Thursday, January 31, 2013

The Why of Safety

I touched on it before, but it bears repeating.  The biggest reason why I am obsessed with not losing money is because I am living through a secular bear market, particularly in my formative years.  If I started in 1990 rather than 2010, my primary goal wouldn't be absolute real returns (positive returns after inflation and taxes); it would be beating the market.  Back then it was a given that stocks will go up, only question was how much.  In other words, the baseline wasn't 0; the baseline was the broad market index.  Nobody cared that you got positive returns.  Everyone did.  The only value you brought to the table was going above the benchmark.  But 10 years of sideways action made benchmarking investing fall out of favor.  All of a sudden, making -45% and beating a -50% market seemed ridiculous.  Sure you beat the market, but still lost tons of money.

My point is we are not in control of how we invest, at least I'm not.  My goals are in direct response to the market environment I grew up in.  It's not a surprise that all enduring speculators and investors are obsessed with safety.  You live long enough and you live through bear markets.  Only those who weren't greedy enough to go after every last cent survived through them. 

But you still face the same old problem: there are no rules to dictate the arrival of bear markets.  The next one may be here today or may arrive the day after you die.  Absolute return funds should grossly underperform indices if the bull market continues.  What's important here, I think, is to be aware of why your strategy is the way it is.  I am deeply conscious that my investment will look mediocre if the next 100 years look like the last 100.  It will underperform indices and it will underperform most investors who overweight stocks.  For me that's ok.

The interesting thing is my "legacy" will differ depending on how the next 100 years look like.  Imagine two parallel universes where I apply my brand of absolute return investing in both. The first look like the last 100 years.  Middling results.  Didn't lose money, but didn't do anything to write home about either.  I am as influential as the next guy (or robot) who bags my groceries.  In the other universe, the next 100 years look like the last 10.  It's plenty volatile, but at end of the day, it goes nowhere.  Now I'm not only surviving, I'm outperforming the benchmark.  All of a sudden I seem to have found the holy grail.  Relatives, friends, strangers all want to know my secret.  So what am I?  Salient or fraud?

At end of the day, the most important thing is having a goal, quantifying it with numbers, then feeling comfortable with it.  A lot of people will make more money than you.  If you aren't ok with that, keep searching for that holy grail.  But don't tell me if you find it; I will be super jealous.