A Little Skill and a Lot of Luck Go a Long Way!

I think it is prudent to start with what is most important.  March was a very scary time and our nation's actions were correct to shut down.  Lives are more important than money.  The economy will recover, and studies have shown that economic slowdowns do not have near the fatality impact as one might expect.  In fact, life expectancy increased during the Great Depression.   This study on life and death during the Great Depression shows that increases in suicides were more than offset by the mortality decreases due to less traffic, less pollution, less smoking, less alcohol consumption, and less work stress. 

Most people in the United States worked less in March.  I did not suffer that same fate.  Times like this are when my services are kicked into high gear.  I spent countless hours dissecting the impact of three rounds of legislation, preventing reactionary decisions by clients, and guiding them through increased volatility.  March was an exciting time for me to prove value!  I essentially act as a barrier to bad decisions during these times.  I am happy to say that no clients switched their allocations and sold low.  Most held, and some even made additional deposits which I invested during the chaos.

The three most important things that I did for clients during March was (in order of importance):

1)  Prevented any client from panicking, selling low, and moving to illusory 'safe' investments

2)  Harvested $900k of losses in taxable accounts, while still allowing clients to participate in subsequent market gains

3)  Invested the majority of March deposits near market lows.

One of my favorite books is Michael Mauboussin's The Success Equation:  Untangling Skill and Luck in Business, Sports, and Investing.   He talks about how difficult it is to see an outcome and determine the impact of luck vs skill in arriving at that outcome.  I will tell you plainly, for #3 on the list above, luck played a huge role. 

For those unaware, my investing philosophy focuses more on what I CAN control, and less on what I cannot.  I cannot predict the market, much like every other investment manager.  I agree with Mauboussin that any investment manager who appears to time the market or correctly predicts the future is more likely simply lucky.  The success of investment managers mimics a bell curve.  There are simply going to be some who get lucky and are at the top of the curve, and still others at the bottom.  Morningstar's active-passive barometer shows us every year that active management (actively applying "skill" to beat the market to justify a higher fee) fails over longer time horizons.  Sure, some managers will get lucky next year and beat the market.  Persistently doing that over a 10-year horizon is rare.  As the distribution shows below, most managers fail to beat their benchmarks after accounting for their fees.

So, I focus on lowering what I CAN control:  FEES and TAXES.  I make portfolios more efficient.

One of these methods is through tax-loss harvesting, which is made easier through the use of ETFs.  For example, many of my clients experienced losses in March as can be shown in the chart below which maps the performance of SPDR'S S&P 500 ETF (SPLG).   You have to be careful not to trigger wash sales with this strategy, but those rules are beyond the scope of this post.  On 3/2 I recognized losses by selling SPLG and immediately purchasing Vanguard's Total Stock Market Index (VTI).  So clients did not miss out on any future gains in VTI.  However, VTI then moved to a loss position.  I had to wait 30 days so as to not trigger the wash sale rules and then was able to sell VTI at a loss and switch back to SPLG.  Since then, SPLG has gained.

The end result?  Over $900k of losses harvested.  I estimate my average client has a marginal tax rate of 32%, which equates to over $270k in tax savings.

Now that I have sufficiently bragged about my skill, I will move to the luck portion of the show.  I had many discussions with clients about investing additional funds in March.   Many of my clients own small businesses or are otherwise entrepreneurial, and have individual 401ks set up.  Most make a one-time contribution sometime during the year.  March seemed like an ideal time to pull the trigger on their 2020 contribution for many of my clients.   I did not perfectly guess (emphasis on GUESS) when the market low would occur.  Indeed, it seems silly to time the market with daily swings of 10%.  However, a majority of contributions to my clients' accounts in March occurred between 3/12 and 3/20, and those contributions have average gains of over 10%.

In summary, the combination of luck and skill in investing is a powerful combination.  The key is determining where to best apply skill.  Skill applied to stock picking is fruitless, and higher fees are not justified.  Skill applied to the areas we can control is better:  such as focusing on lowering FEEs and TAXES.


DISCLOSURE: This material has been prepared or is distributed solely for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Any opinions, recommendations, and assumptions included in this presentation are based upon current market conditions, reflect our judgment as of the date of this presentation, and are subject to change. Past performance is no guarantee of future results. All investments involve risk including the loss of principal. All material presented is compiled from sources believed to be reliable, but accuracy cannot be guaranteed and ComposedPro makes no representation as to its accuracy or completeness. Securities highlighted or discussed in this communication are mentioned for illustrative purposes only and are not a recommendation for these securities. The tax-loss harvest example presented did not represent the actual outcome of any client. 

Tax-loss harvesting is not suitable for all investors. Nothing herein should be interpreted as tax advice, and ComposedPro does not represent in any manner that the tax consequences described herein will be obtained. Please consult your personal tax advisor as to whether a tax-loss harvesting strategy is suitable for you, given your particular circumstances. The tax consequences of tax-loss harvesting are complex and uncertain and may be challenged by the IRS. You and your tax advisor are responsible for how transactions conducted in your account are reported to the IRS on your personal tax return. ComposedPro assumes no responsibility for the tax consequences to any client of any transaction.