Originally published in the Brandywine Asset Management Monthly Report.
With the U.S. stock market racing to new highs and up almost 150% since the financial crisis low in 2009, we thought it might be a good time to talk about the perception vs. reality in the financial world of the differences between investing and trading. A more complete description of this topic can be found in chapter eight of Mr. Dever’s book, which you can read by following this complimentary link: http://bit.ly/utWsNy.
Investing is often thought of as an act of entering into a position and leaving it on for an extended time. It’s been touted as being the virtuous approach. Trading is the description used to explain the act of changing those positions more frequently. It is considered “speculative’ and often referred to as gambling. The fact is that investing and trading are neither. Investing is the process of identifying the best, most rational opportunities for profiting within your means, and then unemotionally following a process that combines those opportunities into a portfolio that has a high probability of achieving the greatest returns possible while limiting risk over a specific time period. Trading (which involves the development of trading strategies based on disparate “return drivers”) is the method used to achieve that return and thus is a component of investing. In contrast, gambling is entering into or maintaining trades with a negative expected outcome or taking unnecessary risks.
Unfortunately, the process that most people have been taught to follow to earn a return on their money is not investing. It’s gambling. A person who is 60% long stocks and 40% long bonds is taking unnecessary risk. It’s not that there is a problem with being long stocks. It’s that exposing 60% of a portfolio to anything is gambling. That includes government bonds, treasury bills, and other “riskless” investments. The fact is that “angry environments” exist. These are the periods when market conditions are least suitable to any given position. To be in such an environment and not adapt is not smart. In contrast, what people refer to as gambling is often much more akin to trading. For example, a skilled poker player varies her poker play based on the hand she is dealt and the expected behavior of her opponents. She adapts. She’s not a “gambler.” That’s one of the reasons she wins at poker. The same behavior applies to investing. If you put a process in place to ensure that when you’re dealt a “bad hand”, you adapt, you are trading. If you don’t, you’re gambling. Buying and holding stocks through an angry environment is gambling.
Another way to determine if you are gambling, and not investing, is to objectively evaluate your psyche. If you are acutely aware of every fluctuation in the U.S. stock market then you certainly have too much riding on the outcome. You are gambling. If it keeps you up at night then it is a certainty you have too much exposure. If you weren’t gambling on the U.S. stock market you wouldn’t care any more about the movement in U.S. stocks than you would about the movement of orange juice, wheat, oil, or Australian dollars, which are equally tradable for individual investors.
After years of powerful stock market gains, many people, afraid of missing out on further gains such as those that have already been registered, are once again shifting towards gambling behavior by increasing their equity exposure. The memory of the pain inflicted on their portfolios during the dot-com meltdown and the financial crisis has begun to fade. But there are alternatives to long equity exposure that have the potential to produce greater returns – and with less risk – than gambling on a sizable equity position. The fact is that there are a myriad of trading strategies and markets that can be incorporated into an investment portfolio. Picking just a couple, such as being long U.S. equities or long fixed income securities is intentionally limiting and exposes the “poor-folio” to unnecessary and avoidable risks.
Brandywine has spent decades developing a wide range of trading strategies that enable us to diversify our clients’ portfolios across more than 100 global financial and commodity markets. The result is that difficult periods for Brandywine (such as the one we encountered over the past five months) produce relatively constrained losses – certainly relative to the extended and substantial losses experienced by portfolios dominated by long equity exposure. That is because our portfolio is balanced across dozens of return drivers and more than 100 global markets. If you’re interested in learning how you can invest in a truly diversified portfolio, rather than gamble on a poorly-diversified “poor-folio,” give us a call. We look forward to showing you the myriad of ways Brandywine creates a truly globally-diversified portfolio.