It is not so difficult to make money. It is easy to lose money. It is very hard to hold on to accumulated wealth over time.
Making money in one’s own business and losing it in someone else’s is too often the case for successful businesspeople. To help you avoid this misfortune, this article will address common misconceptions.
In managing business, we are used to looking at measurements over defined, relatively short periods. We ask what the profits were last quarter, how much did a salesperson sell last month or other such questions. Measurement of investment results is a trickier matter.
For example, we may put money in a company that is in an industry that is consolidating. The investment may produce meager results for several years until the company is acquired at a premium, which results in a very satisfactory rate of return for the entire period. Real estate investors in raw land will recognize the investment strategy.
Similarly, an investment in a company whose industry is out of favor may not produce a satisfactory result until its industry returns to favor even though the company was doing well. Remember that even sound thrift institutions were out of favor until the savings and loan crisis was resolved.
My point about the fickleness of measurement intervals is well illustrated by this year’s extraordinary returns. Clearly, a percentage of this year’s returns is making up for the excess in last year’s decline. In effect, last year’s returns were too low and this year’s are too high. Expand the time period and you have a better measure of investment performance.
Looking forward to the next few years, it is apparent to me that success will require diversification, and I mean diversification for the purpose of improving returns, not just lowering risks.
At current levels, U.S. stock markets challenge us to make heroic estimates about revenue growth and profitability enhancement. If the U.S. stock market promises subpar returns, higher returns must come from other avenues. Our firm is constantly searching for the investment area where returns are superior on a risk-adjusted basis, and we then place some of our money in that area.
A few years ago, real estate had better returns than common stock, and we bought REITs and real estate operating companies. More recently, foreign stock markets promised better risk-adjusted returns, and therefore received more allocation.
Two other categories to place funds are in arbitrage and distressed securities. Arbitrage takes advantage of price discrepancies between related securities. Investing in distressed securities requires careful research to find opportunities, usually in the bonds of companies that have encountered severe problems.
Managers of a business usually should stay focused on their markets. In portfolio investing, it is wiser to scan the investment horizon and diversify into different areas.
Marc Heilweil is president and CEO of Spectrum Advisory Services Inc. The firm manages approximately $260 million in assets, including the Marathon Value Portfolio mutual fund. Reach him at (770) 393-8725.
