Invest based on financials, not politics

If you believe that a trade will make you virtuous, you will be more willing to accept losses.

About 30 years ago, a few mutual fund companies came up with an idea called “socially responsible investing.” The appeal to some investors was that they did not invest in the stocks of companies involved in alcohol, tobacco, guns, or other businesses that some people objected to. They were sometimes referred to as the “sin stocks.” While not having these kind of companies in their investment portfolio made some people feel better or morally superior, it didn’t necessarily improve their investment performance. But isn’t investing for the best performance relative to risk the whole point of investing in the first place?

Here is an example of what happens with some people. You decided to sell “short” a certain stock, i.e., betting the stock price will go down. It may be tempting to see the people on the other side of the trade as the “bad guys” while you are the “good guys.” You may see yourself as part of a movement or effort to impose fiscal discipline on the company’s management or the federal government, and the people on the other side of the trade, the longs, are the enablers. You are the good guys, and they are the bad guys. Don’t do this. If you believe that a trade will somehow make you virtuous, you will be more willing to accept losses.

There were some very angry market bears toward the end of 2022 who were enraged about the excesses of the bull market and the losses sustained by individual investors. They wanted to punish those who they believed to be the bull market cheerleaders in 2021 – like Cathie Wood, manager of the ARK Innovation ETF. They were the good guys, and Cathie Wood was the bad guy. They were heavily short in October 2020 (betting the price would go down hard) and they got crushed. The irony was that the ETF did crash in 2022, but those who were short in 2020 couldn’t hang in there long enough to be proven right. Then they were REALLY angry.

I will say what should be obvious: The stock market (or any market) does not care about your feelings or brand of morality. Or anyone’s morality. There is no good or bad in the stock market, not right or wrong. Just winners and losers. The winners are the ones who were able to predict tomorrow’s prices today; the losers got it wrong. There should be no moral significance to it. The people who get trades wrong aren’t bad people. The people who get trades right aren’t good people. And the two sides will switch places at some point in the future.

Over the past few years, ESG investing has become all the rage among some people. ESG (environmental, social, and governance) is the very definition of virtue investing. They’re going to save us all from ourselves and save the world by buying stocks of companies that don’t burn fossil fuels, or sell tobacco or alcohol, or run casinos, or make guns and ammo, or make weapons of mass destruction. By excluding these stocks from your portfolio, you get to feel good about yourself. Besides the fact this is all nonsense, the truth is that these companies don’t know whether you own them or not and don’t care anyway.

Doing this will also make you more willing to accept losses or underperformance. ESG has blown up in the news lately, so there is not much reason to rehash it here. There are a whole bunch of problems with it, the least of which is the conflicting standards among rating agencies. And there is a lot of empirical evidence that outsized returns can be obtained by also investing in the “bad” stocks. Many of the “bad” stocks pay very good dividends. (Oh, get over it! The added performance will ease your conscience.)

For a while, there was no cost associated with ESG investing. The “good” stocks were actually outperforming. But then we had a huge run-up in energy prices, and that outperformance evaporated. In 2022, even Tesla CEO Elon Musk called ESG “a scam that has been weaponized by phony social justice warriors.” Over the long term, there will be a performance cost associated with ESG investing, and the question you must ask yourself is: “Is it worth having $150,000 less at retirement?” Alternatively, you could just invest in the S&P 500 in your 401(k) and donate $150,000 when you retire. You would probably do a lot more good that way.

After 47 years in the investment business, there is one thing I’ve noticed about investing in the stock market – I’ve never made money on an angry trade. There are a lot of angry people in the stock market. Angry longs and angry shorts. These people never make money, and if they do, it is transitory. Only relaxed, confident, happy people make money in the stock market.

There are exceptions to this, of course. There are a small handful of professional short sellers who wage campaigns against their targets to drive the stock down. For them, it really is personal. They think the companies are frauds, and they think the managers are immoral. Maybe true and maybe not. I just can’t bring myself to be that angry all the time. Why does it have to be personal? They think they are fighting for truth, justice, and the American Way. I don’t know how you can be past age 35 and still be that idealistic. Make your investment decisions, long or short, based upon logic and financials and not on who or what you want to punish. They don’t care.

For the most part, angry traders do not make money. Do you know what will make them even angrier? When the position moves against them. There’s nothing worse than being angry and losing money. The next time you think you’re saving the world with socially responsible investing, think about taking a walk, enjoy the sunset and have a glass of beer or wine with friends and just chill out. Thanks for reading.