Financial Planning Confessions Of A Bull Market Genius

By Steven C. Merrell

I have yet to find anyone on Wall Street, Main Street or any of the side streets who wasn't surprised by the power of the stock market rally in 2020. Pause for a moment and think about what happened. After plummeting 34 percent between February 20 and March 23, the S&P 500 index ignited in an explosive 70 percent rally and ended the year with a gain of more than 18 percent.

However, the rally was not universal. In fact, most stocks barely broke even in 2020. Even the revered Warren Buffett, certainly one of the all-time all-stars in the investment firmament, saw his Berkshire Hathaway return a paltry 2.4 percent for the year. On the other hand, Tesla gained 743 percent. Does this mean TSLA investors are smarter than Warren Buffett? Not necessarily.

Before I get into it, I have a confession to make. I have owned a small amount of Tesla stock in my personal account for the past three years. I didn't buy it because I had deep insight into the inner workings of the company or any particular vision for the future of electric vehicles. I just thought the product was exceptional and I noticed a lot of Teslas driving around. When it comes to Tesla, I was what we call a bull market genius.

Bull market genius refers to the fact that almost anyone can make money during a bull market. It takes no skill and requires no discipline. It can also be very dangerous. If you aren't careful, you can fool yourself into thinking you are a real genius and that your success is more than luck.

One of my favorite books is "Fooled by Randomness" by Nassim Taleb. One of Taleb's key points is that it can be really difficult to distinguish luck from skill merely by looking at results. To illustrate his point, Taleb proposes the following thought experiment.

Suppose an eccentric millionaire were to approach you with the offer to pay you $10 million to play one round of Russian roulette. Would you play? You know with absolute precision that you have an 83 percent chance of walking away a multi-millionaire. However, you also know that you have one chance in six of not walking away at all.

Without knowing the details, outside observers might laud the successful player as a genius. After all, he created a fortune in minutes. However, I doubt any rational person in possession of all the facts would think of Russian roulette as a sound wealth-building strategy.

It is the same with making uninformed speculative forays into the stock market. I know a lot of people are making a lot of money with their tech sector investments right now. The market, in many ways, feels much like it did in the late 1990s when dot-com stocks dominated the news and then-Federal Reserve Chairman Alan Greenspan warned of irrational exuberance. But long-term investment success requires more than blindly throwing money at the latest market fad. You need discipline and skill. You even need to be willing to be wrong in the short-term.

As a case in point, consider Warren Buffett. Buffett is the real deal. Before he invests, he learns everything he can about the company. How does it make money? Is it an exceptional business? Is management trustworthy? Do they know what they are doing? Can I buy the stock at a reasonable price? Speaking in 1998, Buffett said, "I buy businesses, not stocks, businesses I would be willing to own forever."

Learning to invest in such an informed way takes time, patience and discipline. When asked during a television interview what advice he would give to someone just starting out, Buffett stated, "I'd tell him to do exactly what I did . . . which is to learn about every company in the United States that has publicly traded stock." The interviewer protested, "But there's 27,000 public companies." "Well," Buffett replied, "start with the As."

Steven C. Merrell is a partner at Monterey Private Wealth Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to [email protected].