All Things Considered…Equal???

“The conventional wisdom is often wrong.”  Those were the words of Steven Levitt and Stephen Dubner in their blockbuster hit, Freakonomics, which, by the way, if you haven’t read it is well worth the time and money.  This could be no truer than in the financial services realm and, specifically, the sales of investment products and services.  Indeed, the entire premise that an investment’s asset class—its label as large cap stock, small cap stock, international stock, short- or long-term bond—as the PRIMARY determinant of its risk, must be questioned. 

Here’s how Jim Stovall and I put it in The Financial Crossroads in the chapter entitled, “Portfolio Management: All Things Considered Equal”:

Chart  Have you ever heard anyone say, “All things being considered equal…” and then follow it up with a statement?  They may just be an economist.  It’s like saying, “If everything happens the way I expect it to, I’ll be home on time for dinner.”  It’s really an out.  In economics, enormous models are created with assumptions too numerous to count, and the aforementioned phrase gives the economist an out when circumstances beyond his or her control change.  This phrase is especially important in the management of investment portfolios.   

All things being considered equal, stocks are more risky than bonds.  Growth companies, more risky than value companies. Small companies, more risky than large companies.  International countries and companies, more risky than the United States and companies domiciled here.  In investing circles, each of these categories is called an asset class.  If all things were equal, the above presumptions would hold true.  But, especially in the world of investments, all things are never equal!  They’re in a constant state of flux, and as Mark Twain told us, “History doesn’t repeat itself, but it does rhyme.”

Departing momentarily from theory into reality, consider the notion that instead of risk being determined by asset class, risk is determined by the price of that asset.  The risk of a particular asset is not correlated with its label, but instead, its price tag.


You see, we’re not suggesting that the asset class is irrelevant, but it frightens us that the financial industry seems to have built its foundation for investing on the widely accepted “science” that an investment’s risk is determined by its label instead of its price tag.  This concept is theoretically known as Modern Portfolio Theory or the Efficient Market Hypothesis, but has become broadly known  and presented to consumers as Asset Allocation.  You’d probably know it better from the pretty pie chart that most often is pulled out to describe it.  (All you need to do is “rebalance” between the asset classes when the pie chart gets out of whack and VOILA—a lifetime of investing made simple!)

So if you were one who had wondered if your pie chart wasn’t cutting it, or if you were relying too heavily on market logic that seemed all too illogical, we’d suggest that your common sense might actually trump the behemoth financial institution!    


Over the weekend, I was watching a television program on which a financial advisor made his claim that, “The market has always come back and I think it always will.”  Sadly, this has been the sales pitch of stock brokers for generations and only some of those generations have walked away with a positive rate of return.  For this post, I’d like to share with you the open to the fifteenth chapter of The Financial Crossroads titled “Risk Management Investing."  We call into question the now institutionalized thought in the financial industry of “Buy and Hold,” Asset Allocation and Modern Portfolio Theory to remind all of us of the mathematical truth that IT’S EASIER TO LOSE MONEY THAN IT IS TO MAKE IT! 

From “Risk Management Investing”:

"I am more concerned about the return of my money than the return on my money." (Mark Twain)

Mark Twain was the first to wittily claim that he was more concerned with capital preservation (the return of my money) than growth (the return on my money), but it is interesting to note that Twain passed away in 1910, prior to the Great Depression.  Oklahoma’s favorite son, Will Rogers (who died in 1935), also later made this a notable quote.  I have another that I’d like you to chew on.  “It is easier to lose money than it is to make it!”  

That’s not a catchy slogan or tagline.  It’s a mathematical fact.  If you have $100 and you lose 10% of it, it will take an 11% rate of return to become whole.  If you lose 20%, you’ll need to make 25% to get your money back.  What if you lose 50%?  What rate of return would you need to make your money back?  The answer is an astonishing 100%!  I’m not being “tricksy” as Tolkein’s character, Gollum, called the Hobbits in the Lord of the Rings trilogy.  See for yourself:

  • $100 x 90% = $90; $90 x (100% + 11%) = $100
  • $100 x 80% = $80; $80 x (100% + 25%) = $100
  • $100 x 50% = $50; $50 x (100% + 100%) = $100

Once you’re down 50% and facing that big 100% hill, it will take you around seven years, if you’re able to make an annualized rate of 10% per year, to get back where you started.  If you’re making closer to 7% each year, you’ll be waiting a full decade to break even.  If you earn 4% on your money, it will take you 18 years to recover from a 50% fall.

But you say, “I always learned that you need to buy and hold.   The market will go up and down, and we can’t time it, so we shouldn’t try!  It’s not timing the market.  It’s time in the market!”  It is true that market timing is a very dangerous business——betting, if you will.  However, if and when you’re able to see the bearish train coming down the tracks, would it not make sense to get out of its way?  The price of staying in can be disastrous.  From the day the market peaked on September 7, 1929, it would have taken until 1954 to break even if you bought, and held.  That is a pretty long time to wait, especially if you were planning to retire in 1932.

And today?  For the last decade, the market is down over 20%.  You will find that the current logic that runs the financial services realm at the institutional level was developed in one of the best stretches the market’s ever seen.  From 1982 until March of 2000, the market ran upwards with little impedance.  Objectively speaking, Buy-and-Hold and strict Asset Allocation concepts, born in that 18-year stretch, worked very well.  But what about the stretch from 1964 up until 1982?  Believe it or not, that span represented yet another 18-year stretch where the buy-and-holder would’ve made nothing——zip, zilch, nada.  And we in the United States have it good!  Japan’s staring at their 20th year of an atrocious run that leaves the Nikkei still 70% south of its peak at 40,000.  So, eight years into a rough losing streak for the U.S. market——and following a colossal financial demise brought on largely by ignorance and greed on the part of the U.S. government, corporations, and citizens——would you rather be buying-and-holding the Dow or the Nikkei?

It’s not my intent to scare you, so let’s go back, and I can try to give you some answers and some hope.  The world’s best investors are not buy-and-holders, asset allocators, or Modern Portfolio theorists.  They’re risk managers.  These are folks like Sir John Templeton, Jean-Marie Eveillard, Jim Rogers and yes, Warren Buffett.  They spend more time worrying about how not to lose money than they do trying to make it.  I’m not talking about leaving all your money in T-Bills and CDs.  I’m talking about resetting your brain to focus first on managing risk in your investments, then, on your return.