Be a failure

So here’s a question, why do we love motion so much? If motion isn’t what moves us forward, if it’s more like wasted time than productive time, how come we spend so much time on it? James Clear (author of Atomic Habits) has one more helpful suggestion here, he says it’s because motion lets us feel productive without risking anything. Action necessarily involves some risk of failure, which is obviously not ideal. Failure is the worst, or at least it seems like the worst. It’s super uncomfortable, awkward, humiliating, and generally terrifying as a prospect. It makes sense that we want to avoid it.
Malcolm Gladwell has some compelling thoughts on this topic. Based on the multitude of interviews he’s conducted with entrepreneurs and successful people, he discovered that a disproportionate ratio of them are dyslexic. Research backs this up, for some reason around 35% of company founders suffer from dyslexia compared to about 15% of the broader American population. Dyslexia is thought to be a great hindrance, what about a learning disability could push people to succeed? Gladwell suggests that the main reason for this implausible statistic is the fact that those who suffer from dyslexia have become so acquainted with failure. Take school for example, grade school provides an endless arena for dyslexic children to fail from early childhood. Reading, writing, test-taking, all of it is perfectly primed to flunk a dyslexic child. So while the rest of us were earning kudos and awards for our normal learning styles, those with dyslexia were learning a much more valuable lesson, how to fail again and again and again. People with dyslexia often demonstrate proficiency with verbal communication (because writing is very difficult), comfort with delegation (because they’ve had to rely on people for help), and other very helpful characteristics of an entrepreneur in a free market society. These characteristics are grown out of a response to failure and weakness. They’re more than a natural or genetic lean, these are learned out of necessity.
Gladwell is not the only one to theorize on the value of failure, Winston Churchill stated that “success is going from failure to failure without losing your enthusiasm.” C.S. Lewis said “failures, repeated failures, are finger posts on the road to achievement. One fails forward toward success.” Theodore Roosevelt, perhaps most famously, said “far better is it to dare mighty things, to win glorious triumphs, even though checkered by failure… than to rank with those poor spirits who neither enjoy nor suffer much, because they live in a gray twilight that knows not victory nor defeat.”
Failure seems scary, but maybe it’s time for a new perspective. Failure is actually your friend. Failure means that you’re taking risks, that you’re in the game, that you’re learning. So let’s embrace failure, let’s get comfortable with it. No more playing it safe with endless motion, we’re here to act. Be a failure, and find success.

The prediction problem

Investing is hard. If you’ve visited this blog in the past you’ve probably noticed a lean against active types of investing (buying and selling stocks all the time). Trying to predict the market, pick winning and losing stocks, find the best times to be in or out of different market sectors is really hard. Actually, the data suggests that it’s impossible, or at least no one has ever consistently been able to do it (Efficient Market Hypothesis). So prudent investing doesn’t leave space for active investing, the two don’t mesh. For many people, that’s not a satisfactory conclusion. We like to think we actually can pick winners, maybe not every time, but at least most of the times. We like to think we actually can see trends and understand market movements. We like to think we can make predictions. Well, call me a downer, but those instincts aren’t very helpful.
I’ve been reading through Factfulness: Ten Reasons We’re Wrong About the World – and Why Things Are Better Than You Think by Hans Rosling, a scintillating read. Rosling makes the helpful point that predictions about anything are never certain (he even specifically references the market), and advises readers to be especially wary of future predictions that don’t acknowledge that fact. So here’s my question: why is the future so tough to predict? Here’s my stab at it, with some helpful input from Rosling: the future tough to predict is because the world is far more complicated than we like to think. Rosling notes that the complexity of the systems involved make accurate future predictions essentially impossible. It’s impossible to predict the market because there are billions of factors to consider, all moving and changing every second. Even if we were able to consider each of the billions of factors, we would still have trouble guessing which direction they’ll each move because none of us knows the future. It just doesn’t make a ton of sense to actively trade stocks based on our limited understanding of market factors, not even for professionals. But there’s still happy news here. Even though we don’t know how the market will move today or next year, we do know that the long term general stint of the market is up. So we can actually stop worrying about predictions and news and market trends, those things ought to be the least of our concern, all we have to do is own the whole market as efficiently as we can and stay on for the ride. Owning the market efficiently is a separate discussion, that’s something professionals can actually help with, but the first step is to admit the prediction problem.

Are you market timing?

Market timing is the practice of moving money in and out of the market, or in and out of specific sectors of the market, based on a belief that the market, or specific sectors of the market, will do well (in which case you’d be in) or poorly (in which case you’d pull out) in the future. If you’ve read about stock picking, market timing might sound familiar. Market timing is similar because it’s also built on a false premise that the market is inefficient, but it’s also a little bit different. Market timing is more subtle than stock picking. Instead of a belief that you can buy underpriced stocks and sell overpriced stocks, market timing is a larger bet on the future of entire market sectors. It gives the allusion that you can simultaneously be well-diversified and engage in market timing since you might always own a few different asset classes. It’s sort of like stock picking in disguise (it’s often called ‘tactical asset allocation’ which sounds super smart) because it’s essentially picking market sectors (asset classes) instead of stocks. Market timing can seem more legitimate than stock picking, but it’s still essentially gambling.

Market timing is unfortunately just as pervasive in the investing world as stock picking. It is often incited by panic, people move their money around or out when the market seems especially scary and move it back again (or not) when the market feels more safe. The timing tends to be exactly opposite of what should be done, people end up selling low and buying high and sacrificing millions of dollars in returns. But damage is done apart from panic too. Dalbar (an investor research company) reports that the average equity (stock) fund investor stays invested in their funds for only 4 years before jumping to a different set of funds, perhaps unintentionally market timing. Money managers routinely shift strategies within popular mutual funds (referred to style drift), shifting focus between market sectors. Pundits constantly discuss market trends which include market timing suggestions. Similar to stock picking, we’re so immune to market timing that it just sounds like normal investing at this point. That’s bad, here are a few reasons why:

1) People are bad at market timing. A study by William Sharpe conducted in 1975 (Likely Gains from Market Timing) concluded that in order for a market timer to beat a passive fund they would have to guess right about 74% of the time. An update to the study by SEI Corporation in 1992 concluded that the market timer would have to guess right at least 69% of the time, and sometimes as high as 91% of the time in order to beat a similarly invested passive fund. So the important question is: does anyone guess right with that frequency? Maybe you’ve made your own guess by this point, the answer is a resounding no. CXO Advisory did a fascinating study on the success ratios of market timers between 2005 and 2012. They looked at 68 ‘experts’ who made a total of 6,582 predictions during that period. The average accuracy of all predictions? 46.9%, well short of the minimum 69% threshold. These predictions sell news subscriptions and online adds, but they’re detrimental to investor returns.

2) Market timers miss out on returns. Trends are a big topic in the world of investing. Market timers analyze previous trends, they track current trends, and they look for the next trend, it’s incessant. Nejat Seyhun in a 1994 study entitled “Stock Market Extremes and Portfolio Performance” analyzed the period between 1963 and 1993 (a total of 7,802 trading days) and found that only 90 of the days were responsible for 95% of the positive returns. That’s about 3 days per year on average where 95% of returns came from. In all the misguided ‘trends’ talk and the popular practice of moving money in and out and all around, market timers routinely miss the most rewarding days in the market. Instead of focusing on market trends, investors would do much better to focus on the whole market and ride the general stint of the market upwards.

3) Market timers misunderstand the market. The most culpable cause of market timing is panic. People do crazy things when they’re scared and their money is on the line. Don’t get me wrong, the stock market can seem pretty scary, and it definitely involves money, but just because it seems scary doesn’t mean you should be scared. The average market crash of 10% or more lasts just under 8 months, 4 months until it hits the bottom, and just under 4 months to return to the pre-crash high. That’s not so scary. Over the last 93 years (going back as far as we have super-reliable data) 68 years were positive by an average of 21%, 25 years were negative by an average of 13%. Also not so scary. There are 45 countries in the world with free markets and the ability to buy and sell stocks and over 17,000 companies to invest in. What would it take for a well diversified portfolio to lose everything? Only some type of global apocalyptical event, at which point you probably wouldn’t be concerned with the amount of money in your portfolio. That is scary but not because of the market, it’s actually pretty reassuring as far as your portfolio is concerned. Instead of panicking, investors would do much better to rebalance during turbulent markets and capture returns on the way back up.

So market timing is a losing game. It can’t provide any consistent value to a portfolio, it actually causes a drag on returns, and it’s often driven by an inaccurate understanding of the market. Unfortunately it’s prevalent, and many portfolios engage in market timing while investors remain unaware. So take a look, have an advisor do an analysis for you. It pays to understand how you’re invested and to avoid market timing in your portfolio.

Sources:

https://www.ifa.com/12steps/step4/#footnote_3

https://money.usnews.com/investing/buy-and-hold-strategy/articles/2018-06-19/no-right-time-for-market-timing

The Beauty of Budgeting

We tend to think of budgeting as restrictive as best, and an overwhelming pain in the butt at worst.
It’s not fun to put limits on spending. Obviously, money is a finite resource, an empty checking account or a maxed out credit card is limiting, but for whatever reason, a budget feels more limiting. Maybe because when you put together a budget you’re assigning the limitations to yourself instead of letting the limitations set themselves. A budget is a self-imposed threat to our comfortable spending habits.
Budgets can also seem overwhelming, even panic-inducing. First of all, who wants to try to tack every purchase? Second, who would want to know where the money went if you did? A budget does take work, maybe not the life-altering amount of work you think, and definitely less work today with all of the additional tools, but it does take work. Unfortunately it’s also fairly detailed work, and overall it seems like way more work than it’s worth.
So budgeting is basically the worst, we know it’s something we should be doing, similar to pulling a painful tooth, but we avidly try to avoid it. Well, I’m here to tell you that budgeting is actually pretty great.
Here’s a question, how many big, fun, purposeful purchases have you made recently? I don’t mean financed, I mean purchased with real money. Vacation package? Weekend trip? New tech gadget? Large gift? If you’re anything like pre-budget me, the answer is depressing. How are you supposed to afford big purchases, let alone big fun purchases, when you’re just trying to keep your head above water?
Here’s another question, how many of your small, seemingly insignificant, comfortable purchases can you remember? Lunch out a few times last week? Starbucks? An extra treat from the grocery store? Again, if you’re anything like pre-budget me, the answer is depressing. You probably can’t even remember most of the whimsical purchases you made last week let alone last year.
These questions epitomize a problem, we don’t think long-term very well. But budgeting is an antidote.
Budgeting helps you spend money on things you actually really want or need instead of spending it whimsically on things you don’t really care about and definitely don’t need. Budgeting forces you to prioritize what you use your money for, it necessarily brings intentionality to your finances. When you start your budget, you’ll get to think about how you want your future to look as it relates to money. And not only that, you’ll begin to see that said future is attainable! You could actually take a weekend trip with your spouse, or bring your family on vacation, or get a new phone! You do have to give a few things up but those daily lunches which were only good for widening your waistline anyway. Budgeting is actually the opposite of restrictive, it’s freeing; now you’re setting the priorities instead of letting whimsy run your life.
Budgeting also starts to help you think differently about the future. Just about anything is possible with enough time and consistent effort, your budget is evidence. Start saving $50/month and a year later you’ll be about ready to book a nice weekend away. Start reading a book 30 minutes a day and you’ll be well on your way to reading 50 books in a year. Start budgeting daily time to your passion project and soon you’ll be quitting your job!

Don’t quit your job, at least not yet, just get started on that budget.

3 Questions to Ask your Financial Advisor

Your investment advisor is a very important person. You rely on this person to help you navigate your lifelong financial journey, and hopefully guide you to a successful outcome. There are obvious characteristics we want in an advisor: integrity, honesty, diligence, etc., all good things. But there are other, almost equally important things most of take for granted in an advisor: What’s their investment strategy? What’s their view on the market? How do they expect to help you capture returns? These are questions we don’t tend to ask, after all, they’re the professionals, but the answers to these questions will have a profound impact on your future.

  1. Do you think the market is efficient or not?

This is a simple question with massive implications. Basically, you’re asking whether or not your advisor thinks he/she can consistently get you better returns than the market by actively buying and selling stocks (stock picking), moving in and out of different market sectors (market timing), and using funds with the best recent return history (track-record investing). If the market is not efficient then these are valid exercises. An inefficient market means that stock prices could be underpriced or overpriced and assumes that smart advisors should be able to figure out which stocks are which and pick the ones that will outperform all of the others. Unfortunately, advisors don’t consistently beat the market, they can’t consistently pick the winners. The results of choosing stocks and timing the market have been overwhelmingly negative and research has resoundingly supported the assertion that the market is actually efficient (Efficient Market Hypothesis). An efficient market means a stock is never overpriced or underpriced, its current price is always the best indication of its current value. If the market is efficient, that means it’s impossible for anyone to consistently predict or beat it, in fact, attempts to do so are more like gambling than investing. Instead of trying to outperform the market, the goal should be to own the whole of it as efficiently as possible. This brings us to the next question.

2. What Asset Classes Do I Own?

In order to efficiently own the market, you need broad diversification. That means you want to own many companies, but more importantly, you want to own many companies in many different asset classes (large companies, small companies, value companies, international companies, etc.). When you ask, most advisors are going to tell you that the large majority of your money is in Large US Growth companies (S&P 500), which is unfortunate because the Large US Growth company asset class is one of the lowest returning asset classes in history. That’s not to say the asset class is a bad investment, it’s great for diversification, but it’s certainly not where you want most of your money. Small and Value asset classes return better over time, so you want to ensure you’re broadly and significantly invested in those asset classes.

3. How will you help me capture returns?

There are three important components to successfully capturing returns: 1) diversify, 2) rebalance, 3) remain disciplined. Diversification (1) means you’ll have ownership in companies of all different shapes and sizes all over the world. Good diversification does two things for an investor: it reduces risk/volatility and increases return. Since we don’t know which sectors or stocks will do best this year, we own all of them, and then we rebalance, which brings us to point 2. The goal in rebalancing (2) is to keep an ideal percentage of each of the different asset classes in your portfolio. Since stocks and asset classes don’t all move the same way every year when one asset class is up and another is down your portfolio percentages get out of whack. That’s where rebalancing comes in. In order to rebalance your portfolio, your advisor will sell some of the asset class that went up and buy some of the asset class that went down, bringing the percentages back into alignment. This must happen systematically, for example, it could be every quarter, in order for it to be effective. The end result is that you’re automatically selling high and buying low. There’s no gut instinct, no guessing, no market timing, it’s committed disciplined rebalancing, which brings us to point 3. Discipline (3) isn’t something that comes naturally to most of us, but it’s extremely important in capturing returns and planning for your future. There’s a behavior element that all of this hinges on, if an investor doesn’t have the discipline to ride out the ups and downs in the market they can’t be a successful investor. The average investor switches advisors and funds and strategies every 3.5 years, that’s a losing game. So how will your investor help you stay disciplined and on track to capture those returns and achieve your goals?

Since I’m writing this and I’m an advisor, you probably assume I’ve got answers to these questions, your assumption is correct. But this isn’t just a sales pitch, good answers to these questions are critical for successful investing, and far too many people simply have no idea what their advisor is doing for them, whether good or bad. So ask a few questions!