Market Insight: Focus on the Foundation

Every segment of war, whether it’s on land, sea, or air, has tactics and techniques that are specific to that venue. However, at the point of execution – that moment when you engage with the enemy – the best tactics in the world will not make you successful if you haven’t put in the weeks, months, and years of training it takes to prepare for that unforgiving minute. You need the foundation.

In training, it was our goal to push ourselves so hard, that actual combat seemed “easy.” For every young leader that joined my platoon, company, or battalion, I would conclude our initial meeting with the words of World War I vet James Warner Bellah: “A Soldier who has given his life because of the failure of his leader is a dreadful sight before God. Like all dead Soldiers he was tired, possibly frightened to his soul, and there he is – on top of all that – never again to see his homeland. Don’t be the one who failed to instruct him properly, who failed to lead him well. Burn the midnight oil, so that you may not in later years look upon your hands and find his blood still red upon them.”

In training, the distances we moved were longer. The objectives were more complex. Our planning timelines were condensed. Sometimes key leaders were replaced, and crucial weapon systems were removed. This was meant to induce stress – to ultimately ensure that when the time came, we could execute whatever mission we were handed in any terrain, day or night. We preferred repetition over complexity. Like the old saying goes, “the more you sweat in peacetime, the less you bleed in war.”

In actual combat, success in a tough fight wasn’t about the tactics we chose to employ in that moment. Good tactics help of course, but our success was determined by our collective behavior in the months and years leading up to that moment. We had to have a sound foundation in the basics. Show me a battle that ended in catastrophe and I’ll show you a unit that didn’t put in the work beforehand. The same can be said about wealth creation and destruction.

It’s awareness of incoming and outgoing cash flows, of risks and returns, of various investment vehicles, of goals. Awareness. After awareness comes control. Controlling your emotions and accepting that the world has always been a very uncertain place. It also means controlling cash flows by living below your means and directing them in the right investment vehicles over a long time-horizon to achieve those goals. This is the foundation.

Roth conversions, Social Security collection strategies, unique tax planning and various market timing efforts. If done correctly, over time, these small tweaks may strengthen one’s financial position, but very rarely do they materially change one’s financial footing. They are tactics.

In other words, executing a Roth conversion is meaningless if there isn’t the foundational understanding that wealth creation begins with compounding and compounding can’t take place if your first intuition is to needlessly interrupt that compounding by selling in the face of uncertainty. Without some level of risk and discomfort, there can be no long-term returns. As Michael Batnick writes, “What you do need is a plan. And nobody who’s selling all their stocks today has a plan because nobody’s plan is to panic sell.”

We can model drawdowns and market corrections. Our flaw, however, is that as humans when we visualize stock market losses, we imagine ourselves in some hypothetical world where the only thing that has changed for the worse in the stock market. But stock market drawdowns do not exist in a vacuum. What we cannot visualize is the state of the world that causes that stock market downturn and how it feels to live through moments where the headlines are filled with World War III jargon, pandemics, inflation, and civil unrest. It’s these emotions, and their control (or lack-there-of) that can lead us down the path of continued wealth creation or sudden destruction.

Warren Buffett is truly one-of-a-kind. We often focus on how he thinks about moats and business models and the valuation of companies, which is all important. But the real reason that he was able to accumulate the wealth that he has, is because he has been buying stocks for 80 years regardless of the economic environment. That’s how compounding works. Think of this another way: Buffett is the wealthiest investor of all time. But he’s not actually the greatest — at least not when measured by annual returns. Jim Simons, founder of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1988. No one comes close to this record. Buffett has compounded at roughly 22% annually. Simons’ net worth is around $24 billion. Buffett’s net worth is about $116 billion.

Because Simons didn’t really start investing until he was 50 years old (previously he was a mathematician at Stony Brook). He’s had less than half as many years to compound as Buffett. But Buffett keeps buying and keeps investing, even at the ripe age of 91.

To close, I think it’s helpful to revisit another dark time in the history of the markets…October 2008. During that month, Warren Buffett penned an opinion piece for the New York Times titled “Buy American. I am.” Keep in mind this was a month after Lehman Brothers filed for bankruptcy and the housing market was actively imploding. When Buffett wrote the letter, the stock market was far from bottoming; in fact, the S&P 500 would fall another 26% after he wrote his op-ed. But his points remain prescient then and now. In his October 2008 op-ed, Buffett wrote, “The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary. So … I’ve been buying American stocks…Why? A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

I’m sharing this chart because it helps remind me, and hopefully you, that there are always reasons to sell. The only certainty is uncertainty. That’s always been true. Don’t focus on the tactics. Focus on the foundation. This too shall pass.