Financial pundits rarely provide sound investment advice because bad advice is much more entertaining. By contrast, the world's most respected investors usually strike a humbler tone, having learned from personal experience about the unpredictability of markets.
A frequently heard line from the pundits is that smart investors should wait for the volatility to clear in timing their market entry points. We heard a lot of that in 2011 and the early part of this year when news of the European debt crisis dominated the financial press. Writing about market timing in 1979 before one of the biggest bull markets in history, Warren Buffett said: “Before reaching for that crutch, face up to two unpleasant facts: The future is never clear [and] you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.”(1)
When market prospects seem rosy, this information is already incorporated within existing stock prices, possibly limiting upside gains; however, in times of economic uncertainty, unexpected positive news can drive stock prices higher.
Another theme from the pundits is that you should focus on finding market-beating investment opportunities without considering the risk characteristics of your overall portfolio. Asked about this in 2007, legendary investment manager Peter Bernstein said it is better to focus on risk than return. “We really can't manage returns,” he said, “because we don't know what they're going to be. The only way we can play the game is to decide what kinds of risk we're going to take.”(2)
In an investment portfolio, the appropriate level of risk is determined by each investor’s investment goals, time horizon, risk tolerance, and unique financial circumstances. The risk is then managed by selecting a suitable balance of stocks and bonds and through broad diversification within each of these asset classes.
A favorite talking point among pundits is the role of stock picking, the implication being that painstakingly analyzing individual stocks is the key to building wealth. Prompted by a newspaper reporter for his opinion on this piece of conventional wisdom, Charley Ellis, founder of Greenwich Associates, said the truth was actually quite the opposite.(3)
"The best way to achieve long-term success is not in stock picking and not in market timing and not even in changing portfolio strategy," Ellis said. "Sure, these approaches all have their current heroes and war stories, but few hero investors last for long and not all the war stories are entirely true. The great pathway to long-term success comes via sound, sustained investment policy, setting the right asset mix and holding onto it."
There’s not much entertainment value in that advice, but it is a great message for long-term investors.
Jeffrey J. Brown, MD CFA Principal, Shearwater Capital
(1) Warren Buffet, "A Warren Buffett Reader," Forbes, August 6, 1979.
(2) Jonathan Burton, "Alpha and Bets," MarketWatch, April 30, 2007.
(3) Barrie Dunstan, "Global Money Masters," Australian Financial Review, November 2006.