You Don't Have To Dance to the Market's Tune

You might not realize it, but you have one big advantage as an individual investor...

Put yourself in the shoes of a professional portfolio manager. Each year – likely each quarter – they need to keep up with the market.

If the market returns 8.2%, 5.8%, 11.7%, or 8.5%, like it has done in the past four quarters, the professional had better match or beat those returns. Otherwise, clients' money starts flowing out.

On the surface, that seems reasonable. If you're paying a portfolio manager who can't even match the market, why not take your money elsewhere?

But this pattern leads to perverse – and destructive – incentives...

Look, everyone knows this market is crazy. We all understand that stocks have premium valuations today that can't be sustained indefinitely... And many have valuations they can't conceivably grow into.

But if you're managing a fund, and you have to match the market's crazy quarterly gains, you can't take your foot off the gas. If the richest, most expensive stocks keep rising and driving the market, you'd better own them – just like everyone else.

If you decide to worry about a bear market and apply a safer investment approach, you get left in the dust. The money flows out and you lose your job.

The faster and more wildly the market rises, the bigger this problem becomes. That dynamic encourages portfolio managers to keep buying the big performers, fueling the rally even further.

As an individual investor managing your own money, you don't have to care about relative performance or quarterly numbers. By investing more conservatively, you won't match the market in its strongest quarter. You can't outpace the market without taking the full-blown risk.

Reducing risk will generally lead to better returns – just not this quarter, and maybe not even this year. But you have the ability to wait it out.

Meanwhile, financial professionals can't ease up while the market keeps rising. Famously, Citigroup CEO Chuck Prince said, "As long as the music is playing, you've got to get up and dance." He stated that in 2007, just before the global financial crisis struck... and Citigroup shares collapsed by 98%.

Instead of trying to chase the market quarter by quarter, you can take your time finding lesser-known opportunities with the potential for huge long-term profits.

According to my colleague Matt McCall, the next 10 years might be the best decade ever for investors.

During his special presentation last week, Matt explained that the coming boom in the stock market doesn't have anything to do with the stories you hear all the time... like market earnings results, interest rates, or inflation. He shared one major factor that will drive the market for the next 10 years.

The full replay is only online for a limited time. So make sure you watch it right here sooner rather than later.

Now, let's get into this week's Q&A... As always, please keep sending your questions and comments to [email protected].

Q: Doc... I've been religious in following your advice about diversification and asset allocation within my portfolio but am having trouble managing the explosive growth of my bitcoin holdings (a great problem to have!).

How does one balance the desire to "let your winners run" even when it throws your asset allocation ratios grossly out of whack? In my case, I've already taken my initial investment off the table and firmly believe in the future of cryptocurrencies, volatility be damned.

I know you can't give personal investment advice but I'm sure I'm not the only one in this enviable position. – S.S.

A: There are different approaches to rebalancing a portfolio. You can do it at regular intervals – such as quarterly or annually. You can give yourself certain "bands" after which you rebalance to your target. For instance, if you intend to have 5% of your portfolio in an asset, you can allow it to go to 10% before you reset it.

Which of these approaches is better? It depends on the behavior of the market. A trending market will do better with less frequent rebalancing or wider bands. A market that goes back and forth benefits from more frequent changes. And you can't really know which kind of market you'll get!

Bitcoin makes this even more complicated. Some folks treat bitcoin as a unique, fun investment, consider it separate from their portfolios, and let it ride. But what if that "fun" section gets to be 20%, 30%, or 50% of your wealth? Even if it's supposed to be fun, now you're talking about real money. And seeing that go away would be painful.

There's no perfect answer or percentage we can give you here. But an approach that can work in cases like this is "regret minimization."

First, consider the range of reasonable outcomes. This is a bit of a guessing game. For bitcoin, we'd guess it could fall something like 50%. And what's the upside? This is tougher, but another 200% would put bitcoin at $180,000.

Now size your position knowing that either outcome could happen. You don't want to lose too much of your wealth in a drawdown, but you also don't want a position to be so small that you'll forever be kicking yourself for missing the upside gain.

Q: I just read your answer to D.B. indicating the benefits of drinking a little whiskey. Do these benefits also apply to brandy? I like the taste of brandy but not whiskey. – E.D.

A: Thanks for your question, E.D. We've had several other folks ask the same question. And you're in luck.

Like whiskey, brandy contains the antioxidant polyphenols that help your body balance its free radicals. And in some instances – measure for measure – certain brandies have even more of a specific polyphenol than certain whiskeys.

I wrote about the ellagic acid polyphenol in whiskey in this article: Wet Your Whistle With These Beneficial Adult Beverages. It can help do things like slow the growth of tumors, reduce inflammation, and improve metabolic disorders (like type 2 diabetes).

In a 1999 study published in the Journal of Agricultural and Food and Chemistry, researchers tested 12 samples of American bourbon with ellagic acid concentration levels ranging from 9.58 to 13.78 mg/l. However, in seven samples of Armagnac brandy, ellagic acid concentrations were much higher and ranged from 25.21 to 36.35 mg/l.

So enjoy a little bit of your favorite brandy in the evening and get all the health benefits that whiskey has to offer.

What We're Reading...

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig and the Health & Wealth Bulletin Research Team
October 29, 2021