What follows is very important to thriving in chaos because it provides the means to build an antifragile life that allows you to take decisive action in chaos. I will argue that one’s investment strategy is far more than how it’s traditionally defined and that it goes well beyond one’s choices of stocks, bonds, or mutual funds. Rather than a narrow focus on investment products and allocations, it may be best viewed as a holistic life-model approach consisting of three major parts each of which is essential to the end result. The first and most important component is you and your ability to earn through your various earning activities. Without that then everything else is a moot point. The second component is living your day-to-day life as efficiently as possible so that you live beneath your means. If you spend as much or more than what you earn then it won’t be possible to save and invest. Lastly, and perhaps of least importance is the choices you make on where to invest your money. You might visualize it as a three quadrant process – all of it designed to create an antifragile life model. First, are your sources of earnings or income which if they are antifragile should come from as many multiple sources as possible. Your earnings are then funneled into your personal/family operations defined as all of the things you do to run your life (groceries, gas, transportation, medical, birthday parties, vacations, entertainment, housing, electric etc.). Third, the amount left over after your operating expenses are your “earnings” (just as if you are your own personal business) and that excess capital is then invested in assets that grow in value. In this way, every choice you make – earning, spending, and investing is seen as part of the overarching whole and each choice makes an impact.
Invest In Yourself
The #1 thing you can do is to invest in yourself and be successful in your chosen field. This will involve your choices of education and which career path you choose and how you go about your day-to-day existence as an earner of income. Since you want to build as robust of an income stream as possible the best course is to develop multiple income streams (easier said than done). When asked about investments Buffett doesn’t mince words:
Generally speaking, investing in yourself is the best thing you can do. Anything that improves your own talents; nobody can tax it or take it away from you. They can run up huge deficits and the dollar can become worth far less. You can have all kinds of things happen. But if you’ve got talent yourself, and you’ve maximized your talent, you’ve got a tremendous asset that can return ten-fold.
Before you even think of shuffling paper and electrons around in the stock market to increase your wealth it is important to remember that nothing happens unless you first make money and save the excess. Unless you’re a bank robber that’s going to come from work you do. Your #1 financial resource is your ability to earn in myriad environments.
Running an efficient, low-cost, life model
It will also be vitally important to run your life as efficiently as possible. A dollar NOT spent is equivalent to a dollar earned. Learning to live frugally is a more powerful tool than earning more money for a lot of reasons but primarily because it gives you a lot more flexibility. In this regard, any increase in income added to the frugal lifestyle will immediately result in an increased profit margin that can be invested in growing assets. If increased income is matched by increased spending then it’s a net wash and you’re not getting anywhere. A more frugal lifestyle will bring you far closer to things like early retirement and the independent life and there are plenty of examples of people who are power savers who are set for life in their early to mid 30s. Many GO4ITUSA blog posts will be dedicated to this topic so no need to list everything here but anything you can think of to cut costs goes straight to the bottom line. All businesses have their operations and they make choices and trade-offs on how to spend their capital – an individual is no different. We all have to decide how much to spend on our housing and our entertainment needs and our monthly bills and these are part of life – we just want to get those costs as low as possible so we can put our money to work for us instead of the black hole of operating expenses.
Investing your life “earnings” into investment products / assets
There are essentially four ways to do this – 1. Learn everything you can and pick stocks yourself; 2. Invest in unmanaged index funds; 3. Hire a professional money manager who advises you; 4. Invest in managed mutual funds. Which is best? I would say that #1 is potentially the most profitable but is not for everybody. #2 is the best for most people. I would not touch #3 or #4 with a ten foot pole. It’s hard at best to make significant sums of money through investment if a middle man is taking a chunk and incurring tax liabilities – it just is. Remember that it’s important to be as self-reliant as possible and cut costs so that more goes to you in the end.
Picking Your Own Stocks
This is essentially what I’ve done since 1997 after realizing the limitations of managed mutual funds. I’ve read countless other blogs who claim that it’s impossible for the individual investor to beat the stock market and to out-perform professional investors who do this full time for a living. I fundamentally disagree with them and am living proof that it can be done. Is it “Luck?” That’s the usual comeback. No – it’s rooted in the investment philosophy which must be learned and practiced. Individual investors have many advantages over professional fund managers and those advantages are not insignificant.
1. Professionals tend to over-diversify. Why? Because they don’t want to risk losing to the market in any one year timeframe because if they do their clients will dump them and when that happens they lose fee income and get fired. It is far safer to “hug the mean” of the market and be close to the averages so the fund managers have a bias towards portfolios with lots of stocks. By definition, every stock that is added pulls the manager closer to the market average. Then consider that if they are close to the market average what happens when there are high fees and taxes taken out? It is not hard to see why most funds fail to match the overall market. As an individual you don’t care about any of this because only you can fire yourself – you are free to focus on only the best of the best stocks that have better business prospects than the market at large. Munger favors adding money to your best idea instead of to your tenth best idea – never mind your 100th best idea. This can give the individual a significant qualitative advantage.
2. Doing it yourself, you incur capital gains taxes only if you want to and when it suits you. If someone else is managing it for you or if you’re in a managed fund the tax consequences really aren’t their concern. Capital gains taxes eat away at your long-term rate of compounding and should be avoided. Buffett absolutely uses this to his advantage by deferring capital gains as long as he can so the money keeps compounding. An individual can do the same thing. If you’re with a managed account – look out.
3. Doing it yourself, you are not paying any fees except what it costs to buy and sell which at most decent brokerages is under $10 per trade. Do the math. A $50,000 portfolio with two self-directed trades per year costs $20 per year. That same portfolio in a standard mutual fund charging 1% is going to cost you $500 each and every year. A $500,000 portfolio with two trades will cost $20 per year. A $500,000 portfolio in a mutual fund will cost you $5000 each and every year – plus some recurring capital gains taxes. Professional advice and mutual funds kill your returns just by their structure and it’s a headwind that NEVER stops and must be overcome year after year. This is why mutual funds and hedge funds and professionals all struggle mightily to beat the market. Their advertisements and sales brochures and happy smiling faces won’t tell you any of this.
Having said all of that, below is a picture of some of the books I’ve read on just Warren Buffett and Charlie Munger (some 2-3 times to make sure I understood) – it became a passion. These do not include all of the annual reports and investment books not related to Buffett and Munger. That took a lot of time over a period of years. It is “simple yet hard” to borrow a quote. I tore into everything I could find on Warren Buffett and Charlie Munger and did it to the point where I think I’ve mastered how they do it though I could never hope to come close to what they’ve done – time is a limiting factor and I’m not as smart as they are. I’m not willing to ignore my family as Buffett often did as he pored over annual reports. Moreso than Buffett, Munger’s approach is extreme focus – putting your capital into only your very best ideas when selling far below their intrinsic worth. That’s the approach I took and at times it works spectacularly. That methodology takes a temperament that can withstand lots of fluctuation and the guts to hang if the price drops – you can’t “go wobbly” when things get dicey. You’re right about the stock, you know you’re right, and you don’t need the price to confirm your conviction in the short term – so double down. That’s a certain temperament and temperament can’t be taught – you either are wired a certain way or you’re not so the above has its limitations. My stock portfolio usually consists of only 2-3 stocks – the antithesis of what we’re all taught and the exact opposite of what Wall Street does. But I’ll argue that you can’t win if you’re trying to do the same thing as the big boys so you play the game on your terms and do things that they can’t. They don’t do focused portfolios, they invest in a wide selection of stocks and they do a lot of trading – by definition if one does the opposite your performance is going to deviate from the industry’s – hopefully to the upside. But here’s the punch line. If you’re not willing to put in the time to read all of those books, and do all of the studying and research, and if you aren’t wired for paper losses and fluctuation then don’t even think about trying to pick your own stocks. Fortunately, there is another, far easier way.
Buffett recently made a rather surprising declaration – that when he dies, his wife’s portion of the estate will be put 90% into the Vanguard S&P 500 index fund and 10% into cash. That’s it – no frills, no gimmicks, no professionals to hold hands and talk about the weather – just a simple index fund. Wow. He prefers that it go into the index fund rather than his own beloved Berkshire Hathaway stock which is quite the statement. His reasoning is “peace of mind.” With a market index fund you are essentially riding the coattails of a broad array of American businesses which over time have a very high probability of overcoming shocks and growing – so long as the economy grows and you stay invested, you are going to make money. To build an initial position, a simple strategy of dollar-cost-averaging (put money in month after month no matter what happens) will by definition mean that you don’t buy at the top and don’t try to buy at the bottom – things will average out and you are using market volatility to your advantage. If you do this you will likely out-perform 80-85% of all mutual funds who as previously mentioned are weighed down by their stupid fees and tax consequences (an index fund will only cause very minimal tax consequences until you decide to sell) – nothing wrong with being in the 85th percentile is there? Additionally, with Vanguard the management fee is just about the lowest in the business (the index I personally own has a fee of only 0.05% per year). With Vanguard, you are not going to be ripped off by high fees only for the privilege of under-performance. There are virtues in simplicity and Buffett’s life model will do you well – invest in yourself; focus on your passion and do well in your career; dollar-cost-average your money into the S&P 500 index fund; keep it simple, and plug away. To take advantage of chaos it is essential that you maintain your regular money inputs and even figure out a way to increase it. The objective is to buy as many shares as you can when everyone else is scared and things are cheap. I am heeding Buffett’s model as well and have decided that over time I am going to transition out of individual stocks and go towards the Vanguard index – I don’t want to leave my family worrying about which stocks to pick after I’m gone.
Managed Funds and Financial Advisors
This is not meant to criticize professional money managers personally as I know quite a few. There will always be people who prefer to have a personal one-on-one relationship for a whole host of reasons. For the rest of us, if you are serious about lowering costs and being self-reliant then you need to cut the chord and take the time to develop competencies across your life and financial management is perhaps the highest payoff of all. At minimum you need to know what the professional advice is costing you in terms of opportunity cost and the hit to your compound returns. Next time you talk to a money manager ask him/her what their returns are after all their fees and all the capital gains taxes are taken into account. If you don’t get a straight answer within seconds it’s a red flag. The likely response is to show you a performance chart (a distraction) which rarely includes any deductions for both fees AND taxes. Try it. If you don’t get a straight answer and if they are not beating the market over a 5-10 year time period – then fire them without prejudice post haste. The good ones will be more than happy to show you how they’ve beat the market and if you find one who has done it for a decade or so after fees and taxes then go for it. The odds say that you won’t find one. As for managed funds the easy thing to do is to look up the hot fund on the internet and give them your money. This is usually fools gold (I did it myself when my daughter was born and it averaged about 4% for 18 years after the initial investment – a JOKE). Check out the history of all the “hot” funds over time and see how they have stood the test of time – it’s not pretty. Fidelity Magellan? Janus Fund? Legg Mason Value Trust? At various times in their history all of them were market beaters only to suffer the test of time and the ever-present weight of fees and taxes or management turmoil. If you were in one of them then you’re forcing yourself to make multiple decisions which increase your chance for getting it wrong – once your managed fund starts to under-perform you are faced with a whole host of mental conundrums – Have they “lost it?” Is this temporary? Has a philosophical change (which happened at Legg Mason when they broadened diversification) changed the dynamic? The answers won’t be clear until after the fact. There is danger in trying to out-think the problem. Why not just go with the Vanguard S&P 500 Index Fund and call it a day, forget about it, and focus on the most important thing – your ability to earn and be efficient.