After reading Rana Foroohar’s disturbing book, “Makers and Takers,” I decided to review my own investment policy decisions to see if I might be able to identify some guidelines that would be useful to investors. Foroohar concludes that investors would be wise to not seek professional advice and instead, put all their money in an ETF like the Vanguard S&P 500 (VOO ticker symbol).
Let’s begin with a critique of the research project that began February 2, 2015. Graph #1 shows where the market was at that time relative to August 17th 2016.
The market, as measured by the S&P 500, was at an all time high (#2 in Graph 1). Ms Faroohar would have had me invest the entire $100,000 in VOO. My stated investment objective was to earn 8% compounded over the next 5 years using Portfolio Navigation theory developed at PRI. Instead, I initiated the program with the DTR 6% portfolio with 40% in various iShare ETFs and 60% in short term fixed ETFs with a duration of less than 2 years. Why? I personally could not stomach putting $100,000 of my money in the market when it was at an all time high; but would I if it weren’t my money? In 2007 (see #1 in Graph 1) I was managing other people’s money in five trusts for FISERV Inc. and moved all five accounts to a minimum of 50% cash.
Many financial advisors have told me they would not dare hold that much cash for two reasons: 1. fear of being sued if the market went up, as happened in a case reported in Pensions and Investments magazine, and 2. Clients do not want to pay fees on cash held in their account. Hmmm, would it be ethical for me to do one thing with my money and another with client’s money, or not hold cash because I’m not getting a fee for decreasing downside risk? When I correctly forecast the Brexit move and went 100% in cash (see #4 in graph 1 above) would I again be risking a law suit because the market subsequently went up 3%? I cannot ignore the Where and Why described in her book, i.e., where we are (the top of an 8 year bull market) and why it happened (buy backs and monetary policy).
Let’s take a closer look at the period of time since I began the Portfolio Navigation project. Graph 2 shows how volatile this period has been.
Having 100% of one’s money in cash the day before Brexit might be considered dumb, given 20/20 hindsight, but having 100% in equities now is even dumber in my opinion. What you don’t see is all the trades that took place as I was trying to manage this volatile period based on my 60 some years of experience in the investment business and the results of our research at PRI. Graph 3 shows three pictures of uncertainty generated by PRI software.
As we move from 40% in equity (on the left) to 80% (on the right) the potential to exceed the Desired Target Return (DTR) relative to the downside risk goes from minus 10% to minus 60%. I should take 60% more downside risk than upside potential for basically the same expected return of 9% and only 3% more upside potential? No thank you Ms Foroorhar, because: I agree with your analysis and the risk-return trade off shown in Graph 3.
What did I learn?
- I would have been better off if I had just put all my money in the S&P 500 and played golf. After too many trades I have ended up with only $2 more than I started with. However, it ain’t over ‘till it’s over. This old soldier isn’t charging through a mine field for a 3% gain while risking a 20% loss.
- Neither bull markets nor people live forever. Don’t take stupid chances with your money or your life.
- I believe that Foroohar was correct about the need to use a longer planning horizon than 3 months. For people investing for retirement the planning horizon should be the time left until retirement.
- Foroohar is right, it is a complex problem that took her 700+ pages to describe. I disagree with her simple solution: put all your money in the S&P 500 and pray that Hillary will solve the gigantic problem Ms Foroohar describes.
I will continue to search for a better strategy when I resume this research project.