Quote for the Week

Elroy Dimson of the London Business School once defined risk as meaning that more things can happen than will happen. That is a fancy way of saying we don’t know what will happen, but it is a useful formulation when we take up the task of risk management. If more things can happen than will happen, we can devise probabilities of possible outcomes, but — and this is a big “but” — we will never know in advance the true range of outcomes we may face.

For example, the average annual inflation rate in the United States was only 1.4 percent from the end of 1954 to the end of 1965. But in 1965, who could have imagined that inflation would average nearly five times that rate over the next 15 years?

In short, our forecasts are wrong from time to time.

That observation sounds like a platitude, but consider the kinds of questions it provokes. How will we deal with surprises — outcomes different from what we expect? What are the consequences of being wrong in our expectations? This is the point when risk management begins to live up to its real meaning. Risk means the chance of being wrong — not always in an adverse direction, but always in a direction different from what we expected. — Peter Bernstein (source)

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Quote for the Week

Three parts of investment policy are important:

1. Deciding the right asset mix for the particular investment fund.
2. Accepting and working with the reality that each investor’s long-term gross returns for each asset class will very likely be “average” for that asset class — minus manager fees, taxes, and so on — and accepting the corollary reality that underperforming is much more likely than outperforming.
3. Sustaining policy commitments at market highs and at market lows, exactly when that rascal Mr. Market is doing his very best to do his worst.

The reality is that “roughly right” is all we can ever hope for on long-term asset mix, because even the most sophisticated investors must make their judgments on the basis not of facts, but on probabilistic estimates of two great uncertainties, markets and human reactions to markets, and without knowing the consequential leads and lags that will surely be part of the real world. — Charles Ellis (source)

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2022 ended with fears of a recession, rising interest rates, and higher and rising inflation costs. It was the first year in a long time where both stocks and bonds were down. “Experts” predicted more of the same.

2023 proved them wrong. A diversified portfolio, made up of broader asset classes, returned 12.8% for the year. US, International, and Emerging Market indexes, broadly, were up double digits. In fact, the S&P 500 even set a new all-time high!

Bonds performed well. Even cash — via ultrashort-term treasuries — earned a respectable 5% on the year. In other words, 2023 was a great year overall — for those who stuck with it.

Years like 2023 are why investors should not put much weight into market or economic predictions. Markets are noisy in the short run. Pessimism is fleeting. Discipline is key to surviving it.

Markets have a knack for recovering after a loss. The US market, in particular, has a 100% recovery rate. It doesn’t always happen the next year, but it does happen.

Markets are resilient. Investors should take comfort in that. The discipline to hold tight is as big a contributor to long-run returns as your portfolio’s makeup, if not more so. Continue Reading…

Quote for the Week

The difficult thing for the financial adviser and the client—and I learned this when I managed money—is that no one can really identify how he or she is going to react when surprises come along, and yet surprises are inevitably going to come. Somehow investment consultants need to condition people to this fact. I give a lot of talks where I stand up and say, “We don’t know what the future holds,” and I see all of the heads nodding up and down. But people act as if they do know what the future holds, and that’s what gets them into trouble.

So it’s crucial that consultants try to get through to people that it’s impossible to know the future and that surprise is inevitable. As a result, we have to limit the nature of our bets, we have to be obsessive about diversification, we shouldn’t try to be too smart, we shouldn’t try to shoot the moon. All of these are very simple ideas, and people will accept them ahead of time, but it’s hard for them to live with humbly structured portfolios. However, they have to do so if they’re going to survive. The main thing that an investment consultant can do is to get through this idea that you can’t act as though you know the future if you want to be a survivor. The future may be better than you think, and it’s not necessarily going to be worse. But even if it’s better than you think, that’s also hard to handle. It’s that kind of philosophical teaching that consultants have to understand in their hearts, and then get it into the hearts of investors. Once you’ve got the philosophical grasp, the rest is easy. — Peter Bernstein (source)

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Quote for the Week

It’s no secret that traders and market timers who come in and out of the market will miss some of the bad months, but they will also miss some of the good ones as well. When the market goes up, it often goes up rapidly. If you jumped in and out of the market and missed the best 40 months during the last 40 years, you would have reduced your average annual return from more than 11% to around 3% (less than you would have gotten from a money market fund). Market timing is speculating and it rarely, if ever, pays off. — Peter Lynch, 2001 (source)

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