“Three things cannot be long hidden: the sun, the moon, and the truth.”
~ Buddha ~
That which is hidden from the masses in the public domain rarely is brought into the light. Financial analysts, portfolio managers, wealth managers, and financial advisors are certainly not an exception to this rule. In my personal experience on both sides of the proverbial institutional and retail investment wall, group-think is easy to find and routinely metastasizes on Wall Street.
On both sides of retail and institutional investment perspectives, information and statistics are many times used and presented as facts, which after unmasking their derivations quickly can become fallacies upon further contemplation and inspection. Rarely will investors find information that challenges the dogma of financial prognosticators, dogma which includes the investment strategy known as buy-and-hold investing.
Entire business empires on Wall Street have been built on this simple mantra. However, what I am about to reveal is not that a buy-and-hold strategy will not work, it is that a buy and hold strategy cannot work over long periods of time. The reason Wall Street loves to talk about buy-and-hold as a long-term strategy, particularly with retail investors (regular people), is because this concept aligns itself coincidentally [Sarcasm] with their business strategy. Most financial firms are asset gatherers, not asset managers, thus many financial advisors are sales people first, and financial advisors second.
In many cases, these very same financial sales people are only interested in attracting new business and gathering assets (Producing Sales & Revenue), instead of maximizing their clients’ financial outcomes and achieving their unique goals. Thus, a buy-and-hold strategy means every day is a great day to buy financial instruments, both stocks and bonds, so market conditions can be quickly ignored and Wall Street firms always have a willing and unsuspecting retail investment purchaser. Queue up the sales pitch . . .
As a derivatives trader in a “previous life”, I was taught from the beginning that acting in a contrarian fashion against the views of the Wall Street masses was always the best path toward outsized investment gains and long-term returns which outperform mainstream investment benchmarks. Consider the famous poetic work by Robert Frost which the following excerpt is derived:
Two roads diverged in a wood, and I –
I took the one less traveled by,
And that has made all the difference.
When considering investment and financial advice, I would submit to readers that choosing a different path than what would be proposed from a consensus perspective would likely be prudent.
So what proof do I have of the fleecing of the investing public? What secret do I have which will shock the investing world? I have no secrets, because this information is readily available for those willing to spend time looking in the public domain. I have nothing to shock the financial world, because the purveyors of the largest Wall Street dens are keenly aware that this data exists, yet they simply choose not to discuss it openly or honestly with their clients.
To expedite the suspense, or lack thereof, a simple fact rarely noted by the buy-and-hold true believers at firms across Wall Street is the impact of inflation on investment returns and retirement income strategies over long periods of time. Almost daily, a financial prognosticator or a government hack discusses the wonderful bull market we have experienced since the stock market lows set back in March of 2009. After mentioning the bull market in stocks, the investing public is then inundated with sales materials which illustrate index or investment returns which are not indexed to inflation, such as the chart of the S&P 500 Index shown below.
At first glance, this chart looks fantastic for long-term buy-and-hold investors! From the S&P 500 peak set in the late nineties and early 2000’s, it took about 7-9 years to breakeven and 12 years to move to new all-time highs. This surely indicates that a long-term buy-and-hold strategy always works out for patient investors, not to mention it makes for great story telling and produces salesmanship opportunities to produce new sales.
Juxtapose the previous chart with the chart below which takes the same data, and then applies inflation to the historical S&P 500 index returns. The chart below illustrates the breakeven time frame comparing the nominal S&P 500 Index (no adjustment for inflation) to an inflation adjusted index, and also plots an assumed $100,000 actual investment for purposes of comparison.
The key takeaway is that from an inflation adjusted perspective, it took 16 years to breakeven from the previous all-time highs set back at the beginning of the 21st century. The nominal returns touted by Wall Street show a 12 year breakeven, and imply a much different reality than what would have happened to the actual $100,000 investment since 1990.
The timeline to breakeven to the previous highs set back in 2000, adjusted for inflation, and assuming a $100,000 investment made back in 1990, shows a 16 year timeline to breakeven when comparing nominal (no inflation) returns to an actual investment experiencing inflation. However, the key takeaway should be noted on the far right axis.
The implied growth of $100,000 looks great from the nominal and real perspective, but when actual money is applied to the example, the returns look far worse. Inquiring minds likely would like an answer as to why the disparity in actual growth of money is so different. Here are a few of the answers.
First of all, market indexes do not compound in real investment dollar terms in the same manner that they do from a nominal perspective. There is a significant difference between average returns and actual returns because the impact of losses completely eradicates the compounding effect of real money.
Guess which return calculations are used by all Wall Street firms? Answer: Nominal (no inflation) returns of course. If Wall Street had to show the real returns of specific investments, adjusted for actual inflation, the historical performance of these same investments would be altered quite dramatically.
As the example illustrated above, the performance data would be negatively impacted in a significant way. The performance would be altered so much so, that the realization made by rational, sophisticated investors would likely cause the entire buy-and-hold investment mantra being offered as investment advice to be severely called into question, if not completely rejected in its entirety.
I would posit that investment gains cannot truly be compounded if unrealized gains are not locked-in periodically from time-to-time as market conditions warrant. Consequently, I want to be clear that I am not calling for market timing, rather adjusting portfolio investment allocations based on historical parameters that take into account inflation, valuation, and momentum characteristics, among many other financial and statistical measurement methodologies that have been proven to assist in helping guide the portfolio decision discovery process.
I would suggest that the key takeaway from this entire article is that investors should question the motives of Wall Street firms’ employees at all times. If your financial advisor cannot discuss these concepts with you in a cogent, easy to understand manner, you should find a new financial advisor or wealth manager.
As for takeaways for investors considering various strategies for their retirement savings and portfolio management now and in the future, I would suggest discussing a strategy with your wealth manager or financial advisor that is laser-focused on an absolute return portfolio strategy.
An absolute return portfolio strategy is not necessarily designed to keep up with stock market indexes, which are inherently flawed in their very construction when used as a benchmark. The absolute return portfolio strategy is designed to keep pace with inflation, produce income that will be sustainable for long-periods of time for retired investors, and is designed to address longevity risk for current and future retired investors going through the distribution phase of their retirement plans.
Inflation and longevity work hand-in-hand against retirement income for all retired investors. Sophisticated retirement investors need to look beyond Wall Street for answers. Yes, financial instruments should be part of the overall retirement investment strategy, but hard assets like physical real estate, precious metals, and other assets which are rare and have a documented history of keeping up with inflation should be components of the overall household portfolio as well.
Diversification should go beyond traditional stocks, bonds, annuities, and cash. Your wealth manager should be focusing on total, inflation-adjusted returns for all of their clients. Non-correlated assets have been proven statistically to reduce long-term portfolio volatility while simultaneously assisting the portfolio in mitigating significant portions of longer-term inflation risks.
Essentially, avoiding catastrophic portfolio losses is far more important than grabbing all of the upside produced by a stock market index each year. Buy-and-hold investors receive all of the upside, but then they give back some, or all of their gains in the next major downturn in price action. This process prevents their assets from compounding, and as was illustrated in the chart above, losses and inflation produce an incredibly detrimental impact on their long-term portfolio prosperity. If large losses can be avoided consistently through prudent investment strategies, then the compounding effect goes on unabated.
However, the compounding effect is much more difficult to maximize if investors hold the same assets for long periods of time. The discussion and charts above demonstrate the futility in the logic behind the buy-and-hold investment strategy, and entire Wall Street firms’ advice to their clients is based on this faulty logic. The proof is out there, in the public domain, waiting for inquiring minds to be enlightened. Many look to Warren Buffet for sage investment advice, and while he advocates for index related buy-and-hold strategies, he himself regularly buys and sells investments on a quarterly basis. So I ask you, dear reader, why doesn’t Uncle Warren listen to his own advice?
Ultimately, informed clients are great customer relationships for financial advisors and wealth managers, but big Wall Street firms and their financial sales people are scared to death of sophisticated investors who possess uncommon investment knowledge. Why do I say they are scared? Because all of the asset gathering sales techniques are predicated and built around the faulty logic that is the buy-and-hold investment strategy.
“Nearly every time I strayed from the herd, I’ve made a lot of money. Wandering away from the action is the way to find the new action.”
~ Jim Rogers ~
What may be even worse, is that Wall Street firms’ research departments are keenly aware of the fact that buy-and-hold strategies typically do not compound regularly enough to consistently beat inflation. In the end, sales and greed will always trump facts at the large Wall Street firms. After all, their priority is always all about the revenue to their bottom line . . . not yours.