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Insights

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Valuation

“All intelligent investing is value investing – acquiring more than you are paying for. You must value the business in order to value the stock.”
– Charlie Munger

Expectation

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
– Warren Buffett

Consumer Sentiment

“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”
– Benjamin Graham

No Free Lunches

“Know what you own, and know why you own it.” – Peter Lynch

Investment Costs

“The American economy is going to do fine. But it won’t do fine every year and every week and every month…the only way an investor can get killed is by high fees or by trying to outsmart the market.”
– Warren Buffett

Situational Awareness

“You only have to do a very few things right in your life so long as you don’t do too many things wrong.”
– Warren Buffett

Quantification

“What’s needed is an antidote, and in my opinion, that’s quantification. If you quantify, you won’t necessarily rise to brilliance, but neither will you sink into craziness.”
– Warren Buffett

Behavior

“The four most dangerous words in investing are ‘This time it’s different.’”
– John Templeton

Take a look at any investment book and you will see that there is no magic answer and there are no guarantees in investing. The principles of investing haven’t changed much over the years, however, there are many distractions that get in the way – many of them created by the financial industry. The nature of these distractions changes from year to year, but the danger of being distracted remains the same. To help see through these distractions, Jacobi Capital believes that there are several basic principles that everyone must keep in mind to have the best chance of a successful financial future: Valuation, Expectations, Consumer Sentiment, No Free Lunches, Investment Costs, Situational Awareness, Quantification, and Behavior.

Valuation

Everyone knows: buy low and sell high. This applies to individual stocks, sectors of the economy, or to the stock market as a whole. We use sentiment and expectations data to help point us to areas where prices may be low relative to intrinsic value*. Valuation also helps us have realistic expectations for the range of likely outcomes over the long run, say 10 to 15 years. When prices are high, no matter how desperately we want to project high returns over the long term, we know that those expectations likely aren’t realistic. Conversely, when the market can be bought at a low price, we feel fairly confident in attractive long-term returns even if we experience poor performance in the short term.

*Intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as market value.

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Valuation

Everyone knows: buy low and sell high. This applies to individual stocks, sectors of the economy, or to the stock market as a whole. We use sentiment and expectations data to help point us to areas where prices may be low relative to intrinsic value*. Valuation also helps us have realistic expectations for the range of likely outcomes over the long run, say 10 to 15 years. When prices are high, no matter how desperately we want to project high returns over the long term, we know that those expectations likely aren’t realistic. Conversely, when the market can be bought at a low price, we feel fairly confident in attractive long-term returns even if we experience poor performance in the short term.

*Intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as market value.

Expectations

There is no clear distinction in the financial jargon between Consumer Sentiment and Investor Expectation, but we use these terms differently within Jacobi Capital. For us, Investor Sentiment captures information that comes from surveys or other information external to the markets. In contrast, Investor Expectations refers to information revealed by the market itself- investors’ revealed preferences. Over the long term, we can see the ebbs and flows in investor desire for stocks from different parts of the world. Regardless of the differences, our actions are similar when expectations data indicates overreaction. We look for opportunities to invest when investors are overly pessimistic about a particular sector. We tend to shy away from sectors where investors are herding.

Consumer Sentiment

When optimism rules, people tend to feel overconfident when investing. Conversely, general pessimism often leads people to be irrationally nervous about investing. Within our firm, we typically use the term ‘Consumer Sentiment’ to refer to these longer-term measures of general optimism or pessimism about the economy. When sentiment is extremely optimistic, we treat this as a warning to be particularly careful even though many around us will think we are fools. When sentiment is extremely pessimistic, we must force ourselves to embrace the data and invest what we can. This is our greatest opportunity for wealth creation.

Consumer Sentiment

When optimism rules, people tend to feel overconfident when investing. Conversely, general pessimism often leads people to be irrationally nervous about investing. Within our firm, we typically use the term ‘Consumer Sentiment’ to refer to these longer-term measures of general optimism or pessimism about the economy. When sentiment is extremely optimistic, we treat this as a warning to be particularly careful even though many around us will think we are fools. When sentiment is extremely pessimistic, we must force ourselves to embrace the data and invest what we can. This is our greatest opportunity for wealth creation.

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No Free Lunches

Put simply, if you are promised much higher returns with no additional risk, you should be suspicious. This was particularly evident in the aftermath of the 2008 financial crisis when investors were clamoring for income from their investments because bond yields were at historic lows. Wall Street hates a vacuum, and they will create products to fill the void. The sales pitch for many of the alternative investments offered after the financial crisis sounded something like ‘these are a low risk like traditional fixed income, but they provide much higher income.’ This doesn’t ring true. When presented with a magic answer to your investing desire, your first question should be: why am I so lucky? Or as Warren Buffett famously put it,

“If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.”

Investment Costs

Investment costs are boring, but it is important to be aware of their impact. As an example, investors routinely pay more than 2% of assets for money management each year. This includes the fully disclosed but often hard-to-notice fees paid to mutual fund managers. What does this mean to you after 15 years with your starting investment of $1 million? Even if there is no growth in your investment, that still costs you $300,000 over the 15 year period! Costs matter.

View the Forbes “The Heavy Toll of Investment Fees” article.

Investment Costs

Investment costs are boring, but it is important to be aware of their impact. As an example, investors routinely pay more than 2% of assets for money management each year. This includes the fully disclosed but often hard-to-notice fees paid to mutual fund managers. What does this mean to you after 15 years with your starting investment of $1 million? Even if there is no growth in your investment, that still costs you $300,000 over the 15 year period! Costs matter.

View the Forbes “The Heavy Toll of Investment Fees” article.

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Situational Awareness

Good situational awareness involves two pieces, awareness of your environment and awareness of your own personal situation. Awareness of your environment informs you of the opportunities and dangers around you. For investing, this should involve actively analyzing and tracking issues like current valuations, expectations, etc. It’s not enough to be aware that these things are important; you have to pay attention. Analyzing your own situation involves understanding your own opportunities and constraints because they should have a huge impact on the way in which you invest. For example, you would invest $1 million differently if you were a young adult with no family versus having a spouse and children who have to live on that money.

Quantification

Quantifying investment decisions helps to inoculate us against the simple stories that often drive poor investment decisions. The financial industry and the financial media thrive on simple story-telling because they know from experience that stories are easy to understand, and investors confuse understanding a story with understanding an investment. Exciting companies can be bad investments because expectations are too high. Boring stories may represent fantastic investments because no one is interested in the opportunity. To know the truth requires detailed analysis which is often time-consuming and quite tedious, but it is necessary to help avoid the narrative and focus attention on what really matters.

Quantification

Quantifying investment decisions helps to inoculate us against the simple stories that often drive poor investment decisions. The financial industry and the financial media thrive on simple story-telling because they know from experience that stories are easy to understand, and investors confuse understanding a story with understanding an investment. Exciting companies can be bad investments because expectations are too high. Boring stories may represent fantastic investments because no one is interested in the opportunity. To know the truth requires detailed analysis which is often time-consuming and quite tedious, but it is necessary to help avoid the narrative and focus attention on what really matters.

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Behavior

Behavioral economists and other scientists have been studying the nature of human decision making under uncertainty for decades. Many of their discoveries are relevant for investors and can be used to explain things like financial bubbles and the reasons why sentiment and expectations are important. However, if you truly take the research to heart, you are forced to acknowledge your own humanity and the impact it can have on your own investment process. For these reasons, this is both the most important and the toughest of our principles to fully embrace. Investors continue to chase returns, as evidenced in studies of the average investor returns compared to those of various asset classes. Year after year, investors’ annualized returns underperformed the individual asset classes. As investors continue to buy investments that have done well in the last few years, they often catch them near their peak, not taking into consideration the future growth of a company, instead focusing on past performance.