“Don’t Look Back. Ooh, a new day is breakin’. It’s been too long since I felt this way.” -Boston (from the song, Don’t Look Back).
Before we get into this topic, I want to thank our client, Roger P., for the inspiration, as he reminded me of this song and its background as part of an email conversation back in January. I’ve been keeping it on the back burner ever since.
What has 7.0 liters, four doors, and an 8-track player? My dad’s silver 1977 Cadillac De Ville, for one. At least it did when I was a teenager, and it was one of three massive older Cadillac “boats” that he accumulated during the 90s (there were also white and blue ones, and – yes – I looked super cool driving all of them). More importantly, the 8-track player in the silver Caddy was the only working 8-track player I’ve ever had access to (there was also an 8-track player in my parents’ console record player, but that one never worked). And one of the few 8-track tapes that lived in the car was Boston’s 1978 album, Don’t Look Back.
For the record (yep, that’s a pun), I have personally always been a bigger fan of Boston’s self-titled album, but beggars can’t be choosers when it comes to 8-tracks and Cadillacs, so Don’t Look Back became a staple soundtrack of trips in the silver Caddy. I’m sure Boston’s naming of the album wasn’t intended to be infallible life advice (and it wasn’t even the title they originally wanted!), so we should probably take it with a grain of salt. At the same time, it’s a good motif for some investment perspective and for staying in good spirits as we say goodbye to summertime.
When looking back is good
I’m definitely not alone in feeling like I forget far more than I remember because that’s purposely how our brains work. And I won’t pretend that past editions of Alt Blend are among the most vital pieces of information in your life, so part of my job with this blog (and as a financial advisor, in general) must be revisiting essential takeaways. With that in mind, let’s consider some instances where looking back can be helpful…and then also where caution is warranted. Here we go!
Blowups!
As we discussed in The Rub (parts 1 & 2), we can surely learn a lot from post-mortem analyses of catastrophic alternative investment failures (aka “blowups”). Investments that seem too good to be true nearly always are, even if it takes some time for the true colors to reveal themselves. Usually, the allure comes in the form of good returns for seemingly little risk. When “risk” is conflated with “volatility,” and volatility is compressed for a long enough period to appear like it will persist indefinitely, our human brains can be easily tricked into trying to take advantage of such “easy money.”
Inevitably, the investment environment changes enough to uncover actual underlying risk within a strategy (often WAY too much leverage being used), and it’s game over. The problem in those cases is that the perceived risk (illustrated through volatility) was very different than the real risk (permanent loss of capital). There was never too much return for the risk investors were taking. Instead, the risk was simply misunderstood, and the returns were probably too little to compensate investors for what they were getting themselves into (no amount of return can make up for total loss!).
Two weeks ago, I caught a fascinating documentary on the Bernie Madoff scandal. There was a lot to the story, but – at the most basic level – the Madoff strategy consistently made money and paid the dividends it was supposed to regardless of market volatility (or at least it appeared to have been doing so). As you may know, we at TBG are big believers in creating a reliable stream of growing dividends for our clients. However, that also comes with exposure to price volatility because stock prices naturally fluctuate. Madoff had none of that normal fluctuation. Experts couldn’t figure it out, as the returns seemed mathematically impossible (spoiler alert: they were), and they voiced concerns. But no one seemed to care. Ultimately, it took a run on the “bank of Madoff” during the 2008 financial crisis to expose the charade. Investors needed to turn somewhere for cash, and Madoff had done so well that they naturally turned to his fund. New investments (the lifeblood of the Ponzi scheme) simultaneously dried up because of the crisis, and the jig was up. Another interesting component of the story that led to Madoff’s downfall was that the liquidity terms were apparently investor-friendly. I wonder how much longer the scheme would have persisted had he implemented stricter lockups and gating to limit outflows.
Relying on experiences: caution is warranted
The extreme experiences we encounter in our lives tend to stick with us. That notion can help us apply knowledge from past investments to new endeavors, but it also can be counter-productive in leading investors to take an inappropriate level of risk (either too little or too much) because of what they’ve previously encountered.
The risk of too little risk
I’ve encountered many investors who felt they couldn’t stomach the volatility of an equity portfolio following the 2008 financial crisis. Those same investors were often also concerned that the then 30+ year bull market in bonds was imminently ending, so they wanted to keep bond durations short (read: less interest rate risk, but also less yield, and less benefit from the continued falling rate environment that generally persisted until recently). Rather than allowing a long-term financial planning framework to drive their investment allocation, these investors were guided by (misplaced) fear. The result? They missed out on many years of solid market returns while awaiting another significant financial crisis that hasn’t come to fruition.
There are two things I’ve found to be helpful in slowly migrating that fearful mindset into one that is more financially productive, and – in both cases – “knowing what you own” is a vital component:
- Private Investments: while the fund packaging (e.g., limited partnerships, LLCs, private REITs) can initially be unfamiliar to the “average investor,” the tangible nature of private investments can strike a positive chord with them. Real estate is very familiar to most people. Owning a piece of a business (i.e., private equity) or lending money directly to a business (i.e., private credit) is relatable. There can certainly be an associated learning curve, but I’ve found that the educational effort is well worth it – and that’s part of why I write Alt Blend.
- Dividend Growth Stocks: TBG’s approach to Dividend Growth works well to help unfreeze the market-volatility-panic mindset because investors can a) know what they own at a relatively granular level (which are real, cash-flowing businesses!) and b) trust in the growing portfolio-income stream generated by those companies. Those elements can help investors embrace volatility because the up-and-down movement of stock prices isn’t what matters. What matters is the belief that those movements won’t permanently impair capital, which comes from a fundamentally sound investment strategy.
Sorry to cut it short; this topic is getting lengthy, so we’ll look back at the opposite situation (i.e., the risk of too much risk) in the next edition.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
