I'm finishing up this piece today as I overlook Lake Avenue from my daughter's apartment in Chicago and then dashing off to catch a plane back to sunny Florida. I had a grand time here, even though the Cubs didn't pull it off, but I can taste winter in the air and it's time to get back to my alligators. This search for a Grand Unified Theory of Investing has produced some other research avenues and I can't wait to explore them in a much warmer climate.
Before we go on, though, we need to look at our last two buckets. As I mentioned earlier this week, I wrestled with including community banks under the big value umbrella or making it a stand-alone bucket. Buying financially solid small banks below book value is safe and cheap investing at its finest, but at the end of the day I decided they deserve their own bucket. The consolidation wave will continue for at least two more decades and I think you should have at least 20% of your portfolio in this bucket at all times.
As this consolidation wave flows between high and low tide, community banks will go in and out of the momentum section as well, so you will be well over 20% in community banks at times -- and that's fine. The 20% level should be the minimum. I won't rehash the whole idea but I have written about it many times. It is the trade of the decade and beyond and you need to be involved.
The final bucket of the Grand Unified Theory portfolio is the one that I get the most flack about. The idea of holding 20% of your portfolio in cash until a severe crash is something most people just cannot grasp. They see cash as a drag on returns, especially in these days of extraordinarily low rates. The fact is, having cash for a crash is how you end up owning Disney (DIS) at $19, Ashland (ASH) under $10 or Apple (AAPL) under $20.
Investors who had lots of cash in 1998, 2002 and 2009 are now wealthy and that cash that held down returns for a few years turned out to the best investment they ever made. Keep in mind, Charlie Munger's suggestion that "It takes character to sit there with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities."
When I talk about holding cash for a crash I am always asked how to know when the market is crashing. Is it down 20% from the highs? 25%? What is the magic number that tells you the market is crashing and it's time to buy?
Generally, I think it kicks in around 20% down but trust me when I tell you that you will know a crash when it happens. There will be a smell of panic in the air, hedge funds will be liquidating, early afternoons will see waves of margin-call selling, volatility will be spiking and tired-looking politicians and Fed officials will make reassuring statements that are not matched by their haggard appearance.
Similar to what a judge once said about pornography, you will know a crash when you see it. The hard part is not getting caught up in the anxiety and using your cash hoard to buy great companies at incredible prices.
The Grand Unified Theory should work very well for investors who have accumulated some wealth and want to manage it wisely. If you prefer, you might be able to use hedge funds or other pros to manage part of the portfolio and just manage the buckets in your realm of competence. But I don't think there is a lot of rocket science involved and most folks can manage this approach to managing wealth.
If you are in the accumulation phase of your financial life I believe you can pick one or two of the buckets and specialize in those to build wealth over your working years. Community banks should be part of any long-term wealth-building program, regardless of age, but you could pair that with one of the other buckets and do very well with your long-term investments.
Given where we are today I would guess that the 35-year-old investor who starts with community banks and cash for a crash could set themselves up for extraordinary long-term returns.
All five buckets have been proven to earn high returns over time. They do not have huge correlations to each other and the mix of the five should dampen volatility enough to provide a very good night's sleep for even the most nervous investors.