The Wisdom of Sages
Be humble, be alert, and stay the course.
This article originally appeared in the second-quarter 2020 issue of Morningstar magazine.
My first investment experience was with the Templeton Growth Fund. My father introduced me to the fund, and we watched Sir John Templeton together when he appeared on Wall Street Week with Louis Rukeyser. I was impressed by Templeton's plain-spoken manner and his commonsense approach--he spoke about investing in terms that even I as a teenager could grasp. I was so impressed that I dug deeper, reading several books either by or about Templeton that made an indelible impression on me. I was taken aback by his insights and his occasional boldness, such as when he famously borrowed money to buy shares of every stock on the New York Stock Exchange trading at less than $1, betting that America would lead a global recovery and expansion after the horrors of World War II.
Mostly, I was impressed by his humility. One thing Templeton said that has stuck with me to this day was that any time you buy a stock, no matter how well you have researched it, no matter how convinced you are of its merit, you should be prepared for it to drop by 50%, 60%, 70%, or more. I was floored by this claim. Templeton was a stock-picking genius. He had a team of talented analysts. He had access to the best Wall Street insights. Surely he was rarely wrong about a stock, and surely when he was, it was never by this magnitude. I could see my stock picks dropping sharply, but surely not those of such a respected pro!
When I joined Morningstar and began to pursue a career in investments, I recognized a need to expand my reading beyond Templeton. I started a program of trying to read an investment book a week for the next two years. Some of these texts, such as John Train's The Money Masters or Burton Malkiel's A Random Walk Down Wall Street, were similarly insightful, but much of what I read was of a very different tenor. Gone was the humility of Templeton. In its place was a greater degree of hubris about the inevitability of investment success, the certainty of bets now seen in retrospect. While some of these texts conceded that investment returns could be unsteady, they all focused to various degrees on the certainty of long-term winnings, provided one stuck with the program. These writers all assumed that stocks would rise by 10% a year on average--small stocks even more. (And their picks, of course, could be assumed to rise over time by something more than these market averages because at that time it was assumed that great managers regularly beat the market--and the people who got contracts to write investment books were obviously great investors.)
These writers conceded that investment returns might be choppy, say up 20% some years and down 20% in others, but they uniformly assumed that they would average around 10%. None of these experts asserted the possibility, much less the likelihood, of a 70% drop as Templeton had. As such, of course, none addressed what it takes to get back to a 10% average if you experience a 70% decline--especially if it happens early in your experience and it scares you out of the market. In other words, these writers of lesser skill and experience than Templeton had only a fraction of his humility and real-world insight.
As I continued my career at Morningstar, I got more insight into the world of institutional investing and was struck by the even higher level of hubris I saw there. Armed with sophisticated mathematical models, these investors could spit out expected returns and risk exposures to the second decimal. The abject failure of portfolio insurance or the inability of these models to navigate the Asian or the peso crises, the tech collapse, or the 2008 global financial crisis did not diminish the hubris of these pros. The contrast between Templeton's humility and their arrogance could not be more extreme. The more sophisticated your model, it seems, the harder it is to admit that you just don't know.
After all my reading and experience in the investment world, I still come back to Templeton's insight--any stock at any time can lose most of its value in an instant. The best financial advisors embrace this truth. But they also recall Templeton's belief that even given this chance of loss, investing is still a worthy activity and that out of the chaos of great losses comes the opportunity for great gains, as seen in Templeton's big bet on downtrodden stocks coming out of the Second World War. Wise investors must be ever alert to both the dangers and the opportunities the market brings them. You don't need a multimillion-dollar model to tell you that--you just need some courage and some common sense.
When all the latest technology fails us, we can take solace in time-tested wisdom: Be prepared for big, unexpected losses. Be alert for opportunities when others lose hope. Above all, stay the course.
Don Phillips is a managing director with Morningstar. He is a member of the editorial board of Morningstar magazine.