Banking on Investment Principles

On Friday, March 10, and Sunday, March 12, regulators took control of Silicon Valley Bank and Signature Bank, respectively, as runs on both banks unfolded. Less than two months later, on May 1, regulators seized a third lender, First Republic Bank. With increasing anxiety, many investors are eyeing their portfolios for exposure to these and other regional banks.

While the urge is strong to rummage through your portfolio, looking for investments to sell when headlines make you anxious, a better first move should be to review your investment plan. Hopefully, your investment plan is designed with your long-term goals in mind and based on principles you can stick with, given your personal risk tolerances. While every investor’s plan differs, ignoring headlines and focusing on the following time-tested principles may help you avoid making shortsighted missteps.

Six Time-Tested Investment Principles to Follow:

  1. Uncertainty is Unavoidable: Remember that uncertainty is nothing new and investing comes with risks. Consider the events of the last three years alone: a global pandemic, the Russian invasion of Ukraine, spiking inflation, and ongoing recession fears. In other words, it may have seemed as if there were plenty of reasons to panic. Despite these concerns, from March 1, 2020 through February 28, 2023, the Russell 3000 Index (a broad market- capitalization-weighted index of public US companies) returned an annualized 11.79%, slightly outpacing its average annualized returns of 11.65% since inception in January 1979.1 The past three years certainly make a case for weathering short-term ups and downs and sticking with your plan.
  2. Financial Markets are Resilient: Over the past 50 years, there have been three instances where the S&P 500 experienced a 50% decrease in value—January 1973-October 1974, March 2000-October 2002, and October 2007-March 2009. Despite these significant market downturns, American companies have managed to thrive and grow. In the past 50 years, the S&P 500 has increased 35 times and its cash dividend has risen 21 times, surpassing inflation which has only increased seven times. Furthermore, the average annual compound rate of total return (including reinvested dividends) for the S&P 500 was 10.3%, comparable to the hundred-year average, despite having experienced three halvings.
  3. Emotions are Volatile: Our emotions can be one of the most volatile elements in investing, partly due to how our brains are wired. First, investors view stock market declines as “losses” instead of temporary setbacks in the long-term upward trend of shareholder capitalism. Second, these “losses” cause them totally self-generated “pain” that feels twice as bad as advances feel good. Finally—and most weirdly—they think the more the market declines, the greater the risk becomes of an even worse decline.
  4. Market Timing is Futile: Inevitably, when events turn bleak and headlines warn of worse to come, some investors’ thoughts turn to market timing. The idea of using short-term strategies to avoid near-term pain without missing out on long-term gains is seductive, but research repeatedly demonstrates that timing strategies are ineffective. The impact of miscalculating your timing strategy can far outweigh the perceived benefits.
  5. Stay the Course: The stock market consistently and wildly overdiscounts both positive and negative economic cycles and the fortunes of companies. As we have seen, great companies have a solidly positive long-term upward trend in earnings, dividends, and values. Furthermore, population growth, eco-nomic growth, innovation/productivity, and the law of creative destruction positively influence intrinsic values. Therefore, riding out the cycles and letting market prices migrate back toward fundamental values is best.
  6. “Diversification is Your Buddy:” Nobel laureate Merton Miller famously said, “Diversification is your buddy.” Thanks to financial innovations over the last century in the form of mutual funds and later ETFs, most investors can access broadly diversified investment strategies at very low costs. While not all risks—including a systemic risk such as an economic recession—can be diversified away (see Principle 1 above), diversification is still an incredibly effective tool for reducing many risks investors face.

In particular, diversification can reduce the potential pain caused by the poor performance of a single company, industry, or country.2 As of February 28, Silicon Valley Bank (SIVB) represented just 0.04% of the Russell 3000, while regional banks represented approximately 1.70%.3 For investors with globally diversified portfolios, exposure to SIVB and other US-based regional banks likely was significantly smaller. If buddying up with diversification is part of your investment plan, headline moments can help drive home the long-term benefits of your approach.

Preparedness over Speculation

When the unexpected happens, many investors feel like they should be doing something with their portfolios. Often, headlines and pundits stoke these sentiments with predictions of more doom and gloom. For the long-term investor, however, planning for what can happen is far more powerful than trying to predict what will happen.

 

[1] Dimensional Fund Advisors, “When Headlines Worry You, Bank on Investment Principles,” First Quarter 2023 Quarterly Market Review
[2] Consider that a study of single stock performance in the US from 1927 to 2020 illustrated that the survival of any given stock is far from guaranteed. The study found that on average for 20-year rolling periods, about 18% of US stocks went through a “bad” delisting. The authors note that delisting events can be “good” or “bad” depending on the experience for investors. For example, a stock delist-ing due to a merger would be a good delist, as the shareholders of that stock would be compensated during the acquisition. On the other hand, a firm that delists due to its deteriorating financial condition would be a bad delist since it is an adverse outcome for investors. Given these results, there is a good case to avoid concentrated exposure to a single company. Source: “Singled Out: Historical Performance of Individual Stocks” (Dimensional Fund Advisors, 2022).
[3] Regional banks weight reflects the weight of the “Regional Banks” GICS Sub-Industry. GICS was developed by and is the exclusive property of MSCI and S&P Dow Jones Indices LLC, a division of S&P Global.

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.

Data sources for returns and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources we believe to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis nonfactual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes  only  to  reflect  the  current  market  environment;  no  index  is  a directly  tradable investment.  There  may  be  instances  when  consultant  opinions  regarding any fundamental or quantitative analysis do not agree.

The  commentary  contained  herein  has  been  compiled  by  W.  Reid Culp,  III  from  sources  provided  by  TAGStone  Capital,  as well  as  commentary  provided  by  Mr.  Culp,  personally,  and  information independently  obtained  by  Mr.  Culp.  The  pronoun  “we,”  as  used  herein,  references collectively the sources noted above.

TAGStone Capital, Inc. provides this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult your advisor from TAGStone or others for investment advice regarding your own situation.