Monthly Archives: July 2014

Lucky Strike


Photo courtesy of Artotem

Photo courtesy of Artotem

“Nobody gets justice, they either get good luck or bad luck.”

So said American actor and playwright Orson Welles who had generous helpings of both during his life with bad luck tipping the scales. (Read My Lunches with Orson for more on this fascinating and ill-starred man.)

One word that doesn’t come up a lot in investing circles is ‘luck’. But it should. Luck plays a bigger part in total returns than most of us would care to admit. It’s an especially crucial ingredient during our retirement years. And, unless you’re a rishi, it’s something you have absolutely no control over.

Students of finance learn about the Time Value of Money. This is the concept that present money is worth more than future money due to its earning potential. For example, if you have a million dollars today and invest it, it will grow to more than a million dollars in 20 years. Getting a million in 20 years time is therefore worth less than getting it now.  (Layperson’s Translation: “A bird in the hand is worth two in the bush”.)

If you have the good luck to retire on the cusp of a secular bull market, your investments will continue to grow even as you distribute them in the form of income and gifts. On the contrary, if you happen to retire when the market is tanking, (or inflation is growing), you’re going to burn through the funds much faster. This is part of what makes up the Time Value of Fluctuations.

Here’s a nifty example: Say your portfolio loses 5% this year. No biggie, right? Next year it’s going to have to make 5.3% to break-even. That’s achievable. Now let’s take a 30% loss. To break-even you’ll have to achieve a return of 42.9%. How likely is that? An 80% loss will require a 400% increase. (In other words, Game Over.)

Capital depletion, (through market crashes, inflation or a too-rapid withdrawal rate), means that, even when the markets bounce back, your particular bounce is going to be relatively small because you’ve got less capital to propel it.

So, what to do?

First, open a bottle of wine and pour yourself a glass. If you’re on the cusp of retirement, pray for a bull market that never ends or a large inheritance.

Or you can do the following:

  1. Try not to exceed an annual withdrawal rate of 4%.
  2. Find other sources of income like a part-time job, or delay retirement until you have a topped-up nest egg.
  3. Make capital preservation a priority in the early years of retirement. Getting walloped in the first four years could permanently crush your portfolio. Some advisors even suggest moving all your assets into GICs and T-bills at first to ensure the safety of the capital. (This has tax implications so do the math first.)
  4. Set aside 1-3 years of income in money market funds so you don’t have to sell assets at a loss during a market downturn.
  5. If you don’t have a defined benefit pension plan, consider buying an annuity that pays out a steady income regardless of market conditions.

Luck is the ghost in the machine. You know it’s there. Don’t get spooked.


Reality Bites

Photo courtesy of Viri G.

Photo courtesy of Viri G.

In his short story “The Condemned“, Woody Allen writes: “Cloquet hated reality but realized it was still the only place to get a good steak.”

When it comes to investing, like Cloquet, most of us seem to hate reality too.

Take the recent study of mutual fund performance. A research team at S&P Dow Jones looked at 2,862 mutual funds, all of which were actively managed and focused on the broad domestic market. Of the 25 percent best-performing funds in 2010, only 0.07 percent remained in the top-tier five years later. (Or, to put it another way, 2,860 funds failed to maintain their performance record.

Reality Bite #1: The majority of active managers do not outperform the market.

Reality Bite #2: Past performance does not predict future performance.

So why do we bother paying management fees? Why don’t we all just pile in to a couple of different ETFs or low-cost mutual funds and then skip off to the beach?

Investing itself might be relatively simple but the subject of money is anything but. Each of us vests the idea of money with layers of notions and emotions that blur reality.

Take the wealth management industry. As brokerage fees continue to tank due to competition from online trading, advisors are re-branding themselves as ‘wealth managers’. Rather than slave away as brokers and live off dwindling commissions, many advisors now charge a management fee based on  ‘Assets Under Management’.

This arrangement is the goose-that-lays-the-golden-egg because every month your manager gets a nice pay packet that increases along with the rise in the value of your holdings. Compound those management fees over several decades and, if your manager is not consistently beating the markets, you’re paying a premium for something you’re not getting.

But it’s so alluring to tell people you have a “wealth manager” or a “private banker”, isn’t it?  You feel richer just saying the words. And, mama, the offices! The express elevator, paneled in rich wood and trimmed with spit-polished brass whooshes you to the executive floor. The elevator doors open to an intense light. Are you in rich-person’s heaven? A large floor-to-ceiling window overlooks the throbbing metropolis below. As you contemplate your good fortune, a pretty young woman takes your coat, offers coffee, tea, mineral water, cookies.  You sink into the caramel-coloured leather seats with your coffee. The glossy magazines have titles like, “Yachting Life”, “Sotheby’s”, “Cigar”,”Luxury Rental Properties”…

Who wouldn’t pay a couple of extra points for this fantasy?

Many years ago I went shopping for an advisor. I met several men. One, possibly after a bump or two in the bathroom before our meeting, chattered away about some casino stock. The next one, I don’t remember his pitch but we were in a massive boardroom, the thermostat set to “meat-locker”. The leather chairs were the right fit for a Texas oilman or DQ regular.

My last stop was a Waspy boutique brokerage. Threadbare carpets, a lop-sided painting of a big boat against the beige wallpaper, a soigné 70-plus receptionist, and no tea or coffee. The broker was a short, not-young man with mad scientist eyebrows and a nose for money. A bit of a crank, he proceeded to lecture me about what a scam mutual funds were. I was instantly smitten.

Very slowly we built a portfolio. I have kept many of those original investments, adding to them over the decades.

Yeah, reality bites, but fantasy is a right little nipper too.

What’s that line? If you can’t spot the mark at the table, then it’s you.

The Umbrella Shop

Illustration courtesy of Tom Simpson

Illustration courtesy of Tom Simpson

In Paris, on the charming Viaduc des Arts, there are many “one-thing shops”. There’s a perfumery, a framer, and an umbrella shop. Parasolerie Heurtault sells one thing only: umbrellas. Mind you, they are verra, verra nice umbrellas. The proprietor, one Monsieur Michel Heurtault, makes hand-stitched brollies in waterproof silk taffeta with handles made of ebony, Bakelite lacquered wood, and, gasp, antique ivory.

It’s a risk to commit to just one thing. A prolonged drought, a public distain for theatrical presentations of My Fair Lady or Mary Poppins, or some other cause of falling umbrella demand, and, poof! the business collapses.

When it comes to investing, the mantra is diversify, diversify, diversify. To risk-proof a portfolio, pundits recommend owning 4-6 asset classes and over 30 different equities. Today that’s easy enough to achieve with mutual funds and ETFs that mirror the markets.

But sometimes in the rush to diversify, something gets lost: Outsize profits.

While no rational person would ever suggest putting all your money in a fledging graphite stock trading for pennies over-the-counter, making big bets is one way top investors make big paydays.

Whales like Warren Buffett buy entire companies. Not exactly a committment-phobe, he. Further down the food chain, other investors find success by selecting asset classes they believe will do well and tilting their portfolios toward them. Again, this take a certain amount of chutzpah.

Spreading the love around, as an S&P 500 mutual fund does, divvies up the risk but it will never beat the market. And, factoring in management fees, it will always underperform the market.

Size does matter. Sizing investments is probably one of the hardest parts of being an investor. And nowhere is this more nerve-wracking than buying highly speculative stocks. Because most of these are fledging companies with no profits, they’re brittle little birds that could vanish in a blink under a strong breeze.

On the other hand, if they hit, they hit big. The rule-of-thumb is, assuming you have the appetite for them at all, to put no more than 5% of your total portfolio into high-risk stocks. Depending on the dollars this represents, you may be able to buy several of them. Ten-thousand shares might sound like a lot but if the stock is selling for 17 cents, you’re gonna want to back up the truck to get a meaningful position and the potential for a healthy return.

Once that stock starts to move, consider paring back your investment. Double-baggers do happen. (Your graphite darling might go from 17-cents to 34-cents.) But how likely is it to go from 34-cents to $3.40? Not very. If you’re still in love, keep some but play with the market’s money. Take out your original investment and find another undiscovered gem to buy, or send a kid to camp.

Sometimes betting on one-thing is a not-stupid investment. And, if you’re lucky, it can provide you with a nice, big umbrella for that rainy day.

Lucky Star

lucky starHumans are a superstitious lot. There’s the gambler who believes she’s got a ‘hot hand’. The Italian family who eat gnocchi on the 29th of every month to attract money. The Latina who wears a pair of yellow knickers on New Year’s Eve to attract good fortune in the coming year. Every culture has its own charming delusions about how to bring more money into their lives.Hard-boiled, rational sorts, skip the gnocchi and the knickers all together and go straight to insider-trading.

Despite lip service on the many splendored blessings of living a modest, simple life, funny that no one has come up with charms for repelling money.

But are superstitions silly? Maybe they actually work.

A recent study looked at what people do to reverse the perception of bad luck. In all situations if someone thinks she’s jinxed herself, (for example, boasting that her driving record is accident-free), she will perform some kind of avoidant action. She will literally try to push the bad luck away. Hence, avoiding bad luck usually entails throwing salt over your shoulder, knocking on wood, or spitting.

The other side of the coin, so to speak, is performing actions that we believe will draw luck to us. These usually involve drawing something toward us. We eat something (e.g. lentils, gnocchi, grapes, poppyseed…), hold something, (e.g. silver coins), or put something on, (e.g. yellow knickers, certain gemstones and amulets etc.).

Will eating a plate of gnocchi with cash slipped under the plate make us an Agnelli-sized fortune? Probably not. But, chances are, it does work, just in smaller ways.

One of the 14 cognitive biases is called confirmation bias. Basically it’s a form of selective perception. For example, if you’ve been hankering for a gold Cartier Love bracelet, believing this is an iconic piece, then suddenly you’re going see them everywhere. Same goes for your favorite car model.

Now, what if you perform some propitious act: You put on a pair of yellow knickers, cook up a pot of gnocchi and follow with 12 grapes for dessert?

If you believe these actions are making you irresistible to Lady Luck, that’ll trigger your confirmation bias. So, now, when you run for the bus and the driver actually stops, you’ll attribute it to your actions. You’ll pay closer attention when your stock portfolio goes up. You find a quarter in the street. Gradually you’ll begin to perceive yourself as ‘lucky’.

And because everyone loves a winner, this newfound self-perception could actually make you ‘luckier’, giving you the confidence to take risks by expecting positive outcomes.

That’s the virtuous circle of positive superstitions.

(And homemade gnocchi is surprisingly easy to make.)

Salute and bona fortuna.

You Inc.

Photo Courtesy of Thomas Hawk

Photo Courtesy of Thomas Hawk

What’s the most valuable thing you own? A suite of delectable baubles from Van Cleef and Arpels? A first edition of Gaborabilia? A hundred shares of Apple?

Actually, it’s none of those things. It’s you. Yes, you. You’re the most valuable asset of You Inc.

You’re a spin-off from Parents Inc. For 20-plus years, You Inc. is a highly speculative investment. It might be a ten-bagger, (a return ten times the original investment). It might be a total write-off. Parents Inc., is optimistic about its little spin-off and adopts a buy-and-hold strategy.

At some point before never You Inc. gets its act together and begins the process of converting some of its human capital into financial capital. This could last for 50 years or more. Gradually, however, You Inc. tapers off production. By the time You Inc. winds down, any remaining capital is disbursed to benefactors and the tax man.

But what happens when a You Inc. does an about-face and, instead of diligently investing human capital to generate financial capital, it buggers off to Margaritaville? A splendid mini-documentary from The New York Times looks at one such You Inc.

Dr. John Kitchin, a psychiatrist and neurologist, had a booming practice, a mansion on a hill, fancy cars and watches, and even an exotic animal zoo. He was also a suicidal asshole. (So he says, anyway.)

The onset of a physical handicap made it impossible for him to continue practicing medicine. He wondered what to do next. Then he remembered a conversation he had had in the hospital cafeteria decades before.

Kitchin had jokingly asked a 90-year-old man in the cafeteria line next to him, what was the secret to a long life. The man answered, “Do what you want.”

“Do what you want.”  The phrase strikes fear into the hearts of all hardworking, conventional, responsible people.  That’s exactly what Kitchin did and, by the way, he calls himself Slomo now.

Kitchin/Slomo is in the enviable position of probably having a lot financial capital to convert back to human capital. Today, he appears very happy, not suicidal and, proudly claims to no longer be an asshole. He lives very simply on the outside and richly on the inside.

What about you and You Inc.? How much of your time is spent pouring your human capital into money?  And how much of that money goes back into feeding your human capital, in terms of developing yourself intellectually, spiritually, physically, emotionally— supernatural or otherwise.

Don’t let things get too lopsided. If all you do is make money, you risk becoming a bore. If all you do is “self-actualize” you’ll hit the skids, be forced to think about money all the time and become a stressed-out basket case.

Like a good cook, taste as you go. A little dash of human capital, a dollop of financial capital, back-and-forth until it tastes just right.


Photo courtesy of Susanne Nilsson

Photo courtesy of Susanne Nilsson

There is no such thing as a self-made woman or man. Everyone stands on someone else’s shoulders. Lucky people find worthy teachers. (Or the teachers find them, as the saying goes in spiritual circles.) Warren Buffett’s first mentor was the renowned investor Benjamin Graham  who wrote The Intelligent Investor.

Graham, a natural pessimist, spent his days probing Moody’s Manuals in his search for mis-priced companies. He hunted for losers, the cigar butts of the equity world that had been kicked to the curb. Wisely, Graham suspected that some of these stocks had been discarded a tad prematurely. Sure, they weren’t pretty, all mashed up by the side of the road, but some of them had one last puff left in them. His talent was to find these unfortunates and suck out that last puff before tossing them away for good.

Graham’s carrion-like investment style made a strong impression on Buffett who developed a habit of buying distressed companies in the hopes of turning them around. (Textile firm Berkshire Hathaway is one example of Buffett’s several failed efforts.)

That is, until he met Herb Wolf.

Wolf was a New York-based investor and he showed Buffett there was another way to make money. Instead of profiting from dying companies, one could profit from the living. As Buffett recounts in Snowball, “Herb said to me, ‘Warren, if you’re looking for a gold needle in a haystack of gold, it’s not better to find the gold needle.'” 

Treasure hunting is an easy trap for both novice and experienced investors. The more obscure the investment, we believe, the better.

Give someone the opportunity to invest in 100 shares of Royal Dutch Shell, a company with good liquidity, a low P/E and a high yield, or a hush-hush-by-invitation-only venture capital startup, and people will trip over each other to make out cheques to the latter.

An investment in Royal Dutch Shell is the bird in the hand—a solid company that ain’t goin’ nowhere. And, it’s also the bird in the bush—perpetual dividends and capital appreciation. It’s possible that the venture investment will generate higher returns than this blue chip. It’s equally likely that it will vaporize. No bird in hand. No bird in bush. Bye-bye birdie.

Like Buffett version 1.0, I enjoy treasure hunting now and again but I limit it to less that two percent of my portfolio. Over the years I’ve shifted to Buffett version 2.0:

  • Buy winners, not losers
  • Avoid overpriced stocks and high transaction costs to keep a margin of safety
  • Go long

Then sit back, sip an iced tea and listen to the sweet birds sing.

Happy Canada Day!