Retirement prep

Planning for retirement stresses most people out. Most people don’t know how much to save fore retirement. Added to this, they have misconceptions about retirement itself.

With these two ideas in mind, I have two Wall Street Journal articles to recommend.

The first highlights online calculators that help you figure out how much to save for retirement. Let me ruin the plot: there are no magical calculators that tell you everything you need to know. Retirement calculators are all based on assumptions about a future that no one can know with precision. But, the process is worthwhile. Remember Eisenhower’s quote: “Plans are nothing; planning is everything.” Don’t expect the calculators to give you quick and easy answers, but do expect the process to enlighten your understanding and inform your future actions.

The second highlights myths that most hold about retirement. Here, I’ll quote Mark Twain, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Most retire early because they have health problems or get fired–before they are ready to retire. Getting rehired isn’t that easy. Buying a second home doesn’t work out that well. You will have medical costs that Medicare doesn’t cover. You’ll probably spend more than you expect in retirement.

Everyone can prepare for retirement and succeed, but few do. Focus on planning instead of a plan, and make sure you aren’t deluding yourself about the nature of retirement.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Retirement prep

Objective advice, or shady recommendations

Another great article in the Wall Street Journal: this one about how investors are confused about adviser fees and regulation.

The issues may seem nit-picky, but they have a big impact on investor outcomes.

On the one hand, you have fee-only advisers who are paid as a percentage of assets under management, a flat fee, a per hour fee, or a per task fee.  

On the other hand, you have fee-based advisers, who are paid by a combination of fees and sales commissions.  

If the issue seems trivial, let me explain.  A fee-only adviser will not get $5,000 for advising that you invest $100,000 in a particular mutual fund.  A fee-based adviser will.

When you ask a fee-only adviser for advice, you know they aren’t steering you toward a lucrative product which may not be right for you or any good.  With a fee-based adviser, you don’t know.  

Asking a fee-based adviser for advice is like asking a barber if you need a haircut–the answer will always be yes.

Another issue is fiduciary duty.  An investment adviser (a regulatory designation: Investment Adviser’s Act of 1940) must put the interest of clients’ above their own.  A broker/dealer (Securities Exchange Act of 1934) has no such obligation.

When you see fee-based, think broker/dealer and barber.  When you see fee-only, think advice in your best interests.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Objective advice, or shady recommendations

Optimism = poor returns

It’s easiest to invest when you feel good about a company or the economy. That feeling reflects good recent results, and a herd of other people who share your good impression. Good feelings cause people to push prices far above underlying value. When the future turns out to be not as rosy as people’s inflated expectations, prices move back to value and poor returns result.

Exhibit A is 1999, when almost everyone was so optimistic about technology stocks, right before they dropped 76%.

Exhibit B is 2006, when almost everyone was in love with the real estate market, right before it plunged over 30%.

It’s hardest to invest when you feel terrible about a company or the economy. That bad feeling is due to poor recent results, and a herd of other people who agree that prospects are lousy. Bad feelings cause people to sell or not buy, pushing prices far below underlying value. When the future turns out to be not as bleak as most expect, prices move back up to value and better than average returns ensue.

Exhibit C is 2003, after the stock market dropped 48% and the second Gulf War started, right as the market started to climb 95% over the next 4 1/2 years.

Exhibit D is 2009, after the stock market dropped 56% and there were rumors the government was going to nationalize the banks, right as the market started to climb 106% over the following 3 years.

My point: optimism leads to poor returns, and pessimism precedes great returns.

The above is easier to grasp than it is to follow. Most people know they should buy low and sell high, but they mistakenly believe that they should wait “until the coast is clear” to invest, and run for cover “when the future looks scary.” They know what they should do, but they succumb to optimism or pessimism and don’t act.

Warren Buffett is the most successful investor alive because he is “greedy when others are fearful and fearful when others are greedy.” Follow his lead:

  • If the coast is clear and it looks like everything is coming up roses, that’s not the time to double down–expect poor future returns
  • If some people are optimistic and others pessimistic, then you can expect average returns
  • If people are panicking and running for cover, that’s the time to double down–expect high future returns

In other words, don’t expect great results if everything looks safe, and don’t expect poor results just because everything looks gloomy. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Optimism = poor returns

Patient capital

People are generally too impatient. Unfortunately, this doesn’t serve them well.

Whether chasing crash diets, miracle cures, or playing the lottery, most people want quick fixes. They understand that longer term paths to success–eating less and exercising more–work, but they aren’t willing to put in the time and effort to succeed. They want results NOW, so they end up with results alright–bad results!

One reason people do this is they get fooled by randomness (to use Nassim Taleb’s phraseology). Short term solutions sometimes appear to work, and long term solutions sometimes appear not to work. Luck and timing plays a much bigger role in the short run, and this throws people off. If they were more patient, they’d figure out what works over the long run and stick with that instead of chasing quick fixes.

This phenomenon is readily on display with investing. Value investing–making investments with low price to fundamentals (sales, assets, earnings, book value, etc.)–consistently beats growth investing–high price to fundamentals–over the long run. But, randomness leads growth to sometimes out-perform value for a period, which leads impatient investors to chase what is “working” in the short run. They begin their chase only to find value out-performing growth yet again.

Why not just be a value investor through thick and thin? Because it requires a lot of patience.  

Just like people jump into fad diets, they won’t stick to value investing because it isn’t “working” right NOW. After all, it’s hard to stick with something that isn’t working, especially because this under-performance can go on for years (the last 7 being a good, but not historically unusual, example).  

But, just as night follows day, value investing will win over time, and patient investors will be the one’s retiring on time while their impatient brethren are putting off retirement for a few more years.

Such is life.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Patient capital

Unsurprising drop

The stock market was down 2.5% on its first trading day of June. This follows a decline of 6.8% in May, leaving stocks down 10.2% since its high of April this year, and down 18.9% since the high of October 2007. This seems to have surprised, and even shocked, many investors.

When asked what the stock market would do, J.P. Morgan famously said, “It will fluctuate.” Benjamin Graham told investors (in his book The Intelligent Investor) to resign themselves in advance “to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent of one-third or more from their high point at various periods.”

In other words, the stock market is a roller coaster, and investors should anticipate and even expect frequent stomach-churning drops and thrilling climbs along the way. These drops are not a sign of something unusual and dreaded, but something expected and even eagerly anticipated. Why? Because drops lead to opportunity as merchandise that cost $100 a few days ago is now on sale for less (sometimes, much less).

As I pointed out in my posts, Better than zero and “Where’s the market going next year?”, the math underlying expected future returns should have warned investors to anticipate drops. And, as I expressed in my post, All eyes on China, news of slowing growth from China would likely lead markets lower, and it has.

I think investors were surprised because they don’t think of the stock market as a roller coaster, or they try too hard to relish the climbs and forget the inevitable drops. Perhaps they also suffer from myopia, attending to recent company reports and economic news instead of thinking about longer term data. 

Nevertheless, drops will happen, and they should be exploited instead of feared. Lower prices mean higher future returns–clearly a good thing. Panicky investors that sell as the market drops benefit longer term investors that buy from them. I’m not saying the drops won’t pull at your stomach–they will. What I’m saying is drops are to be expected and wise investors will have the courage to act as the market drops to exploit short-term oriented investors.

I’m not panicking as my portfolio drops, but lining up my buy list and making purchases as the market sinks. The more it sinks, the more I’ll buy. Just like riding a roller coaster, I look forward to the plunges and climbs, because that’s the nature of the beast.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Unsurprising drop

Quantity AND Quality

When I offer my daughter the option of ice cream or cake, she frequently replies she’d like ice cream AND cake. To her, I offer a false alternative when the “OR” can very clearly be an “AND.” In this case, her reasoning is sound.  There is no need to give in to the tyranny of “or,” instead we should–as Jim Collins recommended in Built to Last–embrace “and.”

I see this every day while investing. Should you invest in Growth OR Value?  Properly understood, this is a false alternative, because growth is one of the most important inputs to value.  

The value of a company is based on it’s future cash flows. If those cash flows are growing, the company is clearly worth more than if they are not (you get more cash flows over time, all things equal). Value is based on Growth, so Value AND Growth must be understood.

For example, if you want a 12.5% return over the long run, you should pay eight times earnings for a 0% growth company, and 15 times earnings for a 6% growth company (almost twice as much!).  Growth has a HUGE impact on Value.

Another mistake investors make is to focus on either Quantity OR Quantity. Once again, Quality is a key input to Quantity. For instance, a company with high barriers to entry and superior management is more likely to achieve quantitative measures of performance like sales per share, profit margins and growth rates than a company without these qualities.  

The degree of certainty that a quantitative result will occur is a qualitative factor, so the quantitative result is driven by the qualitative situation. Once again, Quality OR Quantity is a false alternative–you must pay attention to Quality to correctly grasp Quantity.

Just think about Coke. An inexpensive, frequently purchased product with addictive qualities (caffeine, taste, habit) is much easier to quantitatively predict than an expensive, infrequently purchased product with no addictive qualities (like washing machines). Quality heavily impacts Quantity.

Successful investing is about understanding the nature of each investment. To successfully do this, you must focus on Growth AND Value, Quality AND Quantity. Don’t suffer from the tyranny of “or,” do as my daughter does and embrace “and.”

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Quantity AND Quality

Picking a money manager

It has been well documented (by organizations like Dalbar as well as tons of academic research) that investors get lousy results over time. 

One reason is that they try to do the investing themselves, but lack the knowledge, skill or temperament to invest successfully. Another reason is that they’re lousy at picking money managers. I can’t help with the first problem–it’s up to each person to be honest with themselves about their own abilities and results–but I can help with the second: picking money managers.

There are basically two ways to pick a money manager:

  1. Examine past results
  2. Examine a manager’s process to see if it is a good one

The benefit of examining past results is that it can be done quickly and seems objective. The problem is that separating random luck from real skill is extremely difficult. 

Every money manager’s past record includes a component of randomness, or luck, and a component of skill. How do investors know whether they are seeing a record due to luck, or skill? They don’t.

Investing results are much more random than most investor recognize, especially over the short term. Looking at a record of less than 3 years is likely meaningless. Records of more than 3 years are more meaningful, but even outstanding money managers can under-perform for 5, and sometimes even 10 years!  Correlatively, some managers have great records that don’t last because they were lucky, not skillful. 

Most investors examine past records, but their ability to pick good managers by looking at investing results is terrible. Even professional consultants and investment committees filled with experts get this wrong much more often than right.

Examining past records has a dreadful track record of successfully picking managers.

The other option, examining a manager’s investment process, is much more time consuming, but has a much better chance of being done successfully.

Specifically, there are two measures that seem to be both reliable (persistent) and valid (actually lead to the desired result).

The first is called active share, which is a measure of how different a money manager’s portfolio looks from the general market. To beat the market, you have to be invested differently than the market. You want to find a manager whose portfolio looks different than the market, and therefore has high active share.

The second measure is called tracking error, which is a measure of how differently a manager’s portfolio moves relative to the market. If a manager is all in cash, his portfolio will not move up and down with the market at all, and that leads to high tracking error. A manager who owns the same stocks in the same proportions as the market will move in lock-step with the market, and that leads to low tracking error. 

A manager with a good process tends to have moderate tracking error, which means his portfolio neither moves precisely with nor against the market. Such a manager doesn’t try to time market segments (all technology or all energy), nor does he try to pick “winning” asset classes (all cash or bonds to get in and out at the right times). A good manager picks investments that don’t mirror the market, but that do tend to move in the same general direction as the market over time.

Most investors use the wrong methodology to pick money managers and their results suffer. Instead of looking solely at past records and hoping they can guess whether that record reflects luck or skill, investors should look at a manager’s process. 

If a manager picks investments different than the market (especially if those investments have been carefully analyzed), and doesn’t try to time segments or asset class exposures, you’re likely to have found a manager that will get good results in the future.

Examine a manager’s process, not just their record.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Picking a money manager