Notes, Views, and the Occasional Provocation March / April 2009  

Since 1929 there have been five major U.S. stock market drops of greater than 40%, and each drop has created a new "lost generation" of investors who abandoned the markets, never to return. These generational mass exits are understandable, but also sad, since most major drops offered the buying opportunity of a lifetime. The article below discusses why investors typically fail to capitalize on this opportunity.

Best regards,

Milo Benningfield

Why Investing Is Simple But Not Easy
The goal of most investors is simple: buy financial assets when prices are low and sell when they move higher. Why, then, is the goal so difficult to achieve?

From the BFA Blog
Several highlights from our blog at more

BFA Media Quotes
A list of recent media quotes. more

Why Investing Is Simple But Not Easy
The goal of most investors is simple: buy financial assets when prices are low and sell when they move higher. Why, then, is the goal so difficult to achieve?

One reason is that we respond differently to financial assets such as stocks than we do to other types of assets. For example, in the chart below, if I tell you that the columns represent the price of tomatoes in cents per pound, most tomato lovers would jump at the chance to buy them on sale at twenty cents per pound rather than five times that amount.

But if you learned that the columns represent a company's stock price in dollars per share from one month to the next, chances are you'd jump back in the opposite direction. The 80% drop from $100 per share to $20 per share is simply too much for most people to stomach.

This is the irony with stocks and other financial assets: the cheaper they become, the more averse most investors are to purchasing them.

Yes, you say, but there's no natural law to prevent a stock traveling from $100 a share to $20 a share from simply passing through the station on the way over the proverbial cliff. This is true, and we need only look at brand names such as Bear Stearns and Lehman Brothers that disappeared from the public equity markets last year to confirm it.

But when looking at a large basket of stocks such as the companies in the S&P 500 Index, the likelihood that the value of the entire basket will go to zero is phenomenally small. In fact, extensive academic research shows that stocks that have fallen hard have, on average, a higher expected return than the broad market. This is why such "value" stocks have been so tempting to professional investors for decades.

It's also why astute long-term investors see opportunity, not crisis in the chart below depicting the U.S. market crash of 2008:

Yet many investors felt far more comfortable purchasing stocks when the S&P 500 Index was above 1,500 at the left of the chart. And now that the index has experienced a "half-off" sale and moved closer to 800, they don't want anything to do with stocks.

In the short term, stocks may well be riskier than they were a year or two earlier, with the uncertainty regarding their future path much greater than before. And if you said you were planning to double down on the market in hopes of a big payout within the next year or two, I'd advise you to go to Las Vegas instead, where you might at least collect a few good memories.

But for long-term investors, the relevant price isn't next year's price or even the price a few years from now; it's the price at which you'll eventually sell an asset in some more distant future. If, despite all the questions raised by the specter of failing banks and automakers, despite the weekly investment frauds we hear about, and despite concerns about the American consumer, you believe fundamentally that capitalism is a self-correcting force, continuously harnessing the ingenuity, hard work, and desire of billions of workers around the globe, well then, today's stock prices represent a buying opportunity you may never see again.

But don't tell that to the part of your brain that climbed out of the swamp and began running away from saber-toothed tigers. The ancient focus of our brains was on day-to-day survival and avoiding short-term losses – something the behavioral economists call "myopic risk aversion." This was a useful trait when "long term" meant hoping to see next year. But for everyone trying to make sure their capital crosses twenty or thirty years intact, it can be counterproductive.

Another ancient bias is our belief that there is safety in numbers and thus sticking with the herd offers the best odds for survival. Community can be wonderful. But when investors all around you are running for the exits, it's hard not to follow. And yet, according to the simple laws of supply and demand, this is typically the worst possible time to abandon financial assets.

When everyone is buying stocks and bidding up their prices, as in the late 1990's, the reservoir of future buyers required to push stock prices up further begins to drain. But when investors are disgusted and handing off their shares to astute players on the other side of the trade, the reservoir of potential purchasers begins to rise again. In this context, moving against the herd can dramatically increase the odds of achieving long-term investment success.

Unfortunately, environmental factors work against our efforts to overcome ancient biases. In particular, the financial media aid and abet our behavioral predispositions and daily work, wittingly or not, to undermine sound long-term investment strategies. The ubiquity of instant stock quotes, continuously streaming news channels, and the Internet make the current bear market the most watched bear market in the history of humankind.

By contrast, the Wall Street Journal recently underscored the importance of avoiding environmental noise by profiling three money managers who, surprisingly, were managing money during the Great Depression of the 1930's. The article noted:

Despite innumerable bull and bear markets, 17 presidents, and countless economic policies, they've remained remarkably true to their investing philosophy. They've also remained remarkably true to their methods: Forget BlackBerrys; most of them hardly touch their desktop computers. And you won't find CNBC blaring in their offices throughout the day; that's more noise than news to these gentlemen. Instead, you'll find stacks of reading material (these guys actually read a firm's annual report before investing) and a lot of old-fashioned...what do you call it? Oh, right. Math.

Another lesson: if you've lived through enough business cycles, you're less inclined to call the current bear market a "paradigm shift" or complain that "diversification didn't work." Rather, you call it "just part of the natural cycle of the market." As one of the three profiled investors put it:

Despite the constant comparisons with the Depression, Kahn says it's "absurd" to think the U.S. is headed for a repeat of the 1930s when people "felt so helpless." Back then, the Feds refused to aid banks and were powerless to adjust interest rates or insure accounts. In fact, Kahn points out, up through 1971, the Federal Reserve couldn't even lend money if it wasn't backed by gold. Today our government is creating billions of dollars – literally – to help get the economy back on track, we have programs to insure individuals don't lose their bank deposits, and there's a general sense that Washington will do what it takes to help both Wall Street and Main Street. That's not to downplay the troubles ahead, and Kahn is the first to suggest ultrasafe government bonds for part of a portfolio. But as an investor who has seen dozens of economic downturns, Kahn plainly says this is just part of the natural cycle of the market. "Investors have no reason to feel bearish," he says. "True value investors are glad the markets are down."

Well put.

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From the BFA Blog
Here are some recommended posts from our blog. You can access the posts directly on the links below, or by clicking on, or by simply going to the home page of our website at

WSJ: Investment Advisers vs. Stockbrokers
What's the difference between the some 600,000 stockbrokers (a.k.a., financial advisers, wealth managers, etc.) and the 40,000 or so independent Registered Investment Advisors (RIA's), and why should you care? The Wall Street Journal lays out the important differences clearly.

Seek Foxes, Not Hedgehogs For Forecasts
UC Berkeley Professor Philip Tetock is not surprised that most financial experts failed to call the Crash of 2008. He's been uncovering the fallibility of experts for decades.

What Do Financial Journalists Want?
Financial journalists know that incentives drive everything on Wall Street, so their mantra is to "follow the money." But the journalists themselves are driven by an important incentive that's worth keeping in mind when reading the headlines.

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BFA Media Quotes
Recent Media Quotes
Investment News, March 29, 2009
Milo was quoted in Sara Hansard's article, "IRA Proposal Irks Some Independents," which discusses a laudable, but problematic Congressional proposal that only independent investment advisers be permitted to provide advice to participants in the small-company retirement accounts proposed by President Obama. Milo noted one major concern: that there aren't enough independent advisers to meet the enormous demand for unconflicted advice. Read the article.

BusinessWeek Online, March 17, 2009
Milo was quoted in Ben Steverman's article, "Retirement Investing: The End Game," which highlighted how "safe" investments carry their own risks. For example, "Inflation is the big threat," says Milo Benningfield of Benningfield Financial Advisors in San Francisco. "It's the silent killer of portfolios." Further, it's not just the general rate of inflation that investors should consider, but rather what Benningfield calls your "personal rate of inflation." Read the article.

The New York Times, February 26, 2009
Milo was quoted in Ron Lieber's article, "Rules For the New Reality," which addresses what clients should and should not expect of their financial advisors. The article quoted Milo at length on the importance of a sense of modesty as a means of risk management:
Milo M. Benningfield, of Benningfield Financial Advisors in San Francisco, notes that we tend to value aggressiveness. "But when I think about the meltdown, I feel like it was overconfidence," he said. "It was a colossal lack of modesty that led people to underestimate the risk involved and believe that they understood things more than they did."

So to him, a big part of being modest is recognizing your own limits. "You're more inclined to say, What if I'm wrong?" he said, adding that he often reaches out for help on insurance and estate planning matters. "I think the definition of incompetence is failing to recognize that you don't know something."
Read the article.

Wall Street Journal, February 14, 2009
Grouped with other letters to the editor under "Invisible Hand Should Restrain Wall Street Excesses," the Wall Street Journal kindly published comments Milo wrote to the editor in response to an article "Greed Is Good" that attempted to justify the Wall Street bonus system. Milo wrote:

Wall Street's preservation of its bonus system despite its central role in perhaps the greatest destruction of capital in modern finance is fundamentally unfair. What the public understands all too well, and the reason for its outrage, is that the payment of bonuses by firms that cannot even exist without a federal subsidy amounts to a sleight of hand, not the productive "invisible hand" that Adam Smith espoused. This type of greed simply cannot be good for anyone.
You can read the other letters here.

That's it for now. Thank you for reading. Please look for our next newsletter in June.

Best Regards,

Milo Benningfield

1 “Stock Pros Who Survived the Depression,” Wall Street Journal, April 15, 2009.

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