UP UNTIL MARCH, the few fund managers who were able to keep their portfolios in the plus column were heralded as investment geniuses. But with the markets up sharply this year, anything less than double-digit returns seems embarrassingly tame. Some sectors haven’t just performed well — they’ve kicked tail. For example, Internet stocks, which we first highlighted last fall, have taken top honors with 100%-plus gains.
But while we’d all like to see our investments on the “top performers” list, what traders should strive for isn’t necessarily the biggest return, but the most consistent.
Let’s define our terms. Consistent trading doesn’t mean that every trade is a winner, or even that in every quarter one is able to achieve a positive return. It does mean, however, that over any statistically meaningful length of time — say, a rolling 18-month period — your overall investments will have gained in value.
The return doesn’t always have to be stellar, but it does have to be positive. With all due respect to Legg Mason fund manager Bill Miller, consistently beating the Standard & Poor’s 500 doesn’t mean much when the S&P declines for three straight years. You can’t spend relative performance.
Indeed, it’s consistent, absolute (that is, positive) return that counts. This undisputable truth stems from the fact that real money is made not by a great quarter or year, but by compound interest over long periods of time. If you can consistently make money, even low levels of return can add up over time.
For example, take the Amerindo Technology D fund (ATCHX), which in 1999 posted an incredible 249% return — a monster number even within the context of the tech boom. Although Fund managers Gary Tanka and Alberto Vilar know how to swing for the fences (according to Morningstar, the fund has lost as much as 26% and gained as much as 42% in a single month), I can’t help but think most investors would prefer solid singles rather than the occasional home run. Because even though the fund is up more than 70% this year alone, its trailing five-year return is still less than 1%. You’d have done significantly better in a plain old bank CD.
But compound interest is just one of the reasons it’s important to focus on consistency. Mental health is another. As we’ve often pointed out, trading is an emotionally exhaustive endeavor. Long losing streaks won’t only strain your wallet, but also your psyche. When we start losing money, our discipline is usually the next shoe to drop. A frustrated investor inevitably becomes a foolish one, doubling down, overtrading or taking on way too much size. There are so many ways to lose money in the market — and shame spirals can be awfully expensive.
But by focusing on consistent return, an investor is given positive reinforcement by a steadily growing bottom line. The emotional highs and lows inherent in any speculative endeavor aren’t eliminated, but they are smoothed out. I’ve found that this approach not only lowers my blood pressure, but also my propensity to do really stupid things.
Finally, consistency is important in a portfolio because while the market has all the time in the world, our years on this planet are more limited. Even in a strong economy, money doesn’t just fall from the sky — it must be earned. That takes time, the one commodity none of us can afford to waste.
As we’ve often pointed out, the goal of investment isn’t to be right, but to be profitable. And when it comes to building savings, it’s often just too hard to make up for lost ground. For example, if a $100,000 portfolio drops 30%, one must achieve a 43% return just to get back to even.
It’s why so many mutual funds are closed or merged away — mutual funds are sold on the basis of their long-term performance, and in the market all it takes are a few bad quarters to turn an otherwise stellar record into a disaster. Consistency counts because, regardless of how good your stock-picking prowess is, it’s well-nigh impossible to catch up if you fall too far behind.
So what’s the best way to achieve consistency? Like most elements of investing, I believe it comes down to technique. The market is chaotic and unpredictable, and it always will be. The challenge of portfolio management is to tame the beast — that is, to manipulate one’s exposure in a way that smoothes out the bumps along the way.
Perhaps the best way to encourage consistency is to pace your outlay of money. I see far too many portfolio managers who practice the “tidal wave” method of investing. A trend is observed and a manager goes after it with fists of cash, hoping to jump on and off before the surf hits the sand. The result: huge percentages of capital go sloshing in and out of the portfolio over very short periods of time. If you’re aiming for consistency, this won’t get you there.
So instead of shooting for a few big scores, I prefer to trickle out investment capital over time. Not only does it help maintain prudent position size, but because the market itself is constantly providing feedback on its next move, it helps me to follow the action rather than chase it. Investing is a marathon, not a sprint.
Another way to be consistent is to be both a saver and an investor. The fact is that while it’s perfectly fine to take a smart risk within your portfolio, at no point should your entire portfolio be at risk. Investing is an imperfect science — no matter how hard you work, sometimes nothing will go your way. So it’s always important to keep a portion of your assets in good old-fashioned savings, regardless of your age. Not only will it help stabilize your portfolio, but it’ll steady your emotions as well. The world is a much happier place when you’ve got a year’s rent or living expenses in cold, hard cash.
In the unpredictable world of investing, the challenge is to be anything but. And by focusing on consistent over outsized return, compound interest will affect your bottom line more than any hot tip or talking head. Moreover, because emotions have a tendency to cloud good judgment, a small but steady approach will help promote the discipline needed for any long-term portfolio success.
– Originally on Jul 14, 2003 by Jonathan Hoenig
