Warburton Capital Management

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A Trip to the Casino

By Warburton Capital | March 15, 2016 | 0 Comment

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So…a buddy comes in and reports that he has been in a casino most of the day.  This spawned the “were you a big winner?” question.  To which he responded, “I never wager”!

“Why would you go to a casino and not wager?” we inquired.  Our buddy explained, “I like to walk around and observe human behavior.  I’ve concluded there are only four personality types at the casino:

  • “The person who comes in with a budget for losing – the ‘I’m gonna gamble until I lose $X’ approach.”
  • “The person who comes in with an expectation of leaving as soon as they are $X ahead – and for the most part these folks also leave after they’ve lost a specific amount.”
  • “The imaginary gambler who comes in and wins every time,” he laughingly continued. “That person really doesn’t exist.  Although I’ve observed many incidences of one time luck, I’ve never observed persistent winning.”

“What about the fourth personality type?” I inquired.  “Oh,” he continued.  “The fourth type is the Casino Owner who makes a lot of money over the long haul at the expense of the tourists.”

We chatted for a few minutes about families and financial goals before our buddy explained he had to leave as he was cooking tonight, which translated into ‘picking up dinner at a drive-thru’.

Upon his departure our colleagues all got together, which is our norm, to discuss Action Items and general information regarding our visitor.  Our collective light bulbs were pointing in the same direction as we each commented that the personality types our buddy observes in the casino are the same personality types we observe as stock market participants.

First, you have the investor who decides he wants to buy a stock because he got a hot tip from a buddy, the Wall Street Journal or CNBC.  This investor plunks down hard-earned cash to buy the ‘can’t lose’ security, then, when the security goes down enough to irritate the investors ulcer index, the investor sells at a loss.

Secondly, you have an investor who similarly buys a few stocks intending to sell them when they go up by some amount.  The greed and fear emotions make clear decision making difficult and this investor either sells with a modest gain (foregoing the probable long-term market advances) or, being intoxicated by the instant gratification of an advancing market, continues to hold until the positions have gone negative and then sells at a loss.  Market volatility is such that you can look smart for a time before the advancing market turns bearish and market correlations draw all securities down.

Thirdly, we look for the Imaginary Investor who is able to profit in the stock and bond markets day-in and day-out.  Although there are tens of thousands of investment managers out there competing to manage your investments, we’ve yet to identify any manager capable of making money every single day, every week, every month, every quarter or every single year.  Hope Goeth Before Despair = It Just Doesn’t Happen.

So – who is the Fourth Personality Type that our buddy referred to as “the Casino Owner who makes a lot of money over the long haul at the expense of the tourists”?  In our estimation, the Investors with the Casino Owner Odds are Long-Term Investors who use Financial Science and build Purposeful Portfolios.

The logical question is “how would Financial Science inform us to build a Purposeful Portfolio”:

  • Start With Asset Allocation
    1. Put A Purposeful Amount In Bonds
    2. Put The Rest In Stocks
  • Identify The Best Bond Funds:
    1. Low Fees
    2. Broad Global Diversification
    3. A Blended Duration Of About Five Years Or Less
    4. Investment Grade Bonds Only
  • Identify The Best Stock Funds:
    1. Low Fees
    2. Low Turnover = Tax Efficient
    3. Broad Global Diversification
    4. Modestly Over-Weighted To Small Cap Stocks As Opposed To Large Cap Stocks
    5. Modestly Over-Weighted To Value Stocks As Opposed To Growth Stocks
    6. Modestly Over-Weighted To Highly Profitable Companies

The above ‘recipe’ for a Purposeful Portfolio will not result in a Miracle Portfolio that makes money every single day, every month, every quarter or every year.  Markets go down sometimes and the phenomena of Security Correlation will drag down the best of and almost all securities in the worst of times.  This is the same as the Casino Owner who may experience daily profitability variance and even experience an occasional daily loss – but – over the long haul – the House Odds Prevail and patience is rewarded.

Investors would do well to embrace Realistic Expectations and realize that a Purposeful Portfolio gives them – like casino owners – the best odds of capturing the long-term expected returns of the Capital Markets without being handicapped by neither the headwinds of High Fees and Onerous Taxation nor the futility of Stock Picking and Market Timing.

Toward understanding Market Volatility, you will find a link below to a graph of The Monthly Distribution of US Large Cap Market Returns.  This chart reveals good news in the form of Positive Volatility Skewness = Most Of The Time Returns Have Been At 0% Or Better = More Often Positive Than Negative – BUT – Sometimes Negative For Extended Periods!

Please click here to view our graph referenced above: The Monthly Distribution of US Large Cap Market Returns.

 

Trusting this will find you well and invested with the House Odds on your side, we remain

Yours truly,

Warburton Capital Management

 

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