10 investment lessons from Jeremy Grantham
Commentary: Expect more from yourself than the market
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By Jonathan Burton, MarketWatch
SAN FRANCISCO (MarketWatch) — Warren Buffett has said that if you look around the poker table and you can’t spot the patsy, you’re it. In that spirit, another famed investor, Jeremy Grantham, is trying to deal investors a better hand.
The chief investment strategist of Boston-based institutional money manager GMO LLC doesn’t mince words. In Grantham’s view, outlined in a quarterly letter published late Friday, individuals launched into the market have embarked on “dangerous investment voyages” that threaten to separate them from their money. They hear the tempting call of countless stock-market sirens — self-interested cheerleaders and barkers who promise that it’s different this time, and that you must buy now or miss the boat. Read more: Grantham: 'The Longest Quarterly Letter Ever.'
Making the journey even more perilous is that stocks around the world are either fairly priced or nearly so, he says. Investors who buy now can expect meager returns over the next seven years. GMO forecasts that after figuring for 2.5% annualized inflation, U.S. large-cap stocks — namely the S&P 500 Index SPX -0.36% — are poised to give slightly less than 1% yearly, while U.S. small caps will lose 1.5% annualized over that time.
The best part of the U.S. market will be high-quality stocks, reflecting about 25% of the S&P 500, with an expected 5% yearly gain, according to GMO. In that case, Grantham points out, the remaining 75% of the index would post a slightly negative return.
Expected returns are more respectable outside of the United States, GMO predicts. Annualized gains from large-cap international stocks could be 5.2%, and 5.6% from emerging markets. Small caps lag overseas as well, with a 3.8% forecasted return.
All bonds, in turn, are money-losers after inflation over the next seven years, with the exception of emerging-markets bonds, GMO predicts.
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Standing at this high-stakes table, Grantham has dealt investors 10 fresh cards, each with a piece of common-sense advice for today’s investment climate. The wisdom hearkens to another important list for investors from Bob Farrell, a veteran equity strategist, whose “Market Rules to Remember” is required reading. Read more: Bob Farrell's 10 investing rules, tailor-made for tough markets.
Sure, some of these chestnuts may seem like platitudes, but only the foolhardy would wager that Grantham is bluffing:
1. Believe in history
The S&P 500 on Friday closed at its highest level since June 2008. The Dow Jones Industrial Average DJI -0.37% , meanwhile, is flirting with 13,000. After a dismal 2011, small-cap stocks are leading the U.S. market. If it seems like the worst is over — don’t believe it, according to Grantham.
“All bubbles break; all investment frenzies pass,” he says. “The market is gloriously inefficient and wanders far from fair price, but eventually, after breaking your heart and your patience … it will go back to fair value. Your task is to survive until that happens.”
2. ‘Neither a lender nor a borrower be’
Never borrow to invest. Period.
“Leverage reduces the investor’s critical asset: patience,” Grantham says. But excessive debt is even more insidious. “It encourages financial aggressiveness, recklessness and greed.”
Debt has ruined countries, communities, corporations and consumers. “It has proven so seductive that individuals en masse have shown themselves incapable of resisting it, as if it were a drug,” he writes.
3. Don’t put all of your treasure in one boat
Obvious, yes, but worth repeating. Diversification isn’t about returns, after all. It’s about resilience, Grantham says. “The more investments you have and the more different they are, the more likely you are to survive those critical periods when your big bets move against you.”
4. Be patient and focus on the long term
“Wait for the good cards,” he says. When you find something to buy, you don’t have to act immediately. Wait for it to hit your price range. As Grantham explains, “this will be your margin of safety.”
Now comes the hard part: handling the pain of investment losses. But often the suffering is worth it. As Grantham notes, “individual stocks usually recover, entire markets always do. … Outlast the bad news.”
5. Recognize your advantages over the professionals
Patience is one of the key advantages individuals have over traders and money managers. Yet many people squander that edge, reacting to day-to-day events and chasing the latest hot stock or sector. “The individual is far better positioned to wait patiently for the right pitch while paying no regard to what others are doing.”
Such a luxury is “almost impossible” for professionals, Grantham says. Wall Street, he adds, worries about jobs, careers, bonuses and the like, needing to look busy (read: costly, frequent trading) to earn their keep.
6. Try to contain natural optimism
Nobody likes a Debbie Downer, but on Wall Street it’s bad for business, Grantham notes; many a professional has been fired for being too bearish. (See job security, above.)
Optimism can win friends and influence people, but it’s a lousy investment strategy. You have to be willing to hear bearish, bad news about the risks you’ve taken with your money — and to make informed decisions about it, Grantham says. That’s doubly true at times when buyers and brokers are exuberant.
7. On rare occasions, try hard to be brave
Professional investors often spot bargains, but (and this is key) they can’t and don’t always act on it.
That’s because the price of being wrong, even for a few months, is just too high, according to Grantham. A manager who lags his or her peers for a couple of quarters will start to get probing questions from disgruntled clients. If those clients pull their money, the manager’s bosses will get upset. If they get upset, they may decide that someone else is better for the job.
Individuals don’t have that worry. So if you find an investment that looks cheap, even if it’s likely to be out of favor for a while, trust your research. Says Grantham: “If the numbers tell you it’s a real outlier of a mispriced market, grit your teeth and go for it.”
8. Resist the crowd; cherish numbers only
Market bubbles and the madness of crowds are exciting — until they’re not. Hard as it might be, don’t jump in because everyone else is, Grantham advises. “Ignore especially the short-term news. The ebb and flow of economic and political news is irrelevant.”
What is relevant? Numbers. “Do your own simple measurements of value or find a reliable source,” Grantham says.
9. In the end it’s quite simple. really
Stocks are bought and sold based on expectations for the future value of a company’s dividends and earnings. So if a stock is trading at a discount to its long-term earnings multiple, investors can assume that over time the gap will narrow and the price will rise. Conversely, if the shares are priced above average, it’s likely the price will decline — and return to the mean — over time.
Estimates and forecasts such as the ones GMO makes for the next seven years aren’t complicated, Grantham says. “These estimates are not about nuances or Ph.D.s. They are about ignoring the crowd, working out simple ratios and being patient.”
10. ‘This above all: To thine own self be true’
William Shakespeare probably would have been a great investor, with his deep knowledge of human nature and foibles. Take a page from the Bard, Grantham suggests, and save yourself a lot of money and mistakes in investing.
“It is utterly imperative that you know your limitations as well as your strengths and weaknesses,” he says. “You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely must not manage your own money.”
In that case, Grantham notes, hire a skilled manager or buy an inexpensive global stock-index fund and don’t look at it until you retire.
“On the other hand, if you have patience, a decent pain threshold, an ability to withstand herd mentality, perhaps one credit of college-level math and a reputation for common sense, then go for it.
“In my opinion, you hold enough cards and will beat most professionals (which is sadly, but realistically, a relatively modest hurdle) and may even do very well indeed.”