More wisdom from the book I’m reading, “Family Fortunes” authored by brothers, Bill and Will Bonner. In addition to running their own businesses in publishing and real estate, they oversee their family office, so they have extensive experience in managing family money. In one chapter they discuss their investment philosophies, of which I will be sharing a few points with you.

“The efficient market hypothesis (think Modern Portfolio Theory), as it is known, was a convenient thing to believe; it allowed the financial industry—fund managers, wealth advisers, private client counselors—to “model” investment strategies based on past data.” They add, and I agree, this also allowed historical measurements of volatility, typically associated with the degree of risk of an investment, but historical data is really not a good predictor of future risk or investment performance, especially in an ever-changing and rapidly-changing world.

“Treating risk as though it were just a mathematical expression of the recent past permitted the modern wealth adviser to tell his client that he could get predictable returns by mixing and matching various investments according to their historical volatility and gains. Put together the right combination of equities, bonds, foreign stocks and so forth and the investor could expect steady rates of return, guaranteed by standard deviations and statistical probabilities that sounded rather impressive. In other words, the young business school grad made it sound like the money was in the bag. Of course, the money wasn’t in the bag at all. The pros were just guessing. Not only that, it was the wort kind of guesswork, because it pretended to be scientific.” Is this what you have been hearing from your investment adviser?

Here is an example. For the five-year period ending 12/31/07, the S & P 500 was up a gross 71.6%, which equals an average of 14.32% per year. The standard deviation (SD) is about 11.36%, compared to the SD for short-term treasuries of 3.45% and international small caps of 13.50%. Wow! You, or your investment adviser, might have said at that time, “That’s great. Time to get into the market now before I miss more increases. I could get a 14% return with relatively low risk (11.36%). Hey, even if I get 10% I’d be happy.” Then 2008 hit and the S & P 500 plummeted 42% (significantly beyond the 11.36% SD), so the six-year average was .93% (less than 1%). Past performance and statistics were not even close to predicting risk or future performance. We can go back further, like 100 years, but that still isn’t going to tell you when the market is ready to go over the cliff and you will experience a big loss, which leads to their next rule.

“DON’T TAKE A BIG LOSS! You can’t afford to climb up the mountain and then climb down again. We know that building a family fortune is a long, hard process. We cannot afford to lose it. Our goal is to succeed, not to win. And we succeed by respecting the first rule: Don’t Take a Big Loss!” Their primary point is a 50% loss requires a 100% gain to get back to just breakeven, and can take years to recover.

“You don’t take a big loss because you can’t recover from it. As a custodian of Old Money or builder of it, you have to make sure you do not bet the farm on anything. You also have to make sure you keep your eyes and ears open, letting the markets tell their story.”

You have read all the books, hired an investment adviser, listened to the pundits on TV, reviewed the literature from 10 mutual fund companies, and visited multiple investment website in search of the crystal ball of investing. Most, if not all of them, recommend doing exactly what the Bonner brothers are saying not to do. In spite of the caveat “past performance does not guarantee future performance,” your investment adviser, and all those other investment gurus, are using past performance to recommend what investments you should have in your portfolio, and you cannot time the market, so just hold on and ride it out, effectively guarantying you will eventually TAKE A BIG LOSS. In other words, plan on TAKING THOSE BIG LOSSES and then wait years to get back to breakeven, just in time to participate in the next 40% to 50% decline. Not what I, nor the Bonner brothers, consider to be “sound investment advice.”

If we listen to Mr. Market’s story, he is telling us there is always another severe decline coming even though he won’t tell us when it will happen. Likewise, he may be saying there is another big increase coming, but again, he won’t tell us when or how long it will last. He has been saying these things since the inception of the stock market. The problem is most people and advisors aren’t listening, partly because listening is a learned skill, and because listening is a lot of work. If your adviser is simply having you complete a risk questionnaire, proposing a predetermined asset allocation model dictated by your answers, then using mutual funds or third-party money managers to fill out the allocations in the model, and recommending a buy-and-hold strategy; your adviser isn’t working that hard and certainly will not hear Mr. Market when Mr. Market blurts out warnings about his sniffles, fever, aches and pains, and eminent sickness.

We always get, as I assume you have asked your adviser, the question, “What do you think the market is going to do this year?” If your adviser answers this question, you are probably already in trouble because your adviser doesn’t know. No one knows! Mr. Market does not share his long-term health condition with us, he only tells us how he is feeling at the moment. Whatever that is, it will change constantly over relatively short periods. He may not feel well now, but in a few weeks he will be up and moving again, or vice versa. One must listen closely every day, every month, and he will tell us if we know what we should be listening for.

Our philosophy coincides with the Bonner brothers, just stated a little differently; “To make money, you cannot lose money.” That philosophy had us out of the market in 2000 and 2008 and not participating in those big declines. No one can know what Mr. Market will do on a daily basis. A hiccup is not necessarily a symptom of sickness. A one or two-day cold does not mean the flu or pneumonia is next. Nor does the fever breaking and the sniffles going away, mean Mr. Market is on the road to good health. Our answer to the above question is, “We have no idea what the market will do this year, but we do know Mr. Market will tell us how he is feeling at any given moment if we ask him and listen carefully, so we will rely on that to determine how and when to be in or out of the market. And, we will continually check his temperature and monitor his pulse.”

If you would like to find out more about investing, business planning, business and family progression planning, inter-generational wealth transfer, legacy creation, family coaching, family office services, and all the ways you and your children can give, and how effective philanthropy can positively impact your family, you can email me at kkolson@familywealthleadership.comm or visit our website at www.familywealthleadership.comm. Telephone: 949-468-2000

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