Don’t kid yourself

A note arrived from a long time Invest-Notes reader claiming bragging rights for having an IRA that did much better than the S&P 500 in 2016. His plan, he explained, was to begin spending more time “managing” his investments since he had “cracked the code” on “beating the markets.” When pressed to explain his methodology for calculating the return earned on his IRA he replied simply, “I took the account value on January 1 of this year and subtracted the account value from the previous January 1.”

There is much to laude in this this narrative. Making regular contributions to retirement accounts and monitoring the performance of these accounts are things we should all be doing. None the less, my spidey-senses were tingling and I pressed for a bit more detail. Did he make the maximum contribution in 2016 ($6,500 for those of us over a certain age)? Yes, and he was just sorry not to have made the contribution earlier in the year. Had dividends been included in the calculations? They had not, but this just proved that the returns were even better than originally calculated. How much trading occurred during 2016 in this account? Clearly not enough considering how well those few trades played out.

According to the Employee Benefit Research Institute the average IRA balance for someone around 55 years old is about $100,000. A late start in saving for the future meant this particular account was below average. But just how much money is needed for retirement? There is a simple calculation in the terrific new book, Right Away and All At Once by Greg Brennenman, that everyone should know about. Calculate what your annual income after you leave the workforce will need to be to maintain your current lifestyle. And don’t kid yourself, there’s not going to be any big decrease in your spending level.

Assume a 5% annual return on your savings – again, don’t kid yourself – and the calculation is straight forward. So if you want to have $160,000 in annual income, you need $3.2 million dollars in your IRA (or whatever savings vehicles you have). You can use whatever number you want, this is just the example in the book. Which also provides the wise counsel, “It is not lost on me that the average household income in the United States is less than $160,000 per year; we all tend to want more than we have. Happiness always seems to be right around the corner.”

It turns out that when calculating the returns on his IRA, this investor included the $6,500 contribution as a return on investments, which it was not. Meaning around 7% of the calculated returns came from his annual contribution. In fact, the S&P earned north of 11% last year and in this case, the actual return on his IRA investments mildly underperformed the S&P. Yet this story does have a happy ending.

First, more things are going right than wrong. His annual IRA contribution for 2017 has already been made and the decision to begin doing more trading in the account has been shelved. Additionally, an effort will be made to set aside some additional savings towards retirement. Second, a healthy dose of reality is good. We all want to be above average, which is a tough goal to reach statistically. The whole point of investment vehicles like indexed exchange traded funds is that average is not a bad thing for most investors. We also tend to overlook account fees and transaction costs, which have an outsized effect on smaller investment accounts.

Finally, and perhaps most importantly, this investor didn’t blame the messenger. We had a constructive conversation and he plans to continue as an Invest-Notes reader. My thanks go to all of you readers for making these kinds of interactions possible.

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Who are those guys?

Butch Cassidy and the Sundance Kid marveled (in the movie at least) at the tenacity of the paid posse of characters tracking them relentlessly for reward money. Perhaps an indication of the mind-set separating guys looking for a quick hit (Butch and the Kid) and those willing to doggedly pursue a profit (bounty hunters).

The source of this musing was a note from the Boys at Bespoke (highly recommended, talking about current trends in the sentiment of investment newsletter writers. An interesting group and one generally viewed a bit warily here at Invest-Notes. There are a few grizzled veterans held in high esteem, folks like Ned Davis and Barry Ritholtz, because they focus on providing context. They help us think about stuff often not found on our personal radar due to both bias and ignorance. They don’t tell us what to do, they teach us how to think.

At the opposite extreme are pundits who focus on the stock du jour. My favorite example is the guy who provided a list of “Ten Stocks to Hold Forever.” His newsletter was aggressively priced, but as I was often told by subscribers he was an entertaining writer and his reasoning seemed pretty good. But it left me wondering; if I only need ten stocks and I’m done, what do I need a monthly newsletter for? Worse, each year featured a new set of “Ten Stocks to Hold Forever” and how is that supposed work? Add ten new stocks every year, or replace your forever stocks annually? Is this guy the criminal or the posse?

I have no hard data to back up this claim, but I’ll make it anyway. Most newsletter writers likely make their money from subscriptions fees, not from the results of their stock picking. To support this idea let’s go back to the Bespoke Report. On a graph overlaying the sentiment found in newsletters with the performance of the S&P 500 starting in 2002 displays little to inspire confidence. This sentiment measurement comes from a weekly survey by Investors Intelligence where the spread between the number of bears (negative on stocks) is subtracted from the number of bulls (positive on stock ownership).

Combine this with a necessity to continually come up with new investment ideas – to keep people reading and renewing their subscriptions – and there is little evidence that any investment strategy based on continual turnover of a portfolio is going to provide value over time. In many ways this concept has the sound of a do-it-yourself mutual fund where the investor gets to churn his account instead of an advisor.

In many cases the best to be said is that the majority of newsletters shared with me by Invest-Notes readers (usually to solicit an opinion on stocks being suggested) is the selections tend to be smaller, and often obscure, equities not much covered by the Wall Street crowd. Though it was Bolivia, a smaller and generally obscure, recommendation about where to go next that lead Butch and Sundance to a regrettable ending.

Another view:

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Got to be a mystic man

There is absolutely no evidence that reggae musician Peter Tosh was an equities enthusiast. Yet it is not impossible that he gave the subject some thought. This idea formed serendipitously after an event that occurred outside of my Invest-Notes bubble when I became re-acquaintance with the title cut from Tosh’s 1979 album, Mystic Man, which I have not heard in many years. Don’t laugh, think about it:

  • I’m a man of the past
  • And I’m living in the present
  • And I’m walking in the future

Okay, now a quick primer on investment strategies, made without judgment (it was Ned Davis, after all, who pointed out that it isn’t the strategy that matters, but the discipline to consistently implement one). The past would be folks like chartists, people who look to past performance, and the way equities have responded previously in similar situations, to create a context for future performance.

The present would be bottom-up analysts – a hedge fund type of thing – where painfully in-depth reviews of K-1’s, financial statements and engagement with current management are combined with analysis of industry performance and sales/distribution channel measurements; in other words, a laser focus on the here and now. Yet regardless of where you land within this spectrum, everyone is trying to figure out how to plan for the future.

So, while listening to Peter Tosh I was reading the third installment of the annual Barron’s investment roundtable when this line from one of the participants glowed on the page, “We expect it to trade for 20 times our 2018 estimate of $6.50 a share; the fiscal year ends Oct. 1. That implies 20% upside. The downside is $100 a share, or maybe $95.” A quick comparison of the 2016 results of this same group revealed the only person who did not have a money-losing investment idea was the owner of this quote. It was notable how few other recommendations even mentioned a downside; let alone what it might be.

The case was made for what could cause this stock to see an increase in earnings, an increase in its valuation (the price-to-earnings ratio) and what potential benefit accrues if these assumptions are correct. This is the standard narrative; why a stock is going up, and how much you could make. What caught my attention was the reasoning behind the downside projection. A well-run company, with a long history of delivering shareholder value (a consistently profitable enterprise through many economic environments) that does not face any obvious headwinds. In other words, in the event of an overly optimistic scenario for the future, the stock should muddle through – and remain profitable while delivering a consistently increasing dividend.

A review of some of the other Barron’s roundtable picks from 2016 showed several companies where the upside was expected to come from major surgery, which either didn’t occur, or after which the patient did not improve and often got worse. In retrospect, this feels more like speculating than investing. The chance and magnitude of potential loss matters, a lot.

The lesson here is to first understand the downside risk, which is more important than creating a dreamy view of an unknown future. As Warren Buffett has suggested, you don’t buy companies with problems to fix but businesses doing just fine that have opportunities for improvement. And just maybe, by starting with a view of past performance, then comparing and contrasting the most current performance and financial information is the most reasonable way to step comfortably into the future when looking at individual equities.

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Bombs away, dream babies

Somewhere between Wonderland and Through the Looking-Glass, Alice called us all out when she confessed, “I give myself very good advice, but I very seldom follow it.” Which of us has not had to admit the same in the face of a self-inflicted bit of financial folly? And today, as the world seems to spin around us with the confused fury of a storm at sea, how can we keep our path true? I offer up an observation for your consideration.

The term “Madness of Crowds” originally entered my vocabulary as a teenager when I read – admittedly somewhat fitfully – Charles MacKay’s Extraordinary Popular Delusions and the Madness of Crowds, first published in 1841. Though much of the book is now long forgotten, the chapters describing a history of financial bubbles remains often quoted by really smart guys like Michael Lewis. To quickly summarize the substance of MacKay’s idea with a quote from the book, “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

Though MacKay discusses the Dutch Tulip Mania of the 1630’s and Mississippi Company Bubble of the 1720’s, we need only look back to the DotCom crash of 2000 and the subprime chaos of 2008 for a personal and up-close look at our own propensity to become part of a crowd that ultimately gets roughed-up financially. Yet there is another way to consider this tendency as it occurs in a less visible but equally damaging way.

This current bull market, starting in 2009 – now the second longest run on record – was missed by many who clung to the notion that the future would look like the immediate past, a very common bias we all suffer from to varying degrees. As measured by the American Association of Individual Investors (AAII), while markets have doggedly moved up to all time record highs, the percentage of their members with a bullish sentiment has been under 50% for 108 weeks. So it is not necessarily that we suffer a financial loss from following the crowd, but that we lose opportunity.

Probably worth noting that in 1845, four years after MacKay published his book on the madness of crowds, he had the following to say about what would become known as the British Railway Mania, “There is no reason whatever to fear a crash.” He was wrong. Later editions of his book include a section about the Railway Mania crowd that he ultimately joined. Go ask Alice, indeed.

Finally, this week’s issue of Barron’s includes a letter to the editor noting that many of the pundits who rallied against a Trump presidency are now beneficiaries of the post-election rally. Specifically, according to Bob Barcell from Fort Collins, CO, “By my reckoning, over half of Barron’s top 50 bullish picks for 2016 owe better than half of their gains to the Trump Bump. Outside of Gotham, it is nothing short of sidesplitting to watch you breaking your collective arms patting yourselves on the back for the results of the thing you railed against, told us couldn’t happen, and swore we would regret if it did.”

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Something to think about

When you finally make the transition from individual stocks and traditional mutual funds to exchange-traded funds (ETF) as the bulk of your investment portfolio, the next step is to start thinking about asset allocation. While it is perfectly reasonable to expect that a handful of ETFs could be sufficient to ensure a solid long term return, it isn’t so much fun if you’ve ever enjoyed “playing the markets” over the years. So the chance to add a little alpha, if you are so inclined, is still possible. Even with an ETF portfolio.

As an example of how this works, let’s propose we become socially responsible investors. No, seriously, in one way or another, we all tend to embrace some investments and shun others for motives more emotional than logical. As noted here at Invest-Notes previously, tobacco stocks are eschewed. This is not a particularly smart decision; over the last five years Reynolds American (RAI) has doubled in price while offering a dividend north of 3%. But something just doesn’t feel right about profiting from a company whose primary product is cancer. Then again, as a long time owner of Heineken (HEINY), the same could be said about a company whose business is selling alcohol – and their five-year return isn’t nearly as compelling.

Okay, so you have an S&P 500 ETF, a couple of others offering international exposure and maybe even a bond fund (don’t laugh, think about it). Yet within the S&P are eleven clearly defined sector groups such as health care, energy, consumer staples and the new kid on the block, real estate investment trusts (REIT). Since the associated sector funds can move independently from the overall direction of the market (and the S&P 500), there can be opportunities to increase dividend yields, bargain hunt among sectors or lower volatility.

Here are two ways to think about framing your search criteria for investment options. First, consider the example above; no tobacco stocks. A decision is made to exclude an industry (or sector) based on personal preferences, not expected performance. A compelling example, despite your feelings about Islam, are the several U.S. mutual funds boasting impressive track records that look to sharia law to determine what stocks to exclude from their portfolio, such as alcohol and traditional banking stocks (because, loan interest = usury).

A second option is to include sector funds – or individual stocks – because they bring added value to your portfolio. The most obvious application is adding a sector fund that has recently underperformed. This is not unlike rebalancing, where on a regular basis winners are pared as losers are added, benefiting from reversion to the mean over time (while not personally a fan of this technique, it remains a viable option for inactive investors in retirement accounts). Another option is to include an individual equity for providing a meaningful dividend. I have some REITs and old fashion blue chip stocks for this role.

If you are less inclined to pick and choose, a variation of this idea is to split your regular investment in a core fund to 75/25, with 75% going to your core holding and 25% going to one of the sectors currently underperforming. Again, this is a way to harness the potential of mean reversion over time.

Yet regardless of whether you choose to hold a small group of well diversified ETFs that you purchase regularly over time, or take a flyer – regularly or occasionally – on a couple of additional holdings with a potential to provide value, your decisions should be made thoughtfully, and in keeping with your overall investment goals.

What, you have no investment plan? Ignore all of the above and get to basics.

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Back to Basics

In response to my musings on the Index of Revolutionary Potential, “Karcher’s college roommate” has asked what I plan on doing about it. Fair enough, Bruce.

First, I’ll be making the maximum contribution to our IRAs in January. Rather than wait until the beginning of the following year (ah, the folly of youth) to make our annual contributions, it should be taken care of first thing in a new year. And with traditional IRAs we also get the deduction against earned income. The reasoning here is simple; the longer your money has a chance to be invested tax free, the better your chances of long term success in saving for those golden years (this as an option to saving for retirement).

Now this does not mean that all the funds are immediately invested. I’ll generally spread the (mostly) ETF purchases over the first couple of months of a new year. But don’t take my word for it. Take a look at a five-year chart of the S&P 500. Except for 2015, where the S&P ended the year where it started – around 2000 – the other four years saw nice returns from investments made early in the year. And of course, in 2016 the massive sell-off in Jan-Feb has been followed by massive gains into the close of the year.

More importantly, while lots of folks have anxiously waited for a big sell-off to get invested, the S&P has moved from about 1250 in January of 2012 to around 2250 as of yesterday. As we’ve discussed here many times, markets tend to go up more often than they go down – especially over meaningful periods of time. So if you want to do some “market timing” try timing your purchases to the times when you have money to invest. A smarter guy than me has some good thoughts on this topic (see Ritholtz link below).

Second, I won’t be paying much attention to the numbers on the dial. There was a lot of excitement when the S&P 500 cracked the 2000 mark for the first time back in 2014. And still, the S&P was at 2000 again this summer. Unless you are highly skilled in the alchemy of gematria, focusing on an index’s current numerical status isn’t so much help. It is more important to be aware of trends in overall market movements, where momentum can be a powerful force and not so hard to divine (see Seth Masters link below). This applies to both the main indexes like the S&P 500 and Dow Jones, but also to individual asset classes such as energy, technology or finance.

Finally, I’m going to be watching (as James Thurber put it) not back in anger nor forward in fear, but around me in wonder during January. Until there is a bit more clarity around what our incoming president will do versus what he’s said he’ll do, I’ll stick with the discipline of making those IRA contributions early in the year, but probably sit tight until February before wading back into equity markets. Which means I can spend some time thinking about asset allocation (to individual asset classes such as energy, technology or finance), another discipline that doesn’t always get the attention it deserves from individual investors.

  1. Barry Ritholtz has an interesting perspective, “I am always astonished when I hear that new market highs are a reason to avoid equities”:

  1. Solid reasoning from a reasonable investor, “But what we can say with confidence is that we will ultimately end up going through the 20,000 level more than once because there will be more volatility ahead”:

This Saturday, December 17, 2016 I’ll be featuring the music of Lee Morgan on the jazz radio show Straight Ahead, at 8:00 am (central time zone). You can stream it live via the internet at, or play it back anytime during the week by accessing the archives at

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Is revolution in the air?

First, there’s a backstory to make it crystal clear that I have taken someone else’s idea as the basis for this commentary. Surprisingly, trying to explain who was actually responsible for the original book excerpt took the better part of an afternoon and ended up being as long as this Invest-Notes post. You can read the curious story by clicking Art-Notes in the navigation bar at the top of this page.

This essay is based on a book excerpt (from 1806, maybe) arguing that the series of riots leading up to, and then causing the French Revolution of 1789 can be explained by mathematics. The parallels to events like the Dot-Com bust, the U.S. housing crisis, the financial mayhem in Greece, the Arab Spring and Occupy Wall Street shouldn’t be shrugged off as outliers after being followed by Brexit and the election of Donald Trump as president. Revolution is in the air, again, and the idea posed in 1806 (maybe) feels eerily prescient.

Essentially a case is made that the cause of the French Revolution was population growth. An estimated increase of the general population in France (of as much as 70%, maybe) during the fifty or so years before the revolution, suggests there were too many people chasing too few jobs, leading to stagnant or declining wages. Conversely, you also had more people chasing fewer goods, in this case corn and milk, leading to higher prices. In 1790 it wasn’t so easy to increase the number of cows or arable land.

But there is an all too familiar twist on this hypothesis, even in 1789 – technology. Improvements (relatively speaking) in health care and hygiene meant more people living longer and lower infant mortality rates. At the same time, the steam engine and other industrial revolution breakthroughs meant fewer manual labor jobs (for most people at the time). From this fact-set the author proposes “the index of revolutionary potential.” Here I’ll simply quote from the book:

“If there are high wages and low prices, this index is low, and one can expect no revolution; if there are low wages and high prices, this index is high and revolution can be predicted…”

While the actual population of the U.S. isn’t expanding dramatically, there seems to be a growing number of people needing a job with decent wages. Not just new members to the labor force, like Millennials, but lots of people who have been downsized, laid-off or are not prepared for retirement – financially or mentally.  Again, it feels like mathematics is the bad guy in all this.

Add to that the reality of a spread between earnings of workers and bosses being wider now than in a generation. Now occupations like legal services are finding themselves threatened by low-cost overseas outsourcing. The movement of consumers from shopping malls to the internet is relentless and gaining momentum. Even the way we save money and then invest it is evolving faster than we can keep up with. The easy money to be made in emerging markets and places like China and Brazil is gone. And yet we understand intuitively that change can mean opportunity.

The point of these musings is to challenge you to take the sound advice offered a generation ago by humorist James Thurber, “Let us not look back in anger, nor forward in fear, but around in awareness.” Think about what this fundamental shift in the world economic order is going to mean for you, your occupation and your investments. It was easy for the Monday morning quarterbacks in 1990 to talk about what it meant “back in the day” when the Baby Boomers and women entered the workforce in huge numbers – remember the 1970’s recession (and burn, baby, burn)? Or the housing bust of 2008? Too many buyers with incomes incapable of affording the overpriced homes available? Sure sounds like “the index of revolutionary potential” to me.

So in 2016, we have a global aristocracy who seem out of touch (the 1%), governments not much trusted by their people (the driver of populism), and lots of workers convinced there are few opportunities to earn decent wages (the driver of protectionism). Despite the rhetoric from the recent U.S. election, the drivers that led to the creation of the “middle class” don’t exist anymore and aren’t coming back. Once again, technology – robotic assembly lines, e-commerce and clean energy – is causing dislocation for people who are today’s equivalent of manual laborers. The world isn’t flat anymore, entire industries are being marginalized and a lot of people are just pissed off without knowing what to do about it. So what are you going to do different now it’s clear that change, and maybe revolution, is in the air?

Terrific interview with Jack Bogle, who didn’t create ETFs, but was in the vicinity:

You may be the 1%:

Okay, even if you aren’t in the 1%, you can still live like it:

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Why bother?

After the last 72 hours, it might be worth taking a few minutes to reflect on why we should even bother to risk the hazards of equity markets – because it can be easy to come up with reasons not to. We all know that neither humans nor markets are rational entities and we all know the folly of arguing with fools and knaves. Events that “cannot happen” do so with regular frequency and beg the question of, “Why bother?”

Well, though it hasn’t been so obvious recently, the most important reason is inflation. As Warren Buffett likes to point out, a dollar he earned 75 years ago only has the purchasing power of a dime today. With lifespans getting longer the value of hard-earned savings can become worth less over time, putting your lifestyle at risk. So at a bare minimum, we need to earn enough on our savings to avoid an erosion of purchasing power. Over meaningful periods of time returns on equities have proven to be one of the best ways to beat inflation. Just ask anybody who decided ten years ago to count on bonds to fund their retirement.

Now, a long time ago in a galaxy far, far away, this is what having a savings account in a bank was all about. You deposited the excess of your earnings with a bank, or that nostalgic entity, a Savings and Loan. Their job was to do due diligence identifying new and existing opportunities, mostly local, in which to invest the pooled savings of their customers. The bank’s depositors, in turn, were paid interest on the money entrusted to the bank, thereby, linking their savings to the profits of the bank and its investments (mostly loans). This was the best option for most people because it was safe, easy and much less expensive and risky than trying to trade individual stocks. And bank savings account weren’t much impacted by events like election outcomes.

As an example, the most visible use of bank deposits at one time was for home mortgages. But as reported last week in the Wall Street Journal (link below), for the first time in over 30 years, banks provided less than half of all mortgage loans. Add to this the challenges faced by banks in conforming to the many “new rules” established in the aftermath of the economic crisis in 2008-2009, and the ways in which financial institutions can invest their customer’s savings has been diminished. Today asset managers like Blackrock and Vanguard, mutual funds and exchange-traded funds are perceived as viable alternatives for individuals to invest their savings.

All of which brings us back around to the debate of active versus passive investing. Putting money in the bank is passive. And a recent Buttonwood column in The Economist (link below) demonstrates again that for most people, passive is the better option when choosing asset managers. In the on-going debate over exchange-traded funds versus mutual funds, here is another example of how the fees being charged by mutual funds can hurt the typical investor. While it has been suggested here at Invest-Notes that investing is about using your money to make money, Buttonwood offers a more nuanced definition of what long-term investing can achieve, or lose, based on something as basic as the cost of stock ownership.

So we should invest for a couple of logical reasons: to stay ahead of consumer price inflation, and to put money to work multiplying itself for our future benefit. Always remember, spend less than you make, and save the rest somewhere you will be least likely to overreact to unexpected events. Frankly, nobody has a clue what’s coming next, and knee-jerk responses to surprises, fear, politics, or the latest prognostication from pundits will only ensure you have an effective way of failing to achieve your financial goals.

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Skeletons walk where questions begin

“Avoid the unforced error, nail the basics and don’t take outsized risks” might be the best advice the individual investor can follow. An often-underestimated influence on equity and bond markets is the heavy hand of luck. Frankly, you can do everything “right” and still get bad results. And since luck can’t be controlled, knowing how to react – whether that luck initially appears to be good or bad – can separate winners from losers. But just because something can’t be controlled doesn’t mean it can’t be managed.

We all know bad things happen that are beyond our control to foresee or influence. Fires, floods and financial crisis come to mind. So we buy insurance, avoiding home purchases in areas prone to flooding and create investment portfolios that are well diversified with a healthy dose of cash savings. But what else?

One of the best thinkers on this subject, and a terrific writer to boot, is Michael Mauboussin. The man knows how to think about how we think – especially as it relates to investing. I read his terrific 2012 book, The Success Equation, when it first came out. Subsequently the opportunity to hear him talk about his book in person helped to clarify some of his more nuanced arguments and observations.

One of the many surprises that will be found in The Success Equation is an important reason why individual investors should look to exchange-traded funds as their best bet to achieving financial goals when using the stock markets. Discussed in many recent posts here at Invest-Notes, by choosing to invest in indexed funds smaller investors earn the market averages over time with much less risk or cost than owning individual stocks or traditional mutual funds. Remember, for as long as equity markets have been measured, they have gone up more often than they go down.

As noted a couple of weeks ago in The Economist, 70% of U.S. stock markets are now owned by large institutions like Blackrock, Vanguard, Fidelity, pension funds and hedge funds. That percentage was just 35% in the 1980’s. This means the self-described investment professionals are competing against each other more fiercely than ever before. As Mauboussin intriguingly suggests, the more skill involved in a competition the bigger the impact of luck on the outcome. For the individual investor, luck is a bad strategy.

Put another way, you don’t have to compete against the younger incarnations of Arnold Palmer or Muhammed Ali to succeed in building wealth over time. You don’t have to go at risk trying to pick up a couple of extra points against the pros, and face the risk of being seriously hurt – also known as suffering a permanent impairment of capital.

By systematically analyzing the outcomes of investment strategies – repeatedly and over time – we can create mental models that help anticipate the unexpected (to minimize risk) while expanding opportunities (to maximize upside). You can easily improve your overall return just by minimizing costs like fees and commissions (nail the basics). You can stay calm and remain inactive during times of great stress (avoid unforced errors). You do not have to go head-to-head with the pros (no outsized risks).

As Rudyard Kipling noted a century ago, just ”…keep your head when all about you are losing theirs…”

NOTE: Apologies for the long absence from this page, but a quick look at Jazz-Notes (link in menu bar at the top of this page) will explain where I’ve been. Hope you get a chance to check out my weekly radio show, Straight Ahead, on KRTU 91.7 FM. Live on Saturday at 8:00 am central, or on-line anytime at

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You should be very afraid

The surprisingly insightful book, Being Right or Making Money, features observations as relevant today as they were when first published in 2000. Ned Davis (of the eponymous market research firm) explores a range of often contradictory investment styles to uncover the common thread allowing each to succeed.

Davis argues that, time and again, the most successful investors, regardless of their style, emphasize the need to be risk averse. All these guys (and in this case, they are all guys) talk about controlling their losses. To manage risk is to make certain that no single investment can so badly impair your overall financial health that recovery is uncertain. In the investment business, this is referred to as “a permanent impairment of capital” and “blowing up.” We must strive to avoid both.

Okay, the thought exercise for today is to pretend you’re a billionaire. Take all your assets, especially the paper ones (like cash savings, stocks and bonds) and your home equity, and add four zeros to the value of each one. Now determine if anything appears out of whack. With a billion dollars to invest, should someone actually put three quarters of it into a single stock? Or hold only gold coins? Or own a home that constitutes 90% of their net worth? When evaluating an investment opportunity always consider the impact a total loss of that asset will have on your overall financial situation. To succeed as an individual investor it is essential to avoid the temptation of focusing on how much an investment could make until after determining what that investment could end up costing.

As Davis reviews the methods employed by successful investors including John Templeton, Warren Buffett, Peter Lynch, George Soros and others, he mentions (without naming names) one who commented that he had never met a wealthy chartist, a wealthy chartist who laughs it off and dismisses the idea of value investing, to which a value investor jokes about the delusions of momentum investors. Davis’ conclusion from these conversations was to look beyond the methods employed and instead focus on how those differing styles could all be successfully implemented.

Yet regardless of their style, four attributes are common to all of these investors:

  1. Use objective indicators. It is important to learn what is real and what is imaginary; gut reactions are not a reliable tool. Biases kill.
  2. Discipline. Once you have a system, stick with it until you have documented results gathered over time that prove change is needed. Never guess.
  3. Flexibility. Being wrong is acceptable, but staying wrong is not. Things change so get used to it, and believe that managing the tension between this rule and #2 above are likely the only chance you have at success. Know thyself.
  4. Be Risk averse. As mentioned by so many great investors, “I am always thinking about losing money as opposed to making money” and “We are cowards. We hate to lose money.” Be scared.
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