“My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
It has been nearly a half century since Jack Bogle launched the first index fund available to individual investors, a revolution that took many years to gain traction. Today, trillions of dollars are managed using passive strategies that attempt to merely achieve the average return of a targeted index. An investment policy that was once seen as defeatist has been embraced by millions of investors. Even Warren Buffett has embraced indexing for the management of his wife’s portfolio following his death.
I have always believed that those who are most likely to dollar cost average into index funds over a long lifetime are the people who know the least about business and investing. Such people keep themselves occupied with their jobs and families and are much less likely to think that they are capable of selecting investments. Ego is less of a barrier when you know that you know nothing about business and investing!
For those of us who do try to pick individual stocks, it is important to have a long-term mentality but this is far easier said than done. This is especially true for value investors who buy companies at a discount to their assessment of intrinsic value. In cases where the stock advances to the investor’s intrinsic value estimate, a decision must be made to continue holding the stock, to lighten up, or to sell entirely.
I suspect that most value investors have experienced the agony of …
- Buying a cheap stock.
- Patiently holding the stock while it remains stubbornly unrecognized.
- Selling the stock when it finally hits estimated intrinsic value.
- Watching in dismay as the stock suddenly gets popular and rockets higher.
For those with a value mindset, it can be more difficult to keep holding a stock that appears to be richly valued than to adopt a stoic attitude holding an unloved stock below your cost basis for a long period of time. There is a tendency to fret more about a richly valued stock declining. Many long term winners have been lost in this manner.
One of my more popular articles in 2020 was My $2 Million Apple Mistake, a real life account of how I purchased 500 shares of Apple at $18 when it was statistically very cheap in the fall of 2000, only to sell the position in early 2001 at $20 for a $1,000 profit. At an intellectual level, I know that there was no possible way to know what the future would bring in early 2001. The iPod wasn’t even released yet!
But at an emotional level, what is now over $5 million in foregone gains stings!
As ridiculous as it sounds today, bankruptcy was not out of the question for Apple during the first few years after Steve Jobs returned to the company. But all I could have lost with my investment was $9,000. My potential gain was effectively infinite. This asymmetry in common stock investing is not considered often enough. Losing $9,000 in 2000 would have certainly stung since it represented nearly a fifth of what I was saving and investing each year, but it would have hardly been catastrophic.
What if I had adopted a strategy of just picking the best investment I could find every year and then doing absolutely nothing for at least ten years?
This would combine active stock picking with a passive hold strategy for at least a decade. In practice, what would have happened is that some selections would have worked out far better than others. But just having one massive winner, such as Apple, would have dominated my results. I would have been content to “admire the flowers” while just stoically allowing the weeds to wither away or even die.
Let’s take a closer look at the concept of “coffee can investing”, an approach that is very simple in theory but harder to implement in practice. After some background on the concept, I will present a proposed variation on the strategy inspired by a practice that both T. Rowe Price and Peter Cundill adopted during their successful careers.
In 1984, Robert G. Kirby published The Coffee Can Portfolio in The Journal of Portfolio Management. While admitting that in aggregate, professional money managers do not produce returns superior to an unmanaged portfolio, Kirby believed that it was possible for skilled active managers to produce superior returns if not hindered by high transaction costs. In order to achieve high returns, such managers had to think like investors with a multi-year time horizon. In other words, active stock selection had to be coupled with a passive buy-and-hold mentality once the selection was made.
How does the “Coffee Can” come into play here?
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