September 23, 2014

When It Comes to Portfolio Management, Your Investments Should Not Be Protean

I do not believe your investments should be protean.  If you have chosen an asset well, meaning the asset continues to churn out constant or ever-increasing sums of surplus cash net of taxes and inflation, and you paid a reasonable price for ownership, the best thing you can possibly do for the long-run is sit on your metaphorical hands, grow richer with each passing year, and figure out intelligent things to do with the dividends, interest income, and rents you accumulate.  

This is the approach I follow in my own life.  Some of my tax-deferred and tax-advantaged retirement accounts, plans, and trusts still hold bank shares that were purchased during my college years; still churning out dividends despite the financial sector collapse.  As the old retail merchant’s creed goes, “Well bought is well sold.”  Remarkably, this is not the approach of most so-called investors; both professional and non-professional.  Due to a mental model called action bias, they feel as if they need to do something to have their portfolios create wealth.  They then begin to try to anticipate the anticipation of others instead of looking at the money a business generates and “buying” the profit.

If you would endeavor to be financially independent, to have the things you need and desire without working yourself to death, you need to approach portfolio management like a collector.  Just as a baseball card collector or model train collector learns to value individual items and patiently waits to add them to his collection at a good price, your objective is to collect cash generating assets that have a reasonable chance to grow with each passing year, don’t require a genius to run, and are fairly simple.   

The specific investments are going to depend upon your own personality.  Some people collect stocks.  Some people collect hotels.  Some people collect music copyrights.  Some people collect soft drink bottlers.  Some people collect farms.  Some people collect restaurants.  Some people collect a widely diversified group of assets.  Whether it is a trucking company that you started with a rig purchased at a bankruptcy auction or a real estate empire that began with a run down apartment complex, the assets that make up your collection will be a reflection of your own temperament and knowledge.  

Me?  I prefer to Benjamin Graham approach to portfolio management, which calls for you to think of your portfolio as an insurance company’s book of policies.  Each individual policy (investment) may or may not work out but if you have chosen wisely, priced the policy with enough conservatism, protected your liquidity, and stayed in areas of risks you understand, over time, there should be a lot of excess money generated despite the occasional tornado or severe earthquake.  It is that excess that can then be reinvested, spent, or given to charity.  

This approach to portfolio management doesn’t mean you should never sell.  There are times to sell an investment.  Perhaps you made a mistake, in which case the wise course of action is to correct it immediately.  Perhaps your situation has changed and the assets in your collection are no longer appropriate.  If you find yourself facing these choices more than once every five or ten years, you’re doing it wrong.