A thorough introduction to Coffee Can Investing
From the internet the story of coffee can investing seems to start with this story:
Back in the 1950s, investment manager Robert Kirby was asked by one of his clients to transfer her recently deceased husband’s stock portfolio over to her account.
When he did, Kirby found the husband, who wasn’t a customer, had been copying all of the advice his firm had been giving to the client but only using the buy recommendations, never the sell ones.
Amusingly, his portfolio had actually outperformed his wife’s, who had followed what Kirby’s company recommended to a tee.
In fact, just one of his holdings — in what would eventually become Xerox — was worth more than the entirety of his wife’s portfolio.
The broad focus of Coffee Can Investing is to buy a slice of ownership in high quality companies, at a relatively good price and then do nothing but sit and wait.
Because Coffee Can Investing prevents you from selling, the focus is on selecting companies that you can stay invested for long periods of time. This means selecting opportunities with very high level of conviction as against punting - i.e not taking a chance at something that could be reversed at the click of a few buttons. You wouldn’t be able to chase fads, as you don’t have the option of exiting them when the fad runs out.
Because Coffee Can Investing prevents you from selling, the focus is to construct portfolios that withstand the test of time. This means owning businesses that you believe will perform well over a long period of time and not just rise or fall with the vicissitudes of the market. It also means having enough diversification that the portfolio can withstand temporary or permanent setbacks in any one or multiple investments.
Because Coffee Can Investing prevents you from selling, the primary operation you are allowed to do to alter the portfolio is by investing more money. Given the long time horizon, and a focus on constructing high quality portfolios, barring really bad news, the investor will continue to accumulate shares in their portfolio through the time period of commitment. This means an averaged out holding cost for most securities at an average of valuations across the period, making the outcome of your investment experience more rewarding.
Because Coffee Can Investing prevents you from selling, you are freed from having to worry about the vagaries of the market on a day to day or month to month basis. In fact, you may even be spared from having to think about quarterly results and jump straight to waiting for meatier data points - such as annual reports. Use the time saved to do something else in your life.
What are the theoretical merits of this methodology of investing?
The general intention of this approach is to treat each share you buy as a slice of a business that you hold through the thick and thin of their economic lives for a substantial long period of time, preferably about 10 years at the minimum. Good companies tend to compound their economic activity over time, but no company does so in a straight line (or over a smooth exponential curve), but in a topsy turvy manner. With a true owner mindset, and committing yourself to owning shares over a long period of time, you give yourself enough time to see through some of the rough weather in order to enjoy the sunniest days.
This does not mean however that all the companies in your portfolio will necessarily succeed in compounding economic activity. Some of the companies held in a coffee can portfolio will necessarily suffer enough degradation that you will suffer permanent loss of capital. However over a well diversified portfolio of well selected securities, such losses will be the tiny minority, while large majority of your holdings return significantly positive outcomes.
Will it beat the market?
The intention of coffee can portfolio is not to beat the “market”, but give you a methodology to achieve superior financial returns, at a low cost of time and money, using behavioural edges. However, the premise of coffee can portfolio is that it beats the market as evidenced here, here and here.
It is prudent to note that Coffee Can Investing is a methodology, and hence depending on what you parameters you use, the results of your outcomes might significantly vary. For instance, a coffee can investor who invests in high dividend yield paying companies will have very little correlation to NASDAQ 100 as an index.
My personal approach is to build a portfolio that is well diversified across geographies, industries, company size, currency exposures, technology changes, capital allocation strategies that the only good comparison is something like the FTSE All World All Cap index. There is initial data that indicates that it is performing well by that barometer, but time alone will tell if it lasts. I believe it will, but let’s see.
How is it compared to Index/ETF investing?
Passive investing by buying and holding Index Funds, or its close cousins - ETFs, is a perfectly good way of building wealth. In fact the vast majority of investors are better off using Index/ETFs for their personal financial needs. I have myself built a good part of my wealth over the past 20 years by using some combination of these and mutual funds and I continue to recommend it for starting investors.
However, indexes have their own flaws. There are two kinds of indexes - (a) dumb ones that are purely algorithmic and hence tend to fall to the whims and fancies of the market and (b) run by humans (like S&P 500), that fall to the whims and fancies of the index selection committee. In both cases the whims and fancies result in trading - i.e. the act of rebalancing and changes in index composition leads to stocks being constantly sold and in some cases at the exact wrong time.
The objective of Coffee Can Investing is to produce equal if not more superior returns by avoiding those pitfalls. However Coffee Can Investing is now vulnerable to your whims and fancies and it is important to recognise that. I am not pompous enough to believe that my whims and fancies are superior in intellect or nature than those of index or ETF whims. Instead I believe my discipline and behaviour combined with an average amount of diligence will lead to good results. It is a matter of backing oneself up and I am comfortable doing it now (at the age of 42, having been in and observed markets for over 15 years). I fully empathise with anyone who doesn’t feel that they are there. In those cases, Index/ETF investing is a perfectly good option.
So what are you allowed to do and not allowed to do in this approach?
When starting the journey, you commit to an initial investment, based on a portfolio constructed with the sole purposes of withstanding the time. You also decide on a timeline (at least >5 years, but preferably no less than 10 years). Once these are committed and actioned upon by purchasing the securities, here is your list of Allowed and Disallowed list.
Allowed
Buy more of the securities you have in your portfolio.
Take out the cash received from your dividend and choose not to reinvest the monies.
If the company spins off a division, you are allowed to sell off the spun off division if you so desire.
Add new companies to your portfolio with money you have spare to invest. This money could either come as fresh investment, or from dividends received from the rest of your portfolio.
You are allowed to change the composition of your portfolio by buying something in a different ratio than before. Thats your primary means of rebalancing (along with adding new securities if deemed necessary)
You are allowed to switch from receiving dividends in the form of cash to shares and vice versa.
If you wish to allocate a subset of your portfolio to an ETF/Index, either because that section of the market is too difficult, or infeasible to structure as individual securities, then structure them as ETFs or Index funds. In future, if it becomes more convenient, or feasible, to structure them as individual securities, you are allowed to swap the value of ETFs into securities. This should obviously be a one-time event for that part of your portfolio and hopefully doesn’t lead to trading-type behaviours.
As mentioned above, if you select an Index/ETF to cover part of your portfolio, you are allowed to swap it out for another index/ETF that offers better tracking or cheaper prices, as one becomes available. Again, I hope these would be few and far between within the timeframe defined in your investment strategy.
Disallowed
Sell shares in your portfolio till the end of the committed period.
In upcoming posts I will write about how to construct portfolios that fit this methodology well, and how to position your finances to make the most of the opportunity. I am hoping to get to some company deep dives from time to time too.
Sounds interesting, yes? Feel free to share it with your financial mates. If not, tell me why through a comment.