“Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.” – Sun Tzu: The Art Of War
The biggest mistake investors make over the long-term is investing without a strategy. The point that Sun Tzu was making, as it relates to investing, is that having a strategy, such as buying and holding stocks, will indeed work. However, doing so without “tactics,” or a methodology to control risk and reduce emotional mistakes, will substantially lengthen the “route to victory.” In investing, “time” is both our most precious commodity and our biggest enemy.
In the mainstream push to promote the “buy and hold” myth, the problem of “time” in the equation is often overlooked. The chart box below shows a $1000 investment from either a period of low or high valuations. It assumes a real, total return holding period until death assuming the individual starts saving at 35-years of age using historical life-expectancy tables. No withdrawals were ever made. (Note: the periods from 1983 forward are still running as the investable-life expectancy span is 40-plus years.)
The gold sloping line is the “promise” of 6% annualized compound returns. The blue line is what actually happened with invested capital from 35 years of age until death, with the bar chart at the bottom of each period showing the surplus or shortfall of the goal of 6% annualized returns.
In every single case, at the point of death, the invested capital is short of the promised goal. The difference between “close” to goal, and not,was the starting valuation level when investments were made.
Back to Sun Tzu.
Strategy is the overarching premise the derives your investment selections. Selecting the right strategy requires some thought about your mental state, aversion or acceptance of risk, and most importantly your “duration” or “time horizon.”
Warren Buffett has a great “strategy” for investing. He buys great companies at “bargain” prices. However, his time horizon is 100-years. You can not invest like Mr. Buffett because you most likely don’t have 100-years to capture the expected return on investment nor do you have $1 billion to buy a company with.
While the example is a bit extreme, the premise is valid. Many investors may “believe” they are long-term investors, but in reality they lack the time frame to achieve the long-term expected returns. The problem becomes the inability for the portfolio to withstand a sharp drawdown in price, and recover, within the actual time horizon they have to meet retirement needs.
Tactics are the methods of controlling risk, taking advantage of short-term opportunities and mitigation of loss. Tactics alone, more commonly known as “day trading,” will end badly for most due to emotional behaviors. Tactics, when married with a strategy, will reduce the risk of drawdowns and increase the probability of investment success over a given time period.
As portfolio managers, we are “long-term” investors by nature. We have positions in our portfolios which are “core”to our investment “strategy.”However, our “tactical” approach to risk management, such as stop-prices, cash levels, and hedging, all are part of the “controls” used to mitigate loss and create returns within the “duration” of client’s objectives.
While the “break out” of the two-month long consolidation yesterday is certainly encouraging, longer-term “sell signals” remain firmly intact keeping our cash levels higher than normal. We are “tactically” looking to take advantage of the breakout by modestly increasing equity exposure as needed, but we do so with controls in place in case something goes wrong.
We are still within a very late-stage bull market with rising stresses from slowing credit growth, elevated valuations, increasing inflationary pressures without offsetting wage growth and geopolitical stresses. This isn’t a “battle” to charge head first into without having a carefully thought out strategy with tactics to back it up.
“Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win”– Sun Tzu: Art Of War
Just something to think about as you catch up on your weekend reading list.
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