Joel Greenblatt: A Prudent Approach To Investing In Today’s Market

We’ve just been listening to Joel Greenblatt’s interview on the Value Investing with Legends podcast. During the discussion he provided some great insights into a prudent approach to investing in today’s market. Here’s an excerpt from the interview:

Joel Greenblatt: Do negative yields make any sense? I’d say no. What we do now is we rank companies, based on cheapness. Their discount to our assessment of cheapness. Always buying the cheapest and shorting the most expensive. So I don’t really have to worry about that. We do a lot of work on the S&P 500. The way we do valuation. We have good data going back to 1990.

I can contextualize, where does the S&P 500 stand today relative to those last 29 years? And right now, ignoring interest rates, that they’re a lot lower that what they were, over the 29 year period. We’re in the 15% percentile towards expensive over the last 29 years. Been cheaper 85% of the time, more expensive 15%.

When its been here in the past year-forward returns have averaged 4 or 5%. The market during the entire period averaged 10% returns. So sub-normal but not negative. The Russell 2000 by the way in the 1st percentile. Been cheaper 99% of the time. When its been here in the past year-forward returns have been negative 3 to negative 5, so a little different. Let’s just go back to the S&P, 4-5% sub-normal returns, but not negative.

If you want to adjust, and say interest rates are really low, I haven’t found that to be helpful, but if you did. You could argue that stocks are not as expensive at the 15th percentile. I don’t know of a better place to put your money right now.

I wrote in the Big Secret, just to go back to something you said earlier. You have to understand yourself. It’s not a question of should you invest in the market or shouldn’t invest in the market, it’s how much should you invest in the market. No-one’s smart enough to be all out or all in, or very few people are. And a lot of people can’t take the pain of losing 40-50% of their money. So you have to decide what’s the most you can put into the market with that caveat that it could always fall by that amount. Because it does. History would say. People are emotional for any number of reasons. Bad things happen! You have to be prepared for a 40 or 50% loss.

So let’s say you can only handle a 60% exposure to the market. I said in the Big Secret. If you’re really optimistic about things, bump that up 10%. Go 70% long. If you’re really pessimistic go to 50%. Not because you’ll be right, cause you’ll be wrong. But I want to limit how much you’re wrong by. I think that’s actually what investment boards do, for the most part, the good ones. They have an allocation. They’ll bump it up and down. But they limit it cause they are going to be wrong. Most likely. So you want to limit that. So you say, you’re going to be emotional, so put those brakes on before you start. I think that’s prudent for most people.

You can listen to the entire interview here (click play):