I went to the MF One event in Seattle this past weekend, which was a lot of fun. It was a real pleasure meeting so many great Fools and I hope to get opportunities to meet a lot more one day (especially on this board!).
MF One is geared towards a different audience than this board, and I think a lot of what they try to teach is aimed at preventing big mistakes (especially emotional mistakes). The Everlasting Portfolio, for example, has the famous 5-year minimum holding period, which means that you’re going to end up holding onto a handful of real losers instead of reallocating that capital; but it also means you’re not going to sell your winners too soon, which is a big problem a lot of people have when left to their own devices. Right now the EP has 33 companies in it, but the interesting thing is that the top-performing 7 companies make up just under 50% of the portfolio now. The bottom-performing 7 companies make up less than 5% of the portfolio.
Tom Gardner said that his brother David has the best track record at TMF, but he’s still only right half the time: 50% of his picks will go on to underperform. But what makes the difference is that the winners are huge and it’s that disparity between gains and losses that leads to outperformance. But that’s only true if you hold onto your winners (and even add to them over time).
Tom even went so far as to muse that maybe the average investor would be better off holding so many companies they couldn’t keep track of them, because when people are focused on their positions and sitting in the pilot’s seat, many will feel like they have to steer the plane and do something – and, unfortunately, that something may be unproductive for their returns (whether it’s trading in and out, or getting scared out of a great company after a large rise in the stock price).
So Tom’s advice was to work hard at running an emotionally efficient portfolio. Take your emotions out of your decisions. Don’t act just to act, but because you objectively believe it makes the most sense for your long-term returns. In the case of the Everlasting Portfolio, they’ve tried to structure it to help the average investor with that through the 5-year minimum holding period (which obviously has trade-offs – they keep losers too – but likely does more good than harm for many people).
Their second bit of advice was to run a tax-efficient portfolio: let your gains compound for you over time and work for you rather than forfeiting a big chunk of them each year. And again, the EP’s 5-year minimum holding period helps with that.
Morgan Housel gave a talk on bull vs. bear markets. I don’t think anyone who reads his stuff regularly heard anything new: corrections and bear markets are a very natural and healthy part of the market. The worst thing you can do is panic and sell in a bear market, but the second worst thing you can do is miss the bull market for fear of the next bear.
He also talked a bit about Hyman Minsky and the idea that stable periods naturally lead to instable periods as people and companies take on more debt and risk (“success breeds disregard for the possibility of failure”). Then, during times of economic stress, the worst companies are destroyed, refocusing resources on the rest who are forced to refocus, innovate, and improve, all of which leads to future success and stability. So bull markets setup bear markets, and bear markets setup bull markets in a natural cycle.
Morgan pointed out again the paradox that past bear markets look like wonderful times of opportunity while future bear markets look like horrible times of risk. His suggestion for mentally managing future bear markets is to pre-plan a “positive action” that you can take in the next bear market. That might be having a little cash on the side that you can invest, or it might be having a watch-list of great companies that you’d love to own if the market dragged the prices way down. But figure out a way that you can view the next bear market more as the opportunity you’ll see it for in hindsight rather than the risk you see it as today.
Finally, nobody knows when the bull market is going to turn to bear. He showed quotes from smart people and leading financial publications that have called the top every single year since 2010, and of course they’ve all been wrong. But those articles all sounded very reasonable at the time given the current situation. Someday this bull market will end, but nobody can call the top. And even if you believe the current market is unsustainable, “unsustainable” market states can last for a long time – much longer than people think. Unsustainable doesn’t mean it crashes tomorrow.
Saul has obviously spoken a lot about his approach and the ways in which it differs from the boilerplate TMF approach. But my takeaway is that they’re actually pretty similar in many ways that matter, with Saul’s absolutely being more efficient and productive, but also requiring better judgement and decision-making. Saul says don’t trade in and out, don’t price anchor, let your winners run (and add to them), and sell your companies that didn’t work out and reallocate that capital to better companies. I don’t think anyone would argue with that approach, but it requires skill and control. TMF fears that, despite good advice, many people are going to react emotionally and sell the good companies too, or get into the habit of trading, or panic in a downturn and sell everything at the worst possible time. They’re more worried about preventing big mistakes that sabotage market-beating returns. So their simplified approach is to just hold all your companies through thick and thin and let your portfolio naturally balance out over time as the winners grow into the majority and the losers diminish into the minority. Better that than selling those winners too soon, or panicking at the bottom, or trying to trade in and out all the time. And you see that with the EP: 3 years and 33 companies in, the top 7 companies have grown to nearly 50% of the portfolio and the bottom 7 have become less than 5% together.
Is it the most efficient approach? No, especially not compared to Saul. But those following the EP are up 24% over the market over those three years, and it’ll be interesting to see how things go from here now that the portfolio has become naturally weighted towards the winners and away from the losers. I don’t think the EP is trying to be the best, but I think it’s trying to be “good enough” in a way that works for a broad audience, including very inexperienced investors.
So I don’t think the big takeaway is that everyone should shackle themselves to 5-year minimum holding periods. But emotions and biases are a huge problem with investing – by far our worst enemies – and I think it’s to our benefit to be humble enough to admit we’re not perfect investors and devise ways of controlling our own personal weaknesses while we try to better ourselves and grow out of them. The 5-year holding period is simply the EP’s broad compromise for helping its members avoid the worst mistakes.
The thing I love about this board is that we’re all working hard to improve each day, both individually and as a group, and a big part of that includes talking about our weaknesses and what we’re doing to overcome them. So looking back at your own investing history, what patterns of mistakes do you see? And what processes do you have in place to help avoid repeating them again in the future?
Neil