfolio is doing this quarter, this year, or even over the next five years, because we are asking that portfolio to provide security for us for the next 30 years....and perhaps beyond that. Moreover, most of us don't want to leave our children and grandchildren wallpaper. We have a great deal of patience, and again that patience has been well rewarded over time. We're not interested in "what's working now;" but we're vitally concerned with what's always worked.
3. DISCIPLINE. The need to pay oneself first - funding your long-term plan before (and, if necessary, instead of) re-modeling the kitchen or grabbing that great deal on a boat - is a discipline. Continuing to fund that plan month in and month out - as opposed to "Maybe we better hold up for a while until this market stops going down" - is a discipline. But without those or similar disciplines, faith and patience - and everything else - are abstractions, as evanescent as New Year's diet resolutions. Discipline is, in that sense, the iron wire upon which all these other beads are string.
And the three portfolio behaviors which, launched from the platform of the three values above, will carry an investor into the 99th percentile are:
4. ASSET ALLOCATION. In their landmark study, Brinson et al. demonstrated that more than 93% of long-term institutional portfolio returns came from which asset class you were in; the other 7% came from selection and timing. But the media, and the culture at large, find no "news" in this. So they stand the truth on it's head, and natter about what stocks, sectors and funds are hot, and whether it's time to jump into tech. Asset allocation is and always will be the dominant variable in portfolio (as opposed to investor) returns. And a huge part of what happens to an investor household over time is driven by its adherence to the dictum be an owner, not a loaner.
5. DIVERSIFICATION. Second only to asset allocation, diversification is the next critical portfolio behavior. Getting diversified and staying diversified keeps you from betting the ranch on a fad at a market top, and from hiding out in cash at the bottom. It is the personification, in our world, or Aesop's tortoise; it's slow, it's steady....and it always wins the race. Diversification is the conscious decision never to be able to make a killing, in return for the priceless blessing of never getting killed.
6. REBALANCING. Sometimes your portfolio gets lopsidedly exposed to something - usually because that something has gone up spectacularly, and not much else has. The typical American response is to sell out of the "laggards" and chase the dream - kind of like electing to be the hare in Aesop's fable. This is because most Americans are (unconsciously) spectators instead of investors; they chase price trends instead of seeking neglected values. (A speculator not only doesn't know that price and value are inversely related; he will get really mad if you try to tell him.) Rebalancing takes some of the profits off the line and redeploys them in (relatively) undervalued areas.