On June 4, 1992, my 40th birthday, I resigned from my job in the venture capital industry and launched Baskin Financial. With no clients and no track record, it was a pretty scary thing to do. Now, twenty years later, I can say without doubt that it was a great decision. Over the last twenty years of watching the markets on a minute to minute basis (an unavoidable occupational hazard) I have learned five things which I think it is important for all investors to keep in mind.
The first and most important point is that the stock market was then and is now the cornerstone of successful investing. No other vehicle provides the same combination of liquidity, transparency, cash flow and return over time. Bonds offer cash flow and liquidity, but bond returns lag those of the market over time, and the bond market is anything but transparent. Real estate can offer excellent returns, but investors pay huge transaction costs (land transfer taxes, real estate commissions, property management etc) and there is little liquidity, particularly in bad markets. Cash is safe and liquid, but over time pays little more than inflation, and often less.
On May 31st, 1992, the TSX closed at 3,388. Over the next twenty years it rose by 6.2% per year, compounded, before dividends. After dividends, the TSX returned about 9.25% per year for twenty years. But the second point, and one that all investors must understand, was that it was not always a smooth ride. Over the past twenty years the TSX had drops of 15% or more seven times, an average of once every three years or so. On four occasions the index dropped more than 25%, an average of once every five years. It turns out that the price of those good returns over time is that investors must live with volatility, sometimes alarming in its intensity. A loss, even if only on paper, of one-quarter of one’s investment in the market is a horrible experience. Understandably many investors let their emotions overwhelm them, and the desire to sell out at any price can become very difficult to resist.
This leads to the third important thing I have learned. It is futile to attempt to time the market. No one knows when one of those horrible 25% drops is about to happen. No one knows how long the drop will last while it is going on, and no one knows when the market will suddenly reverse and rocket back upwards. A great example is the short lived “bear market” of 2002. From March to October of that year the TSX fell from 8,005 to 5,678, a gut wrenching drop of 29% in seven months. Two years after the start of the decline the TSX hit 8,917, up by 57% from the bottom and up by 11.4% from its value before the slide. An investor who did not panic and sell out during those awful seven months ended up having a reasonably good two years, with a return including dividends of about 8% per year.
There is no doubt that many, perhaps most, investors sold out of the market on the way down, and inevitably, many sold out at or near the bottom. It is also certainly the case that most bought back in only after the market had bounced back at least part of the way. Company shares are seemingly more attractive the more expensive they get, and less attractive the cheaper the get. Warren Buffet always says he loves a market sell-off, as he gets to buy his favourite stocks at a discount.
This leads to the fourth point. Value investing is the key to long term success. Fundamental analysis of companies allows the investor to have confidence that the shares that have been purchased have a value that is real, and which may be very different from the price assigned to them by the stock market from minute to minute and from day to day. The ugly experience of Facebook investors over the last three weeks is a vivid example of this principle. For days before its initial public offering, analysts warned that there was no way, based on fundamentals, to value the shares anywhere near the offering price of $38. Nonetheless, hype, hope and hysteria led to a flood of buying at the open, and a price which had little to do with value. As always happens over time, price and value began to converge, in this case very rapidly.
Finally, a word about the news media and its effect on the market. In no other area is it more true that one should not believe everything that one reads in the paper, on the internet, or hears on TV. The combination of the twenty-four hour news cycle and the multiple channels of news distribution has led to an insatiable and never-ending demand for content. Moreover, in the crowded and competitive news market, only the loudest and most controversial voices grab attention. It is the old contrast between dog bites man (markets will be much as they have been for the last twenty years) and man bites dog (the apocalypse is rapidly approaching, life on earth as we know will end). Investors are understandably alarmed by pundits who predict doom and destruction. No one, seemingly, records their prophecies and asks for explanations when they fail to prove accurate.
Twenty years of experience does not make for a perfect investor. There are too many unpredictable things in the world, too many wild cards that can upset the best run companies and defeat the most cautious investors. However, experience has taught me that sticking to the principles outlined above will lead to success over time, even if there are some bad bumps along the way.