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AT THE FIRST Berkshire Hathaway annual meeting I attended, Charlie Munger was explaining an investment that the company had made. He said it was likely to provide satisfactory returns.
At the time, that seemed like an odd statement. Satisfactory? Not great returns. Not market-beating results. Not returns of 10% or 15% per year. Not even market average performance. Just satisfactory.
Since that meeting, I’ve come to appreciate satisfactory returns. Satisfactory covers a wide range, everything from beating the performance of Treasury notes to bragging-around-the-office-coffee-pot returns.
It also allows me to keep holding my portfolio. For the past 30 years, I’ve had a significant small capitalization and foreign stock tilt. With U.S. large-cap stocks on a tear over the past decade, it’s been a tough period for a portfolio with such a tilt. Friends question my asset allocation—as well as my sanity.
I do believe that small-cap stocks will outperform over the long haul. I also think it’s better to pay less for future corporate earnings rather than more. Since most foreign stock markets have a lower price-earnings ratio than the U.S., I believe that performance across markets will converge. That could mean that foreign stocks soar or U.S. stocks struggle. It doesn’t matter to me. Either way, I’ll see some benefit from diversifying globally.
Unfortunately, we may not know if my convictions are correct for another three or four decades. Both small caps and foreign stocks have had long periods of underperformance. It could turn out that having these two tilts will look brilliant. Or it could look like a huge mistake.
Over the past decade, my portfolio has underperformed the S&P 500. But I’m okay continuing to hold it because the returns have been satisfactory. We’ve sent our children to college. We’ve retired on our own timeline. Life is good. I’m satisfied with satisfactory returns.
Well done for staying on the course you selected.
If one trusts the academic evidence ( Fama “three factor model ) and long run ability of the small cap value universe in producing decent returns, if not excess returns above benchmark, then it can be a satisfactory core asset class within both accumulation stage and de-cumulation stage investors portfolios.
If an investor is in their “income” or retirement stage, and wants to create and manage a flexible income stream in a simple fashion, research shows that a 50/50 portfolio representative of the Large and Small cap value universes / indexes has sustained between a “3.5% – 7%” inflation adj annual withdrawal rate ( “sale of shares”, dividends reinvested ), accompanied by terminal portfolio growth, over seventy one rolling 20 year periods ( and even rolling 30 year periods ) since 1931 ( Charts 2 and 3 https://tinyurl.com/yckmev96 ). An investor can own the value stock universe through investment in low expense ETFs.
Further, the aggregate cap appreciation / dividend reinvestment produced by the stocks within the “funds” delivers the income stream described above, rather than a focus on individual company specific dividend payouts. And this repeating for over 90 years as shown in the study.
Most people don’t do the comparison. When I ask them how their results compare to the S&P 500, I usually get a “deer in the headlights” look. Occasionally someone will say they beat the S&P 500 “last year” but that doesn’t really matter either, since you usually invest for a much longer period. A lot of people are happy with their “investment advisor” and don’t even realize how poorly they may be doing. In my Master’s investment class, I constructed a portfolio that beat the S&P 500. It was only measured over a 3-month period, and it was 90% S&P 500 and 10% Total Bond Index. The fact it beat the S&P was an anomaly, and one I confessed to the professor who liked my answer and gave me a good grade.
In 1960, 10% of US stocks were owned by institutional investors. Now it is over 75%. Where does that put small cap? Especially small cap value? I am not sure anymore. In emerging markets, small caps still tend to outperform over the long term.
Kenyon, nice article about taking your good enough approach. As Nobel prize winner Eugene Fama has pointed out, even a sound investment strategy based on historical evidence can potentially take up to a couple of decades to prove correct. I had a similar discussion about having a slight value tilt in a portfolio last year. It had been true that during the past 5 years growth stocks trounced value stocks, so this approach appeared outdated. However this year the tables have turned, and value equities have substantially outperformed growth stocks.
If deviating from an index becomes too burdensome, a simpler option of sticking with a total world market index remains viable. With the onslaught of hysterical financial headlines, it remains challenging for an individual with a sound strategy to stay the course. Being grateful and avoiding wildly swinging for investment home runs has many benefits. If you had preferred to join the FOMO crowd last year, there could have been some enticing crypto options to add to your portfolio.