Investment Fundamentals Part 2. Our Marvelous Markets.

In our last piece, we wrote about how recency bias can damage your investments by causing current crises to loom large, while rewriting your memories of past challenges. Recency tricks us into overpaying during heady times, and bailing at bargain rates, when our confidence fades.

One of the best ways to combat recency bias is by focusing instead on the fundamentals that have served investors well for centuries, if not millennia. In this series, we’ll cover five of our favorites.

But first, it goes without saying that sound spending habits and a meaningful emergency fund are pre-requisites for anyone considering investing in the market. Even the most conservative participation in the stock market can bring surprises and occasional loss. That’s why an appropriately funded savings account can support your ability to ride the ups and downs experienced with any stock holding. Setting aside 3-6 months’ worth of income before investing is a good way to cover an unexpected event of income loss. If you are self-employed, that amount may look more like 12 months’ worth of income. 

Now, let’s talk about our first fundamental, our marvelous markets.

1. Markets are inspired by ingenuity, tempered by diversification.
2. The price you pay matters.
3. Patience is a virtue.
4. Investing is personal.
5. Bring it all together. The financial plan.

Markets Are Robust and Random

Before we describe where stock market returns come from, consider these two quotes:

“Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle.”

— Berkshire Hathaway Chairman Warren Buffett

“Whenever you think you’ve found the key to the market, some SOB changes the lock.”

— E.F. Hutton & Co. Founder G.M. Loeb

So, which is it? Are market returns driven by the inexorable wheels of commerce, as Buffett’s quote suggests? Or do the market’s mysteries remain under lock and key?

The answer is yes—to both. Capital markets and market returns are concurrently robust and random. It’s up to us to accept both and invest accordingly.

Markets Are Powered by Ingenuity

Viewing the market’s daily frenzy, it’s easy to forget where all that action is coming from to begin with. Close up, markets are a messy mash-up of companies, industries, sectors, and regions, often locked in fierce competition. But take a step back to view the whole. In aggregate, the stock market is also a forum for capitalizing on our collective ingenuity, which has generated amazing advances as well as strong investment returns over time.

This is at least the case for those who have been there to capture the returns when they occur. Examples abound to illustrate how often we may feel as if a source of returns has played itself out, only to find ourselves immersed in a fresh wave of entrepreneurs who have just begun to innovate. As Dimensional Fund Advisors’ Weston Wellington points out: “Sticks and stones led to hammers and spears, the wheel and axle, the steam engine, and eventually semiconductors and jet aircraft.”

Here’s how the late, great Vanguard founder John “Jack” Bogle described it:

“If you own the stock market for a lifetime, you get those returns. Playing games in the stock market, over every day of that time, is playing the stock market. The stock market game is rigged, the business of investing is not rigged.

Market Performance Is Sparked by Random Chance

Even as global enterprise continues to amaze us, it usually does so in a random walk. While you’ll almost always find handfuls of remarkably winning investments at any given time, you’ll also encounter bucketloads of losers. Moreover, the winners and losers can trade places on an unpredictable dime. As Dimensional’s Wellington observes: “The benefits of innovation are widely dispersed throughout the economy, often in unpredictable ways.”

Medical advances still playing out in response to the COVID pandemic are a recent example of both the powers and pitfalls of investing in global innovation. As described in this Canadian news piece, the pharmaceutical industry broke speed records in developing the COVID-19 vaccine in less than a year. The fastest prior vaccination was to protect against mumps in the 1960s. It took four years to develop. Creating a defense against Ebola took more than 20 years.

The relative success of the COVID vaccine was probably due in part to an urgent, “all hands on deck” mindset. But it was also thanks to years and years of unheralded research and development that gave the most recent breakthroughs a huge head start. While these earlier advances undoubtedly entailed ample time and money, they may or may not have richly rewarded investors at the time.

Capitalizing on the Engines of Ingenuity

It might help to think of the market as a mighty vehicle, like a train. When you climb aboard, your goal is to reach your desired destination by accumulating miles, or market returns, over time without derailing along the way. For that, you need a solid, Buffett-style engine of global commerce. But that engine also needs a supply of combustible fuel.

This illustrates why markets will always be messy and confusing at a close-up view. Only as we zoom out can we track our progress, in the shape of an upward line of market returns over time and across the long haul.

Because we expect the engines of ingenuity to continue chugging along, we have every reason to remain optimistic, and to stay invested as planned. We also understand why diversification remains equally essential to our efforts—because we never know just where the next sparks are going to fly. For those of us who have spent time waiting at a railroad crossing, we also understand that train is made of a variety of cars: liquid tankers, car haulers, container flatbeds, extra engines and more. Sometimes all the cars are fully loaded with lumber, soy beans and Cadillacs. Other times, the cars may carry heavy equipment, semiconductors and potatoes. Regardless of the cargo, the train keeps moving along the track.

By embracing the reality that stock market returns are random and robust, you can boost your ability to remain calm (or at least calmer) during the maelstroms and improve your chances for reaching your investment goals over time.

We can assist.  Behavioral coaching is a big part of plan execution at SYM Financial.  In Part 2, we’ll take a look at our second investment fundamental: The price you pay matters.