Open Letter To The Finance Committee

For the last seventeen years I have served on the board and/or finance committee of a local non-profit organization. The message below was an email I sent in response to a recent meeting where the topic of the investment performance was discussed. The points in the message apply to retirement investors just as much as they do to charitable endowment or foundation investors…

This absurdly long email is in response to the discussion we had on Tuesday regarding the recent performance of the endowment. There was frustration expressed over the meager amount of growth over the last twelve months. I’m very much in support of the decision to review our strategy in the July meeting and the follow-up discussion with [investment advisor] in August. But before those meetings, there are a few things we should consider.

Tweaking Of Allocations Is Pointless

Finding the perfect mix of foreign and domestic stocks, bonds, real estate and commodities is not only impossible, it’s actually not that important.

Below is some data taken from Mebane Faber’s new book Global Asset Allocation (yes, it’s as thrilling as the title suggests). The table shows the asset allocations of eight different portfolios. A couple are commonly used approaches, the others have been suggested by highly regarded investors like Warren Buffett, Mohammed El-Erian, and Rob Arnott. These are meant to be a mix of assets that one could use for a lifetime, in all conditions. The idea is that you would invest according to these allocations and then, once per year, you’d rebalance to bring the allocations back to the target amounts.

The interesting result is that while these portfolios recommend a wide range of allocations, over a long period of time their performance would have been strikingly similar.

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Please see disclaimer below for specific indexes used in return calculations.

This isn’t meant to suggest that an investor can slap together random selections of investments and it will just automatically work out well. It means that disciplined adherence to a plan that provides some basic things – exposure to growth markets and diversification of risk – is more important than the precise way a portfolio is carved up.

Instead of making adjustments out of frustration, we should take a very long term view of our investment approach and focus short-term management efforts on things like controlling expenses and guarding against unnecessary risk.

Performance Chasing Leads To Disaster

Pursuing the currently hot investment class is probably the most common and harmful mistake that investors make. Over the last twelve months the flat return of the endowment is frustrating because we lagged the performance of the stock market. Our diversified portfolio is the main culprit. Looking specifically at our asset classes over the last year, while domestic stocks did well, real estate and bonds were barely positive, foreign stocks were down and commodities were obliterated.

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But if this suggests that we should concentrate more of our assets in domestic stocks, what does the last fifteen years tell us?

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Over this longer period of recent history, real estate and bonds both significantly outperformed domestic stocks. Look a little closer at this chart and you can see long periods of time where each asset class has been either a comparative star or a dud. With that in mind, ask yourself:

  1. Is it reasonable to assume that any one of these classes has the potential to outperform the rest in any given year?
  2. Is it reasonable to assume that this potential outperformance could be significant?
  3. Is it reasonable to assume that this outperformance could potentially be sustained for a long period of time?
  4. Is it possible for us to know in advance when these periods of potential outperformance will begin, how long they will last, and the magnitude of the difference?

So that’s three yes answers and a no. The takeaway here is that we have short memories. Our basic human nature leads us to place a lot more importance on recent events than they deserve.

The Endowment Has A Distinct Purpose

The [organization] did not establish the endowment as an investment fund. The job of the endowment is to support the mission of the [organization]. We invest the money to combat inflation and spending and to aid in the growth of the endowment, but the investments are not the purpose, they’re just tools – a means to an end.

This pool of money is intended to outlive all of us. We are, and should be, growth investors and we shouldn’t become overly concerned by the natural fluctuation in performance that is the unavoidable consequence of being a growth investor. However, the endowment still needs to be able to carry out the job it was designed to do.

If we invest the same way most of our donors invest, the endowment’s ability to perform its job will be at its worst at the exact moment it’s needed the most. When markets fall and the economy slows and donations dwindle, that’s when the endowment has to be able to provide support. Today our biggest problem is figuring out how to deal with all this damn cash that is piling up everywhere. But bigger challenges will come again and that’s why we are diversified among a variety of both markets and strategies.

Beyond the occasional big market gyration, it’s also important that we be realistic about returns over longer periods. Looking deeper into the Mebane Faber research noted above, most of the portfolios would have produced negative real returns for the entire decade of the 1970s (real return is the nominal return minus inflation). With all those pleasant forty year average numbers listed in that table, it’s easy to overlook a stretch like this, but in real time, we all know that there would be a lot of angst during committee and board meetings. Hopefully, when the time comes, we will remember that it’s discipline during rough patches that make the better periods possible.

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By the same token, it’s discipline during good times that makes surviving bad periods possible.

For what it’s worth, I will have one recommendation for the committee during the July meeting.

I’m going to propose that [details pertaining to organization business].

Thanks,
Pat

Moral of the story: Coming up with a good investment plan is easy. Discipline is hard.

 

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Disclaimer: the S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The MSCI All Country World ex US Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets, excluding the United States.

The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated.

The Morningstar US Real Asset Index represents the performance of liquid “real assets” – 40% Treasury Inflated Protected Securities ‘TIPS,’ Morningstar US TIPS Index), 30% commodity futures (Morningstar Long/Short Commodity Index), 15% REITs (Morningstar US REIT Index Index)  and 15% commodity related equities (10%Global Upstream Natural Resources Index/5% Morningstar MLP Composite Index).

Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors. Talk to your financial advisor before making any investing decisions. Past performance is not indicative of future returns. Information displayed is taken from sources believed to be reliable but cannot be guaranteed. When you link to any of the websites provided here, you are leaving this website. We make no representation as to the completeness or accuracy of information provided at these websites. All indexes are unmanaged and investors cannot invest directly into an index. Unlike investments, indexes do not incur management fees, charges, or expenses. Past performance does not guarantee future results. Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.

Ideas and opinions expressed in this article are the sole responsibility of Patrick Crook/PLC Asset Management and do not eflect any stated opinions of Commonwealth Financial Network, National Financial Servicers LLC or any other person or entity. Commonwealth does not provide legal or tax advice. Please consult with a legal or tax professional regarding your individual situation.

Interview With Corvallis Estate Planning Attorney Nadine Davison

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Estate planning is a topic that often comes up in investment discussions. The complexity of this area and the potential ramifications of doing something wrong makes getting advice from a qualified expert (not me) crucial. Recently I had the opportunity to pass along some of your questions to a highly qualified specialist and expert in the field, Nadine Davison. Nadine is an estate planning attorney and shareholder with the Corvallis law firm of Smith, Davison & Brasier, PC.

Originally from Bethesda, Maryland, Nadine moved here twenty years ago when her husband accepted a position as an English professor at OSU. She has two teenagers, a seventeen year old son and a fourteen year old daughter.

Before moving to Oregon, Nadine practiced for eight years in Washington, DC, representing corporations and individuals in all aspects of complex commercial litigation. After moving west, she continued her litigation practice in Eugene for three more years, and then took a few years off to be home full-time with her children before joining Jeanne Smith and her practice in 2003.

Below Nadine answers many of the questions that have been posed to me over the years. Hopefully, this discussion sparks some thought in your household on whether or not your current plan is up to date and adequate to the task.

1. What’s the danger of not having a plan – let’s say I have fairly typical assets and I die? What’s the danger in terms of my heirs?

Actually, everyone already has a plan – Continue reading

Intentional Evolution for Investors


“Everything should be made as simple as possible, but no simpler.”

                -Albert Einstein

 We are midway through the first quarter of the year and in the thick of some real turmoil thanks to second and third order effects of falling oil prices and Greek elections. Just kidding! It only seems that way if you listen to commentators on CNBC or read the news. The real truth is, the current investment environment is a tale of simplicity.

As an investor, my two main priorities are to, 1) participate in growing markets and, 2) avoid disaster. If we can do that reliably we’re in pretty good shape. Simple, right?

The first task in this pursuit is identifying growing markets. To that end, there are a couple of monster trends that have been in place for a long time that simplify this job. Continue reading

Space Between the Notes

I always listen to what I can leave out.
-Miles Davis

 A lot of art, a lot of life, is made better by subtraction. The sparing use of musical notes or brush strokes or words in a sentence lends greater emphasis to those that remain. The space between the notes is like a showcase, almost a stage of its own.

A garden will have better results with fifteen carrots in a square foot than it will with fifty. Fifty looks more impressive when they first sprout, but they quickly crowd each other out. The patient use of space pays off when it counts.

Most people will get faster results by lifting weights two or three days per week instead of every day. It’s not the lifting of weights that makes you stronger – it’s recovering from lifting weights that makes you stronger. Without space to rest and repair, the workouts will weaken you over time.

In the course of managing an investment portfolio, it is easy to fall into the trap of wanting to always make things happen. Chase from one market to another. From one strategy to another. To keep adding new screens, more complex rules and metrics. These efforts seldom yield good results. The more effective course for most would be to do the opposite. Subtract. Continue reading

You Are Lying To Yourself

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We all do it. Consciously or not, we all lie to ourselves and it costs us money.

“The majority of your beliefs, particularly in business, are driven by what you want to be true.”    -Tom Asacker, author of The Business of Belief

We form beliefs about things based on experiences and perceptions that are often just fragments of reality. An initial impression or a bit of passed down wisdom that we’ve heard from a young age can have an enormous and long-lasting effect on our expectation of how things are supposed to work. This leads us to mainly see only what we already believe and discount things that challenge those beliefs. It’s called confirmation bias and it’s probably costing you money right now.

For example, let’s say you’re Continue reading