How I’ve Strayed

John Goodell

LIKE MANY READING this article, index funds constitute the lion’s share of my family’s investments. But I also own small positions in two individual stocks: Boston Omaha and Markel.

Why have I strayed from a 100% indexing approach? Both companies are conglomerates—multiple businesses that function as a single entity. Conglomerates should—in theory—be able to deliver slightly higher returns, thanks to the business efficiencies and synergies they realize. On top of that, they can offer some of the strengths of a mutual fund: diversification plus intelligent capital allocation.

The classic example of a successful conglomerate is Berkshire Hathaway. Many companies have tried to emulate Berkshire’s model. They’ve failed for reasons that nearly always have the same root cause: poor capital allocation by imprudent management. Admittedly, these competitors have a high bar to surpass. Over the past 56 years, Berkshire Hathaway’s stock has climbed 20% a year, on average, versus 10.2% for the S&P 500.

I sleep soundly knowing we’ll obtain the market’s returns with our index funds. I hope they’ll allow my wife and me to retire in comfort. With the small portion of our investment portfolio not dedicated to index funds, I’ve tried to identify opportunities where we can participate as “high-quality” shareholders—those who invest for the long run. Our hope: To see these investments grow handsomely and then leave the money to charity.

How do we identify such stocks? I have a few rules and rationales.

First, because my wife and I are both age 40, our longer time horizon plays a critical role in how we allocate our capital. We have the potential to earn compound returns for 40 or 50 years. Time horizon is a tremendously underappreciated aspect of investing.

What’s good for a retired investor—who typically needs income to sustain his or her lifestyle—is very different from what we want with decades still in front of us. For instance, the dividends favored by many retirees aren’t a particularly tax-efficient way of realizing returns. I’m looking for businesses that retain and grow earnings by intelligently reinvesting their capital.

Second, having recently worked as the U.S. Army’s supervisory attorney for artificial intelligence adoption, I’ve become keenly aware of the speed of technological disruption. It’s fast and furious. One classic example from the recent past: How Research in Motion’s Blackberry was disrupted by Apple’s iPhone. Such disruptions are happening faster and faster.

I’m simply not smart enough to know what technological advancements will succeed. I was certain that Google glasses were going to be a phenomenal success. Yet, here I sit, typing this sentence wearing Warby Parker’s made-for-the-masses glasses. I’m at peace with my inability to accurately forecast technological innovation. Because we own index funds, we’ll capture the gains of whatever technological marvels the world’s brightest innovators create.

This brings me to the third criteria that I look for in a conglomerate. I want a wide moat that’s hard to disrupt. I’ve always believed that dirty jobs not only pay well, but also they’re often much harder to disrupt with technology. (I’ve always cherished Mike Rowe’s work on this topic for Discovery Channel.) Simply put, drones aren’t going to empty septic tanks anytime soon.

What does all this mean in practice? Tomorrow, I’ll offer my rationale for buying one of our individual stocks.

John Goodell is general counsel for the Texas Veterans Commission. He has spent much of his career advocating for members of the military and veterans on tax, estate planning and retirement issues. His biggest passion is spending time with his wife and kids. Follow John on Twitter @HighGroundPlan and check out his earlier articles.

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