Puzzles of Investing
With two young children at home, we have lots of puzzles around our house. We also have our daily dose of mysteries. The puzzles are much less complicated than the mysteries, because they have knowable answers. For example, our family knows exactly what the puzzles of Thomas the Train, Lightning McQueen, Larry the Cucumber and Bob the Tomato look like when they are complete. Mysteries, on the other hand, pose questions with no definite answers, because the answers are dependent on factors both known and unknown. So we can know that a tiny shoe or sock or heaven forbid, one of our wedding rings is gone, but what contributed to its disappearance and where it might be is much less clear. I think you get the idea.
Investing is similar to living with a child in that they both present puzzles and mysteries. Interest rates, earnings and the unemployment rate are a few talking points that consistently grab our attention. However, these aren’t puzzle pieces – they are but a few items on the endless list of clues to a mystery that has no knowable outcome. In fact, economists and portfolio managers have no more idea where the economy or markets will be in the next few years than I do about where my little boy’s favorite T-shirt is.
However, when appropriately viewed through a long-term lens, sound investing is more like a puzzle supported by empirical facts that present themselves in pieces that are pretty straightforward. For instance:
– Stocks perform better than bonds.
– Stocks of smaller companies perform better than stocks of larger companies.
– Stocks of riskier, value type companies perform better than stocks of growth companies.
– The more profitable a company is, the better the return associated with its stock return.
– Adding bonds to a portfolio reduces the overall volatility of the portfolio.
– Keep costs low.
– Keep taxes low.
Simple enough – unfortunately, the world makes it a little more complicated. When I’m tempted to deviate from these simple fundamentals, I remind myself of what Warren Buffett once said:
“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ….Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble investing.”
Make no mistake, investing – like a mystery – can be entertaining; but it can also be an expensive and frustrating place to figure out who you are when it comes to financial risks such as market volatility and inflation. Instead, first create your own picture and then start putting the pieces together.