We did not name our business Capstone by random assignment
or dart throwing. A capstone is a crowning achievement, a finishing touch if
you will.  If you
have carved out a meaningful life, our belief was that careful management of
your assets could improve your life (expanding your freedom and allowing you
time to allot to chosen goals).

It seems like people in the U.S. are currently concerned
only about jobs, money, taxes, and real estate. These are not the items which
comprise a meaningful life in and of themselves. The World Database of
Happiness shows the United States ranked 20^th in happiness.  The World Health Organization ranks us 37^th
in health care. We rank 14^th in education, according to a recent
OECD study. We are at best in the middle of the pack for homicide rates around
the world.

Shouldn’t we put some of our focus on improving these areas?
Wouldn’t that help us lead more satisfying and meaningful lives? There is still
a lot of wealth in our country and a pretty decent standard of living compared
to most around the globe. Perhaps a deep breath and a grateful nod to our
abundance could be useful every once in a while?

The answer will quickly tell you who you are working with. The “faith advisor” will answer about how you are in this for the long run, how you don’t make a lot of changes if you truly believe in America and in capitalism, etc. They buy into the full faith and credit of the financial services industry and are supported by many experts from the industry (kind of like lobbyists in their approach). On the other hand, the “business advisor” will be able to answer in terms of a process to manage risk as the future unfurls. We suppose there could be a third group who are not able to answer coherently on either side of this issue. That is an answer worth hearing and probably tells you to move on in searching for the “right person”.

The choice is yours. For us, we have a strong belief that you should manage your investments much like you manage a business. You need a process, you need beliefs, and you need to evaluate and adapt as you move forward. A business which does not do this is unlikely to succeed over the long haul.

A good example might be a successful local coffee shop. The owners would have founded their business on a set of core beliefs and would have developed successful processes to implement their belief system. Now, imagine that they hear that that national coffee chain (yes, that one!) is going to open up in the next block. They could ignore this fact and rely on their faith in their current business model and clientele. A better course of action would be to assess the risks (and opportunities!) that will arise from their new competitor. Which business model would you choose and which business do you believe is more likely to survive?

You can (and we believe must) apply these same principles to your investment portfolio. You need to develop a set of beliefs, and then implement them as processes, but also make an ongoing assessment of risks and opportunities an important process which loops back to your portfolio design. In our opinion, investing with faith only is no way to run a portfolio. Or a business.

The third rule of investing is really the only one you need because- you can actually follow it!  Lose money as infrequently as possible and limit the amount of each loss!!

This gives you a plan for investing that you can execute (unlike the far more well known edicts of Mr. Buffet). The process needed to follow this rule will be challenging but you can do it. To lose money as infrequently as possible is to only enter into investments which have a reasonable expectation of being profitable. Buying a tech stock in late 1999  with a price-to-earning ratio of 400 was just not a reasonable concept. Could you have doubled your money as the P/E ration zoomed to 800? Of course, but this was not a likely or reasonable outcome. This investment was more likely to lose money than to make money and should have been avoided. If you did foolishly make this trade (an infrequent loss we hope!), what was your process to keep your loss small? If you allowed your tech stock to fall 90% in value (as most investors did!), you clearly had no process in place that was designed to limit the scope of your losses.

So, make it a mantra and figure out how you are implementing it-

Lose money as infrequently as possible and limit the amount of each loss!!

In reality, we have transferred our debt problems from individuals and corporations to the government (this process is referred to by the dirty word “Bailout”). Why didn’t we ever blame individuals for any of these problems? That is simple. You don’t get many votes by informing the voters that they have made foolish decisions that are not sustainable. Nope, it is much better to blame “them” (the government or the corporations) for all of our woes. Ultimately, of course, we are the government and the corporations, but……..that is a small detail that can be easily overlooked.

The world of behavioral finance teaches us that a dollar is a dollar. We often ascribe different meaning to it (e.g. “government debt is worse than my personal debt”), but that is unrealistic thinking that leads us astray. We need to bring our books into better alignment. Our future cannot be one in which we continue to consume by spending money that we don’t have.

So, a simple idea. We must all admit it is pretty much an across the board problem that we have. People, corporations, and the government made bad decisions, spent money they didn’t have, believed that doing so was not a problem, and now the “chickens have come home to roost”. If all three conspired to cause this problem, then don’t all three have to be involved in the solution? By having a realistic discussion and a holistic solution, we could successfully address our long term issues. We can and must move forward together, learning to live within our means, deciding what that costs and how we will pay for it, etc. This means that we need to behave like…………….grownups!!!

Whether you are old enough to appreciate Pete Seeger or the Byrds, you are no doubt exposed to their classic, Turn!Turn!Turn! Taken from Ecclesiastes 3:

“To everything there is a season, and a time to every purpose under heaven: ….a time to plant, and a time to pluck up that which is planted;”

We still have a lot of “financial experts” explaining that the time to own a basket of stocks is now, in the future, and always. If they could only embrace the simple message of Ecclesiastes 3, they would begin to understand the folly of their advice

Doomsday marketers are everywhere now and they are succeeding in their marketing efforts. One famous doomsday fellow predicts the Dow will fall to 1000! That would mean that stocks would fall by over 90%. If earnings were flat, that would mean that the return on your investment (earnings versus investment) would be over 50% per year when the market is at 1000.

We don’t know about you, but we would gladly put all of money into stocks well before our return would be need to be 50% per year. Alternatively, we might consider that earnings would have to fall 90% from current levels. As current earnings are rebounding from rather low levels, it is hard to imagine that scenario either. Anything can happen, but this is about as likely as being struck by lightning.

But the doomsday crowd is succeeding in frightening people and we are getting calls about how to invest in the likely fall of the market. We don’t say that a market crash is impossible or that a decline will not take place. We do say that profiting from a market decline is the most difficult strategy to employ and that the skill and timing required to do so successfully is daunting.

First, stocks have an upward bias. This is just common sense. A big company makes money every day, so it is literally “worth” more each day. The counter balance to this is that the market has over valued the stock (i.e. investors are paying too high a price in order to own part of the company) and so it will fall even though its worth is increasing daily. So, our common sense means it is relatively harder to make money on stocks falling as opposed to their increasing in value.

Second, let’s go back to the notion that we are market realists. One of our favorite market realists is Jeremy Grantham. He has long produced his 7-year market forecast with astonishing accuracy. He basically normalizes earnings and uses them to figure out likely returns over 7 years given current valuations. His latest forecast shows positive real returns (above the rate of inflation) for all stock classes over the next 7 years.

Many are below normal, but all are positive. These seven years will likely include some big plus and some big minus periods. But, if at the end of the day returns for the period are positive as he predicts, you are once again swimming upstream by trying to invest in a market fall.

We believe we are in a difficult environment and that you need to take more risk when stocks are cheap and rising and less risk when stocks are expensive and falling. To try to make money based on the doomsday scenario,…….., just doesn’t make much sense to us. It is betting on a long shot.

Let take two investors, each of whom has $100,000 to invest. Investor A (the tortoise) gets 20% of market up and 20% of market downs. Investor B (the hare) gets 100% of market ups and 100% of market downs. Now, let’s add some volatile market returns (certainly not beyond the realm of possibility). The market goes up 50% and falls 40% in year 2.

Investor B has a lot more fun at cocktail parties than Investor A. Our hare (B) gets to brag about the huge returns in year one, while the tortoise (A) tries his best not to discuss his portfolio. Arithmetically, our hare ends up with a 5% annual average return (up 50% and down 40%). Our poor tortoise averages only 1% per year (up 10% and down 8%).

The hare, unfortunately, has only $90,000 of his original $100,000 investment left after year 2. Perhaps his excitement was worth $10,000 but we are not that interested in excitement here at Capstone. The tortoise has $101,200 to show for his investment. He averaged less arithmetically, had less excitement, but saw the return of his principal along with a small return on his principal.

When the odds of favorable outcomes are heavily on your side, it may be better to be a hare. When the odds are more neutral or against you, think hard about being a tortoise. The tortoise can make a bit of money in a turbulent environment while the hare loses his.

The “sales forces” of financial services are out there now beating the drums for this new decade. Surely after a poor decade we should return to the norm by having excellent returns on our investments, shouldn’t we? Unfortunately, this decade is not really setting up to be any easier for investors than the previous one.

Stocks are certainly not beginning the decade by being cheap by historic measures, so we should expect an average to below average return. Thus, the range bound or secular bear market is likely to continue for some time in equity markets. Unfortunately, commodities and bonds are no longer cheap like they were at the beginning of the past decade. So, returns will be still tough to come by moving forward.

We think the key moving forward will be to be tactical with your risk budget. By that, you or your advisor needs to keep an eye on what are the risks and what are the potential returns of investments. So, if the stock of a great company has fallen to a very low price, buying the stock may increase your risk but be justified by potentially large gains. On the other side, if a stock is very expensive by historic measures it may have rather limited potential appreciation and considerable potential loss. To sell that position and reduce your risk may be the prudent decision. 

So, while investors traditionally have to decide on how much risk to take and stuck with that decision, we believe the prudent course is to adjust your risk budget by the opportunity available to garner good returns. You might still average the same amount of portfolio risk through a market cycle, but get to that average in a way that benefits your bottom line.

We have long held that for us personally retirement was not a goal. Restylement, with its ability to give you more time to pursue the things that are most important to you, is what appeals to us. There is something that we don’t like about retirement- there is a connotation of withdrawing in the word that does not appeal to us. We know retirement will still be the goal for many, but others will increasingly choose restylement as their goal. The ability to do the things you are passionate about and spend less time doing the things that you don’t enjoy.

This past week we were on “vacation”, but it did not work out that well. We found there were pressing work issues that needed to be dealt with during our time away. So, it occurred to us to re-think vacation a bit also. It seems to us that “vacation” is a corollary to “retirement”. The root word “vacate” has to do with leaving, emptying, etc. Our goal when we go away is really not vacating, but recreation. We want to re-create, not merely empty. Our goal in getting away is to refresh, step back, enhance, get new ideas flowing, etc. So, we did not really have our “vacation” spoiled by having to do a bit of work while away. We were still able to enjoy all the benefits of the time away and have it serve us well in “re-charging” for the road ahead. So- no retirement and no vacation, but bring on restylement and recreation. They both sound good to us.

Their approaches are extremely different (Jim is certainly the more offensive of the two to us), but ultimately they both share only one goal-self promotion. They are the anti-fiduciaries. They do not put your best interests first. They are all about promoting themselves. If you perish as fodder in their self promotion scheme, they will not miss a meal nor feel a moment’s sorrow.  I am pretty sure if Warren Buffet listened in daily to Mr. Cramer and followed all his advice he could have had his home foreclosed upon by now. Cramer uses the shotgun approach, trying to hit a home run by taking 100 swings in every direction. So, he usually has a home run or two to remind you about. The other ideas strike out and are replaced by another hundred swings for the fences.

Suzie’s approach is far more demure but just as lacking in ultimate usefulness. She likes to make sweeping generalizations (“X is a bad thing to do as an investor”). The problem is she has not taken the time or effort to understand your unique situation and needs, so her “advice” might be right for over 50% of listeners but dead wrong for you. You become the fodder in her fame.

A fiduciary, plain and simple, is charged with putting your interests first. The person may be inept and may not give you good counsel. However, they at least must attempt to give you good counsel. That would seem like a good first step in evaluating who you should listen to.

We know it is a little late for New Year’s Resolutions, but………..How about it! Why not tune out Jim and Suzie and devote that time to something that will add to the quality of your life?