3139: Want to Be a Better Investor? Stop Staring at Your Portfolio by Vitaliy Katsenelson on Building Wealth

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[00:01:00] This is Optimal Finance Daily. Want to be a better investor? Stop staring at your portfolio. By Vitali Katzenelson of ContrarianEdge.com. Investors are prone to two opposing but equally debilitating fears. The fear of missing out when times are good and the fear of loss when markets are volatile.

[00:01:22] These two fears have a zero-sum relationship with rational decisions. The more you are dominated by these fears, the less rational you are. So what can we do as investors to move towards maximum rationality? Here's one piece of advice. Don't constantly watch your portfolio. Next time you notice the price of a stock you own moving up or down, think about the factors that may be influencing that move.

[00:01:48] Stocks are owned by people who have very different time horizons. You'll have mutual funds and hedge funds whose clients often have the patience of five-year-olds. They're getting in and out of stocks based solely on what they expect them to do in the next month or six months. A rounding error of a time period in the life of a company that lasts decades.

[00:02:09] Some buyers and sellers are not even humans, but computer algorithms that are reacting to variables that have little or nothing to do with the fundamentals of the company you invested in. These players have a time horizon of milliseconds. You'll also have folks who are buying and selling a stock based on the pattern of its chart. Not that they don't know what the company does. They'll tell you that they don't care what it does. For them, it's just a chart with one squiggly line crossing another squiggly line.

[00:02:39] Then there are folks who spend more time researching the next movie they're going to see than the stock they're about to buy. Some of them buy a stock after reading a single article on the internet, while many others buy on the advice of their brilliant neighbor Joe, the orthodontist. The Active Dangers of Passive Investing Deciding not to constantly look at your portfolio is not necessarily the same thing as embracing the latest craze, passive investing.

[00:03:07] This one is a bit personal and requires a small detour. Interest rates are the foundation of the discount rate, also known as the required rate of return that investors use to convert future cash flows into today's dollars. Think of the discount rate as being composed of two layers. The foundational layer, or the risk-free rate, the interest rate, let's say on the 10-year treasury, and a risky layer that should compensate you for additional asset-specific risks.

[00:03:37] During the Great Recession, when central banks artificially changed the price of money by buying trillions in government and corporate bonds, they made the Soviet-planned economy look like child's play. Instead of messing with kiddie stuff like setting prices on shoes and sugar, like Soviet central planners did, a few dozen free-market central bankers set the price of the single most important commodity,

[00:04:03] the risk-free rate, which is at the core of most economic decisions and the valuation of all assets. Valuation of companies whose earnings lie far, far in the future benefits dramatically from falling interest rates, while the valuation of companies whose earnings are not growing as much and are concentrated in the present and near future doesn't enjoy that benefit. A similar dynamic happens in the bond market. Bonds with short maturities, similar to value stocks,

[00:04:33] are impacted a lot less by declining interest rates than long-term bonds, similar to growth stocks. As the impact of suppressed interest rates rippled through the markets, active managers that had even a modicum of discipline in their stock selection found themselves trailing their benchmarks and even getting fired, while customer money flowed into index funds that indiscriminately buy what's in the index. What's in the index, you may ask?

[00:05:00] Most popular indices today are constructed based on companies' capitalization. Thus, companies that have done well lately, for example, the tech giant FAANGs like Facebook, Apple, Netflix, and Alphabet's Google, get a much greater portion of new capital. In fact, the FAANGs account for about 10% of the S&P 500 index.

[00:05:23] So high-duration companies are benefiting from both low interest rates and the dumbness of the indices. However, as investors who hold long-term bonds in 2018 are discovering, rising interest rates can hurt. We don't know what interest rates will do in the future, but today, the U.S. government is running a trillion-dollar budget deficit at a time when the economy is growing at a rate of almost 5% before adjusting for inflation.

[00:05:51] What do you think the deficit is going to be when growth slows down or turns negative during a recession? Yes, those things do happen. To make things worse, these deficits add to the $21 trillion of U.S. debt, which doubled over the last 10 years, while the government's interest payments didn't change thanks to low interest rates. Higher, maybe even much higher interest rates are not unlikely going forward.

[00:06:18] If you own the S&P 500 or long-term bonds, you implicitly think one of several things is true. Number one, interests have a zero or insignificant probability of going up. And number two, I'll be able to get out in time. Or number three, I have a life-size statue of John Bogle in my living room, and I have a very, very, very long time horizon. Remember, you're an owner.

[00:06:44] Back to the various actors who are responsible for daily ticks of your favorite stocks. If you're a fundamental investor, you're not just buying stocks, you're buying fractional ownership in a business. You spend hundreds of hours on research. You read company financial reports. You talk to management, competitors, customers, suppliers. You build a financial model that looks years into the future to value a business, and also to predict what could kill it. If after you've done all that,

[00:07:14] you still find yourself glued to the computer screen watching the price change tick by tick, you're basically giving credence to the idea that what a company is worth should be decided by algorithmic funds. The guy who reads charts but cannot even spell the name of your company. Joe the neighbor and an ETF with the IQ of a Halloween pumpkin. I don't want to insult everyday pumpkins here. In short, the less time you spend looking at your portfolio, the more rational you're going to be.

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[00:10:14] of making investing look complex and fueling those fears. The thing that helps me navigate this is only investing money that I won't need for the next 10 years and expecting the market corrections that are inevitable. Remember this, when your portfolio is down, you don't actually lose money until you sell your investments and lock in those losses. The way I see it, the fact that I'm a long-term investor is intrinsically tied to my ability

[00:10:41] to handle those inevitable drops in my portfolio. I accept that investing in the stock market requires a tolerance for volatility, especially when you have a 100% stock portfolio like I do. I deal with the volatility in two key ways. Firstly, I just don't watch the rollercoaster ride of the stock market very closely. While Vitaly doesn't seem to be a fan, I'm an enthusiastic passive investor in low-fee total market index funds.

[00:11:10] If you chose an investment strategy that's more active, you certainly need to look at it more often. But history has shown that active investors don't have better outcomes than passive investors. So I personally don't see why I would bother with it. I look at the money I invest like a tax I'm paying to my future self. I see that money as not really mine, meaning present-day Diana has no claim to it. So whether my portfolio is up or down doesn't really have an effect on me right now,

[00:11:39] and I can happily ignore it. Secondly, I pair my investments with a really strong cash position. Most people think that I'm holding way too much cash because I have about a year of expenses just sitting there, earning no meaningful interest. But for me, holding this much cash provides extra assurance that whatever financial needs arise, it's unlikely I'll need to tap into my investments anytime soon and so I can truly leave them to grow over time.

[00:12:08] A passive investment style alongside some blissful ignorance and long-term focus makes the natural and expected volatility of the stock market much more tolerable for me. And that will do it for another edition of Optimal Finance Daily. Have a great day. Thank you for listening. And I'll catch you tomorrow where your optimal life awaits.