Client's Corner Sample 2018: Two Lights Along Your Pathway

[This essay is typical of the pieces I make available to newsletter subscribers most months, in pdf format, for direct transmittal to clients, though not in newsletters or any websites, which would open these essays up to the non-sub- scribing world. I retain the copyright, which must be cited. PLEASE NOTE THAT THE INCLUSION OF THIS ESSAY IN THIS SAMPLE ISSUE IS FOR ILLUSTRATIVE PURPOSES ONLY; NON-SUBSCRIBERS MAY NOT SEND IT ON TO ANYONE, WHICH WOULD CONSTITUTE COPYRIGHT INFRINGEMENT.]

FROM 11/17 ISSUE

The equity market observed a couple of minor milestones during the last few weeks that—if you will allow them to do so—may serve as lights along your path to becoming a successful lifetime investor.

In the first, the S&P 500—with dividends reinvested—reached a level that was exactly twice its 2007 peak. In the second, Warren Buffett won his bet.

October 9, 2007 marked an all-time closing high for the S&P 500. But there were already storm clouds on equities' horizon. Two hugely leveraged subprime mortgage hedge funds managed by Bear Stearns had gone bankrupt at the end of July, and there was a dawning sense that the supposedly recession-proof housing market was in fact collapsing. Still, the equity market had staggered on until that fateful October day.

What followed, over exactly seventeen months, was the greatest decline in stock prices since the 1929-32 event. Peak to trough, and ignoring dividends, the S&P 500 went down 57%, finally bottoming out on March 9, 2009.

Now, suppose you had invested in the S&P 500 at the 2007 peak and held on—indeed, reinvesting your dividends as you went along. (You can't actually buy an index, but you get the idea.) Well, one day around the beginning of this October, your holding would have been worth almost exactly twice what you paid for it—a compound annual rate of return of 7.2%.

Admittedly, 7.2% isn't the long-term compound return of the S&P 500, which is closer to 10%. But it is certainly better than a poke in the eye with the proverbial sharp stick. And I'm betting that it's more, and perhaps quite a bit more, than you'd have guessed off the top of your head, had I asked you, “If you bought the Index ten years ago at its tippy-top just before a 57% decline set in, and reinvested your dividends, about where do you think you'd stand now?”

The lessons of this experience are, I think, patience, discipline, and not selling when everyone around you is selling. My guess is that these admonitions sound somewhat familiar to you, because they almost certainly represent the counsel you received (and are still receiving) from your financial advisor.

The other little ray of sunshine that illuminated the investment landscape these past few weeks is that Warren Buffett won his million dollar bet with a Mr. Ted Seides, co-manager of a fund of hedge funds—that is, a fund that invests in multiple other hedge funds.

Specifically, Mr. Buffett bet a million dollars (for charity) that the Vanguard S&P 500 Index Fund would outperform, over a ten-year period to December 31, 2017, a portfolio of any five funds of hedge funds, net of fees and expenses. Mr. Seides, taking up the gauntlet, chose five funds of funds with total exposure to more than a hundred different hedge funds.

It will not have escaped your notice that the end date of the bet is still two months away. This turns out not to matter. The S&P 500 Index fund is so far ahead of Mr. Seides' portfolio that he cannot possibly catch up.

To me, the lesson of this experience is: no matter how well a highly complex, very expensive investment strategy appears to have done in the very recent past, it's very difficult for that kind of “sophisticated” strategy to outperform buying portfolios of high-quality equities and just sitting still for the long run.

In the age-old race between the tortoise and the hare, my money—and I hope yours—is always on the tortoise.

© November 2017 Nick Murray. All rights reserved. Used by permission.