Annual Letter to Clients and Friends - 2017
Reinforcing Investment Policy
It will be worth reiterating, in the context of this annual letter, the nature of my philosophy of advice. Generally speaking, my experience has been that successful investing is goal-focused and planning-driven, while most of the failed investing I've observed was market-focused and performance-driven.
Another way of making the same point is to tell you that the really successful investors I've known were acting continuously on a plan—tuning out the fads and fears of the moment—while the failing investors I've encountered were continually (and randomly) reacting to economic and market "news."
Most of my clients—and I certainly include you in this generalization—are working on multi-decade and even multi-generational plans, for such great goals as education, retirement, and legacy. Current events in the economy and the markets are in that sense distractions of one sort or another. For this reason, I make no attempt to infer an investment policy from today's or tomorrow's headlines, but rather align clients' portfolios with their most cherished long-term goals.
I don't forecast the economy; I make no attempt to time markets; and I cannot—nor, I'm convinced, can anyone else—consistently project future relative performance of specific investments based on past performance. In a nutshell, I'm a planner rather than a prognosticator. I believe my highest-value services are planning and behavioral coaching—helping clients avoid overreacting to market events both negative and positive.
My essential principles of portfolio management in pursuit of my clients' most important goals are fourfold.
- The performance of a portfolio relative to a benchmark is largely irrelevant to financial success.
- The only benchmark we should care about is the one that indicates whether you are on track to accomplish your financial goals.
- Risk should be measured as the probability that you won't achieve your financial goals.
- Investing should have the exclusive objective of minimizing risk to the greatest extent practicable.
Once a client family and I have put a long-term plan in plan—and funded it with the investments that seem historically best suited to its achievement—I very rarely recommend changing the portfolio beyond its regular annual rebalancing. In brief, my principle is: if your goals haven't changed, don't change the portfolio. My unscientific sense is that the more often people change their portfolios, the worse their results become. I agree with the Nobel Prize-winning behavioral economist Daniel Kahneman, when he said, "All of us would be better investors if we just made fewer decisions."
Going back to 1980, the average annual intra-year decline in the S&P 500 has exceeded fourteen percent. Yet even without counting dividends, annual returns have been positive in 28 of these 37 years, and the Index has gone from 106 at the beginning of 1980 to 2239 at year-end 2016. I believe the greatest lessons to be drawn from these data are that—historically, at least—temporary market declines have been very different from permanent loss of capital, and that the most effective antidote to volatility has simply been the passage of time. I can't predict that it will always work out this way. I can only fall back on the wisdom of the great investor and philanthropist John Templeton, who said that among the four most dangerous words in investing are it's different this time.
The nature of successful investing, as I see it, is the practice of rationality under uncertainty. We'll never have all the information we want, in terms of what's about to happen, because we invest in and for an essentially unknowable future. Therefore we practice the principles of long-term investing that have most reliably yielded favorable long-term results over time: planning; a rational optimism based on experience; patience and discipline. These will continue to be the fundamental building blocks of my investment advice in 2017 and beyond.
The year 2016 began with what have been termed the worst six weeks in equity market history—the S&P 500 declined more than eleven percent from its 2015 close through February 11. In June, the market went down nearly six percent in a (trading) day and a half following the Brexit vote. And there was a moment, somewhere around 2:00 a.m. eastern time after the presidential election, when I saw the futures on the Dow Jones Industrial Average down 800 points! (Thank heaven this didn't happen during the regular trading day.) Yet despite all that unnerving market volatility, the S&P 500 closed out the year at 2239. With dividends at about two percent, the market's total return this volatile year was percent. In a sense, then, the equity market put on a tutorial in 2016, highlighting the wisdom of tuning out shocking current events and the attendant volatility. During such episodes, it seems to me that the best investment advice I can offer is always, "Turn off the television."
There can be little doubt that the major market imponderable in the last third of the year was the U.S. presidential election. Indeed, the pall of uncertainty was so heavy in the run-up to the voting that the S&P 500 managed to close lower on nine straight trading days—a feat it had not accomplished since 1980. Thus, the most important aspect of the election from the market's perspective may simply be that it's over. We know the outcome, and that's no small thing. Because in my experience, what the equity market hates most is uncertainty. It can deal with anything, as long as it knows what it's dealing with.
It is not at all a political or partisan observation but a simple statement of fact that the incoming presidential administration, enjoying solid majorities in both houses of Congress, is likely to pursue more pro-business, pro-capital, pro-growth policies than the other candidate might have. Everything else being equal—which it almost never is—I believe these policies should tend to be favorable to the long-term equity investor.
It is to me one of the enduring mysteries of financial journalism that it always manages to see the equity market as "overvalued." I beg to differ, not at all in the sense of predicting what the market will do in 2017—heaven forbid—but in the hope of gaining a sense of where we are. According to the statistical research service FactSet, the current price/earnings estimate for the S&P 500 in 2017 is 17.1. The 25-year average forward p/e is 15.9. Accepting the consensus earnings estimate, it is difficult to see the market's current valuation as much greater than average. I would add only that valuation has never been a reliable market timing tool.
So it appears that cautious optimism continues to be the best attitude going into the new year. Indeed, were there any alternative remotely superior to optimism as both an investment and living philosophy, I would be eager to share it.
With those thoughts in mind, you can expect little to no change in the investment philosophy of Trident Financial Planning in the near future. I have developed my policies with careful study, observation, and experience to provide a simple, understandable investment process to clients with the aim of capturing returns sufficient to achieving the financial objectives as they are described to me.
I am honored and privileged to serve as the trusted advisor to so many wonderful client households and pledge to continue my development in this most interesting and challenging of professions.
Happy new year! May your 2017 be prosperous and fulfilling!