A Hope And A Dream
With 2020 nearly wrapped up, I think we can all agree it’s been a very difficult year. As the old saying goes, “The only constant in life is change”, and that was certainly true in 2020! The world is a constantly changing place… this year especially!
Despite 2020 being one of the worst years economically in recent memory, the stock market was actually up in 2020. Which seems a bit strange at first, but it probably has more to do with extremely low interest rates rather than improving corporate profitability.
It’s the one shiningly positive part of 2020 everyone can look back at!
But let’s not fool ourselves, the stock market can and will change its tune at any time. Next year could be a terrible year.
Most people invest with the hope the stock market is going to go up — They hope to make money, but in reality have zero control over what the stock market is going to do. They invest their money, and then hope for the best.
“Up! Up! Up!” go the chants of the hopeful.
Is this actually investing? Or is it speculation? To me, it’s speculation. Gambling. It’s no different than sitting down at a casino, and putting your money on the table.
This year investors got lucky. They rolled the dice and won … this time. What about next year?
Hope Is Not A Strategy
“Hope is not a strategy.” A very smart person once told me this, and he was absolutely right. It’s a philosophy that I’ve carried with me for years, and one I want to share it with you today.
Winning (or succeeding) is not about relying on hope. Hope brings success only if your lucky. Strategy is about being prepared for many potential outcomes, and finding a way to win regardless of whichever outcome happens.
This is the difference between investors and speculators. Real investors invest with a strategy and they can make profits in all kinds of markets. They also stick to a strategy instead of getting sucked into whatever’s fashionable that year.
While it might seem like a smart strategy to buy into whatever stock has momentum (like Tesla this year, which did incredible), sooner or later you’re going to make a big mistake. This is not a true strategy. It relies on luck.
Remember, Wall Street is anything but a constant and steady earner. One year internet companies might be in fashion (like in 2020). Other years it might be value stocks or airlines that are in-vogue. Who knows!
Without a true strategy, we are subject to the whims of the market. Will the next decade be a positive one? Maybe. I have no idea what the stock market might do, but I do know that real investors will find a way to profit regardless of what Mr. Market is doing.
This is what it means to have a strategy, and why the ultra-wealthy will always find ways to grow richer.
Luck has very little to do with it.
Learning Strategy From The Ultra-Wealthy
When it comes right down to it, I’ve been pretty lucky in life. Not because I’ve picked all the right stocks, but because I’ve had the opportunity to learn about investing from a few extremely wealthy people. I’ve had the opportunity to see up-close what a strategy can do for a investor.
(Note: I consider those with a net worth of $10 million or more to be ultra-wealthy).
A few things have stood-out to me about their financial strategies:
- Their success is NOT dependent on the stock market being agreeable. They will be wealthy even if stock prices are flat for a decade. If stock prices go up, they’ll just be even wealthier.
- Most of these ultra-wealthy investors took years to develop their winning investment strategy. Knowledge had to be gained, and this took time. They didn’t start out as winners immediately.
- They’re usually well diversified, with assets uncorrelated from one another. Assets both inside and outside the stock market.
- Most of these ultra-wealthy investors have a steady and reliable cash flow engine. For a few, this means a very high paying job. For others, it’s a business they own that spits of a steady stream of cash.
- They’re highly opportunistic. They can smell a change in the wind and aren’t afraid to take advantage of those changes. Change isn’t a bad thing. Change means opportunity.
Notice I didn’t say anything about hunting for fast growing investments? While growth is important, it also attracts competition. Competition usually kills profitability.
Most of the ultra-wealthy investors I’ve known have actually made the bulk of their money in slow growing (but reliable businesses) — rental apartments, concrete, coffee shops, retail stores, and even bonds.
Those are all slow-growth assets/industries! It wasn’t industry growth that made them wealthy, but the strategy they used.
Most people discount strategy these days, and instead focus on growth. They assume growth will continue forever, and rely primarily on what’s called “The greater fool theory” — Investing in the hope of finding a greater fool with which to sell to.
Developing Your Own Strategy
No one can accurately predict the future. The sooner you accept this, the sooner you can get your head screwed-on the right way and start building a investing strategy.
Because we can’t predict the future, it’s important to design a strategy to succeed under a variety of potential outcomes.
Be prepared for some investments to NOT work out. That’s just part of the game. How you deal with those bad investments should be a major part of your strategy.
Personally, my strategy employs a scorecard for every investment. I update and evaluate that scorecard regularly. I do this at least once a year, if not more often. This strategy works for me because it takes the emotion out of my investing decisions. I can make objective decisions based on hard metrics that I’ve selected.
And this works for me. Your strategy will be entirely different from mine. Find one that works for you.
The important part is that a strategy should be more than “hoping for the best”. Not all investments are going to be winners. A strategy should work in both up and down markets.
What are you going to do when an investment doesn’t work out? Sell it? Buy more? Sometimes it makes sense to double down, and other times it makes sense to cut your losses. Figure out a strategy to help you decide when to pull the plug on a investment before it can cause major damage to your portfolio.
When it comes to winners, my strategy is to mostly let my winners run. They win, and keep winning because they have a the ability to compounding continuously… and that’s super important. As long as I can see the results of the compounding, I will continue to hold those stocks (even if they’re down in a given year).
When designing a strategy, ask yourself “How will those investments compound?” If the investment is going to retain cash (internal compounding), how is that cash being invested? What rate of return are they earning on that retained cash? If the company pays a dividend, will you reinvest that dividend (external compounding)?
If you’re going to keep earning in both up and down markets, compounding really matters. This is one of the reasons why I’m so ultra-focused on always making certain I’m compounding.. It’s a major part of my strategy, and one that’s paid off.
Either You Get It Or You Don’t
Now obviously there many ways to invest, and not everyone is going to agree with me on the importance of a strategy. That’s totally OK. Either you understand the importance of a strategy or you don’t. It takes all sorts of people to make a market.
For me, when I finally understood the difference an investing strategy brings to the table, it was like a lightbulb going on in my head. I suddenly understood why some investors actually grow wealthier in down markets. It’s not luck, it’s strategy.
Ever since that lightbulb went on, I’ve endeavored to invest without the need for ‘luck’ or ‘hope’. When done right, a true strategy makes investing almost like a mathematical certainty.
While hoping for a better future is still very important part of being a positive person, I’d much rather wager my hard-earned dollars on a mathematical certainty.
How about you? Do you invest with a strategy! Please share in the comments!
[Image Credit: Flickr, Flickr2]
Excellent article and well thought out strategies.
Fitting for the end of 2020.
Thanks
Thanks Mike!
This is an interesting topic, Mr Tako. I think you know that we early-retired basing a lot of our future on the 4% rule – not 100% as we have rental property and we’re spending closer to 3.5% yearly so far.
However, I think about your point quite a bit. When you mostly invest for dividends like you do, I feel that you have a lot more stability in your plan. Sure, dividends can be cut back or out completely, but hopefully, diversification keeps you rolling just fine overall.
With the 4% rule in general, you’re just investing based on the assumption that the market will appreciate over time. Yes, it accounts for ups and downs as well, but everything is based on historical data. Will it be different in our lifetimes? Maybe or maybe not.
I’d like to build up some other income streams as well over the years to help protect a little bit against that “maybe not” factor. Otherwise, one day I might be sleeping on your couch! Make room for Lisa and Faith, too! 😉
Haha! Sure, you can couch camp at my place until you get back on your feet, but it’s a noisy place with 2 boys running around!
Technically I don’t “invest for dividends”, even though it looks that way sometimes, I actually invest for total return (Dividends, capital appreciation, share buybacks, and growth). Dividends are just the bird in the hand, instead of the birds in the bush (capital appreciation, share buybacks, and growth) which are effected by market sentiment, interest rates, etc.
The problem as you correctly say is the 4% rule is based on historical data. A number of the things that were true during that study (interest rates, corporate growth rates, population growth rates, etc) are no longer true today. It might continue to work as a rule in the future, but that’s totally dependent on Mr. Market being well behaved.
Strategy is a definite. Ours has always been to invest for income. Seek companies which pay you income, grow it over time and your income should grow regardless how the market reacts. In fact our income grows faster during down markets. Especially nice as we’ve been retired for over 15 years.
Very nice indeed!
My main strategy is to invest pretty conservatively. Most of our stock market investment is in passive index funds. We have a sizeable amount in our dividend portfolio as well. Those are invested in “value” stocks. I only have a few growth stocks.
These days, I rarely sell. It’s just easier to hold. I don’t sell unless there is something seriously wrong with the company or business model. I’ll go over our dividend stocks soon. Many companies suspended dividends this year, but I’ll probably hold on to see if they’ll recover in 2021.
Generally I like to give most stocks a 3 year “chance” to right the ship. If they can’t show some growth/compounding in three years, it’s probably not the investment for me, and I’ll sell.
Letting the Winners Run is sound; similar to Trend Following with Diversification. I like to now keep 90% on low fee direct indexing, but still keep 10% on moonshots like NVDA or ABNB, where I let the profits ride. Being disciplined about your cutoffs is my biggest key to grooming only the right pony. I am lucky in 2020 to have found an independent Fiduciary and no more dealing with crooked brokers.
Great article, Mr. Tako. I know that I don’t know enough about investing to pick stocks, therefore I’m in the index fund crowd…mostly. I have just a few individual stocks here and there as I’m self educating myself along the way. My strategy for now is time and staying the course with the funds and diversification out of domestic markets. We will also dip our toes into real estate in the near future, probably through a combination of crowd street and REITS. I’m not sure I want the added stress of true land lording—I don’t even like dealing with maintenance issues on my own house
I agree with you that low interest rates have really given most investors no other option than the stock market. As I get closer to my FIRE date, if interest rates aren’t high enough for me to warrant allocation, I may go the dividend stock route as a substitute. Especially as I learn more from dividend investors like you. Great post.
Am I a dividend investor? Sometimes it might look that way, but dividends are just one small piece of the puzzle. Income is important, no doubt about that.
I invest primarily through passive index funds, as I’ve found they tend to outperform my individual picks (which skew toward value). I also wrote an algorithm to crunch 10k data to pick the top 1% of stocks each month based on combination of value/growth/quality/risk – that has outperformed the S&P by a few % per year the last several years; I think it’s more rigorous and performs better than my subjective analysis of single stocks, so I’m focusing on plowing more money there than to individual picks.
Also trying to grow my real estate portfolio with a focus on multi-family for cash flow plus modestly-levered appreciation. I’m also going in a fairly sizable way into a fund that buys, rehabs, and rents single families in affordable markets. Since these real estate strategies have similar expected returns to equities, I think they should maintain returns while dampening volatility. I see very little value in bonds long term at the moment.
For us, the other key leg of the stool is to live on much less than we make, so we can stay/increase investment through down markets. I want to get to a point where passive income covers all expenses with buffer before retiring.
Although I think you are mainly referring to speculative buying or buy-sell-buy-sell-buy-sell transactions, I wonder if your definition of strategy applies to passive investing. Let’s say your plan involves buying and accumulating VTSAX. Is that a strategy under your definition? What would one do in a US scenario like Japan’s Lost Decade (which is now 30 years and counting) if their strategy was to keep buying VTSAX? You could keep buying at lower prices if you had a source of income & you could reinvest dividends but capital gains is where the major gains are. Imagine if you graduated from college in 1989 in Japan. Your stock market still hasn’t gotten back to its 1989 levels and your interest rates have been under 1% for the last 20+ years. Your strategy is fine but it seems like more work & knowledge than most would want to do or have, respectively.
Thanks for your thoughts Dan. There’s a lot of strategies out there, and buy and hold can be a good one if there’s some certainty the assets can truly compound. Doesn’t matter if that’s a index fund, stock, rental building, or other business.
Most people get confused on the whole compounding thing. They confuse saving for compounding, when they are most certainly not the same thing.
This was such a profound way to end 2020, Mr. Tako! Having ultra-wealthy friends and connections is a great way to learn from their habits and behavior. I completely agree that although Tesla had a killer year, it doesn’t mean everyone should hop on the train too. This post is exactly what everyone needed to hear to go into the new year with a winning strategy.
Thanks FLA!
This is thought provoking. I guess our strategy is to follow smarter folks (like you) and learn. We’re dollar cost averaging into S&P tracking index funds. We’ve never sold. Someday we’d like to buy a slightly bigger place and rent out our current townhome.
Seems like a smart strategy (the rental). Don’t put all your eggs in one basket.
It truly is just a guessing game, which will go up and which will go down. Despite my best efforts, it seems I’ve guessed right recently. Will that hold? I sure hope so.
I agree strategy is important. The most important strategy I have found is spend less than you make and invest the difference. In what? Who knows. Nothing looks good today.
Hope is not a strategy, so true. As I posted about recently it helps in life to sometimes see things with a dash of pessimism, enough to make a plan to deal with it.
Well said!
. I recently stopped working in a high income job that let me reach my 3% swr goal, and now want to grow wealthier in income.
Im interested in suggestions of other boring cashflow businesses, that have small fixed costs, and small capital outlays. Business is interesting because I’d like to use my current wealth to create more autonomy for my time than what a high income job would provide. The reason for low fixed costs and low capital is that I’d like to be able to move if my country collapses (emerging market) without losing everything like if it were property or a factory. Any ideas? Do you see a lot of wealthy individuals in boring software or online businesses? They seem to require a lot of luck, versus a coffee shop? Is it possible to find businesses that are low cap, low costs, because surely they’d then be super competitive because the only other barrier to entry is intellectual…
Thoughts? Just stick to the high paying career and stop grumbling about autonomy?
Banking/Fintech, Reinsurance, and Software come to mind immediately and I’ve known very wealthy people in all kinds of businesses. Some are easier to compound in than others. Software companies tend to be very low capital, but the competitive advantage is generally quite low and they can easily be out-innovated.
Something like a coffee shop is low capital and there isn’t much innovation there. There also isn’t a “race to the bottom” as far as coffee pricing goes either. People like fancy expensive coffee. It’s real estate related though, so location location location…
My friend that owned a chain of coffee shops had hits and misses. Some new locations would do great, others did less well.
I read all of this and couldn’t help but think back to my days of developing an investment thesis for every stock pick and letting it all play out.
It didn’t work for me. Strategy or not.
Well, I should say… that strategy didn’t work for me.
But the investment strategy I have now does. And it’s dead simple. I just hope “buy everything” counts as a strategy 😉 Sometimes you don’t need anything more than average.
Mr Tako, thanks for writing this thought provoking article. Has made me to think a lot about
“Hope is not a strategy” and the way I do things in my life.
I also read your replies to people’s comments and found it very informative to read your response ” I don’t “invest for dividends”, even though it looks that way sometimes, I actually invest for total return (Dividends, capital appreciation, share buybacks, and growth)”
For 2021 would you mind sharing your insights as to which sectors of economy are you planning to allocate your capital.
Hi Mr. Tako,
Thanks for putting together this post to reflect the reality of what it takes to get wealthy, which is mostly a level-headed strategy, and patience.
I’ve found what you said to be especially poignant for things that are more volatile, like crypto. For example, crypto can go up or down and any time you buy anything, it’s completely speculative. That’s just “hope” and if you win, that’s just good luck as opposed to skill. But you might win very fast (or lose very fast). Having suffered a bunch of losses, I moved to a more sustainable strategy where I just have a bot search for arbitrage opportunities and execute on them. The gains here are much slower, because opportunities don’t come along too often, and each trade only has a very small amount of gain.
However, over the long term, an arbitrage strategy will consistently net gains (and remains market neutral, so you get returns whether crypto is going up, down, or sideways) whereas one where I’m just YOLO’ing into a doge or whatever will be more or less based on luck (and is completely dependent on how the market is feeling that day)