For over 26 years, SMI's teaching on investing has been built on a handful of biblical foundational principles.

We've written about these in different places and different ways, but here's a quick overview as summarized in SMI's 7 Key Principles For Christian Investing report:

The Bible speaks of four particular problems that affect us:

1. Our wisdom is flawed (1 Cor. 3:18-19)
2. Our motivations are impure (Jer. 17:9)
3. Our emotions can overpower us (Rom. 7:18)
4. Our vision is limited (James 4:13-14).

These four problems tend to pull us in self-destructive directions — and they are why we need "boundaries" for our own protection.

God has given us such boundaries in the Bible, boundaries that can help us define our priorities and develop an investing strategy. Yes, in a sense, having boundaries takes away your freedom to do what you might want. But a strategy based on boundaries offers a new kind of freedom — the freedom to do what you should!

That report goes on to identify four boundaries that will help ensure a focused Christian investment strategy:

  • objective, mechanical criteria for decision making;
  • a portfolio that is broadly diversified;
  • a long-term, get-rich-slow perspective; and
  • a manager's (rather than owner's) mentality.

One of the most important applications of that "objective, mechanical criteria for decision making" principle is found at the center of every SMI investing strategy: a robust selling discipline. What does that mean? It means that before we buy anything in an SMI strategy, we already have objective, mechanical rules in place that tell us when it will be sold.

That may seem odd at first, but it makes perfect sense when you consider that one of the most important aspects of long-term investing success is managing your emotions. Investing is an emotional activity, and investors are emotional creatures. Having pre-defined, easily-measurable selling criteria eliminates much of that emotion, because you've essentially limited your own ability to make bad transactional decisions based on "falling in love" with an investment that has been successful (or the opposite, selling something too soon because you've had a bad emotional reaction to its initial performance).

Whether you're investing in entire asset classes (stocks, bonds, real estate, etc.) as we do in SMI's Dynamic Asset Allocation strategy, specific broad-based mutual funds as we do in Stock and Bond Upgrading, or narrow sectors of the market as we do in Sector Rotation, the constant thread linking all of these approaches is the application of an objective selling discipline that tells us when to exit these funds and shift our investing capital into a new vehicle.


I was reminded of the importance of SMI's selling discipline recently while reading about the sad downfall of one of the great mutual funds of the past half century, the Sequoia Fund. Here's how investing blogger Josh Brown described it:

Sequoia was the very best that the industry had to offer. The gold standard. Forever. Long-term oriented, unselfish and willing to close down when too much money had poured in, intelligently run, brimming with continuity and experience, legendarily cautious, reliably faithful to its mandate.

It had the imprimatur of being the only fund blessed by Warren Buffett himself, who exhorted his investors to put their cash there when he closed down his private partnership. It had a universe-beating track record that was decades and decades in the making. It did Ben Graham-style value investing better than Graham did it himself.

Brown goes on to describe how decades of superior discipline and stock picking were undone by a single spectacularly failed holding. The implosion of this one particular holding was so damaging to the fund's long-term track record (not to mention its more recent performance) that the long-time CEO and co-manager of the fund wound up falling on his sword and retiring. It was a mess.

But this is where the story reaches a fork in the road. Many, like Brown, read it as an indictment of actively managed funds. Their logic is that if this can happen to the very best of the best that active management has to offer, how can you ever feel safe about owning any actively managed fund? They're all vulnerable.

And the painful fact of the matter is, that's true. While the nature of this fund may have made it particularly vulnerable to the specific problem that caused this performance meltdown, the reality is that every fund is potentially vulnerable to any number of issues that could undermine its performance.

But rather than throw up our hands and conclude that the active management path is hopelessly flawed (a common conclusion for those who practice the indexing approach to investing), we point to our protective boundary and how an objective selling discipline would have helped us navigate this crisis.

Given Sequoia's long history of success, it's no surprise that SMI's Stock Upgrading strategy has recommended it in the past (most recently in 2012). While we didn't own it as it went through its recent crisis, it's easy enough to look at the numbers to construct a "what if we had" type scenario.

Our Stock Upgrading strategy only makes buy/sell decisions once each month, toward the end of the month. So it's easy enough to establish exactly when our selling discipline would have told us to exit Sequoia — on or around 10/26/15. That's the month-end when Sequoia would have first fallen enough to drop below the 25% level (top quartile) of its peer group and been replaced.

When Sequoia might have been bought is harder, because it would have largely depended on when another fund needed to be replaced (and is hypothetical anyway, given that its performance hadn't been superior enough for us to recommend it at the time). But we can easily look back over the prior months and establish that if it had been bought a month earlier near the end of September, the loss we would have incurred holding it through 10/26 would have been -9.8%. If it had been bought two months sooner (8/26), its loss would have been -13.6%. And if a reader had bought at the absolute peak of Sequoia's price on 8/5, they would have lost -19.6% through 10/26 when Upgrading's sell discipline would have kicked in.

Now whether the loss is 9.8%, 13.6%, or 19.6%, none of those would have been fun. But neither would any of those losses have been catastrophic, particularly if it occurred as part of a well-diversified portfolio (like our Stock Upgrading portfolio). The reason Sequoia turned into an active management horror story is the losses continued to mount all the way through the end of this past June (2016). By that time, an investor would have lost a whopping ~43% from Sequoia's peak the prior August. But Upgrading's mechanical selling discipline would have cut that loss at least by half, and likely more than that.


The point here isn't to engage in the active management vs. indexing debate that some have tried to turn the Sequoia tale into. Whether you're using actively managed funds, as we primarily do in Stock Upgrading, or index funds which are the basis for our Dynamic Asset Allocation strategy, the principle of instituting and closely adhering to a robust, mechanical selling discipline still applies. Without it, even the most seasoned veterans can be led astray by their own emotions.