A Thousand Words

Adam M. Grossman

AS THE SAYING GOES, a picture is worth a thousand words. Over the years, I’ve found certain images and illustrations to be immensely helpful in discussing investment concepts. These are the ones I’ve relied on the most:

Only in Australia. A key challenge for investors—if not the key challenge—is that none of us has a crystal ball. It’s impossible to know what markets will do next month or next year. As a result, all we’re left with is our best guess and, for that reason, it’s natural to extrapolate from recent history. The problem is, there’s a first time for everything. We can never be too confident that something won’t happen, even if it hasn’t happened before or hasn’t happened recently.

This notion was best illustrated by author and retired investor Nassim Nicholas Taleb in his book The Black Swan. In most parts of the world, swans are white—but not in Australia, where most are black. But if you’d never been there, and if every single swan you’d ever seen was white, you might feel safe in concluding that all swans are white. The lesson: Don’t dismiss risks and possibilities out of hand just because they seem unlikely.

In a new home. Suppose you were furnishing a new home. How would you go about it? If you’re like most people, you’d start with the basics—a table and chairs for the kitchen, a couch for the living room, and so forth. You probably wouldn’t start by purchasing an umbrella stand. That would be nonsensical.

But that’s the way the investment industry markets mutual funds to consumers. Open a financial publication or go to a financial website, and you’ll often see ads promoting all sorts of different funds—everything from stocks to gold to cryptocurrencies. As a result, many people start their investing careers by assembling a collection of investments without an overall blueprint—like buying an umbrella stand before anything else. A better way: Tune out Wall Street’s marketing machine and instead think about building your portfolio the same way you’d build a home, with an overall plan as your first step.

In the war chest. It’s common to think about asset allocation in percentage terms. You might, for example, ask whether you should have 50% or 60% in stocks. While that makes sense, I also recommend thinking in dollar terms—specifically, the amount of dollars you hold outside of stocks.

Suppose you’re retired and require $100,000 a year from your portfolio. As an asset allocation, I might suggest holding $500,000 to $700,000 in a combination of cash and bonds. Those are the dollars that would help carry you through a stock market downturn, and I wouldn’t worry too much about that sum as a percent of your portfolio. Fellow financial planner Matthew Jarvis calls these cash-and-bond dollars a “war chest,” and I think that’s an excellent image.

In the studio. Pablo Picasso was obviously very productive, but the state of his studio might have led you to think otherwise. It was a mess. Among the canvases lived an assortment of cats and dogs, as well as a monkey that liked to sit on the artist’s shoulder as he worked. But a lot of good work emerged from that chaos. The lesson for investors: Know what’s most important, focus your energy on getting those basics right, and don’t fret too much about the rest.

On the elevator. Mutual funds make it easy for investors to build diversified portfolios. But they’re not perfect. A key flaw: A fund’s gains or losses are shared pro-rata by all of its shareholders. Normally this isn’t an issue, but in market downturns it can be a problem.

That’s because downturns will always cause some investors to become spooked. If enough shareholders request redemptions from a fund, it can cause the fund manager to sell holdings, triggering a tax bill for the taxable-account shareholders who remain. That’s why I compare being an investor in a mutual fund to being a passenger on an elevator: Everything will probably be just fine—as long as everybody else behaves. But since the world is unpredictable, I try to minimize that risk by sticking to exchange-traded funds (ETFs), and especially to index-based ETFs, which are structured in a way that lend themselves to being more tax-efficient.

On the farm. I’ve often quoted what I believe to be the only published poem in the world of personal finance. In 1938, John Burr Williams included these words in an otherwise math-filled volume called The Theory of Investment Value:

A cow for her milk

A hen for her eggs

An orchard for its fruit

Bees for their honey

Williams used this image to illustrate a key concept in finance: intrinsic value. The idea is that an investment only has value because it can produce something. Stocks, for example, can produce dividends. Bonds produce interest. Real estate produces rent. That’s why I avoid things, such as cryptocurrencies, which might be interesting but have no intrinsic value. The risk: Assets lacking intrinsic value are worth only what the next person is willing to pay for them. That makes their prices more volatile and unpredictable.

In the infield. Warren Buffett has offered his own colorful illustration of intrinsic value. If you took all of the world’s gold, he noted, it would form a cube about 67 feet high. It would fill most of a baseball diamond. That might seem valuable, but what would it do for you? Buffett says, “You could get a ladder and climb on top of it… you could polish it… you could stare at it… but it isn’t going to do anything.”

In other words, gold—unlike stocks and bonds—doesn’t produce dividends or interest. “All you’re doing when you buy that is hoping that somebody else… will pay you more to own something that, again, can’t do anything,” says Buffett. While gold is a bit of a special case because of its long history, the point remains: If an investment isn’t capable of producing any income until you sell it to someone else, it’s going to be inherently more risky and its value more subjective.

At home. In recent weeks, I’ve discussed the risk posed by hackers, and that’s one of the reasons I recommend not holding all your assets at the same institution. That said, I do favor consolidating most of your assets under the same roof. Here’s how I think about it: Suppose you’re babysitting two children. To keep things under control, it’s best if they’re both within your line of sight. But if one is playing in the yard, and the other is running around in the basement, anything could happen. It’s the same with your portfolio. The fewer places you have to keep tabs on, the easier it’ll be to monitor your portfolio and to make changes.

On the road. Some years ago, I was heading to a meeting in Upstate New York. At a certain point, I realized I was going too fast, and for no good reason. If I slowed down, I still would’ve gotten there on time. But if I’d gotten pulled over, then I would’ve ended up being late. It’s the same with asset allocation. We all want our investments to grow. But if we hold too much in stocks, it can end up backfiring. Sometimes, it’s better to slow down a little, so we avoid getting derailed.

Running away. Groucho Marx famously said, “I don’t want to belong to any club that would accept me as one of its members.” Years later, venture capitalist Andy Rachleff offered investors advice along the same lines. The most successful venture capital, private equity and hedge funds, Rachleff explained, have no shortage of potential investors, such as university endowments willing to write eight- or nine-figure checks. It’s only investment funds with poor track records that are out marketing their funds to individual investors. So, if you’re on the receiving end of a pitch like this, Rachleff says, “Run away.”

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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