Napoleon’s definition of a military genius was “the man who can do the average thing when all those around him are going crazy.”
It’s the same in investing — especially as markets get wild, as they’ve been these past few months.
It may be hard to tell from the indices that make most of the headlines, but as of this writing, on March 17th, 2022, out of 8,565 stocks in my Finviz database, 70% (6,052 issues) are below their average price over the past 10 months (200 trading days to be specific). The stock markets are in an evident decline.
In these types of markets, excelling over time doesn’t require exceptional insight or complex strategies. What it does require is maintaining a level head during periods of upheaval. That is what we are doing at Shadowridge.
Billionaire investor Howard Marks once talked about an investment manager whose annual results never ranked in the top quarter of industry rankings. He’d been solidly in the 27-47% quartile every year for 14 years. His investments were making sort of middling returns.
And where do you think that put him within his competitive universe for the 14 years overall? The top 4 percent!
Most folks would say that if you rank from 27% to 47%, you are at about a 37% rank on average. But the real answer in his case was a rank in the top 4%.
The reason is compounding, or what I like to call the math of gains and losses. Specifically, the importance of minimizing losses when you are investing.
The difference between being down 33% and 50% on your money does not seem all that great. They both would feel terrible, right? But recovering from more significant losses is disproportionately difficult.
A 33% loss requires a 50% gain to get back to even – a high but doable hurdle. But a 50% loss takes twice as much, a 100% gain, to get back to even. The math goes like this: Start with $1.00 and lose 50% ($.50). To recover, you need to earn $.50 while starting with only the $.50 that remains. 100% gains – doubling your money – is extremely hard to do. For this reason, avoiding large losses is most critical in successful investing.
We often suggest clients evaluate us, or any advisor, with performance over a complete market cycle, so that you see the performance in both up and down markets. Most managers can make money in up markets, but few are good at minimizing losses in declining markets, which makes all the difference for long-term investors. These stock market cycles I refer to are not the 5-10% declines we frequently see but are full-blown bear markets that have taken 50% or more of index values and happen on average every 5 years, with even longer cycles more recently. Making money in up cycles does little good if you take massive losses in down cycles. Strategic money managers like Shadowridge Adapt to Changing Markets® and are good at minimizing damage in down cycles, something index funds can’t do.
To gauge how important Playing Defense is for our clients, I did a study covering the decade of the 2000s, which included two deep bear markets: 2000-03 when the S&P 500 lost 52% of its value, and 2007-09 when it dropped 56%. Here is a chart of the S&P 500, with dividends reinvested, during the study period. It shows the S&P 500 losing money over the 10 years.
The study started with all equity mutual funds (holding greater than 60% stocks) in existence since 1999 and eliminated all of the higher risk funds. Those that had dropped 75% or more of the index loss in the two bear markets mentioned (39% and 42%, respectively) were removed from the study. The remaining risk-managed funds produced the following performance for the 1999-2009 period.
If you understand the math behind compounding, you realize the most important question is not “How can I earn the highest returns?” It is “What are the best returns I can sustain for the longest period of time?” Just staying in the game consistently through chaos determines the winners.
You could be considered an investing genius if you:
- Kept your head on straight when the market crashed in 2000;
- Remained calm during the crash of 2008;
- Haven’t panicked over the last few months of volatility.
It doesn’t take much, but it makes all the difference.