“You’d be making a terrible mistake if you stay out of a game you think is going to be very good over time because you think you can pick a better time to enter it.”
Warren Buffett
General Principles
It is worth restating, even in the context of a letter primarily focused on the year just past, our overall philosophy of investment advice. It is goal-focused and planning-driven, as sharply distinguished from an approach that is market-focused and current events-driven. Every successful investor we’ve ever known acted continuously on a plan; failed investors, in our experience, become failures by reacting to current events in the economy and the markets.
We neither forecast the economy, nor attempt to time the markets, nor predict which market sectors will “outperform” others over any time period. In a sentence that always bears repeating: we are planners rather than prognosticators.
Once we put a plan in place for a client—and have it funded with what have historically been the most appropriate types of investments—we hardly ever recommend changing the portfolio, so long as your long-term goals haven’t changed. As a general statement, we’ve found that the more often investors change their portfolios (in response to the market fears or fads of the moment), the worse their long-term results. We sometimes use the metaphor that your portfolio is like a bar of soap. The more you put your hands on it, the smaller it gets.
In sum, our essential principles of portfolio management are fourfold. (1) The performance of a portfolio relative to a benchmark is largely irrelevant to your long-term financial success. (2) The only benchmark we should care about is the one that indicates whether you are on track to accomplish your financial goals. (3) Risk should be measured as the probability that you won’t achieve your goals. (4) Investing should have the exclusive objective of minimizing that risk.
Current Observations
We’ll note that 2018 was perhaps the strangest year we’ve experienced in our careers as financial advisors. Most importantly, it was one of the truly great years in the history of the American economy, and by far the best one since the global financial crisis of 10 years past. Paradoxically, it was also a year in which the equity market could not get out of its own way.
It is almost impossible to cite all the major metrics of the economy that blazed ahead in 2018. Worker productivity, which is the long-run key to economic growth and a higher standard of living, surged. Wage growth accelerated in response to a rapidly falling unemployment rate. Household net worth rose above $100 trillion for the first time, yet household debt relative to net worth remained historically low. Finally—and this sums up the entire remarkable year—for the first time in American history, the number of open job listings exceeded the number of people seeking employment.
Earnings of the S&P 500 companies, paced by robust GDP growth and significant corporate tax reform, leaped upward by more than 20%. Cash dividends set a record; indeed, total cash returned to shareholders from dividends and share repurchases since the trough of the Great Panic reached $7 trillion.
But the equity market had other things on its mind. Having gone straight up without a correction throughout 2017, the S&P 500 came roaring into 2018 at 2,674. There ensued in February a 10% correction, followed by several months of consolidation. The advance resumed as summer waned, with the Index reaching a new all-time high of 2,931 in late September. It then went into a severe decline, falling to the threshold of bear market territory: the S&P 500 was at 2,351 on Christmas Eve, off 19.8% from the September high. A rally in the last week of trading carried it back up to 2,507, but that still represented a solid six percent decline on the year, ignoring dividends. Thus, 2018 became the tenth year of the last 39 (beginning with 1980) in which the Index closed lower than where it began. At the long-term historical rate of one down-year in four, that’s actually just par for the course. The major economic and market unknowns at the start of the new year are trade policy, Fed policy, and an aging expansion. These and other uncertainties were weighing heavily on investor psychology as the year ended. For whatever it may be worth, our experience has been that negative investor sentiment—and the resulting equity price weakness—have usually presented the patient, disciplined long-term investor with enhanced opportunity. As the wise and witty Oracle of Omaha wrote in his 1994 shareholder letter, “Fear is the foe of the faddist, but the friend of the fundamentalist.”
Dear clients, please be invited, and indeed encouraged, to raise with us any questions prompted by this very brief summary. That’s what we’re here for.