I have been asked the same question repeatedly over the last few weeks. In fact, what began as a seemingly innocuous trickle has turned into a deluge of disillusionment and despair. So often now have I fielded this question that the time has come to dissect and reveal its true destructive force on a portfolio.
The offending question is often asked as a rhetorical with a pregnant pause at the end:
“Bret, at the beginning of 2008 my US equity portfolio was valued at X. Now, the value is 1/2 X, so I guess I should just hold on to my positions and wait for them to come back…. I mean they always do, right?”
Sometimes this question is followed by the Tweedle Dumb and Tweedle Dee of investing platitudes: “I can wait because I’m a long term holder”, and, “You haven’t lost money until you sell it”.
If I seem glib, I don’t mean to and if I have offended some I apologise. There is nothing lightweight about this question. In fact, it reveals a serious condition that can be terminal to a portfolio. The condition is called complacency. How has this malignant complacency been allowed to spread through the mind of the suffering portfolio owner? And what must be done to reverse the effects? I will attempt to answer these questions.
I see two main reasons for the complacency:
1) Ego gets in the way of good judgement all the time. The ludicrous apothegm that you have not lost money until you sell was most certainly created by someone trying to coddle his ego. Admitting you were wrong is difficult to do but is almost certainly the first step on the road to redemption.
2) For roughly 50 years the US equity markets behaved in a manner that bred, fostered and encouraged complacency. You see, from the 1950s to 2000, the market averages were higher at the end of each 5 year increment. This phenomenon was even recognized by the education system and eventually universities churned out students who believed in the myth that is called ‘A Random Walk Down Wall Street’. Of course, no one even bothered to point out that the averages were constantly reformulated during the five years with the worst companies being taken out and replaced with stronger ones. Nope, from universities on up to investment professionals the concept of buy-and-hold was preached with the faith that markets always go higher. Well, now the game has changed. The averages were lower in 2004 than in 2000 and will be lower in 2009 than in 2004.
So, let’s reverse the effects of complacency:
Step one: Simply forget about your ego and stop wasting time trying to point fingers. My advice: Don’t look at the level of your assets at the beginning of 2008 and try to come up with a scheme to recover it all tomorrow or bury your head in the sand and hope what you own will recover. Instead, look at the level of your assets today and imagine it is all cash. Ask yourself what would you do today with this cash in this environment to best protect the assets and make them grow. Then execute on this new plan. If you need help with this process I humbly suggest you spend some time on our website. You will find letters we have written to our investors as well as monthly updates on individual positions that may offer some guidance.
Step two: Recognize that the game has changed and the rules are different. After the crash of 1929 it took the averages over 2 1/2 decades to go to new highs and no doubt the complexion of the averages changed during that time. So, holding a portfolio of losers after the crash probably resulted in an even worse outcome. The rules have changed and you must change with them. Find out what areas of the market will perform best in this environment and don’t hesitate to realign your portfolio. Actively manage your assets, don’t be passive anymore.
I will leave you with this image. Conceptualize if you will that you were playing football for the last X amount of years. You knew the rules, you wore pads, you played on turf and wore cleats to help grip said turf. Now all of a sudden you find yourself playing a different game. Let’s say, ice hockey. You will still need pads, but the rules have changed which will take some getting used to. Take your time, be methodical, study. If you run out onto the ice still wearing cleats you will fall all over yourself. This is precisely what most of the best money managers of the last 50 years are doing today: falling all over themselves using tools that worked in the last cycle but can’t possibly work in this one.