MONEY Tech

Why Apple is Not a Tech Company

hand pulling iPhone box off shelf
Maxim Shemetov—Reuters

Peter Thiel argues that buying Apple means betting against innovation.

As the founder of PayPal, and the one of the first external investors in Facebook, it’s hard to argue that Peter Thiel doesn’t understand innovation or technology companies. But in his new book, Zero to One, Thiel takes somewhat of a radical approach to these concepts, drawing a line in the sand that may irk many traditional tech firms, as well as their investors.

Despite being both the largest and most well-known firm in The Valley, Thiel’s personal opinion is that Apple APPLE INC. AAPL 0.372% isn’t much of an innovator these days: Just a few years ago, Apple’s stock was a bet on new technology — today, it’s a bet against it (at least according to Thiel).

In a recent phone interview, Thiel told me why he doesn’t consider firms like Apple, and most of the members of the Nasdaq 100, to be technology companies, and what that might mean for their investors.

An odd transformation

Thiel has somewhat of a problem with the concept of a “tech firm” — or at least, what people generally define one to be. In Thiel’s mind, true technology companies are firms leveraged to innovation — to new business models designed to shake up the status quo. Plenty of firms begin their life as a tech company, but those that find success often become something quite different.

“A whole bunch of the Nasdaq 100 stocks are bets against innovation … it’s a long list. [There's] a very short list of companies where you’re actually betting on innovation … Most of [the members of the Nasdaq 100] just throw off huge cash flows, and the risk is actually that there’s some innovation ….These companies are always described as ‘tech stocks’ because they were tech stocks … at some point in the past, but [today] they’re bets against technology.”

Although most still consider Apple, Oracle, and Microsoft to be technology firms, few hold the same opinion of General Motors. Yet according to Thiel, it’s all relative — simply a matter of timing and perspective.

“GM was a tech stock in the 1920s — it was still sort of a tech stock in the 1950s. [But] by the 1980s, you invested in GM as a bet against German and Japanese innovation. You said, ‘I’m long GM because Germany and Japan are never going to build cars that are that good.’ At some point, a lot of these tech stocks become weirdly changed to being bets against technology … [Of course] the companies can never say that, because their internal narrative and their external story is [based] so much around how they were historically innovative.”

Know what you’re buying

Admittedly, General Motor’s transformation from technology firm to incumbent took decades, but Thiel believes the shift is often far more straight-forward: Simply look for the founder to depart. With Apple, the change occurred just over three years ago, with the passing of Steve Jobs that thrust Tim Cook into the spotlight.

Thiel is a fan of Cook’s management skills (“I think Tim Cook has done a very good job in an impossible position to try to fill Steve Jobs’ shoes,” he told me) but believes the Apple story is fundamentally different with him at the helm: Once, people bought stock in Apple because it was creating revolutionary new products — today, it’s all about the cash flow.

“No one is investing in Apple because they think it will create new products. People are investing in Apple because it’s generating massive cash flows, and the bet is that the cash flows will go on [for] somewhat longer than people think … that the rest of the world will not innovate; will not succeed in closing the gap.”

While plenty of investors may disagree with Thiel (the new Apple Watch, for one, gives investors something to look forward to) it’s indisputable that Apple is generating billions of dollars of cash, largely on the back of one product: the iPhone. Apple generated $10.3 billion in cash flow alone last quarter — enough to acquire many members of the S&P 500 outright. The iPhone brings in more than half of Apple’s revenue, and likely the bulk of its profits.

Not a bad investment

But even if Apple’s best work is behind it, it doesn’t make it a bad investment. In fact, Thiel believes Apple could be an excellent stock — so long as the iPhone cash-cow continues to deliver.

“Apple [will keep] generating massive cash flows so long as nothing much changes — as long as it maintains a certain brand lead, a certain premium on the iPhone. [If so,] it will generate huge cash flows [for many years] … the risk is that other people will catch up.”

That risk could come from rival handsets. Competitors like Xiaomi and OnePlus have attracted a fair amount of attention recently for their quality handsets, which they sell at a fraction of what Apple charges for the iPhone. Or it could come from advanced wearables — watches and other gadgets designed to replace the traditional smartphone. It may come from a radical reinvention of the handset — something like Project Ara, that shakes the current smartphone business model to its core.

Of course, it may not come at all — or if it does come, not for many, many years. In which case, the cash flows should continue, and Apple should reward its shareholders.

“Maybe there’s not much innovation happening. Maybe people overestimate innovation … but I think it is very helpful to try to get the framing right and understand, ‘OK, I’m betting against technology here.'”

MONEY stocks

October Can Be Frightful for Stocks. But It Can Also Be Fruitful.

THE DARK KNIGHT RISES, Tom Hardy, 2012.
Ron Phillips—Warner Bros/Courtesy Everett Collection

By reputation, October is the scariest month on Wall Street. In reality, this month tends to be either very good or bad for the market. Which one will it be this time around?

This story was updated on Oct. 15, 2014

Is the Ghost of October Past haunting Wall Street again?

By reputation, October is the market’s scariest month. Six years ago, October witnessed several knee-buckling plunges during the financial crisis — an 8% drop on the 9th, an even-bigger 9% fall on the 15th, followed by a 6% slide on the 22nd.

Go back further, to the Asian currency crisis, and the Dow plunged 554 points on Oct. 27, 1997. Go back further still, and there was Black Monday, when the S&P 500 fell 20% on Oct. 19, 1987. And don’t forget that the stock market crash that set off the Great Depression will commemorate its 85th birthday at the end of this month.

At first blush, this October seems to be trying to join this list.

On the last day of September, the Dow Jones industrial average had climbed as high as 17,145. Two weeks later, the benchmark index was more than than 800 points lower, thanks in part to fears over the slowing global economy, escalating Mideast violence, continuing Russian conflict, and quite possibly the spreading Ebola virus.

Yet October gets a bad rep, and some market observers think this could be a buying opportunity.

While October may be pockmarked with a minefield of securities devastation, history is also filled with examples of strong Octobers for the S&P 500, according to the Stock Trader’s Almanac. Among them: 1966 (up 5%), 1974 (16%), 1998 (8%), 2002 (9%), and 2011 (11%).

return
Ycharts

Plus, when you average out historical performance, this autumnal month isn’t so shabby.

In fact, if you look at each month’s returns from 1988 to last September, October turns out to the third best-performer on average, behind December and April. The S&P 500 has gained at least 3.8% in three of the last four Octobers, according to data from Morningstar.

Liz Ann Sonders, chief investment strategist for Charles Schwab, noted that while some investors might be taking profits after a sustained run up for stocks, “we don’t see anything that indicates a more sustained downturn is in store.”

In a note published online, she added:

“We are entering a traditionally positive period seasonally for stocks. According to ISI Research, since 1950, December and November have been the highest returning months of the year, on average. Additionally, according to Strategas Research Group — also since 1950, in midterm election years — October has been the best performing month, followed by November and December. The recent selling we’ve seen could just be setting up for a nice year-end run.”

So is Sonders right? Will this October turn out to be a treat for Wall Street? Or will it just be one big trick?

MONEY Warren Buffett

Why Warren Buffett Wants to Sell Houses, Cars and a Whole Lot More

Warren Buffett has one of the most respected names in business. Now he's trying to turn that respect into cash.

Even those with only a passing interest in business affairs are familiar with the grandfatherly visage and folksy wisdom of investing sage Warren Buffett. And his long-time investing vehicle, Berkshire Hathaway, is almost a household name as well. Yet, for the most part, the Berkshire brand has remained behind the scenes.

But as new report from the Financial Times highlights, that may be changing. A range of Berkshire subsidiaries and acquisitions are rebranding to emphasize their affiliation with Buffett and his golden reputation. Soon, consumers will be increasingly likely to think of the Oracle of Omaha when they shop for homes, cars, and even when they look at their electric bill.

Earlier this month, Berkshire announced it was buying Van Tuyl Group, the nation’s fifth-largest auto retailer, and renaming it Berkshire Hathaway Automotive. The new business will include 78 locations in 10 states. And that number is set to grow: Buffett says he plans to buy even more dealerships in the future, adding them to the Berkshire fold.

Prudential Real Estate, meanwhile, has already placed more than a thousand real estate agencies under the Berkshire Hathaway HomeServices brand after striking a franchising deal with the conglomerate in 2011. That number is still expanding, both in the United States and internationally. The company plans to pursue further licensing deals in Europe and Asia, in addition to other American markets.

Depending on where you live, Berkshire’s trademark could even be coming inside your house. MidAmerican Energy and PacifiCorp, two utility companies serving Western and Midwestern markets, were recently renamed Berkshire Hathaway Energy and now share a logo.

Why the sudden marketing push for the Berkshire name? Analysts say his celebrity holds value, and could bring in additional business if successfully monetized. “Like Virgin reflects Sir Richard Branson’s rebelliousness and Apple reflects the genius of Steve Jobs, Berkshire Hathaway has brand equity around trust, stability and integrity,” Oscar Yuan, a partner at consultancy Millward Brown Vermeer, explained to CNBC.

The irony of Buffett’s new branding effort is that virtually all consumers already have a deep attachment to Birkshire’s brands. It is, after all, the corporate parent of Heinz ketchup, Benjamin Moore paints, Fruit of the Loom underwear, Brooks running shoes, Spalding basketballs, and the Geico gecko, to name a few. The company’s catalogue even extends to military uniforms (Fechheimer), sweets (See’s Candy) and engagement rings (Ben Bridge Jewelers).

In one way or another, we’re all Buffett customers. Now, it seems, he just wants us to know it.

MONEY Markets

Warren Buffett Tells You How to Handle a Market Crash

Berkshire Hathaway Chairman and CEO Warren Buffett
What would Buffett do? Nati Harnik—AP

Are you starting to panic? Heed the advice of the Oracle of Omaha.

Warren Buffett has never been shy about packing lessons for successful investing into his annual letter to shareholders. That letter is a treasure-trove of insight, presented in a folksy manner that is not only easy to read but incredibly entertaining.

With the market tumbling we’re all likely in need of a few doses of Warren’s unpretentious advice, so I dug through his past shareholder letters to find some gems that may help us navigate the current market drop and build a bigger nest egg for retirement.

1. “It’s better to have a partial interest in the Hope diamond than to own all of a rhinestone,” wrote Buffett in 2013.

Buffett is always hunting for great companies that he can buy for Berkshire Hathaway shareholders, but if he can’t buy the whole company, he’s OK with owning a smaller piece of it instead. Applying this advice to our own investments means spending less time considering how many shares of a company we can buy and more time figuring out where we believe the company will be in ten years. Doing that will help us avoid the pitfall of foregoing investments in great companies like Amazon AMAZON.COM INC. AMZN -8.3403% ) or Priceline THE PRICELINE GROUP INC. PCLN 0.6587% when they’re on sale to buy lower quality companies with smaller share prices.

2. “A ‘normal year,’ of course, is not something that either Charlie Munger, Vice Chairman of Berkshire and my partner, or I can define with anything like precision,” wrote Buffet in 2010.

Sure, the average annual return for the S&P 500 has been 8.14% over the past decade, but assuming that will be our return this year, next year, or any year is folly. Returns are volatile and will continue to be volatile, so we should focus less on the returns for any one period of time and instead focus on buying great companies and socking them away. Consider this point: While the S&P 500 has experienced plenty of fits-and-starts over the past 10 years, those who have owned it all along are up 103%.

3. “Long ago, Charlie laid out his strongest ambition: ‘All I want to know is where I’m going to die, so I’ll never go there,'” wrote Buffett in 2009.

Buffett avoids businesses whose future he can’t evaluate. Instead, he focuses on finding businesses that offer a predictable profit for decades to come. Taking the long-haul approach to finding great companies goes far beyond identifying the next big thing — after all, during the Internet boom there were plenty of Internet companies that soared on expectations rather than profit, and many of those companies have since gone bankrupt. Instead, we should be investing in companies we can understand that are likely to remain winners.

4. “We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback,” wrote Buffett in 2009.

Warren’s cash stockpile is a thing of legend, and while that cash hoard holds back his returns in periods of growth, it also protects him when markets turn sour. Importantly, it also gives him the financial flexibility to take action and buy when prices are right. That plan-ahead mentality is something every investor can embrace by making sure there’s always some dry-powder around to deploy during the market’s inevitable declines.

5. “We would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from decisions made too slowly — or not at all — because of a stifling bureaucracy,” wrote Buffett in 2009.

Buffett doesn’t hesitant when he’s presented with an idea that hits the mark. He recognizes that he won’t be right every time, but he also believes that taking action is critical to realizing the potential of an opportunity. As investors, we can emulate Buffett’s approach by making sure that once we’ve done our due diligence and picked our favorite investments we take action and buy, regardless of the market’s short-term machinations.

6. “Unlike many business buyers, Berkshire has no ‘exit strategy.’ We buy to keep. We do, though, have an entrance strategy, looking for businesses in this country or abroad…available at a price that will produce a reasonable return. If you have a business that fits, give me a call. Like a hopeful teenage girl, I’ll be waiting by the phone,” wrote Buffett in 2005.

Buffett keeps strictly to his investment discipline, but he also keeps an open mind to great ideas that fit into his strategy. Those ideas can come from various places. His acquisition of Clayton Homes, for example, was sparked by an autobiography of Clayton’s founder Jim Clayton which had been given to him as a gift by some University of Tennessee students. Keeping open to opportunities, regardless of their origin, may help us find worthwhile investments for the long term, too.

7. “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful,” wrote Buffett in 2004.

Buffett knows that emotion is a dangerous weapon that, if used incorrectly, can result in significant loss — and, if used correctly, can result in significant gain. Emotional reactions to surging or descending markets can make people buy when they should sell and sell when they should buy. Buffett often compares taking advantage of market slides to shopping for groceries. Last week on CNBC he summed it up by saying, “If you’re buying groceries, you like it when prices go down next week. And you like it if they go down further the next week.” Just as we like getting a good deal on the items at the grocery store we would be buying anyway, we should also be fans of getting a good deal on our favorite companies.

Following in Buffett’s footsteps

Buffett has no idea whether he’ll outperform the S&P 500 over the next year, but he does know that Berkshire Hathaway’s book value has grown a compounded annual 19.7% over the past 49 years. Similarly, we don’t know if our investments will outperform the market daily, weekly, or yearly, either. What we can feel pretty good about is the knowledge that investing in great companies like Coca Cola THE COCA COLA CO. KO 0.4161% and Wells Fargo WELLS FARGO & CO. WFC 1.1858% — two companies that are long-standing Buffett holdings — may help put us on a path to a less-worrisome retirement.

MONEY stocks

Putting the Market’s Tumble in Perspective

Specialist Jason Notter works at his post on the floor of the New York Stock Exchange, near the close of trading, Friday, Oct. 10, 2014.
Specialist Jason Notter works on the floor of the New York Stock Exchange, Friday, Oct. 10, 2014. Stocks continued to fall on Monday. Richard Drew—AP

Investors have some cause for concern — but the recent volatility in the stock market needs to be put into context.

Monday’s late-day selloff left many investors pale, as the Dow suffered another triple-digit loss while the S&P 500 suffered its worst three-day drop since 2011.

Chalk it up to a blitz of bad news — including troubles in the Middle East, the Ebola outbreak, and fears about slowing global growth, particularly in Europe.

But it’s important to put matters in proper perspective.

The major stock market indexes have sunk in recent days, but not by a huge amount.

^SPX Chart

Some stocks have been hit harder — for instance airlines, thanks to fears over the economy and Ebola

^SPX Chart

… and small-company shares, which are more volatile to begin with.

^RUT Chart

Still, even with the sell-off, the S&P 500 has gained slightly more over the past 12 months than its historic annual average of 10.1%.

^SPXTR Chart

And while investors are more frightened than before, as measured by the so-called VIX “fear index”…

^VIX Chart

… the recent spike in the VIX pales in comparison to investor anxiety in 2011…

^VIX Chart

… or in the financial crisis.

^VIX Chart

There is one thing investors should worry about — and that’s market valuations.

Screen Shot 2014-10-13 at 6.01.22 PM

The so-called Shiller price/earnings ratio, which compares stock prices to the past 10 years of average corporate profits, is as high as it was heading into the financial crisis. And history shows that when the Shiller P/E, popularized by Nobel Prize winning economist Robert Shiller, is this far above the historic average of around 16, future stock market returns tend to be muted.

Will that be the case this time? Only time will tell.

MONEY Warren Buffett

Warren Buffett Hates Gambling…Unless He’s the House

The Oracle of Omaha has a history of winning bets. Here's a look at some of his past wagers.

Earlier this week, investing sage Warren Buffett made headlines by predicting Hillary Clinton would win the 2016 presidential election. In fact, he added, he’s willing to put some coin behind it. “Hillary’s going to win,” said Buffett, speaking at Fortune’s Most Powerful Women Summit. “I will bet money on it. I will. I don’t do that easily.”

But that’s not quite accurate.

Sure, the Oracle of Omaha has publicly denigrated gambling, including comments to his Berkshire Hathaway shareholders in which he called it a “tax on ignorance” and “socially revolting.” And he even bought a 10-cent slot machine in his home to teach his offspring the evils of casinos. “I… put it on the 3rd floor of my house,” Buffett explained. “I could then give my children any allowance they wanted, as long as it was in dimes, and I’d have it all back by nightfall. I wanted to teach them a good lesson. My slot machine had a terrible payout ratio, by the way.”

But in fact Buffett has a long history of making very public wagers — and a pretty good track record of winning them. Here are a few of his most famous bets.

$550 on College Football

Earlier this year, Buffett placed his first-ever Las Vegas stake, betting $550 that Nebraska would beat Fresno State by more than 12 1/2 points. The Cornhuskers went on to destroy Fresno, 55 to 19, making Buffett (and other gamblers who rushed to copy him) a healthy return.

$1 Million on Index Funds Beating Hedge Funds

Buffett has consistently recommended index funds as the best investment vehicle for most investors, specifically endorsing Vanguard’s funds in a March letter to shareholders. He’s so sure indexes are the way to go that he bet $1 million that the S&P would outperform a “fund of funds” portfolio of hedge funds over 10 years, after fees, costs, and expenses are taken into account. An asset management firm called Protege Partners took the other side of the bet. So far, Buffett is on track for a payday: Fortune reports that, after six years, Buffett’s horse—Vanguard’s Admiral shares—was beating the firm’s five funds by more than 30% at the end of 2013.

$30 Million on World Cup Soccer

In a way, gambling of a kind is actually a routine part of Buffett’s business—and I’m not talking about his equity investments. One of Berkshire Hathaway’s many revenue streams is selling insurance that protects companies in the event that they have to pay out large cash prizes. For example, Bloomberg reports that in 2010 Berkshire insured an Omaha-based business that agreed to pay one of its clients if the French soccer team won the World Cup. If France wins, Buffett explained at the time, “I think we’re going to lose 30 million bucks or something like that.” But once again the Oracle of Omaha came out on top: Les Bleu were knocked out by South Africa in the group stage.

$1 Billion on March Madness

Thanks to Buffett, NCAA basketball got a lot more interesting this year. In January, the investor teamed up with Quicken Loans to offer a $1 billion prize to anyone who submitted a perfect March Madness bracket. The odds of Buffet losing? According to math site Orgtheory.net, the likelihood of correctly filling out a 64 team bracket randomly is less than 1 in 9 quintillion. But, because March Madness predictions do involve some level of skill, the true odds are difficult to determine. “There is no perfect math…There are no true odds, no one really knows,” Buffett told CNN. That said, he still liked his chances. “I don’t want to say it’s impossible, but it’s basically impossible,” admitted Buffett.

Buffett ultimately won his bet, collecting an undisclosed insurance premium from Quicken chairman Dan Gilbert (“Dan says it is too much and I say it’s too little,” he joked), but it was a close one. In March, ABC News reported that one man, Brad Binder, had in fact filled out a perfect NCAA bracket—he just hadn’t entered it into Buffett’s contest. “I wish I could give you a better reason why I didn’t enter other than I was rushed and heading to work,” Binder told ABC. “Obviously, I didn’t think I’d be where I am now.”

So is Buffett really a gambler after all? Not so much. Other than the Vegas wager, all of Buffett’s other bets gave the Berkshire chairman hugely favorable odds, or involved an industry where his expertise is unmatched. Buffett would probably agree that gambling isn’t really so bad — if you’re the house.

MONEY Bitcoin

Why Bitcoin Fans Don’t Believe in Bad News

People attend a Bitcoin conference on at the Javits Center April 7, 2014 in New York City.
Andrew Burton—Getty Images

Bitcoin might be doing poorly, but for the currency's online proponents, it's always time to buy. Here's the reason behind their optimism.

Updated—Friday, October 10

Last weekend, Bitcoin crashed. The dollar value of a single Bitcoin began to decline on electronic markets starting on Friday and by Sunday afternoon had fallen 14%, to $290.

It recovered a bit in the days that followed, but the slide appears to part of a broader trend: At the Thursday price of about $350, the digital currency has lost almost 70% of its value since its all-time high of $1,147 in December 2013. At the New York Times, Paul Krugman used the roller coaster weekend as an occasion to once again call Bitcoin a long con.

But among the Bitcoin faithful, the sun never stopped shining. On Reddit’s Bitcoin discussion board, for example, home to almost 140,000 enthusiasts of the electronic currency, the price drop was framed as good news. “The good old days are back! Massive walls, manipulation and a true financial wild west – I love it” chirped one of Monday’s most popular posts.

“Who else is enjoying the firesale?” asked another popular participant who claimed to be “picking up tons of cheap bit coin.”

How to explain the eternal optimism? Is it possible that Bitcoin’s most dedicated fans are simply more tuned in to the currency’s long-term potential than the broader market and therefore have a more favorable view of its true value?

Sure, it’s possible — but Meir Statman, a professor at Santa Clara University specializing in behavioral finance, has a more plausible explanation for the findings: Confirmation bias. In short, he says, Bitcoin communities tend to be echo chambers of optimism, giving their members a false impression of the currency’s true value. “What you hear, really, is what you want to hear; what is easy for you to believe: That bitcoin is going to take over and banks are a thing of the past,” explains Statman. “And when you have people who reinforce it, people are not looking for the truth, they are looking for views that are going to support their prior beliefs driven by ideology and self interest and so-on.”

This explanation would seem to be supported by a recent study of Bitcoin users by researchers at the University of Illinois, who found that those who participated in online Bitcoin communities were far more bullish about the currency’s future price than other Bitcoin holders. When asked about the long term value of Bitcoin (which the survey defined as the coin’s price in early 2019), users who talked about Bitcoin on various online platforms produced estimates 68% higher than those who did not.

Screen Shot 2014-10-08 at 10.11.02 AM
An r/Bitcoin user asks (and receives) reassurance following a December, 2013 price crash.

Of course, that’s not a phenomenon unique to Bitcoin or online forums. “There is a similar finding about communities where people describe their investment success more generally, because people tend to brag about their success and not brag about their losses” the professor warns. “If you are not careful, all you hear is that people are making tons of money.”

Statman suggests yet another psychological explanation for the behavior of the Bitcoin community, noting that many people who invest in Bitcoin — and other alternative assets like gold — do so in part because it fits their broader global outlook and ideology. “It is fair to say that lots of the people who invest in gold invest in a view of the world: That the United States is going down, bad things are going to happen, inflation is going to rise,” Statman says.

That makes hard truths particularly difficult to accept, he says. After all, divesting from a stock is easy. Divesting from a world view, well, that’s a lot more painful.

Statman advises investors of all types to avoid confirmation bias and “ideological” investing by talking to people with different perspectives. For example, he jokes, Bitcoin buyers should have asked his opinion of the currency before last weekend. His take: “I think it’s a scam.”

After being contacted by Bitcoin advocates, Statman clarified his position to MONEY. “My initial thought when I heard about Bitcoin from my students is that is a scam. I know now that the technology of Bitcoin might prove useful but I am puzzled by the rush to it.”

MONEY stocks

How to Stay Calm in a Rollercoaster Market

Man in business suit in hammock
PeopleImages.com—Getty Images

After a five-year bull market, investors worry that a big drop is right around the corner. Here are some ways advisers ease clients' fears.

Market swings are top-of-mind for people who still can’t relax, five years after the 2008-2009 stock market meltdown. Investors worry that the five-year bull market in stocks could suddenly turn.

Clients of financial advisers worry about market swings even more than they fear running out of money in retirement, according to a Russell Investments survey.

The reason? Many investors can’t erase memories of 2008, said Scott E. Couto, president of Fidelity Financial Advisor Solutions. The Dow Jones Industrial Average dropped 54% between October 2007 and March 2009. After that dive, the market has risen 133% from March 9, 2009 to Sept. 29, 2014.

“Losing hurts worse than winning feels good,” Couto said. Many older investors are particularly cautious because they are taking retirement distributions, or will need to do so soon.

Relaxation Strategies

Advisers can ease clients’ fears by describing market swings in a long-term context, Couto said. For example, advisers can share statistics with clients to show how long it typically takes for markets to rebound after a downturn, and how stocks have yielded decent long-term returns, despite fluctuations.

Other strategies include holding the equivalent of a “Back to School” night for advisers to tell clients what to expect for the year, said John Anderson, a consultant for SEI Advisor Network in Oaks, Pa., who counsels advisers on running their practices.

Advisers can also prepare clients for future risk, Anderson said. For example, advisers could show estimates of how much money clients would lose if the S&P 500 stock index dropped 20%, 30%, or 40%. That could prompt clients to switch to less volatile investments or at least assess their risks.

That type of groundwork is part of every first meeting with new clients for Robert Schmansky, a financial advisor in Livonia, Mich. Most clients, as a result, never ask about market fluctuations, Schmansky said.

Schmansky’s strategy uses stocks to maximize growth, while balancing portfolios with less volatile assets such as Treasury Inflation-Protected Securities (TIPS) and short-term bonds.

The approach eases clients’ minds because they know that part of their portfolio is safe from market swings and always available for income, he said.

Such strategies have grown more popular since the 2008 crisis, said Couto. Some advisers now pitch “outcome-oriented” investing that focuses on clients’ objectives, such as having a certain dollar amount for retirement or putting kids through college, instead of returns. The adviser may speak of dividing assets into “buckets,” each designed for certain objectives, such as achieving growth, hedging against inflation, or preserving capital.

Some advisers go even broader when adding investments to clients’ portfolios. They may include commodities, such as gold or timber, which could move in a different direction from stocks, or market-neutral funds that claim to do well regardless of the direction of the market. Couto cautions, though, that the risks and fees associated with some such strategies may overwhelm the benefits.

He suggests advisers build stability into portfolios by adding less-volatile bonds, shares of dividend-paying companies and quality big companies with market values over $5 billion.

More importantly, having conversations about risk and volatility can separate the great advisers from the average ones, says Couto. “One of the best things advisers can do is help clients understand their long term objectivesand stay focused on their ‘personal economy,'” he says.

MONEY Markets

Why the Smartest People Aren’t the Best Investors

woman with head in a book
Image Source—Getty Images

The four most important words in investing are, "I have no idea."

In his book The Quest of the Simple Life, William Dawson tells the story of an exam at a 19th century London prep school. One question asked was, “Give some account of the life of Mary, the mother of our Lord.”

Dawson wrote, “One bright youth responded, ‘At this point it may not be out of place to give a list of the kings of Israel.'”

This was a common problem at prep schools. Students were not trained to think. They were taught to recite specific facts and formulas. Anything requiring creative thinking left them dumbfounded. To them, there was basically no world outside of the facts they had memorized. Faced with any question, they responded, often absurdly, with the only facts they knew, Dawson wrote.

I had dinner earlier this week with the portfolio manager of an endowment fund. We talked about a problem in finance: Some of the smartest people we know are abysmally bad investors. Not just average, but abjectly terrible.

We agreed that the cause of this quirk was the same problem faced by 19th century prep-schoolers.

The smartest people we know are geniuses at fields where you can memorize facts and formulas. But any problem requiring squishier, creative thinking is unchartered territory. When faced with these problems, they inject the only thing they know: the facts and formulas they were taught to memorize.

These people are textbook geniuses, but they don’t know the limits of their intelligence. Or even the context of their intelligence. And that’s just as bad as being stupid.

There are economists — very smart ones — who said there was a 100% chance we’d have a recession in 2011. There are brilliant investors who have been certain since 2009 that the market is inches away from collapse.

They made these predictions because they are trained math geniuses who created statistical models showing that these events were certain to occur.

But there is an infinite amount of stuff in finance that can’t be answered with math, facts, or formulas. There are things we can’t measure, and things we can’t understand, ever. Herd behavior, future trivia, and psychology aren’t things we can predict today. It’s just insanity and chaos.

That’s not acceptable to you if you’ve been trained to measure things with facts and formulas. Just like the prep school student, there is no world outside of the facts you’ve been trained to memorize. So you try to predict human behavior with standard deviation, or the decisions of a despotic dictator with a bell curve. And you fail, virtually every time.

Realizing the limits of your intelligence one of the most important skills in finance. P.J.O’Rourke described economics as “an entire scientific discipline of not knowing what you’re talking about,” which is pretty accurate. When you pretend you know something you don’t, your perception of risk becomes warped. You take risks you didn’t think existed. You face events you didn’t think could occur. Understanding what you don’t know, and what you can’t know, is way more important than the stuff you actually know.

In that sense, the four most important words in investing are probably, “I have no idea.”

I have no idea what the market will do next.

I have no idea if we’ll have a recession this year.

I have no idea when interest rates will rise.

I have no idea what the Fed will do next.

Neither do you.

The sooner you admit that, the better.

Check back every Tuesday and Friday for Morgan Housel’s columns. Contact Morgan Housel at mhousel@fool.com. The Motley Fool has a disclosure policy.

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Kickstarter Backers Are Investors, and It’s Time They Got Used To It

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Many Kickstarter users still don't quite understand what they're getting into, or why the site is predicated on risk.

It’s been a rough September for Kickstarter. After a three-week period during which two major projects—each of which had raised more than $500,000 on the site—failed spectacularly, the crowdfunding platform has begun to look a little less like a harmless way for underdog visionaries to fund their passion projects and a little more like a casino. It hasn’t helped that a handful of Kickstarter scams and con men were exposed in recent months.

Recently, Kickstarter appeared to respond to the bad press by revising its terms of service. The new document does a better job of laying out the responsibilities creators have to their backers. No scamming, do your best, try to make it up to people if you fail, and so on. But that move likely won’t fix the deeper problem: That most of the site’s users believe that their donations entitle them to some kind of tangible reward, be it a smart watch or a bamboo beer koozie. In reality, nothing of the sort is guaranteed. That’s because Kickstarter backers aren’t customers making a purchase. They’re investors. And like all investments, Kickstarter projects have a chance of going bust.

To an extent, the confusion is understandable. Kickstarter calls itself “a new way to fund creative projects,” which sounds a lot more innocuous than “Craigslist for angel investing” — even though the latter may be closer to the truth. Backers generally have limited information about the people they are supporting. And once a project is funded, they’re on their own when it comes to enforcing contracts with a creators — to the extent that such contracts even exist. In the event that a scammer takes everyone’s money and runs, Kickstarter won’t offer a refund or even chip in for legal fees. But at least in those cases there’s a clear basis for taking legal action (fraud); when money is squandered in a more conventional way — through bad business decisions — funders have no recourse at all.

However, before anyone deletes their Kickstarter app or swears off crowdfunding for good, it’s worth pointing out that you may have staked your retirement on a similar system: The stock market. Equity ownership, after all, comes with startlingly few guarantees. If Tim Cook decides tomorrow to spend all of Apple’s capital on a strategic Cheetos reserve, there’s really not much the average investor (without a controlling stake in the company) can do about it other than sell off the stock. Sure, the stock market does have additional important protections: greater transparency; legally empowered and (theoretically) independent boards of directors; dedicated regulators and watchdogs, and more. But in both cases investors take on a large amount of risk.

Does that make Kickstarter a bad deal? Not at all. In fact, the risky nature of Kickstarter is arguably the very thing that makes it worth using. Project creators offer something to backers — even if it’s just early access to their product — as a reward for taking a chance on a risky idea.

But it’s important to remember why the maker of that sweet felt iPhone case is giving you priority treatment: Things could all go south. And if they do, you’re the one who’ll take the hit.

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