Sports analogies for investing get overused. I’m going to continue that tradition here (don’t hate me).
The point of having a plan is so you can effectively play both sides of the court. Without a plan, you essentially play offense or defense but rarely both, leaving yourself exposed on the other end.
The typical mistake of buying high and selling low is repeated ad nauseam. There’s a good reason. Without a plan, the “plan” devolves into choosing one over the other. That mentality drives the focus on whatever has happened most recently in the market. Great returns become chased returns and poor returns are fled from.
A plan – playing offense and defense – forces a balanced approach that ends the cycle of being wrong in both directions.
The latest letter from Seth Klarman brings up the importance of always managing both sides (if you haven’t read it yet, Twitter search is your friend).
Last year, a friend asked us whether Baupost can play offense and defense at the same time. Our answer: we not only can, we must and at all times. This is core to a value approach. Investors can’t observe the market to tell where it’s going. The market is often a tease. When it’s acting well is usually the worst time to invest, and when it acts poorly is usually the best. True investors don’t continuously dart in and out of the market, they invest for all seasons. But they still must calibrate between offense and defense, which is the hard part. A value investing approach is defensive by nature, emphasizing preservation of capital through the purchase of investments with a margin of safety. Our strategy is to hunt for bargains, and we typically find more when the market is weak, fewer when it is strong. This is our way of going against the grain, owning less not because of a hunch or feeling about the market but when there is observalby less worth doing, and owning more when there is clearly more to do. Calibration remains essential, because excessive risk takers eventually pay a high price for their folly, while excessive caution also has a cost that is mearsured in foregone returns. The pursuit of investment gain always involves incurring risk. Thus, to compound capital over time and do so safely, we must multitask, combining a strong defense with a nimble and versatile offense.
You don’t need to be a value investor to borrow this idea. It works for a passive index allocation as well as others by using bonds and/or cash. Maintaining some balance between offense and defense prepares you for whatever happens next.
And that’s the point. The future is hardly knowable.
Nobody knew when the market would turn in ’07, or how far the market would fall in ’08, or how long it would take to turn around, or how long the bull market would last. Nobody knows when the next bear market will arrive. And the market will continue to tease and misdirect investors into believing something big is about to happen. How do you handle all of it without a plan on offense and defense?
The problem with only playing one side of the field is that it ignores the risk that the market moves in the opposite direction. Playing offense embraces the chance of market losses. Playing defense avoids the chance to capture market gains.
Somewhere between those two extremes exists a happy medium that allows you to do both, tilting as risk changes over the market cycle. A plan on offense and defense prepares you for most eventualities the market throws at you and is far better than only being prepared for one.
- Anatomy of a Bull Market – Flirting with Models
- Charlie Munger at the Daily Journal Meeting – Youtube
- Getting Rich vs. Staying Rich – M. Housel
- The Key to Good Luck Is an Open Mind – Nautilus
- Forecasting Factor and Smart Beta Returns – Research Affiliates
- Interactive Smart Beta/Factor Charts – Research Affiliates
- How Europe Became So Rich – Aeon
- Industrial Revolution Comparisons Aren’t Comforting – T. Cowen
- Bill Gates 2017 Annual Letter: Warren Buffett’s Best Investment – Gates Notes
- Want to Make a Lie Seem True? Say It Again. And Again. And Again – Wired
- How the Flash Crash Trader’s $50 Million Fortune Vanished – Bloomberg