Business | Investment
A steady hand at the tiller wins out
Long-term strategies can allow investors to maintain purchasing power and ride out financial storms
- By Robert Arnott, Financial Times
- Published: 00:00 November 21, 2009
In the face of investors collectively gaining thousands of billions in the 1990s, losing the same amount in the aftermath of the tech bubble, gaining it in the 2003-07 bull market, losing it in a market crash and then gaining it again in the mother of all rebounds, it is easy to overlook long-term goals, in an effort to play these short-term market moves to maximum advantage. Yes, two to three year market moves are short term for most investors.
We often hear that the best investors, like the best sailors, have a steady hand at the tiller, maintaining course through the storms, while positioning themselves to benefit from the wind direction and even playing the occasional rogue wave to maximum advantage. But the best investors and sailors never lose sight of their course or their end goals.
In 2006, in the Financial Analysts Journal, I posed the question, "What is Wealth?" A "millionaire" in 2009 is not in the same league as a "millionaire" a few generations ago; a dollar or pound or euro or yen won't buy what it once could. Nor is wealth defined by the inflation-adjusted value of our portfolio.
An octogenarian with a million in liquid resources is in far better shape (financially, anyway) than a trust fund baby with $1 million (Dh3.67 million) to last a lifetime.
The truly relevant measure is a simple one: how much purchasing power will our portfolio sustain, for as long as we're likely to need that spending power? Our octogenarian can spend more from a $1 million portfolio than a 30-year-old trust fund baby. In my 2005 paper, I termed this concept "sustainable spending".
Perspective
Viewed from this perspective, the true long-term investor can ride out even a horrific storm like 2007-09 with considerable aplomb. Suppose I had $1 million at the October, 2007 peak of the stock market.
My $1 million in October 2007 was producing only $18,000 in annualised income. Being a millionaire isn't as fine as it used to be. A scant 16 months later, even if I had reinvested my income, I had only $490,000. Painful. But, even with savage dividend cuts by some companies, my $490,000 was now producing $19,000 in annualised income. Market crash?
What market crash? My sustainable spending actually rose. Bear markets only matter if we need to spend our money right away.
In a separate article, I showed that a dull 60/40 portfolio — rebalanced monthly to contra trade against the markets' constantly shifting views of our future economic prospects — would have delivered a steady five per cent growth in sustainable spending . . . as long as you reinvested your income.
Real yield
Alternatively, if we "spend our real yield", we can spend about three per cent of our portfolio; we can ratchet up our spending to match inflation. And we can ignore all the bull and bear markets history has ever sent our way. Unfortunately, this analysis ignores taxes, fees and trading costs. But, long-term buy-and-hold investors can typically manage these costs way down, if we choose to do so.
So, we can still spend two to three per cent of our portfolio, with spending indexed to inflation, more or less forever. If our time horizon is shorter than "forever," we can safely spend more.
Spending
Let's pessimistically assume that inflation and taxes take most of our return. We can divide our assets by the years we'll need them, and safely spend that sum.
I'm 55, so the actuarial tables tell me that I've got about 25 years left. If I have $1m invested, I can spend 1/25 of that, or about $40,000, with no harm.
If my investments do well, yields tumble, so I must not fall prey to temptation by ratcheting up my spending by more than inflation, just because markets are up. Reciprocally, if the markets tumble, my yields soar, so I don't need to cut my spending either.
This analysis also ignores some of the wonderful opportunities that the markets send our way, to cut investments in the most popular fads and to seek investments that are deeply out of favour. While contra trading against fads, bubbles and crashes is very uncomfortable, it is a powerful part of our investing tool kit.
If we embrace a long-term ‘sustainable spending' mindset, where does this leave us? It encourages us to spend at a sustainable pace, rather than lulling us into overspending. If we spend sensibly, we can remain blissfully unruffled by the drama of bull and bear markets.
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