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Quarterly Letter to Clients

April, 2024

Indices at quarter-end (March 31, 2024):

Dow Jones Industrials: 39,807.37 1Q'24 +5.62% YTD +5.62%

Standard & Poor's 500: 5,254.35 1Q'24 +9.11% YTD +9.11%

Sometimes numbers do not tell the whole story without context. For example, in 2023 the NASDAQ index was up 43.4%. Breathtaking.

Put it into context, though: in the prior year, 2022, that index was down by 31.1%. Ah, one may think, the 43.4% gain surely made up for that. One would be wrong.

If you start with one dollar and give up 31.1% you would have 68.9 cents left. If that amount then gained 43.4% the following year, you would end up with 98.8 cents. The huge gain of 2023, it seems, did not even bring you back to the starting point of 2022. Over that two-year period you would be negative 1.2%.

My general goal is to be 4 percentage points above inflation. That may not sound like much, and I may not achieve it in any given year. The past two years, when inflation ran so hot, it was very difficult to hit the numbers. But if, over a longer term, you can consistently return 4 percentage points over inflation, you will be very happy.

It is appropriate to measure returns in light of the amount of risk that one assumes. If you have a portfolio of bonds that yield you 4.5% while the stock market runs at 7%, well, it is apples-to-oranges to compare the two. Bonds are viewed as significantly less risky than stocks, though in any given year anything can happen: in the two-year period 2021-2022 bonds lost 15-18% (cumulative). It's hard to come back from that if your yield is capped in the 4.5% range.

So it is important to be selective in terms of your asset allocation. How important is it to you to achieve above-market returns versus protecting against loss? Does your happiness when you gain outweigh your distress when you lose? Or vice-versa?

Human nature is multifaceted: one facet is that we want more, and we want it now; another is that we want to protect what we have, and do not want to risk it. Markets are a psychological place, where we learn things about ourselves. Where do we lie along the spectrum of greed versus fear, of risk versus reward?

For me, I hate to lose, but I also hate to not keep up with the averages. A satisfying return for me lies somewhere between what the Dow and the S&P do in a given up year, and/or to lose less in a down year. Further, I judge results against a 5-year rolling average. I want to achieve this while having a mix of approximately 60% stocks and 40% bonds. That is the level at which I am comfortable. Your level may well be different.

If my account is 60% stocks, and my objective is to land somewhere between what the Dow and the S&P do, I also have to account for that 40% bond allocation. There I would want to be around the mid-point of what the two bond averages that I track do. Thus, I take 60% of the midpoint of the stock averages and 40% of the midpoint of the bond averages, and the total of those two is my target. I can't reasonably expect such an account to compare directly to the Dow or the S&P.

We learn our lessons and form our expectations personally. Back in 1987 I was just beginning to see the light, meaning that my personal assets (which at the time were 100% stocks), had enough digits for me to believe that financial independence was not an illusion. The crash of that year reduced my personal assets by the value of my house--in one day(!). I vowed to myself that I would never again put myself in such a vulnerable position, and as stocks recovered, I began shifting assets into bonds.

Of course, if I had held steady my net worth today would be significantly more than it is. But I would probably also have ulcers. Each of us has to find our "sleeping point," that balance between risk and safety that leaves us able to sleep soundly through the night, even when markets are in turmoil.

Investing is a long-term project, and success is most relevant when measured over an extended period of time. I admit to a conservative nature; it is more important to me to not lose money (or at least to lose less) in declining years than to be at the top of the rankings in bull years. Consistency wins the race.

Jim Pappas