The Pit and the Pendulum (Part 1)

What’s the key to investment success?

Many people have pointed to many different things. Some say it’s diversification, which reduces risk. Some say it’s having a long-term perspective, which enables you to be patient through the ups and downs of the market. Still others point to flexibility, or organization, or having appropriate expectations. These are all part of the total picture.

But the one factor that really stands out—if I can summarize it in one word—is “cheapness.” Buying a security at a low price relative to its fundamental value makes that purchase safe. You’re far less likely to lose money when you spend less for something than it‘s worth. Ben Graham used to call this the “margin of safety.”

What’s frustrating about cheapness in investing is that it depends on other investors. In the midst of the financial crisis we could buy Johnson & Johnson bonds as if they had a 50% chance of defaulting. We didn’t create that opportunity—others did. The market was paralyzed by the fear of a global financial meltdown. So, prudent investors could be aggressive. All you needed to make money was cash and nerve.

Now the situation is different. Ultra-low interest rates have pushed investors out on the risk curve. Pension funds, endowments, and others need 8% returns to reach their goals, and they think they can’t get this with traditional investments. So they’ve moved into high yield bonds, private equity, and hedge funds. Not because they want to, but because they think they have to.

At times like this it pays to be prudent. The market doesn’t provide high returns just because we need them. And as others get greedy, there’s nothing wrong with being a little fearful.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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