Elon Musk Is Now Richer Than Warren Buffett

I’ve been writing a lot about Warren Buffett these days. Perhaps I’m looking for a little sanity in a world that seems to have gone insane. The Oracle is certainly one to put things in perspective.

But adding to that long list insanity, last week Elon Musk passed Warren Buffett on the list of the world’s richest people. Musk’s company – leading electric car maker Tesla (Nasdaq: TSLA) – is up nearly 300% this year, which helped catapult Musk into the spot of the world’s seventh-richest person.

I like Elon Musk. As a fun fact, Robert Downey, Jr. modeled his Iron Man / Tony Stark character on him. I could imagine Musk building his own weaponized robot suit to fight the forces of evil.

But he shouldn’t be the world’s seventh-richest man. And Tesla shouldn’t be worth $290 billion. To put that in perspective, that’s more than six times as large as Honda Motor Company (NYSE: HMC) and more than eight times as large as General Motors (NYSE: GM).

I get it. Tesla isn’t an old economy car company. It’s a new economy tech company that happens to make cars. Or at least that’s the justification investors are using today.

But this story goes far beyond Tesla and its would-be superhero CEO. Tesla is a particularly nutty case of market insanity because it’s never turned a consistent profit in its 10 years as a public company. But there are signs everywhere that the U.S. stock market, let by tech stocks, are in a bubble.

I’m not calling the top just yet. If the recent surge of virus cases and the threat of a new round of quarantines hasn’t killed the bull market, I don’t know what will. But I think it’s important to have a game plan for when all of this ends. So, let’s go through a quick checklist.

Check Your Allocation

Unless you’re fresh out of college and just starting your career, you shouldn’t have all of your money in stocks. There’s nothing wrong with using a buy-and-hold strategy, of course. But even if you’re buying and holding, there’s room for regular rebalancing. If you’re in or near retirement, you probably shouldn’t have more than 60% in stocks, and I think you could make a case for having a lot less than that today given stock valuations.

So, check your allocation. If you’re a little too heavy in stocks, consider selling down your portfolio to a level that makes sense.

Value is Dead… at Least for Now

I’m a value investor at heart, so it pains me to say this. But value investing really is dead for now. Value investing has trailed growth investing for over a decade, and the coronavirus has actually made this trend worse. Tech growth stocks tend to be the most “virus proof,” whereas a lot of value stocks have been hit particularly hard by forced closures.

This will turn… eventually. At some point, investors will come to realize that value stocks are too cheap to ignore and tech stocks are priced for unrealistic growth. But I don’t see any catalyst in the immediate future to make that happen. So, at least for the time being, don’t try to be a hero and call the bottom in value.

Don’t be Afraid of Momentum

John Maynard Keynes famously commented that the market can stay irrational longer than you can stay solvent. We have no idea how much higher this bubble has to go before it ultimately bursts. Alan Greenspan talked about “irrational exuberance” in 1996, and the market went on to rally for nearly four more years.

It may be irrational. But it’s also perfectly fine to ride it higher so long as you have rules in place for selling.

That’s the key. Have selling rules in place and actually follow them. If you set a 10% stop loss (or whatever you use to manage risk), you have to actually honor it or it’s useless.

The 60/40 May Be Dead, but the ‘Permanent Portfolio’ Is Worth Revisiting

I wrote a few months ago that the 60/40 portfolio is dead.

“Dead” might have been a little harsh, but with bond yields as low as they are today and stocks close to hitting new all-time highs, a portfolio that is invested 60% in stocks and 40% in bonds isn’t likely to generate the kind of returns we’ve come to expect.

But what about that old relic of the 1980s, the Permanent Portfolio?

The Permanent Portfolio was a concept popularized by the late Harry Browne, a writer, investment adviser and two-time Libertarian presidential candidate. The portfolio is simple yet elegant. Because you can’t know with perfect foresight what sort of economy you’ll be living in, you have to plan for everything: inflation, deflation and everything in between.

Browne divided his Permanent Portfolio into four equal parts: stocks, long-term bonds, cash and gold, and he rebalanced it annually with the idea that there’s always a bull market in something.

Stocks tend to do best during times of stable prices and solid economic growth. Long-term bonds do best during times of falling inflation and during recessions. Gold is a natural inflation hedge and does best during times of rising prices or currency instability. And cash is the ultimate crisis hedge, giving you that all-important dry powder when you need it.

The Proper Permanent Portfolio Allocation

The Permanent Portfolio is simple. You can put it together with just four ETFs: The Vanguard Total Stock Market Index Fund ETF (VTI), the iShares 20+ Treasury Bond ETF (TLT), the SPDR Gold Shares (GLD) and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), a substitute for cash.

Once a year, you sell down the ETFs that have moved above their 25% weight and buy more of the ETFs that have drifted before. The idea is that the Permanent Portfolio will always have you buying low and selling high.

That sounds good. But does it work in the wild?

Indeed it does.

In the six months up to May 31, the Permanent Portfolio based on these ETFs returned 8.5%. You would have never known there was a world-ending pandemic just a few months ago.

Over the past three, five and 10 years, the Permanent Portfolio would have returned 8.8%, 6.8% and 6.7%, respectively.

Now let me be clear: The Permanent Portfolio is not perfect.

It’s completely arbitrary to set each portfolio weighting at exactly 25%, and 25% allocated to cash is an awful lot of permanent dry power for most investors. It wouldn’t be hard to build a better mousetrap based on the same basic principles, and that’s exactly what Ray Dalio did to grow his firm Bridgewater into the largest alternatives manager in the world.

Dalio’s $160 billion hedge fund essentially just runs a more sophisticated version of Browne’s Permanent Portfolio.

That said, there are a couple of aspects of Browne’s portfolio that I think are particularly well-suited for this climate.

To start, it’s really heavy in gold. With the Fed essentially determined to print its way out of the COVID-19 crisis, I think it’s very likely we get inflation and dollar instability in the coming years, which is wildly bullish for gold.

I also expect a lot of volatility in the months ahead. So, that large 25% cash cushion suddenly seems a lot more reasonable.

I would recommend deviating from the standard Permanent Portfolio in one key way, however. Be willing to rebalance more often than once per year. An epic market crash like March of this year would have been a fantastic time to rebalance and put some of that cash to work.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, an RIA based in Dallas, Texas.

COVID Force You Into Retirement? 3 Ways to Make the Most of It

This first appeared on Money & Markets.

Retiring is a little like having children. If you wait for the right time, it will never happen.

I say this as I have two children of my own with a third on the way shortly.

The middle of a pandemic-related recession isn’t an ideal time to be growing a family. It’s also not the best time to retire, but you may not have a choice in the matter. A lot of people have been forced to retire early due to the rough economy we’re in.

So here’s some advice to the recently retired. This is less a specific action plan than a collection of general guidelines. But hopefully this will help you get a little more prepared for your life in retirement than I am for the arrival of my baby girl!

Growth is Important, But Safety is MORE Important in Retirement

You’ve seen the statistics. The stock market “always” returns 8% to 10% per year over time. Or at least that’s been the case for the decades.

But even if we take these numbers at face value, the timing of those returns matter. Over a 30-year horizon, you might enjoy returns in that 8% to 10% range. But you’re going to get some nasty bear markets along the way.

That’s normally not a problem. If you’re taking something like 4% to 5% distributions from your portfolio each year, you have plenty of cushion. But if you hit one of those bear markets right at the beginning of your retirement, it can wreck your plans.

Here’s an example. Let’s say you had the great timing of retiring the day the 1990s tech bubble burst and that you had your entire portfolio in the S&P 500. You took normal 4% withdrawals to fund your retirement.

10 years into your retirement, you would have lost more than two thirds of your nest egg.

So, if you’re recently retired, do not put your entire portfolio into the stock market. I know bond yields are terrible today. I get that. But taking too much risk early in retirement isn’t worth it.

Don’t Chase Yield

I’ve always been a sucker for a high dividend yield. But this is another area where you  need to be careful. Divide the current annual dividend by the stock price to find the dividend yield. The yield can be high for one of two reasons:

  • Either the dividend is exceptionally high.
  • Or the stock price is exceptionally low.

More often than not, the yield is high because the stock price is low… and it’s low for a reason. Some of the highest-yielding stocks are often companies with serious financial problems at risk of cutting their dividends.

This doesn’t mean you have to avoid all high yielders. As I wrote recently, I think REITs, business development companies, pipelines and other high-yield stocks have a place in a portfolio. Just be smart about it, and make sure you’re not overconcentrated. My general rule of thumb is that no single stock should be more than about 5% of a portfolio. And no single sector or strategy should be more than 20%.

Get a Hobby

This last recommendation isn’t financial, but it’s important nonetheless, particularly for men. Various studies have shown that men who retire early tend to die younger. We can theorize as to why this happens, but I think it’s because men lose their sense of purpose without a job.

So find a healthy hobby. I’m nowhere near retirement (I have a new baby to feed…), but I’ve taken up gardening. It helps me clear my mind. And I really enjoy seeing the results. I’m also learning basic carpentry to fix all  the little things around the house my children break.

Maybe your thing is fishing… or playing the drums… or building adult-sized Lego sets. It doesn’t matter. Just be sure you find something that keeps you active and healthy… Also make sure it doesn’t involve watching 24-hour cable news. No matter what your political persuasion, watching the news is bad for your mental health.

Now, if you’ll excuse me, I need to finish assembling a crib.

43% of Your Portfolio in a Single Stock?

I mentioned earlier this week that Warren Buffett was on the hunt for investments again, dropping $10 billion on Dominion Energy’s pipeline assets.

Well, Mr. Buffett was in the news again. MarketWatch reported he had fully 43% in a single stock — Apple (AAPL).

There are a couple of caveats.

To start, we’re talking about Berkshire Hathaway’s portfolio of public stocks. Much of its capital is tied up in private businesses and insurance operations.

So the “real” allocation to Apple is a lot smaller. At today’s prices, Buffett’s Apple investment accounts for about 21% of Berkshire Hathaway.

But 21% is still a big number. And it brings diversification into the spotlight.

Warren Buffett has said that “diversification is protection against ignorance. It makes little sense if you know what you are doing.”

That’s true. As investors, we diversify to protect ourselves from the unknown.

But the “correct” amount to invest in any single position depends on a couple of factors.

Short-Term or Long-Term Diversification

Conventional wisdom says that short-term trading is riskier than long-term investing.

But I disagree. Short-term trading can be a lot less risky.

If you trade in and out of a stock, you’re not likely to ride it all the way to zero. But if you’re a passive buy-and-hold investor — you just might.

For a long-term buy-and-hold position, I put a cap at 5% of the total portfolio. That assures diversification.

If a stock does really well and grows to a larger percentage, I might let it run for a while.

But I’m comfortable investing 3% to 5% of my portfolio in a single stock for a long time.

Here’s how this could play out.

If a 5% position gets cut in half, you’ve lost 2.5% of your total portfolio. In a $100,000 portfolio, you’ve lost $2,500. We can recover from that.

Using a short-term trading strategy with hard and fast rules telling you when to enter and exit means you can put more of your money into a trade.

But be smart. You don’t want to make a massive trade right before the company releases quarterly earnings, and get caught with your pants down.

Investing more than 10% in a single stock is OK if you use good risk management and keep a close eye on the position.

How Big is the Stock?

Apple is one of the largest companies in the world. It has an army of analysts watching its every move.

Taking a large, outsized position in a stock Apple’s size isn’t crazy. Apple makes up about 6% of the S&P 500, for crying out loud.

If you own shares of an S&P 500 index fund, you have a concentrated positon in Apple — whether you wanted it or not.

But think about a small-cap biotech or cannabis stock. Do you really want to invest a large chunk of your net worth in something speculative that could go out of business tomorrow?

Use the example of another successful investor: Ray Dalio of Bridgewater fame.

He popularized the concept of “risk parity.” In a nutshell, it means you should base the size of a position on its risk. The riskier a position, the smaller it should be. The less risky, the larger it should be.

Through this lens, Buffett isn’t crazy to overload his portfolio in Apple.

If you’re going to have an outsized position, it’s better to do it in something large and, relatively speaking, safe.

In the end, even those of us who know what we’re doing would be wise to diversify. It’s protection against ignorance.

And, frankly, as passive investors without a seat on the board of directors, we’re all a little ignorant.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, an RIA based in Dallas, Texas.

Warren Buffett Is Buying Pipelines. Should You?

Well, it finally happened.

Warren Buffett put some of his massive cash hoard to work. He spent nearly $10 billion buying Dominion Energy’s natural gas pipelines and storage assets.

Berkshire Hathaway, Buffett’s holding company, agreed to a $4 billion purchase of Dominion’s natural gas assets. It took on another $5.7 billion in the company’s debt.

Given the Oracle of Omaha’s reluctance to buy anything these days, this is making headlines. It marks his first significant purchase since the COVID-19 outbreak started. It’s his largest acquisition since his 2016 purchase of aerospace company Precision Castparts.

The financial press pores over every move Buffett makes — and picks each one apart for clues.

So, today, we’re playing Monday morning quarterback (technically Tuesday morning, I suppose).

We can glean insights from Buffett’s latest buy.

It Wasn’t THAT Much Money — to Buffett

Sure, $10 billion sounds like a lot of money.

But Berkshire Hathaway had over $137 billion in cash on its balance sheet as of last quarter.

And Warren Buffett’s big bets dwarf $10 billion.

He spent $37 billion on Precision Castparts and $44 billion to buy railroad Burlington Northern Santa Fe.

Look at his public stock portfolio. His stake in Apple (AAPL) is worth about $62 billion. He has nearly $20 billion each in Bank of America (BAC) and Coca-Cola (KO).

So, taken alone, we shouldn’t draw major conclusions that Buffett is “betting big” on energy infrastructure. But it’s an interesting buy for a couple of reasons.

All About Moats

Warren Buffett has said for years that he likes businesses with “moats” that protect them from competition. For example, it’s hard to compete with Coca-Cola in soft drinks. Building the size, scale and brand recognition are just about impossible.

Natural gas pipelines are anonymous metal tubes. There’s not a lot of branding there. But they do have competitive moats.

Getting permission to build a pipeline is tough these days due to environmental protests and government pushback. That makes the position of existing pipelines stronger.

And pipelines are natural monopolies. Once a pipeline serves a given area, it doesn’t make sense to build more.

Our economy gets greener with every passing day. But the natural gas in these pipelines is part of that greening process. It burns cleaner than coal and petroleum.

Wind and solar energy will make up a bigger slice of the pie. But natural gas will be with us for the foreseeable future.

Be Greedy When Others Are Fearful

Warren Buffett is a natural contrarian. In his own words, the secret of his success is to be greedy when others are fearful and fearful when others are greedy.

Well, most investors are terrified today of pipeline stocks:

  • The sector has been under pressure since 2015.
  • It’s unpopular with younger investors.
  • And it’s under constant attack from political opponents.

This is precisely the kind of setup a value investor lives for.

I don’t have $10 billion to plow into cheap pipelines these days, and I’m betting you don’t either. But the good news is that we don’t have to.

Some of the largest pipeline operators, such as Enterprise Products Partners (EPD), trade today at prices first seen a decade ago.

We’ll watch to see if Mr. Buffett follows his pipeline purchase with bigger investments in public pipeline stocks.