Why Value Investing Works

In this episode of Industry Focus: Financials, Jason Moser chats with Motley Fool contributors, Jason Hall and Dan Caplinger about the latest news and earnings reports from Wall Street. They'll talk Berkshire Hathaway and its investment strategy; Next, they move on and discuss a specialty insurer that some describe as a mini Berkshire Hathaway. And finally, they talk about how the current low and negative interest rate environment should impact your investing strategy, how to invest with less stress, and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Aug. 10, 2020.

Jason Moser: It's Monday, Aug. 10. I'm your host Jason Moser. On this week's Financials show, we're going into the latest earnings reports from Berkshire Hathaway (BRK.A -0.46%) (BRK.B -0.34%) and Markel Insurance, we're going to talk about negative interest rates and investing. We've also got a few tips for how investors can approach and deal with stressful times like these we're witnessing now with the pandemic. But joining me this week, I've got a full squad here with Jason Hall and Dan Caplinger. Guys, how is everything going?

Jason Hall: I have to say, I've never been referred to as part of a squad, that's pretty exciting, I'm pretty happy about that.

Moser: Fool squad, full strength here.

Hall: Love it.

Moser: Yeah.

Dan Caplinger: Going great here, JMo. How are you?

Moser: Oh, doing well, doing well. Trying to beat the heat here in Virginia. I've just noticed the past couple of days, I walk outside early in the morning and I can smell fall. It's just little small changes in the air, but it's coming, and I am kind of happy about that. It's still, like, 90-plus degrees up here. I'm ready to call it a summer.

Hall: It's going to be 90 degrees all week here in Southern California. So, we're going the other way, I guess.

Moser: Well, Jason, a couple of weeks back I was down in Georgia; I went down there to be able to play golf with my dad.

Hall: Dan Caplinger, you may not know, but Jason Moser's dad -- is he still practicing?

Moser: Yeah, he is, believe it not.

 Hall: He's a physician at the hospital I was born at in Moultrie, Georgia.

Caplinger: Oh, wow! that's awesome.

Hall: Yeah, it's a small world.

Moser: But, yeah, the golf course there is, like, right across the street from the hospital. So, you know, Moultrie, Georgia, just small-town living, life at its finest. And got to go down there for a few days, hang out unplugged, but the heat. [laughs] Oh, my God! the heat, it was 95 degrees in the shade. But that was all right, I'd rather play golf in the heat than the cold.

Hall: There you go.

Moser: [laughs] Well, guys, let's jump into a couple of stories here that I'm sure a lot of our listeners are going to be very interested in and a couple of companies that many of our listeners and our members follow. And we'll start here with Berkshire Hathaway.

Dan, I'll jump to you first here, because, you know, Berkshire Hathaway earnings came out over the weekend. I mean, it was not a bad quarter by any means. I think we saw more or less what we expected. Operating profits fell 10% for the quarter. I mean, obviously, no company is immune to the economic turmoil that we're all facing right now during the pandemic. But it does seem like, certainly, Berkshire Hathaway, given its size, is a bit better prepared to deal with times like these. But they bought back a lot of stock during the quarter as well, didn't they?

Caplinger: They did. Yeah, that's been the big headline is they finally upped their buybacks. Spent more than $5 billion during the quarter, which is a big boost from the first quarter. There were a lot of folks that were saying, "Hey, what are you doing, Warren, you're not buying the stock back in February, you're not buying it back in March?" And so I seriously doubt that Buffett took that to heart and that this is the answer to it. What I'm guessing instead is, you know, if you watched the annual meeting, and I did, and it was a little bit disquieting. He sort of did his usual "optimistic on America" deal, but there was sort of a downbeat tone to it, and you can kind of pick up that maybe there was a little bit of a concern, especially on the insurance side, as far as, well, how much liability there might be as a result of COVID-19.

And keeping some of those reserves available, rather than buying back stocks at huge bargain prices, keeping some of that money, it made some shareholders wonder, hey, you know, is he keeping that money for a reason? Are there going to be claims to pay out, is there going to be actual serious underwriting losses that we're going to be paying attention to? And the message I take, from at least a small boost in buyback this quarter is that some of that systemic risk, Berkshire seems to be getting a handle on it. We're starting to see some improved conditions in the insurance and reinsurance markets, stronger premiums bode well for the future. So, I'm kind of excited about it.

I think that there are some people that are just excited -- hey, buyback means higher stock price -- but I think it actually says more about the safety and security of Berkshire's insurance business going forward. And so, yeah, I see it as a potential beginning of a trend, we could see more buybacks in the future, especially if the stock price stays relatively attractive like it's been lately.

Moser: Yeah, and, Jason, the one thing we saw with Berkshire Hathaway over the past couple of years at least is, Charlie and Warren, they're always very good about having a process, having the checklist. There's a standard. You got to check these boxes off before you do something. And they had that set with buybacks, and I think it was 1.2 times book value. That was the floor there. And that's all fine. I mean, buybacks, yeah, Dan, you're right, fewer shares in theory should result in a higher share price down the road. By the same token, and I'm not a Berkshire Hathaway shareholder here, but it really does feel like they're missing out [laughs] on an opportunity perhaps here to pay a dividend and maybe light a fire under a new shareholder base with this business, right? It does feel like it's gotten a little bit stale, the story there. ... We've been talking a lot about a dividend here: What are the chances of this company paying a dividend anytime soon?

Hall: I'd say, [laughs] they're still incredibly low. I think as long as you've got Buffett and Munger that are still actively involved in making capital allocation decisions, you're not going to see a dividend. Maybe I'm wrong, because here's the bottom line. I think if there's one thing that Warren Buffett has taught us, it's the power of being mentally flexible. You know, Apple has been one of the company's most successful investments, and this is somebody who didn't invest in tech stocks when they were the hot item 20 years ago because he didn't understand them. But over time, as he's learned more and the conditions have changed, his opinions and his views are changed based on the facts on the ground. So, I think you can never say never, but I still don't think it's going to change.

Here's some observations that I have, just real quickly. It's something that I looked at, I don't know, maybe a month or so ago. Over the past 10 years, and it's easy to be arbitrary with numbers, it's changed a little bit over the past month, but over the past 10 years, Berkshire Hathaway stock has generated about 161% in gains. The S&P 500 has generated 266% in total returns. At one point, maybe a month or so ago, two months ago at this point, the S&P 500 had lapped Berkshire, and had generated double the returns over the past decade. But here's the thing: Buffett has told us that generally in strong bull markets, Berkshire, at this stage of its existence, is not necessarily going to outperform the market. But in downturns it should prove its value, right? We haven't completely seen that; we've seen it some as it's started to come back over the past couple of months. But, you know, it's just really interesting how the business has changed.

But again, Munger and Buffett are very much about process over outcomes, and that remains the case. They love banks. The megabanks have really, really weighed on the returns for the business, there's no doubt about that, in terms of the portfolio.

Moser: Yeah. I mean, Wells Fargo is not doing anybody any favors right now. So, hopefully, we see things kind of turn around there. And I understand why investors would believe that would be a case, I mean, you don't own that sort of a market position in the mortgage market and just disappear overnight -- you can't. But it was an interesting point you made there and I agree with it. That a lot of the value in Berkshire can be seen in tougher times where maybe it's a bit more of a defensive holding or at least that's been the perception -- it withstands tougher times a little bit better.

But now we are seeing, at least with this pandemic, we're seeing a change in the way business is done. We're seeing the development of this digital economy. We're seeing businesses being -- the relevancy being pulled forward really, frankly, a couple of years, like Satya Nadella said it, whether it's medicine or document agreement or payments, I mean, we're seeing just new ways of doing things that are all very tech-related. And I wonder, Dan, do you feel like that starts to work against Berkshire Hathaway at some point? I mean, I understand that the wonderful success he had with the investment in Apple, let's all also acknowledge the fact that Apple is not really that difficult of a business to understand and as far as tech investments go, I'd say it's a pretty green circle-type business.

Does this company feel like one that needs to be on investors' radars, though, going forward, given this move toward this digital economy that we're witnessing today?

Caplinger: I do, but I don't think it's a player in that tech innovation. I think that as far as tech is concerned, Buffett and Munger are going to be passive investors. They're not going to add value, they're not going to have insights, they're not going to be contributing to the business models that major technology companies are doing. That's not their area of expertise, they would never pretend that it was. They found a great partner in Apple; I think they trust Tim Cook implicitly. They've taken stabs at tech elsewhere with mixed results. IBM, obviously, having been a pretty bad outcome, and yet, I think there's some recognition that tech is an important player. I think that motivates the Apple position.

But I'll also just point out, I first became a Berkshire shareholder in 1999, and it was sucking wind back then, it was not doing well. And all these dot-com companies were doing great, and the future was tech. And everybody was absolutely correct at that time that the internet was the future and that that was where returns were going to come from. The question was, of the companies that were available to invest in at that time, which ones panned out well? And during the dot-com boom, for a whole bunch of companies, the answer was "no." And so, when those companies started going down, they dragged the Nasdaq down, they dragged most of the stock market down, Berkshire performed really well.

We've seen the same sort of thing happening. There's been a big emphasis in growth investing, [and] value investing has underperformed for years now. And I think Berkshire is going to be a value investment, it's always going to be a value investment no matter -- you know, once Buffett is gone, his successor is going to be a value investor. And so, yeah, if you're convinced that growth investing -- you know, things are different, it's not cyclical, it's going to be growth investing from here on out, then, yeah, Berkshire is not your pick, but if you think that there's a cyclical element to this where, yes, growth comes into style, and then somebody decides, oh, these stocks are overpriced, value comes back into style, that's where, I think, you're going to get Berkshire to outperform and that's why I think it's still worth investors paying attention to it, even though, like Jason said, it hasn't done very well lately. In fact, it's done really poorly compared to even the S&P 500, let alone some of those high-growth tech stocks that you're talking about.

Moser: Do either of you have any concern -- and we'll wrap this up here and move on to Markel -- but I just wanted to throw this out to both of you, because I noticed the company took a pretty sized writedown on its Precision Castparts acquisition this quarter. That was a deal, I think they paid somewhere $32 billion for the deal.

Hall: Yeah, they took about a third of it.

Moser: Yeah, about a third of it, a writedown of about $10 billion. And that, arguably, would be a business that would be right up Buffett's alley in understanding. Again, I think it goes, obviously, in a very, very unique time here, globally speaking, but is that something that concerns either one of you at all?

Hall: You know, I don't think it necessarily concerns me. I mean, every deal is not going to go swimmingly. But I think a lot of us were relatively bullish on the Precision Castparts investment. But looking objectively at Berkshire today and thinking about the portfolio, thinking about its biggest successes in terms of its equity investments, it's really been in brands, right? I don't really view Apple anymore as a tech -- yeah, sure, it's a tech company, but it's a massive consumer brand, and that's a huge draw. Coca-Cola is the same thing. I think you could even say American Express is the same thing.

So, if I'm looking at Berkshire today -- it's actually floated on to my buy list; I sold probably four or five years ago, but now it's back on my buy list because it looks like a value. A massive portion of what it holds is banks. And I think most banks are probably undervalued, it's not a great environment for banks, but I still think they're undervalued. So, I tend to agree with Dan's take, and I'm not particularly concerned.

Caplinger: Yeah. And I'll just throw in here too, you know, I understand the writedown, I think it's appropriate given the response in the industry, there's still huge uncertainty as far as where commercial aviation goes from here. But I am heartened, at least a little bit, by the fact that we're seeing some of Precision Castparts' publicly traded [peer] companies, they've bounced back. I mean, a company like TransDigm Group, ticker TDG, well off its lows, not near where it was before the pandemic hit. But you're starting to get some good news; it looks like the 737 MAX might eventually fly. Boeing is starting to see at least some strength come up. There's still lots of, not sure what things are going to look like, but I think Buffett is not worried about taking a writedown or about one year's worth of results. He just wants to make sure that over the long run these airplane manufacturers need components, and Precision is in a good place to keep delivering them as long as there is demand for the aircraft.

Moser: I love how Buffett-Munger -- I mean, what, Buffett is like 88, Munger is like 92 or something like that, and we still talk about the long term with these guys. [laughs] We're thinking, like, 20 years down the line. I mean, I just love it. That mentality, let's just hope it never fades.

OK. We're going to move from Berkshire Hathaway to what a lot of us like to call our baby Berkshire Hathaway. Another company that probably a lot of Fools are very familiar with, probably a lot of listeners own or have this stock on their radar. Markel Insurance, which is a very similar business to Berkshire Hathaway in a number of ways, a much smaller business. Markel being in specialty insurance -- so, typically writing insurance for things that other people just don't have the expertise to write. And that could be everything from horseback camps to speedboats and everywhere in between. I mean, yes, those things have to be insured too.

Markel [had] a very similar quarter to Berkshire's. They note the challenged business environment, and, Jason, the one thing that they talked about on the call, which I thought was pretty interesting, is they're talking more about how the insurance market, we've entered what they called a hard market for most insurance and reinsurance lines. And ultimately talking about how they're really focusing on writing good business, premiums are going up, and they're not just taking any business they can get.

But I wonder, with Markel, what stood out to you in this quarter, both good and bad?

Hall: So, I think the first thing, just some background for folks to know. So, combined ratio, anything above 100% means they lost money on their premium writing on their underwriting, and below 100% is good, meaning they made money on their underwriting. So, you go back to the last quarter, the first quarter, I think the combined ratio was, like, 118%, it was almost 120%.

Moser: Something abnormal, yeah.

Hall: Yeah. Massive. And again, it was a single [cause]. They said $325 million in underwriting losses directly related to COVID-19. So, a good example of coming out of the Berkshire annual meeting, back in, I guess it was May, when some concerns about big insurers and potential massive underwriting losses from COVID. So, we saw that with Markel last quarter.

Then in the second quarter, the combined ratio fell to 88%. So, that was, we see some normalization as the company adapted pretty quickly. And with Markel, sure it has more Markel Ventures, which is aggressively growing, which is its acquisitions of both stocks and equities and its wholly-owned acquisitions of subsidiaries to kind of build the Berkshire idea of this conglomerate that has these other operating businesses. But right now, insurance, it's still the lion's share.

And I think, you know, we were talking about this transition into a hard market for people, that's just a change in the cycle of the insurance business where you see more insurers start to kind of withdraw, and the market, the prices start to kind of go up. I think that's a great thing for Markel, because they have such a great history of underwriting that it puts them in a position -- especially in these specialty markets where there already isn't as much competition as things like home and auto -- to get back to really having that great underwriting success and see that combined ratio, potentially, go even lower. So, that kicks off even more float that it can then use to find opportunities to invest.

Just as an example, there's one thing I saw from the quarterly filing. I can't remember the name of the company, but they kind of doubled down and they've acquired a majority stake in a building distributor, a building supplies something. They spent around $500 million, and they own about 90% of it now.

So, one of the things I like about looking at these releases, especially from Markel, is it kind of gives you an idea of where management's looking, or management's thinking. When I saw that, I'm like, "Well, you know what, they see this trend of a shortage in housing as a major long-term trend, you think about millennials trying to get into the housing market and they see a big tailwind, they're willing to spend half a billion dollars to buy a building materials distributor." So, I thought that was really interesting to point out is, this is where they see the opportunity. So, I think that was a really interesting takeaway.

Moser: Yeah. And with Markel, again, it's one of those companies where you try to ignore the quarter to quarter, you focus more on the year to year, because we do see where -- I mean, Markel, like any other insurer, they're going to be susceptible to lumps in the business. So, there are three drivers with the business. The insurance business that you've talked about, Markel Ventures and then their investment portfolio. If you look at their investment portfolio, net investment losses for the first half of 2020 were $770 million compared to a net gain of $1 billion -- $1 billion! -- last year. So, basically, that's a decline of $1.8 billion just in investment losses -- well, investment gains and losses, which, to be clear, that I'm sure is overwhelmingly, if not all, unrealized, right. It's not like they're buying and selling stocks like they are day trading.

Hall: That's a really good point, that I think it's good for people to understand that a few years ago there was a change in GAAP, where they're required to show quarter-over-quarter unrealized, so it's just changes in the value of the equity portfolio, they have to show that on their GAAP results, so even though they're still holding these investments.

Moser: Yeah, that's what they call that mark-to-market, right? I mean, that's just showing you quarter-to-quarter, this is what the market is saying. What the market is saying isn't necessarily the reality of the situation, it's just the reality at that given point in time. And, Dan, we were talking about this earlier, we've got some 13Fs coming out here soon that are going to really shine some light on the companies that these companies are owning. The companies that Markel and Berkshire are investing in. I mean, I'd be fascinated to see if they've added any or if they've added too many positions, it was always fun for me to look at the differences between Berkshire and Markel's holdings.

Because Markel and Tom Gayner, you could see there was a little bit more of a propensity to bring tech into that portfolio, things like Amazon and Alphabet and Facebook and whatnot. Not necessarily the same dynamic with Berkshire Hathaway, although they're getting better. But, again, going back to that driver in the investment portfolio, I mean, that is still one of the top three drivers of the business. And so, even though those aren't really permanent losses, nor are they permanent gains, it's not something we can ignore, is it?

Caplinger: No. I mean, you can't ignore it, as much as Buffett would tell you to. You know, Buffett is [laughs] definitely not a big fan of the change in accounting practice, even though it seriously worked in Berkshire's favor in the second quarter, because you know, we had the big bounce and saw all these stock prices came back up, it created a huge headline net income number for Berkshire for the quarter. But they're still down for the first half of 2020 significantly -- more than the overall market has been.

And it's exactly because of, sort of, that value proposition that, both, Markel and Berkshire have kind of embraced. Like you say, Markel not quite to the same extent or with at least a nod toward innovation. But you just sort of have to kind of go with it and say, OK, yeah, if your GAAP accounting records are going to force you to take these mark-to-market things, you're going to get volatility in their earnings that you didn't have when you were just able to kind of carry at book value and call it good from there.

So, you know, it's something that you take into account. And then depending on your propensity, if you're a long-term investor, you just turn right around and ignore it, most of the time, because you know it's just three months' worth of stuff and what went down in the first quarter, went up in the second quarter. It evens out in the long run, and hopefully goes up, and then you can kind of make your judgments from there.

Moser: Yeah, and in most cases, they can probably, both Markel and Berkshire's teams there, can look at their portfolios and feel good knowing quarter in and quarter out, they, generally speaking, I think, feel really good about the state of the businesses that they own. Stock price notwithstanding, macroeconomic conditions notwithstanding, they like the businesses.

Caplinger: But one thing I will point out. We all know that Berkshire sold off their airline holdings, you know, that was made very clear. But one analysis I've looked at of the financial shows suggests that there were more sales in the investment portfolio that aren't accounted for by those airline sales. And so, like you said, you know, we've got the 13Fs due Aug. 15, that means, you know, Friday is Aug. 14, so that's probably when they'll come out, and it'll be interesting to see.

My own personal pick, my guess is, he's going to cut more of Wells Fargo. It's below 10%, so he won't have had to report it along the way. But, to me, the choice of a preference in Bank of America, we've seen the Bank of America purchases over the past several weeks and months, I think that that is, he's finally starting to say, OK, I'm not going to invest in the entire industry, I'm going to pick a favorite, and it may well be Bank of America is that favorite. If we see on Friday that Wells Fargo has shrunk again, and it's been on the decline, it's well below 10% at this point already -- if we see further declines from there, I think it's a clear statement of this is the player that I like.

Moser: Yeah, I tend to agree. Matt and I talk a lot about that, it's really interesting to think about how these banks, you know, they've traded places. I mean, it was -- I don't know, it was maybe seven years ago, like, we would talk about Bank of America like they would just wake up and step in poo every day. Like it was just, you could just mark it, like, it was like the sun coming up. And now, it really does feel like Wells Fargo has taken that title and Bank of America just can do no wrong, and this is really turning out to be Buffett's favorite bank, apparently, because that's where all of his money is going. [laughs]

Hall: And I think now is a good time to do it, right in the middle of a major economic downturn. From a financial perspective, it's probably creating operating losses and investing losses that Berkshire can use to offset those gains that it still has in its Wells portfolio, so the tax implications are easier to swallow right now and start transitioning into better choices.

Moser: Portfolio management; I like it, I like it a lot. Well, speaking of management, portfolio management, financial management, looking at things beyond just our stock-driven world, we wanted to talk a little bit today -- Dan, we had a question on Twitter that came in the other day that I thought, we want to talk a little bit about interest rates, about how low interest rates are today. I mean, there's all this talk about negative rates. How investors can deal with this type of environment when they have money to put away, you know, what are some ideal vehicles to use?

And we got a question here from Scott Gosavi on Twitter, his Twitter handle is @energyismyname. And Scott tagged this actually for MarketFoolery, so I'm stealing it from MarketFoolery, we're taking this question on today's show, because really, this is right up your alley, Dan. So, I want to hear what you have to say here. And of course, if Jason has any thoughts too.

But here's the question, Scott asks, he says, "I'm looking to invest my market gains in bonds for a short term. Are bond ETFs like BND ... " ticker symbol BND, " ... a good idea for a retail investor like me? What other options do I have to earn decent returns on short-term investment, timeframe, one to two years? Thanks in advance."

And, you know, Dan, this is a question we get often from investors, whether it's one to two months or one to two years, folks trying to look for a way to maximize yield for money that they don't want to put in the market. And it just kind of feels like we're coming back to there's not really a very good answer, but maybe you've got a good one for us today.

Caplinger: Well, you have to manage your expectations and you have to understand the risks involved. And so, with a short-term investment like this, I like to match up short-term needs with short-term nature of the investment. And so, in this case, answering Scott's question directly, no, I do not feel like that the aggregate bond ETF BND matches up to that one- to two-year timeframe that you're talking about. And that's because it's a general bond index. It's got some short-term bonds in it, but it's got a lot of intermediate-term 5- to 10-year bonds, it's got some long-term bonds -- 10-, 20-, 30-year bonds in there. The problem that folks like Scott have, and it's a [laughs] difficult one to overcome, is that it's these long-term bond ETFs that have done the best. And it's because, as crazy as it sounds, when you have a long-term bond, a 30-year bond that goes from 2% down to 1.5%, that translates into a huge capital gain on a bond ETF, we're talking 10%, 20%, 30% returns on some of these longer-term bond ETFs.

And so, people say, "Hey, I want to get out of the stock market, I want to reduce my risk, I want 20%, 30% returns, why don't I get this bond ETF?" And the answer is that, as quickly as those bond ETFs have gone up in the falling interest rate environment, they can go down 10%, 20%, 30% in a rising interest rate market. And so, what you're doing when you invest in a long-term bond ETF is a short-term trade. And, yes, I'm calling one year, two years short term for these purposes. You're making a bet that interest rates are going to stay low and they're going to keep going down.

Now, I'm not going to tell you that's a bad bet, there's a lot of macroeconomic reasons to think that that's the case. And, frankly, JMo, I've been warning people about this bond ETF risk for years, and I've been dead wrong from a trading perspective, because the rates keep going down. You know, when the Treasury bonds were at 3%, we were like, they can't go any lower than this. Then they go to 2% and it's like, well, they can't get any lower than this, and you know, now they are 10 years at, like, 0.5%.

And in the past, we were sort of, like, well, at least there's one thing we know, it can't go below zero. And now, Europe is like, you know -- no, we're going to play that game. And so, now the U.S. is just about the last major economic nation in the world that has positive interest rates. Go look in Europe, there's negatives all over the place. Japan is right about zero. So, yeah, it's crazy.

But to answer Scott's question -- if you want short-term money, then you just have to resign yourself to the fact that you're not going to get very good interest rates. The place to go right now, oddly enough, is banks. Usually, online banks have the best CD rates, you can get a one-year CD, a two-year CD. Yeah, they're going to pay you, like, 1%, and it's going to hurt, but if that's money that you need next year, it's money you need two years from now, you know, you put the money in, you know you're going to get that 1%, you know that's what it's going to be. And from a portfolio standpoint, that's what I'm going to tell you to do, because it matches up with what your needs are.

Moser: Jason, do you have a philosophy or a mindset that you typically follow when it comes to something like this? I mean, it's a problem we've been dealing with for a while, so I suspect you've had to address it at least once or twice.

Hall: So, this is where firebrand Jason comes out. This whole question smacks of market timing to me. I don't know your individual situation or what's happening, but we've all seen a market that's come roaring back. This year we've seen the fastest 30% drop in history, we've seen the fastest -- we've seen, I think, the worst month, and the best month this year. And the market seems incredibly dislocated, and there's a lot of reasons for that.

And this doesn't sound like somebody that's 63 that's planning to retire in two years that wants to set aside cash. I hope I'm not insulting anybody, but I probably am, but I do that. Here's how I think about it. So, I'm 43. So, I have 20 years that I'm saving for retirement. I have 15 years before my son goes off to college. So, here's how I think about investing and here's the process that I have to keep me from making dumb decisions and to avoid those unforced errors. Because I think that's where retail investors, just like amateur athletes, make the most mistakes, is doing dumb things that we choose to do.

So, here's my process: I think about, do I have any assets tied up in something that could cause fundamental harm to me financially over the next two years? In other words, do I have enough cash set aside to pay the bills if I lose my job or if my wife loses her job or if we have an illness or something like that? So, No. 1, I have that margin of safety that has nothing to do with my investing portfolio.

And then I look at my portfolio itself, and I think, do I have the ability to react quickly to market opportunity? So, having cash set aside, so if we do see another 10%, 20%, 30% drop, do I have some -- there's the term "dry powder" that gets tossed around -- but do I have some capacity to be able to act as a buyer to take advantage of those opportunities? And I do, I tend to aim to have about, in a normal environment, about 5% of my portfolio in cash, because we see a 10% drop every few years, right, every year or two. We see a 20% drop about once a decade. I think we've seen a 30% drop over the past 70 years, I think we've seen, like, maybe five of them; five or six. So, we don't see them very often. So, you pull a bunch of cash out and you're sitting on cash that doesn't generate return, you buy bonds that don't generate much return, or potentially you buy a [laughs] bond fund that could actually lose you money, you're working against yourself, right?

So, think about what your goals are, don't think about what the market is going to do in the next two years. What are your goals? And then build a strategy based around your goals, and then do some things to hedge yourself from making mistakes, like keeping a little bit of cash so that you can buy when there's a market crash, and not try to sell some stuff that you own on the way down, and then wait for the bottom to buy back in, and then you end up missing. I mean, imagine being somebody that sold in late March, because the market was falling and you knew things were going to get worse. And then here we are today, and the [laughs] market is almost back to where it was, and you've been sitting on half of your portfolio in cash when the market has come roaring back. It's hard as hell to get back in right now when you know the market is going to just fall again, it's going to happen. [laughs] You could have said that any time from 2010 up until Feb. 21 of this year that the market was going to crash, and the market went up, what, 400% in total returns. I mean, think about your goals and not what you think the market is going to do. Build a process and you'll avoid making mistakes. Don't get caught up in bond yields and that kind of stuff, because it's not what matters, and it leads to making mistakes. I'm going to stop, I'm just going to stop.

Moser: Well, I mean, I think you make a good point though. I do feel like we -- you know, I always say, like, investing is as easy, as difficult as you want to make it. And I feel like when we start going down these rabbit holes, this is where we can make it really, really difficult, not only just the mechanics of it, but the emotions that are involved as well, and the ups and the downs of getting in and out. Like, all of a sudden, you get a couple of things wrong and you wonder why are you even trying to do this in the first place, and you just resign yourself [laughs] to giving up.

I mean, I can certainly understand when people get frustrated, but again, I think that just really goes back to why we invest the way we invest, because frankly, it works, it's just ...

Hall: Or even worse, you get a couple of things right, you call the top and sell, and then you think you're good and you were just lucky one time. And then you spend the next 10 years underperforming, because you thought you had some skill that you didn't really have.

Moser: You got to pay the piper one way or the other, right?

Hall: Yeah.

Moser: Well, in line with what we were talking about there from Scott, I'd like to wrap this conversation up maybe with, not necessarily a negative rates and saving and dry powder type of question, but just generally speaking, you know, in times like these. And I mean, Jason, you made some good points there, and just saw the fastest trip to bear market territory ever, followed by really -- it had to be the fastest recovery ever. And I'm certain nobody predicted it. It's been a crazy year, and it looks like the rest of the year is going to be challenging in a best-case scenario.

As an investor, and Dan, I'll just start with you -- as an investor, what's one thing, a tip, a suggestion, something you put into practice to help you cope with these types of volatile, uncertain headline-driven times? What's something you do that you feel like our listeners might want to consider putting into practice?

Caplinger: I think that what I would urge everyone out there to do is to remember what this year has felt like, because we had a 10-year stretch where, you know, there were some pullbacks along the way, every once in awhile, [but] there wasn't any serious bear market, there weren't, like, any sort of major periods of uncertainty about what was going to happen. We have a bull market that moved almost straight up. And so, these discussions about, OK, well, "What's your risk tolerance?", they were all theoretical, you know, they were all in your head, because you had never gone through it. Well, now you've gone through it, and so, from now on you'll be able to say, "Yeah, when I answered that questionnaire, I said I would be able to handle a 20% drop just fine. Turns out, when I actually got the 20% drop, I sold everything, I panicked, I did the worst thing possible." Now you know the answer, now you know what you need to work on.

If it turns out that you had the discipline to stay the course, maybe, like Jason said, even maybe add when stocks were really low priced, then that's great. That means that you're on track and you have the ability than in the future -- you're probably beating yourself up, you're saying, oh, I should've bought more, I should have done more. And it's like, don't beat yourself up for it, but don't forget it either. Make a note of it, and remember it, so that the next time, when the next thing happens that causes the market to hiccup, go down, you'll be like, "Yep, here it is. I was thinking, I want this to happen. Back in 2020, I was looking forward to the next time. This is the next time, let's do it." And if you can keep that perspective, then it keeps the emotions from taking hold of you and it gives you a chance to really, kind of, refine your investing and make yourself a better long-term investor, that you just keep learning, we all keep learning, and it's been a great, though painful, learning experience.

Moser: I love it, I love it. That's great stuff there. Jason, how about you?

Hall: Here's what I do. So, and I think that it's really helpful. So, this is kind of tied to my long diatribe from a minute ago. I look at my portfolio and I think about my investments. And this is not my savings, this is not emergency money, this is not the operating money that my wife and I earn, that pays our bills, this is truly investments. And I look at it and I say, if this was worth 30% less -- in six months from now if this was worth 30% less, how would this affect my ability to meet my financial needs in the next five years? And right now, the answer to that is, no, it won't. There's no impact.

Now, for other folks, if you look at your portfolio and if it were to lose 30% of its value in the next six months, if that would meaningfully impact your ability to meet your financial needs, you own too much stocks, right? You need to have that conversation about finding appropriate investments based on your timeline. And that might mean buying some bonds, build a ladder where you have bonds that are going to mature when you need to sell them. So, you're not fighting upstream against a change of interest rates by owning a bond fund. So, No. 1, I do that.

No. 2, I have some rules that help me deal with that volatility. So, I try to have about 5% of cash in my portfolio. The market falls 10% over a short period of time, the S&P 500 from a near-term top to a near-term bottom, I just take half that money and I buy something. I buy great companies that have fallen more, just because they've fallen, not because the business is troubled. Now, if we see a 20% drop, I invest half of what's left. If we see a 30% drop, I blow it all out, [laughs] I spend every penny that I have set aside in cash. Now, this is on top of my regular 401(k) contributions and regular monthly, quarterly investing that I automatically do. So, by having those rules, it keeps me from thinking, well, I need to sell, I need to -- this feels a little top-heavy, you know, it helps make it easier to avoid those unforced errors. So, those are the two things that I would say people should consider doing.

Moser: Yeah, I like all that stuff. And one thing I'll just throw in there, sometimes I talk with people and they get nervous, they -- I don't know if they're losing sleep at night, but they're genuinely nervous about this portfolio of companies, that it's worth less than it was the day before or a year ago. Whenever I speak with people who are getting to that point, and they know they're doing the right thing but they're nervous. I tell them to do one of two things, either continue investing and just invest in an S&P index fund and keep that going, so that you feel like you're getting that nice broad diverse exposure without having to pin all your money onto one particular stock that may or may not succeed.

And another thing that also you can do, and this is something that my daughters do, we got them into doing this when they started investing was, every time they buy a stock it has to be something new. So, once they've bought Starbucks, they can't go back and buy it again, it's got to be something else. And the basic idea is there, I want them to build out a diversified portfolio. Now, diversified is going to be different for everybody, and it's ultimately understanding, how old are you, what are your goals, yadda yadda yadda. But if you're looking to build a portfolio of 20 stocks. Well, you know, I mean, you need to get to 20 first. And a lot of people want to buy stuff on the dip or whatnot. And take advantage of adding to a position, but I've always felt like, diversification, you know, Warren Buffett is kind of right, it's for people that don't know what they're doing. [laughs] And I don't mean that to come across the wrong way, but it just really is. I think it's good for all of us, because there's a level of ignorance among all of us, OK, folks, let's just be very clear. [laughs] We don't know everything, and you certainly can't predict the market's psychology at any given point, but I feel like always, kind of, going back toward diversification can never be a bad thing.

So, hopefully, those are some tips that will help our listeners cope during this difficult time, but it seems like it's improving time, it seems like it's improving.

Dan, Jason, guys, thank you so much for taking the time out of your schedules today to fill in for Matt Frankel. And let me say, not only fill in, but I'm going to have to craft an email for Matt here once we get done taping, because now we've got some Monday job concerns, some job security concerns that I think I'm going to have to talk with Matt about. You know, let me open the topic up with him, but you know, we'll need to get back together here later on in the week and see about maybe getting together and doing this again, because I had a lot of fun.

Hall: I feel like I just might have lost a drinking buddy.

Caplinger: [laughs] It was great to be on, JMo, I really appreciate it.

Moser: All right, guys. Well, we'll see you somewhere out there on the air very soon again, I'm sure. But for now, that's going to do it for us, folks. Remember, you can always reach out to us on Twitter @MFIndustryFocus. You can drop us an email at [email protected].

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

A big thanks, as always, to Mr. Tim Sparks, for juggling all of this, mixing the show and making it sound so good for us, every day. For Jason Hall and Dan Caplinger, I'm Jason Moser, thanks for listening, and we'll see you next week.