On this episode of The Long View, Jim O’Shaughnessy, author and founder of O’Shaughnessy Asset Management, which was acquired by Franklin Templeton in 2021, discusses how he became a quantitative investor, his work in the public and private markets, and lessons for investors from his latest book, Two Thoughts: A Timeless Collection of Infinite Wisdom.
Here are a few excerpts from O’Shaughnessy’s conversation with Morningstar’s Christine Benz and Ben Johnson.
Why Long-Term Investors Should Love Bear Markets
Christine Benz: What factors do you think investors can take to the bank in terms of how they might construct their portfolios, whether they’re individual stock investors or using funds? Which do you think have some predictive power and could carry them forward to better results?
Jim O’Shaughnessy: My advice in this regard tends to be really boring, because I think that the vast majority of investors would be well served to think of their future selves. We really tend to be hyperbolic discounters. Let’s say you’re 45 or you’re 50, and you want to retire from your job at the traditional age of 65. You’ve still got another 15 years, right? And when I see it happen with young people, that really kills me because young people are time billionaires, right? And so the simplest advice I think is also the best. And that is, understand why you’re investing in the first place. It’s not to have a blast. It’s not to have fun. Certainly, there is an area for speculation if you have a very small amount of your account dedicated to that. But the best advice that I can give is to have the patience to just understand that markets go up and markets go down.
If you’re saving for the long term, you should love bear markets because they allow you to add significantly more in terms of the number of shares, be it a fund or a stock, that you can add to your portfolio if you have a long-term perspective. Again, it sounds so simple, and yet it is not easy because we’re all buffeted by whatever’s happening today, right? We read the headlines, “Oh my goodness, this is going to be horrible,” or “this is going to be great.” So, my advice is really, really simple: Have in your savings—for your retirement or for whatever you’re saving for, your kids’ education, etc.—a very long-term view and keep it simple, sweetheart. If I were talking to a 22-year-old today, and they were saying, “Hey, what should I buy here?” I would say you’re probably going to be best off with a diversified world equity portfolio. You might have some additional investments in bonds or whatnot—I’m not a huge bond fan, though, if you’re young, I definitely would not load up on bonds—but again, simplicity wins the day. We are just bombarded by all of the competing narratives, by everyone’s opinion, by all of the various chatter about what markets are doing and why.
My friend, Nick Maggiulli, wrote a book called Just Keep Buying. And I teased him about the title. I’m like, “That’s very bold.” But I kind of think he’s right. If you’re young and you look at the history of America, at least, since the founding of the New York Stock Exchange under the buttonwood tree back in the late 1700s, US stock prices have been positive about 74% of the time in any given year. That’s a really great base rate.
And so, let’s put it this way: I would never short the United States of America. It comes back from every calamity, every potential misfiring. And when you look at history, that’s exactly what happens. Even Eisenhower, when he was president, he had a heart attack. And the market swooned because the president had a heart attack. I often say, really successful investors unstick themselves from time. They look at what has been, they look at what’s going on now, and what they could reasonably anticipate is a good bet on the future. And yet it’s so hard to do. We become addicted to what’s happening right this minute. I mentioned human nature a moment ago; that refocuses our brain to such an extent that it makes it really, really hard for us to imagine ourselves five or 10 years from now. And we are only thinking about now, it’s kind of like fight or flight, right? And these are very real, powerful emotions. Unless you learn how to deal with them successfully, you’re going to get sucked in, and kind of be like me—selling your puts the day before the biggest bear market in a long time.
Why Bonds Should Not Be Seen as Riskless
Ben Johnson: Jim, I wanted to back up for a second to the remark you made regarding bonds. It strikes me as somewhat contrarian, especially in this moment, when at long last, after years of people making off-the-cuff jokes about return-free risk in the context of many fixed-income securities, risk-free return is back, and there’s a real secular bid for bonds if you just look at where the most money is with most investors and where those investors are in their lifecycles. Is there anything to like about bonds, and what specifically do you not like about bonds?
O’Shaughnessy: Let’s have some disclosures first. I am a real risk-on kind of guy, and when you look at the historical returns for bonds versus stocks versus other asset classes, the long-term data is rather definitive. Now, I don’t universally hate bonds. For example, in the ’80s, my father was looking for a much more risk-free type of portfolio. I was living in Minnesota at the time, and I was finding Minnesota revenue bonds—and for those who don’t know the difference, those are bonds that are backed by not the full faith and credit of the municipality but by the revenue from the project that those municipal bonds are financing—that were 30-year double-digit coupons and noncallable. There, I love bonds, Ben.
But my basic feeling about bonds is certainly they’re, as you mentioned, I think the bond market is what, 4 or 5 times the size of the stock market. And in terms of liquidity and lack of volatility, of course, bonds can play a very key and important part in your portfolio. It’s just that if you’re a long-term investor, the results are rather definitive. I think the 30-year Treasury beat the S&P 500 over the prior 30-year period, like, four times from 1900 forward: 1944 and 1945, and then the Lollapalooza we had ending in 2009. Long-term bonds actually outperformed the S&P 500 over a 30-year period, but there were only four. All of the hundreds of those rolling 30-year periods, stocks did significantly better. My approach is basically predicated on the idea, what are you trying to do here? Are you trying to maximize your portfolio value for a terminal date? Then you’re going, depending of course on your age and your objectives, probably should be favoring stocks.
If, on the other hand, you want to take that volatility off the table, then absolutely, bonds have a place in your portfolio. I would suggest, if you’re doing it yourself, I would suggest using a laddered style, which is buying varying expiration dates. Then you can continually just roll that money forward on your ladder. But there’s also a ton of great bond funds. If it were me, I’d probably be focusing on government bonds because, again, if you are making the trade to reduce volatility and variability, that’s what you’re going to see there. But I would also caution that a lot of people think bond equals safe. If you look at the historical inflation-adjusted rates of return, even on US Treasuries and bonds, they’ve had some massive drawdowns. I think it’s very important that people understand, yes, they’re considerably less risky than stocks, but they’re not riskless.