March 25, 2022

How to Be a Genius

Napoleon’s definition of a military genius was “the man who can do the average thing when all those around him are going crazy.”

It’s the same in investing — especially as markets get wild, as they’ve been these past few months.

It may be hard to tell from the indices that make most of the headlines, but as of this writing, on March 17th, 2022, out of 8,565 stocks in my Finviz database, 70% (6,052 issues) are below their average price over the past 10 months (200 trading days to be specific). The stock markets are in an evident decline.

In these types of markets, excelling over time doesn’t require exceptional insight or complex strategies. What it does require is maintaining a level head during periods of upheaval. That is what we are doing at Shadowridge.

Billionaire investor Howard Marks once talked about an investment manager whose annual results never ranked in the top quarter of industry rankings. He’d been solidly in the 27-47% quartile every year for 14 years. His investments were making sort of middling returns.

And where do you think that put him within his competitive universe for the 14 years overall? The top 4 percent!

Most folks would say that if you rank from 27% to 47%, you are at about a 37% rank on average. But the real answer in his case was a rank in the top 4%.

The reason is compounding, or what I like to call the math of gains and losses. Specifically, the importance of minimizing losses when you are investing.

The difference between being down 33% and 50% on your money does not seem all that great. They both would feel terrible, right? But recovering from more significant losses is disproportionately difficult.

A 33% loss requires a 50% gain to get back to even – a high but doable hurdle. But a 50% loss takes twice as much, a 100% gain, to get back to even. The math goes like this: Start with $1.00 and lose 50% ($.50). To recover, you need to earn $.50 while starting with only the $.50 that remains. 100% gains – doubling your money – is extremely hard to do. For this reason, avoiding large losses is most critical in successful investing.

We often suggest clients evaluate us, or any advisor, with performance over a complete market cycle, so that you see the performance in both up and down markets. Most managers can make money in up markets, but few are good at minimizing losses in declining markets, which makes all the difference for long-term investors. These stock market cycles I refer to are not the 5-10% declines we frequently see but are full-blown bear markets that have taken 50% or more of index values and happen on average every 5 years, with even longer cycles more recently. Making money in up cycles does little good if you take massive losses in down cycles. Strategic money managers like Shadowridge Adapt to Changing Markets® and are good at minimizing damage in down cycles, something index funds can’t do.

To gauge how important Playing Defense is for our clients, I did a study covering the decade of the 2000s, which included two deep bear markets: 2000-03 when the S&P 500 lost 52% of its value, and 2007-09 when it dropped 56%. Here is a chart of the S&P 500, with dividends reinvested, during the study period. It shows the S&P 500 losing money over the 10 years.

The study started with all equity mutual funds (holding greater than 60% stocks) in existence since 1999 and eliminated all of the higher risk funds. Those that had dropped 75% or more of the index loss in the two bear markets mentioned (39% and 42%, respectively) were removed from the study. The remaining risk-managed funds produced the following performance for the 1999-2009 period.

If you understand the math behind compounding, you realize the most important question is not “How can I earn the highest returns?” It is “What are the best returns I can sustain for the longest period of time?” Just staying in the game consistently through chaos determines the winners.

You could be considered an investing genius if you:

Kept your head on straight when the market crashed in 2000;
Remained calm during the crash of 2008;
Haven’t panicked over the last few months of volatility.

It doesn’t take much, but it makes all the difference.

* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Performance and activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.

** Indexes are unmanaged lists of stocks considered representative of a broad stock market segment. Investors cannot invest directly in an Index.

This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.

In all investing, past performance cannot assure future results, and as such, our efforts are not guaranteed. Losses can occur. All strategies offered by Shadowridge Asset Management, LLC, adapt to changes in the markets by changing the investments they hold, therefore, comparisons to broad stock market indexes such as the unmanaged indexes mentioned may not be appropriate. Sometimes client accounts are invested in stocks or markets not included in these indexes. Past performance does not guarantee future results. Investment return and principal value will vary so that when redeemed, an investor’s account values may be worth more or less than when purchased. Mutual fund shares and other investments used in our managed accounts are not insured by the FDIC or any other agency, are not obligations of or guaranteed by any financial institution and involve investment risk, including possible loss of principal. Advisory services offered through Shadowridge Asset Management, LLC, a Registered Investment Advisor. Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence.