In an article about the challenges of autonomous vehicles, I came across a chart of the Hype Cycle from the consulting firm Gartner that supposedly models the life cycle of new technology:

Maybe it’s just me, but I found this curve to also describe my self-confidence in investing over time.

• Trigger. One day, something makes you want to learn about investing. For me, it was finally leaving broke academia and getting a “real job” that had triple the salary and this 401(k) match thing.
• Peak of inflated expectations. Read some books! 8% annual returns… double my money every 9 years… yes! Asset allocation… backtesting… of course! 4% withdrawal rate… just accumulate 25x expenses… simple!
• Trough of Disillusionment. I get laid off at the same time that my nest egg drops in half? No way. After an entire decade, which is 1/3rd of my lifetime so far, I could actually end up with less money than I put in? No way. Multiple countries will shut down completely for 3+ months at a time, one after another? No way.
• Slope of Enlightenment. After some time, that advice about diversification, liquidity, understanding true risk, and knowing your temperament starts to feel a bit different. There is still more to learn.
• Plateau of Productivity. Wow, that last crisis wasn’t as bad. I have a plan and have enough assets and liquidity to implement that plan. My overall vision has changed and it includes working for longer but at something that I enjoy and without short-sighted corporate metrics.

Of course, maybe I’m still be overconfident, and I haven’t truly hit that big trough yet. Good thing I stocked up on the antacid.

When the market sell-off first started in February, there were several articles proudly pointing out how few 401k investors made any changes to their accounts. Nobody panicked! Yay! I remember thinking that such a declaration of victory was rather premature. If you have held onto your stocks so far according to your formal investment plan, then I applaud your conviction (or ability to not check your 401k balance). However, I also think it’s important to realize that the ride may be far from over.

This chart made the rounds in 2007 during the Great Financial Crisis, and has been copied so many times (you can tell by the blurriness) that I have no idea the original source. However, I still come back to it time and again.

Based on my own experiences, I can show you comments which gradually change from “This is just a temporary setback. I’m a long-term investor!” to “I can’t handle any more losses. I am selling and waiting this out!”.

My wild guess is that we are past the Anxiety stage and are somewhere in the Fear stage. There is still room for Desperation, Panic, and Capitulation. It’s like the awful seven dwarfs… I feel these emotions too, even if I don’t act on them. We are living through a historic moment. However, I see no permanent impairment in the power of productive businesses.

You won’t see a lot of market commentary on this site, as I don’t think adding to the noise is helpful. Thanks to the scientists and healthcare workers that will get us through this one, thanks to the other essential workers that have to stay out and about, and thanks to those that are helping by staying at home. Onwards (good movie BTW) to Hope and Relief!

I’ve been sitting on this post for a week, but I’ll feel better just letting it out. When we talk about investing, a lot of it is about long-term thinking and exponential growth. There are many charts showing that the person who starts saving early and stops completely after 10/15 years does better than the person who waits around but eventually saves twice as much per year. Once the ball starts rolling, it’s hard to stop. Here is one example from ForUsAll.com:

This is the power that comes from forced savings (pensions) and automated savings with default contributions (401k/403bs). Along the same lines, here’s a chart of Warren Buffet’s net worth over time from ValueWalk. Most of his money came very late in life. Look at that compound interest.

This understanding of exponential growth and the importance of early intervention applies to viral pandemics as well. If you act early and aggressively, you can stop the exponential growth. St. Louis acted aggressively during the 1918 Flu Pandemic, shut down the city early, and saved many lives. It was unpopular, but it worked. Taiwan has been aggressively screening, testing, and tracking since December 2019 and despite its proximity to China has only 45 coronavirus cases. Singapore acted similarly.

Meanwhile, Italy went from only 3 confirmed cases to 15,000 confirmed cases in a span of 5 weeks. (February 6th to March 12th. Source.) The other option is to take a slow, reactionary stance. You let the exponential grow happen. The result is that you will need to shut down the entire country and do it more extremely and for a longer time. You picked the “Save more later” option. Unfortunately, here it means a lot more dying people and overwhelmed hospitals. It also means bankrupt businesses, less hours available, less jobs available, and huge childcare problems.

Do you think the US will be closer to Italy or Taiwan? The US has only tested 5,000 people total, ever. South Korea has tested 200,000 and is 1/6th the size. That’s 240x the testing rate. If you don’t test, you can’t get a “confirmed” case and they remain invisible. If you don’t track the infected people down and isolate them, you can’t stop the spreading. This is bad!

I’m not saying the world is going to end. I have not sold any stocks and am following my established investment plan. I believe that we will eventually get through this together. Mostly, I am greatly saddened that our local, state, and federal leaders have collectively decided to choose to the option of deferred, greater pain.

Bottom line. Each day that we delay widespread testing and tracking, the longer we will have to shut down our lives to get back to normal. It’s coming. Be ready. Think about how you are going to manage childcare when schools are shut down. Make sure you’ve built up that emergency fund in case your job hours are cut. If you’ve been meaning to lower your interest rate on debt, now may be a good time to transfer it to 0% APR. If your financial situation is stable, try to refinance your mortgage and lower your monthly expenses.

While we see the live price of the S&P 500 index everywhere, there is much less talk about its dividends. Dividends are an important component of the total return from stocks. I love seeing my quarterly dividend payments arrive every quarter, and combined with our reduced work income, they are enough to cover our household expenses. How reliable is the income stream from owning an S&P 500 index fund (or similar total market fund)?

Here is the growth of the 12-month dividend per share of the S&P 500 on an inflation-adjusted basis (source).

Looks pretty good overall, but how bad were those drops? Inside this Movement Capital article about managing sequence-of-return risk, I came across a helpful chart showing the historical drawdowns of dividends (inflation-adjusted) from the S&P 500 index since 1900.

William Bernstein has been quoted as saying that you can only treat 50% of your dividend income as reliable. Below is an excerpt from his book The Ages of the Investor that provides more context:

If you counted on your stock holdings to see you through retirement, you’re likely to be seriously disappointed. Yet, there is a small part of the equity portfolio that can be considered in the funding of retirement: the “safe dividend flow” from stock holdings. Although the value of stocks can fluctuate wildly, their stream of income is much more stable. At no point in the history of the U.S.stock market has its real dividend stream fallen by more than half, even during the Great Depression. During the most recent financial crisis, for example, although stock prices fell by more than 50%, dividends also dropped, but by only 23% from their peak, and only temporarily.

That pretty much agrees with the top chart. Dividends have dropped by up to 50%, but it has not dropped that much since around 1950. Since about 1950, the greatest drawdown of overall S&P 500 dividends has been about 25%.

Dividend payout ratio. The dividend payout ratio is the percentage of net income that a business pays out as dividends. For example, a company might earn $10 a share in net profits and pay $6 a share as a dividend. That is a dividend payout ratio of 60%. In the 1930s and 1940s, the dividend payout ratio consistently averaged above 60% (source). The majority of profits were paid out to shareholders. However, since then the dividend payout ratio has been dropping, with the average now in the 30% to 40% range (chart source):

In theory, it should be much easier to maintain a dividend when you are only paying out 30% of profits as cash, as opposed to 60% of profits as cash. Of course, anything can happen. At the minimum, your withdrawal plan should be prepared for a 25% drop in dividends at some point in the future.

Bottom line. The S&P 500 dividend has dropped by up to 50%, but it has not dropped that much since around 1950. S&P 500 businesses have been steadily decreasing the percentage of profits being paid out as cash dividends. Today, dividends only account for about 30% of overall profits (not 60%+). In theory, this should make the dividend less prone to large cuts.

During times of market volatility, people often start looking for other options. There is always a new “alternative” asset class being pitched that in theory both reduces the risk in your portfolio and increases returns. Longboard Funds looked at data from the past 15 years and examined what happened when you added 20% of various asset classes to a traditional 60/40 stock/bond portfolio. Below is a chart of the results based on two factors:

• Did the asset class have a lower or higher correlation in declining markets? This reduces maximum drawdown.
• Did the asset class improve overall historical return?

The 6 asset classes that both lowered max drawdown and increased overall return were:

• Managed Futures (Trend Following) (SG Trend Index)
• U.S. Treasuries (Barclays 1-3 Yr US Treasury TR Index)
• Master Limited Partnerships (Alerian MLP TR Index)
• Municipal bonds (Barclays Municipal TR Index)
• Gold (S&P GSCI Gold Index)
• TIPS (Barclays Gbl Infl Linked US TIPS TR Index)

Not coincidentally, Longboard Funds offers a managed futures mutual fund. The expense ratios for are 2.87% and 2.88% for the two share classes. I would be concerned that a 3% drag on the the SG Trend Index might change up the real-world results?

My take. Your next consideration should be to research each asset class on your own and determine which ones you have strong faith in over the long term. As diversifiers, these asset classes will have long periods of poor performance during bull markets. You must be able to hold onto these asset classes so that they can eventually help you in a bear market.

Personally, I believe that managed future are too complex and the available products too expensive. I feel the same about MLPs. I don’t own gold myself, but can understand why others might include some in their portfolios.

This leaves me with the classic high-quality bonds: US Treasury bonds, Municipal bonds, and TIPS (also fully backed by the US government). I do indeed own these in my personal portfolio. Hopefully you’ve owned these for a while, as the interest rates just keep getting lower (and the value goes up, for now). Ah well, I’m still buying as needed even though the yields are tiny.

While helping a 92-year-old relative with her estate planning last week, I discovered that she receives dividend checks from ExxonMobil mailed to her every quarter. I also discovered she was an early retiree herself, retiring at age 50 with a government pension and these Exxon shares. What a long retirement! She has the literal mailbox money that Jack Bogle was talking about!

I went home and ran some quick numbers. I’m not going to disclose how much she owns, these are just some round numbers. In 1980, the Exxon quarterly dividend averaged 8.45 cents per share. As of 2019, the quarterly dividend has grown to 87 cents per share. (Thank you Divdata.com.) That means that the dividend has grown roughly 10X in the last 40 years, roughly 6% annualized. That’s if you spent the dividend every 3 months without any reinvestment at all and completely ignoring any increase in the share price!

That means if she was cashing checks for $1,000 a year in annual dividends in 1980, she’d have all that income for 40 years while still cashing checks for $10,000 a year today. ExxonMobil is a Dividend Aristocrat, which means it has raised dividend payouts for 25 consecutive years or more. (It’s actually raised dividends every year for the last 37 years.)

This was even greater coincidence because just a week earlier, I had bought additional ExxonMobil (XOM) shares in my “Fun Money” account – my only individual stock purchase so far in 2020. The XOM share price has been struggling in the short-term, due to a variety of reasons (lots of natural gas = low crude oil prices, large reinvestments = low free cash flow, etc). However, I believe it to be cyclical and haven’t seen any reason to doubt its long-term prospects. If somehow we discover a cheap, limitless source of energy that makes oil worthless, I would happily take that win for society and see my Exxon holdings go to zero.

This is not meant as a recommendation to buy ExxonMobil stock, as my Fun Money account is more of an educational tool for myself and someday my children. I want them to understand that stocks are parts of real businesses. This story about their favorite great-grand-auntie will be a great reminder that while the news is often scary, we can’t forget the benefits of a long-term perspective.

Berkshire Hathaway (BRK) has released its 2019 Letter to Shareholders. I highly recommend sitting down and reading the entire thing straight from the source. It’s only 13 pages long this year and written in a straightforward and approachable manner. Here are my notes with quoted excerpts. In my opinion, the overall theme of the letter was “Here’s why Berkshire will be fine without Warren Buffett”.

Buffett reviewed the various unique points of BRK and why he make it that way. Allowing their wholly-owned companies to retain earnings lets them grow exponentially like compound interest. Each company is run by their own management with great freedom. Their insurance side has both exceptional underwriting skill and effective investment of the float. If you can’t own an entire company, you can own part of it through common stocks. The shares of companies that BRK owns have high returns on net tangible equity capital (solidly profitable) and do not hold a lot of debt.

In other words, Berkshire is (still) built to survive and thrive beyond the next recession. None of these things are dependent on Buffett or Munger.

“Your company is 100% prepared for our departure.” If you didn’t read between the lines, Buffett straight up says it.

The two of us base our optimism upon five factors. First, Berkshire’s assets are deployed in an extraordinary variety of wholly or partly-owned businesses that, averaged out, earn attractive returns on the capital they use. Second, Berkshire’s positioning of its “controlled” businesses within a single entity endows it with some important and enduring economic advantages. Third, Berkshire’s financial affairs will unfailingly be managed in a manner allowing the company to withstand external shocks of an extreme nature. Fourth, we possess skilled and devoted top managers for whom running Berkshire is far more than simply having a high-paying and/or prestigious job. Finally, Berkshire’s directors – your guardians – are constantly focused on both the welfare of owners and the nurturing of a culture that is rare among giant corporations. (The value of this culture is explored in Margin of Trust, a new book by Larry Cunningham and Stephanie Cuba that will be available at our annual meeting.)

I remember a quip by Charlie Munger on this topic that went like this: “Do you really think Warren will mess this up?”

Stocks and interest rates. BRK owns a lot of stocks and zero 30-year Treasury bonds at 2%. I look to their actions as well as reading their words:

Forecasting interest rates has never been our game, and Charlie and I have no idea what rates will average over the next year, or ten or thirty years. Our perhaps jaundiced view is that the pundits who opine on these subjects reveal, by that very behavior, far more about themselves than they reveal about the future.

What we can say is that if something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments.

The catch. Individual investors should read this carefully:

Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater. But the combination of The American Tailwind, about which I wrote last year, and the compounding wonders described by Mr. Smith, will make equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!

Personally, I do agree that Buffett has spent a lot of time on the “estate plan” for Berkshire Hathaway. I applaud that, as it is another example of his rationality. People usually hate thinking about their death and put off making wills, etc. He has done everything in his power to keep the Berkshire culture going for decades to come. As a shareholder myself, I really do hope that he is successful. I don’t plan to sell any shares upon his death. However, I’m comfortable that most of my money is in index funds as any company culture can erode over time.

Past shareholder letters.

• 1977-2019 are free on the Berkshire Hathaway website (PDF). 1965-2018 are $2.99 at Amazon (Kindle). Three bucks seems pretty reasonable for a permanent copy with the ability to make searchable highlights using Kindle software.
• 2018 Letter discussed using debt very sparingly and the importance of holding productive assets over a long time.
• 2017 Letter discussed patience, risk, and why they have so much cash.
• 2016 Letter touched on the rarity of skilled-stock pickers and some insight on his own stock-picking practices.
• 2015 Letter discussed his optimism in America and his “Big 4” stock holdings.
• 2014 Letter discussed the power of owning shares of productive businesses (and not just bonds).
• 2013 Letter included Buffett’s Simple Investment Advice to Wife After His Death.

Berkshire’s 2020 annual meeting will take place on Saturday, May 2nd. Last year, I again enjoyed listening to it in the car via the Yahoo Podcast. Here are the many ways you can access Berkshire Hathaway Shareholder Meeting Full Videos, Transcripts, and Podcasts.

XCKD’s latest comic is about stock picking and the efficient market hypothesis:

The hidden hover text goes on – On the news a few days later: “Buzz is building around the so-called ‘camping Roomba’ after a big investment. Preorders have spiked, and…”

XKCD is finding humor in the idea that stupidity can be made profitable. But highly efficient markets really do take away the effects of stupidity, because the prices are already adjusted accordingly. You can’t be convinced to buy Apple at $500 a share when it’s trading at $320. On the other hand, if you find success in picking stocks, it’s really hard to separate luck and skill. Humility is in order.

I would also extend the idea of humility to also include skepticism. The promise of easy money solutions anywhere should always ring alarms. It really hurts to read about people being told that buying another new car is the solution to not being able to afford their current car. We have doctors convincing other doctors within Facebook groups to lose millions in a cryptocurrency hedge fund where instead of brokerage statements, they accepted phone screenshots.

Edges are rare. Why does your edge exist? What is your evidence that it exists? Why has nobody else thought of it? How much will it cost to make the bet? If it does exist today, how long will it last? Why is it durable?

In addition, remember the Kelly Criterion and adjust your bet size with the size/confidence level of your edge. Even if you knew with 100% certainty that a coin was biased 60% heads and 40% tails, you could still go bankrupt if you bet improperly! I make some “Fun Money” bets, but they are very small portion of my net worth.

What I like about my retirement portfolio is that I could not touch it for 50 or 100 years, and I wouldn’t worry too much. I can be a little stupid; I don’t need to watch it like a hawk or be a hedge fund genius. My bets are relatively humble.