Embrace Volatility!

S&P 500 returns

As I’m sure most you are aware, that’s what the market has done the past week. Just today the market opened down 1,000 points only to regain almost all of those losses by mid-day and then crash back down in the afternoon. I knew the panic was real when multiple people (who have very little interest in the stock market) reached out to me asking what’s going on. I think one of my friends thought I was out of a job by 10:00 am 🙂

The funny thing is, I didn’t even know the market fell so much until those friends contacted me. I try to pay as little attention to the overall stock market as possible. As a concentrated, long-term investor I think paying much attention to the stock market is a negative free roll. This means there is no upside and only downside. The downside would be the declining market affecting my emotions to where I make a rash decision. There is no upside because no matter what the overall stock market is doing it’s not going to positively affect my job. On a daily basis my investing to-do list is some combination of:

  1. Keep up to date with my current holdings
  2. Seek out new companies to look into
  3. At any one time I probably have 2-3 ideas I’m researching extensively as potential future investments

It doesn’t matter if the stock market is increasing or decreasing, I’m still doing these same things. A decreasing market actually makes the last two jobs easier as there are more companies going on sale.

“In stocks, it’s the only place where when things go on sale, people get unhappy. If McDonald’s reduces the price of hamburgers, I think it’s great.”
– Warren Buffett

I also pretty much always have a non-opinion on the macro outlook and where the market is going. My friends have to get annoyed when they ask me six months apart “where is the stock market headed?” and my answer hasn’t changed from “in the short-term I have no idea, in the long-run it will go up.” Virtually all of my investments (like Hornbeck Offshore Services and Navigator Holdings) are based on a 2-5 year time line so short-term market volatility has virtually no effect on my opinion of my holdings. Mr. Market is very old, grumpy and should mostly be ignored.

In addition, on a personal level I measure my job performance on a relative, not absolute, basis. Gaining 20% a year is fantastic—unless the year was 2013 when the markets increased 30%. Then an automated index fund kicked the thousands of hours of grunt work’s ass. Likewise, if the market drops 20% next year and Wiedower Capital breaks even, I’d consider that a successful year. I won’t earn anything in performance fees, but that’s ok. I can’t control the investing environment that I’m in so I view beating the market as my job. And sometimes breaking even (or even losing money) can be an impressive year.

Off-Topic Ramble
(The above example where I earn no performance fees when breaking even vs a market that loses 20% is a large flaw in performance-based fees. In my opinion, beating the market by 20% shows large outperformance by the money manager and should be compensated. I think the most fair fees for both manager and investor is something like the manager getting 40% of the difference between the manager’s returns and an agreed upon benchmark. I solely focus on companies under a $1 billion market cap so a small cap index is probably the best benchmark to compare my returns to. If small caps return -20% next year and I breakeven, I think I deserve to be rewarded for that. In the example of 40% of this difference, Wiedower Capital would be paid 8% of the investor’s assets under management. With a high water mark, this is the best of both worlds as I only make money when I beat my benchmark and the investor only pays me when they are ahead of that same benchmark. The problem is most investors scoff at the idea of potentially having to pay a money manager when they lose money. Anyway, this side note is long enough. This is a fee structure I love and may consider moving to in the future. Who knows.)

Back to Important Things
I’ve briefly mentioned it on this blog before, but I played poker full-time for a couple years when I was younger (and several more years part-time). I plan on writing a longer blog post in the future on the correlations between poker and investing, but I think the #1 benefit is my attitude towards volatility (in poker, the term would be variance). In poker, the short-term is mostly luck. Someone who has never played before can sit down and beat Phil Ivey if he gets the right cards. However, over the long-term the better players win. This degree of luck adds a large amount of variance into a professional poker player’s income. It’s not unusual that a winning player has a losing streak that lasts several months. Even the best tournament players only profit in a single event 15-25% of the time.

Most people enjoy the safety of a guaranteed income (for good reason of course) but I’ve always thought that sounds boring. Likewise, I think earning a smooth 20% every year in the markets would be boring. The ups and downs constantly change the investment environment which is what makes investing so fascinating. Every day the environment is a little different and every day I’m learning about something new. This intellectual stimulation is what keeps me excited about investing on a daily basis.

When I first started playing poker, the variance drove me crazy (not quite this crazy). Bad beats (when a hand with a low percentage of winning gets lucky to beat the favored hand) pissed me off and losing sessions could ruin the rest of my day. Eventually though, I came to control my emotions and embrace the volatility. All I can do in poker is make the best decision with the (imperfect) information that I currently have and let the cards fall as they may. This background allows me to look at days like today and basically say “meh” and go back to researching companies. Even if this market drop turns into a full blown downswing, there’s nothing I can do about it except keep looking for cheap companies to invest in. Eventually the market will go back up and reward sound investments. I think one of the keys to investing (and poker, and life in general) is worrying about the things you can control and learning to accept that there is a large amount of randomness in everyday life. Easier said than done of course.