Offensive or Defensive: Portfolio Strategy for Your Life 2

I mentioned Howard Marks in a previous post and I listened to a great interview with him here:

https://www.youtube.com/watch?v=bfgNtbr2KuE&t=1666s 

He introduces the concept of InvestCon levels based on DEFCON based on US Military classifications. Based on your assessment of the global macro and investor sentiment.

“Things are elevated, but I don't think it's a bubble because a bubble is

characterized by just crazy psychology. And I  did not detect that.

I still don't detect crazy psychology, but stocks have gotten more expensive as the year has gone on. And so you know I  said in the recent memo calculus of value that Nancy and I like to watch action movies and when the bad guys threaten the United States, the Pentagon declares you know like Defcon 2. 

They always say, "Well, should we buy or sell? Buy or sell, hold or dump?" And the world is not black or white. It's gray. It's always gray. And anybody who understands how the world works understands that it's always gray. And it's never risk on or risk off. But I think that we should manage our portfolios conscious of our balance between offense and defense. And we can change that balance given what's going on in the environment. So, I said in the memo that I recommend possibly going to Investcon 2. 

Now if you decide you want to be a little more defensive than usual for whatever your usual is,  you can go to Defcon 1, which is stop buying. Defcon 2, which is tilt your portfolio more toward defense. Sell some of your aggressive holdings and buy some more defensive holdings. Number three, which is get out of all your aggressive holdings. Investcon four is sell some of your defensive holdings. Number defcon five is to sell all your holdings. And number six, defcon six is to go short the market. 

And I'm never confident enough. It's not my nature to be confident enough to go to five or six. But I think it's reasonable at this point in time to just be a defcon two, which is to say just to start biasing your portfolio more towards defense and less towards offense. I'm not saying get out of the markets. I'm not saying don't have investments. And I'm just saying maybe you should shift some of your investments towards lower returning

things which offer more safety.” 

What an interesting framework to act on. While he got the Defcon Numbers flipped, Defcon 1 is highest readiness and most defense, while Defcon 5 is lowest readiness and peacetime, the point still stands. Classifying the present investing or economic environment will help you figure out the best course of action. Even better if these actions are pre-planned already and automatically triggered without too much analysis paralysis which many of us get stuck in sometimes. 

Marks gives guidance in how you do this with a concept called asset allocation: 

 “I wrote a memo called ruminations on asset allocation, roughly October of last year and I said there are two kinds of asset classes: owning and lending. Your brother-in-law  wants to start a business and your spouse says you have to give him money. 

You have two choices. You can lend him money in the hope that he'll pay you interest and get your and you get your principal back at the end. You're not involved in the business. You don't rise and fall with the success of the business, but you hope to get repaid at the end. 

Or you can become a partner and if he kills it, you do well. And if he does terribly, you lose all your money. Ownership or lending. Stocks are ownership. Bonds are lending. If you shift towards lending because it's safer, you usually give up return, but you offload a great deal of uncertainty. If you stay with ownership, you have the possibility of a much higher return, but also the possibility of a low return or a negative return or a total loss.  So every investor at every point in time has to ask themselves what do I want? Do I want to maximize my potential return or do I want to minimize the uncertainty I face?

You can't do both at the same time. I said in  one of my books that people come to me for financial advice, friends, and they ask what  they should do and I say, "Well, which is more important to keep what you have or make more?" And what did they say? Both. Yes. You can't  maximize both. You can't maximize the probability of increasing your wealth and maximize the probability of holding on to what you have at the same time. Everybody has to make a choice and I think it's reasonable to alter your choice as conditions in the world change.” 

All this is directly applicable in life. Have plans for different scenarios. Do you take more risk like work for equity, invest in crypto or startups or do you go more conservative. Ie. get a job, go cash or focus on cash flow. It all depends on the situation. Where do you spend your time with something as basic as spending more time with close friends or family or branching out and meeting new people? 

“I think today by saying none of this is easy and it's not. It's a complex field. It

requires expertise. You know Charlie Munger Warren's partner who passed away a year and a half ago, he said to me and I put it into my first book. None of this is meant to be easy. Anybody who thinks it's easy is stupid. You know, the worst thing you can do in the world is overlook complexity and think things are easy because if you do, you're likely to be victimized.

I'm not panicked. And you know the most important thing if you're going to be play in this game and be investing, you better not panic because if you permit yourself to be ruled by your emotions, you will constantly do the wrong thing. And I don't panic, but this is not the time for a carefree attitude.”

This all sounds a lot like life in general. And as I wrote in a previous post, investing is life. You are investing your life force, your time and your energy. Life is meant to be variable & challenging, it’s meant to have big ups and downs. Bringing portfolio management skills & thinking can help you weather the inevitable challenges better.