Dow Wealth Management’s well-defined and disciplined investment strategy is based on modern investment theory and experience dating back to the 1930s.
A good investment policy is one that never changes with changes in market conditions.
An investment policy should be modified only with a major shift in one’s investment time horizon, and/or a change in one’s personal tolerance for risk and volatility. Tolerance, for most people, will probably remain constant throughout their lifetimes. In other words, a suitably formulated investment policy for a particular investor should probably never change throughout that investor’s life.
The following outline will help to acquaint you briefly with Dow Wealth Management’s philosophy.
Some Basic Principles
The most important principle upon which to premise an investment philosophy is to recognize that “there is no free lunch.” All investing involves trade-offs. For every perceived reward, there is some associated risk—whether perceived or not. Hence, it is incumbent upon every investor, tempted by the potential rewards of any investment, to ascertain the nature and magnitude of the risks involved.
To assume that such risks do not exist, just because they are not readily apparent, may be an invitation to disaster.
A common characteristic of most successful investments, investment portfolios, and investment programs (as with insurance products and estate plans) is their simplicity.
An investment product or program that is not easily understood is probably not one that is desirable, but, rather, is one for which the risks and costs are merely less visible than the benefits.
Three Primary Investment Objectives
We believe that there are only three investment objectives capable of being achieved and, so, worthy of pursuit:
A. Staying out of irretrievable trouble—which is usually to be accomplished by owning high-quality securities and being broadly diversified.
B. Participating in the markets or market sectors appropriate to the individual’s investment time horizon and personal tolerance for risk and volatility.
C. Accomplishing the foregoing in as efficient a manner as possible in terms of minimizing taxes and not paying for services which add little or no incremental value to the investment process.
High Quality & Diversification
High quality and diversification in an investment portfolio serve a purpose similar to that of fire insurance on a house.
We carry fire insurance not because we “expect” our house to burn down. We carry it because, if we do not have it and our house does burn down, we may not be able to recover financially from the catastrophe.
Similarly, “high-quality” and “diversification” serve the purpose of “insurance” in an investment portfolio.
They provide some degree of protection against an economic, monetary, or market calamity which we cannot foresee and do not expect, and which we might not otherwise withstand —or from which we might not otherwise recover without the added protection, should such a calamity come to pass.
Risk vs. Volatility
It is useful to draw a distinction between “risk” and “volatility” in the securities markets. If “risk” is defined as the possibility of experiencing a decline in the value of one’s investments from which one cannot recover, it should probably be minimized for most people. If “volatility” is defined as the normal fluctuations to which all securities markets are subject, it must be endured, if the rewards bestowed by those markets are to be enjoyed.
Time Horizon
For most people, the time horizon for their investment portfolio planning probably should be longer than they initially think. The attainment of retirement age is hardly a logical point at which to modify one’s investment policy.
At the very least, one should plan for a period covering one’s life expectancy, and married couples should plan for a period covering their joint life expectancy. The life expectancy of an individual age 65 is 21 years, and the life expectancy of the second to die of a couple, each age 65, is 26 years. If one expects to bequeath a portfolio to one’s children and hopes that they will pass it on to subsequent generations, the time horizon for investment planning, for all practical purposes, becomes infinite.
Investment objectives are meaningfully expressed only in terms of investment time horizon and tolerance for risk and volatility, and not in terms of desired return. Everybody desires a maximum return but should expect to earn no more than what the markets in which they are invested bestow.
Stocks
We feel that investment in common stocks can be justified if the individual believes that there is at least a 50 percent chance that the money so invested will not be withdrawn for other purposes over the subsequent 5 years. Over the past 50 years, the probability of an investor’s earning a positive return on his money over this investment time horizon, with even a randomly selected, unmanaged list of stocks, has approached 90 percent.
Market Timing
We participate in markets; we do not try to outguess them.
Market timing is a futile activity.
The most successful investors, over time, are usually those who remain 100 percent invested at all times.
The evidence is overwhelming and incontrovertible that even the highest paid professionals are unable to predict with an accuracy of better than 50 percent such factors as short term moves in the market, onsets of recessions or recoveries, changes in the direction of interest rates or foreign exchange rates, or changes in the rates of inflation. Therefore, such considerations should remain irrelevant to both the formulation of an investment strategy and the timing of investments or disinvestments.
One should put money in the market when one has it to put there and withdraw it from the market when one wants to use it for something else.
There should be no other timing considerations.
The reason is that, for all practical purposes, the securities markets are efficient.
The concept of employing a “professional money manager” to try to time the markets, rotate from market to market or sector to sector, or to buy individual securities when they are undervalued and to sell them when they are overpriced, is an exercise in futility. In this sense, there are no such “professional” money managers and so paying for such a service is counterproductive, serving only to reduce one’s overall total return.
Investing for Total Return
Except in cases where prohibited by law (as with certain trusts where income beneficiaries’ and remainder - men’s interests conflict), investors should utilize the “total return” concept of investing. This means that for investment selection, performance evaluation, and spending purposes, we believe they should draw little distinction between income derived from interest and dividends and income derived from growth of principal.
Market Returns
The best estimates anybody can make about future rates of inflation and future rates of total return are simple extrapolations of past long-term rates of inflation and long-term rates of total return. In this regard, the best historical measures we have cover the 98-year period from 1926–2022 and are as follows:
Inflation, 2.9 percent;
Cash, 3.2 percent;
U.S. Government Bonds, 5.3 percent;
Corporate Bonds, 5.7 percent;
Large Capitalization Common Stocks, 10.1 percent; and
Small Capitalization Common Stocks, 11.8 percent.
The differences between historical rates of return among the various asset classes are not random events. They are based upon a fundamental principle of capitalism that, for the system to attract investment capital, the greater the uncertainty of the timing of one’s rewards, the greater must be the magnitude of those rewards. The most successful investors usually maintain broadly diversified portfolios of the common stocks of high-quality, growth-oriented companies in unregulated (non-utility) industries.
Security Selection
A good investment is one that represents the simple direct ownership of manmade, value-added, productive resources (plant, equipment, organization, patents, copyrights, trademarks, franchises, and human talent) as opposed to claims on mere commodities (precious metals, the commodities futures markets) or artificially created and/or leveraged risks (derivative securities such as common stock and interest rate options). If and when possible, it is far more efficient to own securities outright, rather than through the medium of either a mutual fund or a closed-end investment company. Though we may need to pay to buy or sell a security, we should not need to pay to own or hold that security.
Above-average current yields on investments are indicators of less desirable investments.
High current yields usually indicate low quality and a likelihood that the current yield is unsustainable, a low likelihood of any significant improvement in future performance, or both.
Mutual Funds: Lower Returns
Over the 30 years ending in 2022, the average owner of equity mutual funds earned 2.84 percent points less per year than the average shareholder invested directly in a randomly selected and unmanaged list of U.S. stocks. $100,000 invested from 1993 through 2022 theoretically could have appreciated to $1.6 million if invested directly in stocks versus just $722,000 if invested in equity funds. Additionally, for taxable accounts, mutual funds and ETFs prevent investors from tax harvesting losses which may result in unnecessarily higher taxes.
Foreign Investing and Real Estate Investing
Foreign investing and real estate investing are best accomplished and easily achieved, we believe, through the ownership of the common stocks of domestic operating companies. A typical portfolio of U.S. companies derives over 40% of its sales and profits from overseas operations. About 20% of U.S. corporate assets consist of real estate. As well, to the extent that an investor owns his home or other properties, he already has significant real estate exposure. The ownership of foreign securities or real estate investment trusts to participate in these two market sectors is both unnecessary and inefficient.
Initial Public Offerings
Initial public offerings (IPOs) should be avoided. Those that turn out well are generally unavailable or in very limited supply, while those that turn out poorly are generally marketed aggressively because of otherwise inadequate demand. The result is that the investor who participates in the IPO market ends up with little of the former but much of the latter and below-average market performance with IPOs in general.
Portfolio Monitoring
Except to accommodate a particular income tax or diversification objective, the decision whether a specific security in a portfolio should be held or sold generally should not be predicated upon the behavior of its “price” while it has been in the portfolio.
If the securities markets are “efficient,” which for all practical purposes we believe they are, the “current” price is the only “correct” price.
The decision to hold or sell should then be based upon an assessment of whether or not the company’s quality and potential for earnings growth continue to conform to the standards established for the portfolio, irrespective of the price of the stock.
Usually, high-quality companies that stumble eventually pick themselves up and get back on track again. For such companies, the question of whether to hold or sell becomes one of whether or not one wants to wait out the “turnaround time.” If the turnaround time is apt to be too long, it is probably better to trade the stock for one that appears currently to have its act together and to be able to keep it that way for a while.
Taxes
Though an important consideration, the tax on a gain, if realized, should not necessarily be a barrier to the sale of that security. Over the past 10 years (through 2023), just a randomly selected, unmanaged list of common stocks has accrued capital gains at an average annual rate of 8.5% per year; for growth portfolios, the rate has been considerably higher. If, on average, one realizes gains at a rate less than the rate at which one accrues gains, securities become “locked in,” and it becomes increasingly difficult to adapt the portfolio to the standards of diversification, quality, and potential for growth that optimize the investor’s longer-term interests.
Portfolio Advisors
Legitimate roles for a portfolio advisor are the following:
A. To help the client view his investment portfolio in the broad context of his overall individual circumstances and aspirations, with special consideration being given to appropriate income tax, retirement, and estate planning objectives.
B. To help the client (1) identify an appropriate investment time horizon over which to plan; (2) assess his personal tolerance for risk and volatility; (3) become acquainted with the rates of return historically available with alternative investment policies, and the degree of risk and volatility historically associated with each; and (4) structure a diversified portfolio of securities that conforms to his personal investment time horizon and tolerance for risk and volatility.
C. To monitor the portfolio over time to make sure that the individual securities in it continue to conform to the client’s standards of quality and potential for growth and that the portfolio as a whole remains reasonably well diversified.
D. To provide the client with a perspective with which to assess his portfolio’s ongoing performance which, for any short period of time, may differ dramatically from expected longer-term results. Though disparagingly referred to as “hand holding,” this function is vitally important for most clients, if they are going to continue to be successful investors.
On a cruise ship in the middle of the ocean in a violent storm, even the most experienced traveler may need reassurance from the captain that the vessel is not leaking, that the engines are still running, and that the ship is still on course. This is a relevant metaphor for the Dow Wealth Management approach.
ENDNOTES
1 2023 SBBI Yearbook, pages 248-250 and The Wall Street Journal, 12/29/2023
2 2023 SBBI Yearbook, pages 379,371,357,347,331,339, respectively.
3 Over the past 10 years ending 12/31/23, the total return earned on the Dow Jones Industrials exceeded the total return on the Dow Jones Utilities by +42.4% (an average of 2.4 pp per year). S&P Dow Jones Indices, spglobal.com
4 Over the past 50 years ending 12/31/23, the average annual total return on the Standard & Poor’s 500 Composite Index was 11.9%; gold, 5.3%; and silver, 4.1%. Sources: 2023 SBBI Yearbook; moneymetals.com.
5 We use the S&P 500 as our proxy for a randomly selected and unmanaged list of U.S. stocks (average 9.7% per year ending 12/31/22). Average Equity Investor as determined by Dalbar | Study source: Dalbar QAIB 2023 study, Morningstar, Inc. The S&P 500 Index is an unmanaged float-adjusted market capitalization-weighted index that is generally considered representative of the U.S. stock market. It is not possible to invest directly in an index.
6 40% of aggregate S&P 500 revenue comes from international sources.https://insight.factset.com/sp-500-companies-with-more-international-exposure-reporting-revenue-decline-for-q1
Over the past 20 years ended 12-31-22, the average annual total return of the Dow Jones Industrials (10%) has exceeded that of the Morgan Stanley World Equity ex USA Index (6.2%), on average, by 3.8 percentage points per year. Over the past 20 years, the return on the Dow Jones Industrials has exceeded the return on the National Association of Real Estate Investment Trusts (reit.com) Index of Equity REITs (3.6%), on average, by 6.4 percent points per year.
We use Net PPE as a percentage of Total Corporate Assets for the Dow Jones Industrial Average stocks to approximate real estate assets.
7 Average annual 10-year total returns through 12/31/23: Dow Jones Industrial Average, 8.5%; S&P 500 Growth Index, 11.6%. spglobal.com