Before I begin, I want to give you a little background as to why I am discussing this topic now. I am currently studying equities and investment analysis at Deakin University and listening to a podcast from the oracle of Omaha, Warren Buffett, and his offsider, Charlie Munger. Now at university, what I am being taught about investing is that I should be doing an extremely thorough analysis of a company through extremely robust mathematical, accountancy equations to find out if I should invest in that business or not.
Then, what I am hearing from arguably the greatest investor of all time, Warren Buffett, is that to invest in a business, it should be so damn obvious, you couldn’t pass it up even if you tried. At university, I am being taught that I should be trying to project future cashflows of the business then discount them back to the present value to see their growth potential (whatever that means). Whereas Buffett is saying that I should be looking into a business’ past to understand their present and future position. When he says ‘past’, he means going back to when the company originated and following its story over the years.
Ok, so with the above out of the way, let’s begin. I am a financial planner, not an investment analyst. 20% of my time is clarifying goals with clients, crafting a lifetime plan and funding that plan with an appropriate investment portfolio. The other 80% of my time is helping clients continue to work their lifetime plan, through all the cycles of the economy, politics and markets, to ensure their goals are being met.
None of my time is spent analysing a single company’s cashflow or growth potential to invest in. I repeat, 0% of my time as a financial planner is spent trying to predict which company will outperform the market or trying to time the market’s high or low point. What I spend my time on is in my circle of control and what I don’t spend my time on is outside of my circle of control.
Two key concepts I believe in for investing is regression to the mean and a zero-sum game. Yes, these are fancy university words, but let’s break them down to simplify their meanings. ‘Regression to the mean’ is simply saying you will achieve the market’s average return over the long run.
Remembering that the market is just the collection of the great businesses of this world. Some businesses will do extremely well one year, and others will perform poorly. But if you owned the whole stock market, you would receive the average return. The mean stands for the average or the middle. We will always regress back to this average return as average investors because we don’t have the knowledge of businesses that a Warren Buffett has. This average return from the stock market is absolutely fantastic to generate multigenerational wealth as it has provided an 11.1% return from 1950 to 2018 (JP Morgan, 2019,p. 63).
Some years will be lower than this and others will be higher, but for arguments sake, let’s say the average return of the average investor is 10%, assuming that all their investments are shares. It’s a completely different argument when property and cash are involved in a portfolio, as this could increase that return or reduce it. But that’s for another article.
Lastly, a zero-sum game means for you to win, someone else must lose and vice versa. If you are constantly trying to select companies for outperformance, buying and selling, timing the market, you will win some and lose some in the short run. However again, over the long run, you will receive the average market return… But hang on just a minute….
All this buying and selling is increasing your fees and costs. To buy a small piece of a company costs money (brokerage). To sell a small piece of a company costs money. You may incur capital gains tax issues. You may offset these gains with your previous losses. All this effort and anxiety to receive lower than the average return, due to fees. Is it really all worth it? I haven’t even mentioned the people that sold their shares at the bottom of the 2007-2009 Global Financial Crisis and then tried to buy back in later when the market was recovering. Yes, this is a topic for another article!
The point of all this is to say that investing is counter intuitive and counter cultural. If we want to be good at something, what do we do? We work extremely hard at it and learn all we can to be the best at it. In terms of investing, if you simply buy a passive index investment, whereby passive means all you do is contribute more to the investment each month and rebalance the portfolio once a year and index meaning buying as much of the global stock market as you can, at the lowest possible cost, then you will succeed in generating lifetime wealth for your family.
Rather than researching individual companies and actively trading each week, spend this time earning more money to invest, learning something new, maintaining your health and fitness or pursuing a favourite hobby, as well as spending time with family and friends. Don’t worry about what the markets are doing today, tomorrow or next week. Worry about living a great life and letting the great businesses of this world look after you and your family over the long run (20 to 30 years).
JP Morgan (2019). Guide to the Markets. Retrieved from
https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets, accessed 29.03.2019.
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