HAPPY NEW YEAR 2023 – AND THOUGHTS ON INVESTING

I wish you a happy and prosperous New Year. The year 2022, that we are filing away, has been a tough one for investors. As we take 2023 out of inventory, may it bring us better investment opportunities. I will continue sending posts. My sincere thanks to you for following them. I hope that you have gotten as much from reading them as I have from writing. And I hope that you continue to find them worthwhile.

This new year is special to me, and its beginning is, I hope, a good time to share some thoughts on investing in general.  The following is for the person who must deal with the constant challenge of managing his or her financial life.

AN ENCORE

Two years ago, I stepped away from the investment company I co-founded in 1989. It was time to set a new direction in my life. This ‘sabbatical’ has allowed me to reflect on the 57 years I have been a serious investor and adviser to others. (My first ten years was an education in what not to do). Our goals change. The world around us changes and learning to invest well is a life-long process.

A few basic rules always apply. Markets change; human nature does not. And the most important rules involve conquering emotions that make a shamble of good investing intentions at the most critical times. But while long-term goals and strategy remain constant, the tools to achieve those goals have changed for the better over the last half century.

These are my thoughts on one of the most important things in your life - your financial well-being. I have tried to distill everything worthwhile I have learned in 57 years.

THE BOTTOM LINE

Your financial goals are unique to you. Some goals are attainable; some are not. After many years, I finally grasped the financial goals that people can control, and more important, the ones they cannot. People spend a lot of time trying to master what they cannot control. And far too little time on the things they can.

You can afford to not be a great investor. But you can’t afford to be a bad investor.

Things You Can Control:

Savings Rate – How much of your income you put aside for the future

Diversification – How many of your eggs are in one basket

Costs – Keep investment costs low, pay only for value added

Taxes – Keep income tax and estate tax as low as possible

Things You Can’t Control:

Beating the Market by Picking ‘Winners”

Timing when to get in and out of the market

If you already practice these things, you can stop reading now. You are probably a good enough investor to meet your financial goals.

But be warned – most people will never follow these rules. They are simple, but they are not easy. People need help, either because they cannot control their worst impulses or because they don’t want to invest their time and can afford to pay someone else to do the work for them.

For those of you who want more information, you can read what I have learned from experience, sometimes bitter experience.

DO’S

SAVING

How smart you are at investing does not matter if you do not save systematically. We all have wants that exceed our ability to satisfy them. Most people will not forego purchases now to build a nest egg for unknown needs in the distant future. They are One Marshmallow Children. If you cannot save, forget about planning. It won’t matter. You will not have anything to invest.

PLAN

Make a list of what you now own, what your income is, and what you expect it to be. Most people have never taken this first step. If you don’t know where you are, how can you figure out where you are going? Set a long-range plan of how much money you need and want (two different things). Then work through what you can realistically do to reach those goals.

DIVERSIFICATION

Owning several types of investments is common sense. Everything does not go up and down at the same time. Concentration is great on the way up, but a disaster when things go off the rails.

Asset Allocation

The portfolio needs to be spread across stocks, bonds, and perhaps real estate or private businesses. The mix should reflect the risk you are willing to take – how much you can afford to lose before you stop sleeping well. (Hint – It may be less than you think.)

Rebalancing

Rebalance by selling things that have gone up so much, or declined so much, that they are not near the target amount you set for them. The benefit is risk control. Over time, stocks should return more than other assets. If the portfolio is not rebalanced back to the target mix, it is vulnerable to market corrections; the portfolio will experience outsize losses. The opposite is true if stocks shrink to too small a portion of the portfolio.

COSTS

While charging handsomely for doing so, the financial industry has destroyed more customers’ capital than Karl Marx ever dreamed possible. Most people have no idea how costs erode their wealth. Low costs have nothing to do with market performance. When you pay less, you keep more, regardless of whether the markets are up or down. So, dig deep into what your costs are.

The investment industry’s sales pitch often plays on your emotions and promises to give you what you want, at that moment, to keep you happy. This happiness comes at a high price. The financial business is geared to extract from you the maximum possible. Before 1975, this was with brokerage commissions that sometimes were to 2 or 3% of the transaction for both buyer and seller. Or mutual funds with ‘front end loads’ that took up to 8% of your principal before you invested a single dollar.

Fortunately, competition and innovation have driven brokerage commissions to almost nothing, but the industry has new ways to part you from your money – fees that are sometimes in two or three layers, and not clearly explained.

INCOME TAX

By far, the biggest threat to your wealth is income tax. With the wrong choices, income tax will take 15-20% of your gains. For those with high earned income, the tax can approach 40%. Your goal should be to minimize the money that goes to your two uninvited partners, the IRS and your state tax department.

Asset Location

Asset location can help. Most people will have a “regular” account exposed to taxes and one or more accounts where the tax is deferred or avoided entirely – IRAs and 401k’s. Locating the right assets in each of these accounts can reduce taxes.

Withdrawal Order

At retirement, choosing which account to draw the money from may reduce your tax bill. This choice needs to be made annually, depending on your over-all income for that year.

ESTATE TAX

With the existing estate tax exemption, only the very wealthy should be subject to an estate tax. But if you are, the tax can be onerous, taking as much as 40% of a major piece of your estate.

The current generous estate exemptions are subject to change, and you need to stay informed about current law and update your plans accordingly. You do not want to subject your estate to a 40% tax on everything you have accumulated in a lifetime. Careful, and constant, planning can reduce this potential estate burden on your heirs.

DON’T’S

TRYING TO BEAT THE MARKET

Nobody wants to be average, but over the long run only a handful of investors beat the market by enough to justify their time and cost. I have watched geniuses come and go for decades, and eventually, for most, success was more luck than skill. A few talented people, like Warren Buffett, rack up a lifetime of great performance, but the chances of finding them early is no better than finding the great stock well before anyone else does.

I created a partnership in 1976, a small cap value fund. It returned 11.4% a year after fees for 41.5 years, 1/1/80 - 6/30/20. A proprietary computer program worked well in the early years, but internet websites now offer tools that can replicate such programs for anyone.

How did my partnership (converted into a mutual fund about 1990) compare to a comparable Russell index? The answer was a surprise. My fund, the S&P 500, Russell 2000, and Russell 2000 Value Indices differed little in results (from 10.7-11.6%). My fund had not made a high enough return to justify its fee.

Another innovation is the Exchange Traded Fund (ETF). My fund had realized gains that required tax payments each year. Those taxes reduced many clients return by at least 20%. With Exchange Traded Funds (ETFs) capital gains are deferred, and you can choose when to pay the tax on them. It is also possible to hold an ETF for years and escape all taxes when you die.

TIMING THE MARKET

Truly great investors never attempt to forecast whether the market will move up or down. Great market timers are usually famous for getting the “call” on a market top or bottom correct only once. Given the thousands of forecasters, one or two will make a single lucky guess, never to be repeated. One wrong timing bet can lose/reduce what you have created with either lost money or opportunity that you miss.

FINAL THOUGHTS - BEHAVORIAL COACHING

As a good coach, an investment adviser can add the greatest value to a client’s wealth. An adviser can help clients keep long-term perspective and discipline, rather than timing the market or chasing performance. Trust is key: You need a strong relationship before bull - and bear - markets shake your confidence in the plan you have made, as they most certainly will.[i]

[i] Vanguard Research estimates that an advisor applying all the tools available can increase the client’s returns over the years by nearly 3% a year.