Caveats on the Long-Term

“Risk comes from not knowing what you’re doing.” – Warren Buffett

I got some pushback on my piece last night called Why Does Buy and Hold Have to be Impossible?. I know what you’re thinking — people disagreeing on the Internet!?

Here are some clarifications on some of the main topics covered:

Think and Act for the Long-Term
What it means: Understand your time horizon for every investment you make. A multi-decade time horizon for retirement savings is much different than a 3 year time horizon for a down payment on a house. The definition of long-term is time horizon and event specific.  If you’re investing for retirement then act accordingly.

What it doesn’t mean: Blindly assuming that you can invest all of your money in stocks and they will work out no matter what for every savings objective you have at every point in time.

The Caveat: The long-term means different things to different people. If this quarter’s performance numbers are making you sick with worry and you don’t need to touch your investments for 20-30 years you’re not doing it right.  Volatility really matters if you need to pay for something in the next few months or years but it shouldn’t matter if it’s the next few decades.

Buy and Hold
What it means: Stocks, bonds, REITs, cash and factor tilts all serve different purposes for an investor’s portfolio.  Buy and hold each over a stated time horizon and sell them for risk management or spending purposes. It also means don’t day trade your retirement account or get scared out of any investment because you’re worried about some event that’s out of your control.

What it doesn’t mean: Never sell any of your investments because they always go up.

The Caveat: You have to define your holding period before making any investment.

Passive Investing
What it means: Have a rules-based process that’s based in reality which can be used over a number of different market and economic environments. A set of rules can ensure decisions aren’t made ad-hoc and fueled by emotions. Passive investing means doing nothing most of the time, that is until your plan or circumstances tell you to do something.

What it Doesn’t Mean: Buy an S&P 500 index fund and never make any changes to your portfolio.

The Caveat: Even doing nothing requires a decision to not act. Doing nothing can actually be even more difficult than doing something.

Stocks for the Long-Run
What it means: Historically, a longer time horizon has decreased the variability in stock market returns. The chances of seeing a positive return in stocks have increased substantially over 20-30+ year time frames.

What it doesn’t mean: Stocks will always and forever offer you a 9-10% return if you just hold on for 20-30 years. As Morgan Housel pointed out this week, the sequence of returns can vary greatly depending on the start and end points. This is mostly determined by the luck of the draw based on when someone starts investing.

The Caveat: Market are cyclical. The 1980s and 1990s gave investors extraordinary returns while the 1970s and 2000s weren’t so kind.  In the words of Kurt Vonnegut, “And so it goes.”

Diversification
What it means: Reducing unsystematic or company/industry-specific risk by owning a wide variety of holdings, asset classes, geographies and investment structures. Diversification allows you to plan on experiencing a wide range of outcomes without trying to forecast the future.

What it doesn’t mean: Avoiding all systematic risk in the event of a market crash.

The Caveat: You are bound to hate some of your investments at times with a diversified strategy and sometimes markets are highly correlated over the short-term.

Most of the time long-term thinking, buy and hold, passive investing, stocks for the long-run and diversification work…but not always. Every investment principle is an over-generalization until you apply it to your own personal circumstances.

There are caveats to everything. How you choose to interpret or use them is up to you.

The question still remains — does making your portfolio or decision-making process more complex ever help?