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Looking Long

Charles D. Ellis

TIME IS IMPORTANT in investing—far more important than most of us seem to appreciate when we structure our portfolio’s asset mix.

Regular readers may remember that I believe we tend to focus too much on one part of our total portfolio, the securities we own. We often ignore other important parts of our total portfolio, such as Social Security, any pension plan, our homes and—particularly for the young—the present value of our future earning power.

We also focus way too much on the short term and not nearly enough on the long run. At age 40, how many of us say to ourselves, “If our life expectancy is 85 to 90, that means we’ll be investing for 45 to 50 years, so that should always be the main way we frame our thinking about investing”? Not many of us, I’d imagine.

If length of time is crucial to getting investing right, we would be wise to take full advantage of time realities in our policies and practices. In the very short run, the daily prices of securities fluctuate significantly. But as we add more and more time, those daily price moves tend to offset one another. They become less and less significant, while the long-term price trend looms more and more important.

In a plot of prices over, say, 20 to 30 years, the day-to-day ups and downs tend to disappear. Over 50 years, they lose all significance. All we see is the long-term trend. The long term is—and always will be—significant for serious decisions on investing.

We tend to focus on “how the market did today.” We would be wiser to focus on much, much longer time periods because we’re going to be investing not for days, but for decades. Since decades are the more relevant unit of time for most investors, we would improve our results if we’d focus our thinking and our feelings on what’s best for us over the very long run.

This is not easy.

Most of us have learned—or taught ourselves—to live by the “longer term” when eating to avoid gaining weight. Those with teenage children have learned not to overreact to the kids’ reactions to “stuff.”

All long-term investors know how hard it is not to react to Mr. Market’s short-run gyrations. He tries to trick us into taking action—any action at any time—with his clever ruses designed to grab our attention. That’s why successful investors appreciate the value of benign neglect, otherwise known as patience.

Target-date retirement funds get a lot right, but then make mistakes. One mistake—unavoidable in a portfolio that isn’t customized for each individual—is to focus only on the securities part of an investor’s total portfolio. Another is to anchor the biggest asset mix decisions around age 65, presumably because so many of us think of retiring at around 65.

Since we’ll likely live another 20 years or so, is age 65 the right date to target? After all, that leaves out those important last 20 years of our life.

While all investors would be wise to have a cash cushion to meet unexpected spending needs, this amount should be determined by careful analysis. Many investors will also want to have a layer of bonds for “peace of mind.”

One way to determine this bond amount is to see whether spending exceeds income and, if so, by how much. If our spending doesn’t exceed our income, then the bond layer can be small, probably zero. What if our spending is greater than our income, such as the spending needs for retirees after taking into account Social Security and any pension income? We might multiply that spending need by three years or so to determine the gap that needs to be filled with bonds, so we’re ready for a stock market downturn.

Once that gap filled, the investor can then focus on longer-term investing. Since the long-term return on stocks is greater than the long-term return on bonds, the bulk of the informed investor’s portfolio can be invested in stocks—ideally low-cost index funds.

As a double check on this decision, the wise investor will determine the historical difference in rates of return between stocks and bonds over, say, 10 years or more. She will multiply that figure by the value of her bond holdings to see what those bonds will probably cost her in returns forgone. If that cost seems low as an “insurance premium,” the bond layer can be increased. If it seems high, the bond layer can be reduced.

We are emotional people. The big mistake we should avoid is thinking we’re more capable of maintaining calm rationality than we really are. That said, chances are high that many investors are being overly protective of themselves. They are paying too high a price, particularly over the long term, to feel secure—free from worries about daily, monthly or even annual stock market fluctuations.

Every investor is unique. No other investor has the same age, the same years to live, the same assets, the same attitude toward market risk, the same financial responsibilities, the same rate of savings, the same understanding of the markets, the same interest in investing, the same views on philanthropy, and so on. Since each of us is unique, our optimal investment portfolio should be uniquely tailored to suit ourselves.

Because this takes relatively little time—and produces great value—why not break away from conventional wisdom and design the investment program that’s best suited to yourself? The work is interesting and the benefits can be great. It could well be our best investment ever.

Charles D. Ellis is the author of 18 books, including Winning the Loser’s Game, which is now in its 8th edition, with 600,000 copies sold. Charley has taught investing courses at both Yale and Harvard business schools, and he served for 17 years on Yale’s investment committee. Check out his earlier articles.

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John McHugh
John McHugh
6 months ago

On the threshold of retirement I can’t not think about 20-year spans where stocks went nowhere after delivering big hits. Twenty years (not 30) is about how long my portfolio must last.

Still, I resist the urge to overweight bonds too much for exactly reasons stated. Plus a new concern – the inflation hedge stocks may represent.

This isn’t easy, but it beats the alternative and is mostly about good problems to have.

5Flavors
5Flavors
6 months ago

Good article, thank you. What if your goal is not to maximize but hold the middle ground? It’s a validation when retirement assets go up but we live modestly and an increasing IRA mostly means higher RMD’s later. At some point, it’s enough and taking risk when it’s not necessary seems foolish. We are overweighted in bond equivalents and am sure would be much richer had we done differently but money is the one thing I don’t worry about. Perhaps we should have more imagination on the spend side but Covid has pretty much shut things down. Hard to even replace my 12 year old Subaru which hopefully has a few more years left in her.

Jack Hannam
Jack Hannam
6 months ago

Interesting summary. I have read many well written articles, on Humble Dollar and elsewhere, about the role of bond funds in a portfolio, but most address investors who already own bonds. I own equities (BRKB and mutual funds) and cash, but no bonds. You shared your views on bonds in your earlier post along with this one. What is your opinion of cash versus bonds to meet needs in the next five years or so?

Dan Malone
Dan Malone
6 months ago

Professor Ellis, please keep contributing your wisdom to HumbleDollar. I love your writing and long-term perspective, especially this nugget: “If our spending doesn’t exceed our income, then the bond layer can be small, probably zero.” Two questions: 1) Since you encourage taking historical stock and bond returns into account, why not also bring historical PE or CAPE ratios, and domestic vs. international allocations, into one’s decision-making process? These are the areas where it seems more “professional” advice might be helpful. 2) Similarly, while your individualized-design approach is well suited for an Ivy League professor of investment courses, where should the rest of us look for a reasonably-priced expert to “hold our hand” and assure we aren’t overlooking important factors or otherwise making a dumb mistake in our planning process?

parkslope
parkslope
6 months ago
Reply to  Dan Malone

I really don’t think one needs to be an expert to design a good individual investment program. In fact, the information on this website is sufficient for most people, although it would also be best to also read some of the excellent books on investing.

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