Novel Investor

Compounding investing wisdom...

Foiling Mr. Market

by Jon

This imaginary person out there — Mr. Market — is kind of a drunken psycho. Some days he gets very enthused and some days he gets very depressed. – Warren Buffett

I like the way Warren Buffett simplifies Mr. Market. On any given day, Mr. Market can quote great prices or terrible prices. You can get caught up in his manic depressive behavior or you can ignore it. You can see the market as a tool to use or it can be a tool that uses you. It’s your choice.

Ever since Ben Graham offered up the first iteration of the Parable of Mr. Market, others have stepped up with their own versions. Charley Ellis has a more descriptive version I also like: Continue Reading…

Wise Words on Surviving Bull Markets

by Jon

Investing is a balancing act between the fear of missing out and fear of losing. Bull market optimism often makes it easy to forget losing is possible. It’s infectious. And the side effects can be costly.

Because greed, envy, and over-optimism around bull markets can lead to excesses in a portfolio. The stock portion grows in size, as markets rise, in relation to the rest of the portfolio. This can add to your returns in the short term. It may even tempt you to move money out of whatever is underperforming to put it into stocks. But both cases adds risk that can blow up when you least expect it.

This brings us back to the balancing act. It’s a trade-off. Gains against losses. Reward against risk. You don’t get one without the other. In fact, an excess of one means the other isn’t far behind.

So protection from losses is a critical piece of a portfolio. It needs to be weighed at all times. Especially in bull markets, when profits are easy to come by and losing seems impossible.

Because the long history of markets suggests that the current bull market is far more likely to end, like all the rest, than go on indefinitely. It’s best to prepare for that eventuality the further it drags on. Not doing so can be disastrous.

Finding the perfect balance is never easy but it means weighing the odds, diversifying, keeping the downside in mind, and not letting over-optimism infect your investment decisions.

Of course, it helps to keep some of the advice below in mind: Continue Reading…

Adjusting Return Expectations

by Jon

Expectations tend to seep into investment decisions. Not always in a good way.

Take the return expectations from a recent study by Schroders:

Expected Returns for US stocks

15.38% seems awfully specific. Maybe the U.S. stock market hits that mark over the next five years, but it’s eerily similar to returns over the last five years. From 2o16 to 2020, the S&P 500 earned an annual 15.22% total return. So recency bias may play a role. And with the S&P 500’s historical return closer to 10%, I think it’s safe to say those expectations are over-optimistic.

A safer assumption for future returns would be achieved with a formula John Bogle devised. Bogle’s simple formula looks like this: Continue Reading…

The Stock Market Pendulum

by Jon

Where are we now? It’s a question often asked about the stock market cycle that leaves everyone wanting. That’s because the nature of markets makes precise answers impossible.

So instead, most responses come in the form of analogies. Baseball innings are a popular one. “What inning is the market in today?” “The seventh inning, hope that helps.”

A pendulum swinging back and forth is a better example. Howard Marks uses it in both of his books to describe the market cycle. Edwin Lefevre even used it back in 1901.

Robert Kirby, an investment adviser who conceived of the coffee can portfolio, gave one of the better descriptions of the market pendulum during a talk in April 1999: Continue Reading…

The High Price of Free Trades

by Jon

The cost of trading may be higher than its ever been even though trading is free. In a bygone era, the cost of trading was mostly apparent. A commission was charged on every transaction.

Commissions acted like a speed bump or a governor on a car’s engine. It was tangible. It was obvious. It forced investors to slow down, realize a cost was involved, that had to be overcome to make a profit. It also didn’t take a genius to know how the broker made money.

Today that speed bump is gone.

There’s a second cost of trading that’s less obvious and easily overlooked. It’s self-imposed. It’s driven by human nature. It comes in the form of errors and mistakes. And, put simply, that behavior can be manipulated and extremely costly.

Warren Buffett once warned about the role brokers played in the markets (in relation to derivative securities), which seems especially relevant today. Continue Reading…

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