The Riskiest Word in Investing: Hedge

Never Hedge Your Retirement Portfolio

Never hedge your retirement portfolio! This is one risk you must control without a hedge.

Why is “hedge” the riskiest word in investing? Because it shows that you don’t understand risk.

If you are trying to hedge your retirement portfolio, let’s see if you might not pick a more appropriate term.

Continue reading at F.I.Physician right here: https://www.fiphysician.com/the-riskiest-word-in-investing-hedge/?fbclid=IwAR1kARrBhzcTX0V3e_C1QnkvfWSJlAZLaIgkOa9MTdirtd28AFjkO2Zk0l0

Last Man Standing · Collaborative Fund

Amazon in 2014 was a puzzle. It was big. It was growing. It had market share and mindshare. Competitors feared it as much as customers loved it. What it didn’t have was a good business. Profit margins wobbled between negligible and negative. That might be acceptable for a young startup, but Amazon was two decades old at the time. The whole thing was easy to mock and call a bubble. Jeff Bezos had a different view: Margins don’t matter. Dollars do. A huge business with low margins was preferable to the opposite. He explained in 2014: Margins are not one of the things we are seeking to optimize. It’s the absolute dollar free cash flow per share that you want to maximize. Free cash flow [is] something that investors can spend. Investors can’t spend percentage margins … What matters always is dollar margins: the actual dollar amount. Companies are valued not on their margins, but on how many dollars they actually make. There are parts to quibble with here, but I just liked Bezos’s simple logic: The business with the most dollars wins. Not the best margins or the highest quarterly growth. Just how many dollars you generate over the long run. Let me propose the equivalent for individual investors. It might push you away trying to earn the highest returns because returns, like margins, don’t matter; generating wealth does. Everything worthwhile in investing comes from compounding. Compounding is the whole secret sauce, the rocket fuel, that creates fortunes. And compounding is just returns leveraged with time. Earning a 20% return in one year is neat. Doing it for three years is cool. Earning 20% per year for 30 years creates something so extraordinary it’s hard to fathom. Time is the investing factor that separates, “Hey, nice work,” from “Wait, what? Are you serious?” The time component of compounding is why 99% of Warren Buffett’s net worth came after his 50th birthday, and 97% came after he turned 65. Yes, he’s a good investor. But a lot of people are good investors. Buffett’s secret is that he’s been a good investor for 80 years. His secret is time. Most investing secrets are. Once you accept that compounding is where the magic happens, and realize how critical time is to compounding, the most important question to answer as an investor is not, “How can I earn the highest returns?” It’s, “What are the best returns I can sustain for the longest period of time?” That’s how you maximize wealth. And the most important point is that the best returns you can earn for the longest period of time are rarely the highest returns in any given year, or even decade. Charlie Munger says “the first rule of compounding is to never interrupt it unnecessarily.” Interrupting it can happen in many ways. The most common is finding a strategy that produces high returns for a period of time then abandoning it when it inevitably has a few bad years. Investing in a strategy or sector that produces great returns for five years but shakes your faith to the point of abandonment after a collapse in year six will likely leave you worse off than a strategy that produces merely good returns but you can stick with for years six, seven, eight, 10, 20, etc. This is especially true if, after abandoning a strategy in its down year, you move on to whatever the new hot thing is only to repeat the process. Complexity is another door to interruption. It can produce higher returns. But the more knobs you have to fiddle with, the more levers you have to pull, the higher the odds that something, at some point, will cause you to second-guess yourself, or reveal a risk you hadn’t considered, or tempt your clients to leave – all of which stops the clock of compounding and can outweigh any return advantage you had when the strategy worked. None of that is intuitive in the moment, because the pursuit of the best returns at all times feels like the best way to maximize wealth. It’s not until you consider the time factor of compounding that you realize maximizing annual returns in a given year and maximizing long-term wealth are two different things. Carl Richards once made the point that a house might be the best investment most people ever make. It’s not that housing provides great returns – it does not. It’s not even the leverage. It’s that people are more likely to buy a house and sit on it without interruption for years or decades than any other asset. It’s the one asset people give compounding a fighting chance to work. Everyone’s different, with varying levels of confidence and tolerance for what they can put up with in investing. But the idea that endurance is more important than annual returns even if annual returns get all the attention is something virtually every investor should think more about. Airbnb CEO Brian Chesky once said, “If you’re trying to win in the next year, and I’m trying to win in the next five years, we both might win. But I’m ultimately going to win.” That’s the whole idea. Bezos’s goal isn’t to have the best business. It’s to make the most dollars. Likewise, investors’ goals shouldn’t be the best annual returns. It should be to maximize wealth. And you get that through endurance – not to be the best in any given year, but to be the last man standing. This kid has it all figured out:
— Read on www.collaborativefund.com/blog/standing/

The Investment Risk Pyramid: CEFs, ETFs, & Mutual Funds by Steve Selengut

Excerpt: “The Risk Pyramid is basically an asset allocation tool for “financial” risk, as opposed to “market”, “interest rate”, “concentration”, “sector”, “region”, “liquidity”, “inflation” etc. If there is no risk (bank deposit, cash, money market), there is no real investment, so most “classical” pyramids included these on the ground floor as a place, perhaps, where neophytes could just hang out until they learned a bit more about investing.”

Continue reading at LinkedIn right here: https://www.linkedin.com/pulse/investment-risk-pyramid-cefs-etfs-mutual-funds-steve-selengut/?fbclid=IwAR09FVI3vlYYBPV5AsLA3eWBsnFWLYMUHWQWUp1jrnUclXzmvj5h3JJqBXM

The Thrill of Uncertainty · Collaborative Fund

By the end of the study, pigeons were pecking a food lever up to five times per second “for as long as fifteen hours without pausing longer than fifteen or twenty seconds during the whole period.” B.F. Skinner made a pigeon lose its mind. Skinner, a Harvard psychologist, studied the science of incentives. He did this by giving thousands of animals different incentives to be rewarded with food. Sometimes the animal just had to hit a lever, and a food pellet popped out every time. Sometimes it had to learn a pattern – two lever taps, or a long tap, or a tap and a delay and another tap. Pigeons and rats are remarkably good at figuring this stuff out. Part of Skinner’s research was determining what incentives are so powerful that they can’t be ignored, causing animals to become obsessed beyond the need for food pellets. What kind of incentives make a pigeon lose its mind? He basically found three types of incentives: Fixed. One tap gives one food pellet. Same result every time. Animals figure this out quickly but don’t get excited about it. “This is how I get food. OK. Move on.” Changing. Today you get food with one tap. Tomorrow it will take two taps. The next day, a tap pattern. This gets animals excited. It’s a stimulative puzzle. “Oh! Let’s figure out how to get food today!” Variable interval. Tap the lever and you will get food on average every hour, but that might mean five pellets in the next hour and then nothing for the next five hours. Animals will get the same amount of food over the course of a day, but at random and unpredictable times. This turns them into addicts. They lose their minds. “I know food will come so I’m going to keep tapping but AHHHH MAN WHEN IS IT COMING THE SUSPENSE IS KILLING ME JUST KEEP HITTING THE DAMN LEVER.”

Continue reading “The Thrill of Uncertainty · Collaborative Fund”

Death, Taxes, and a Few Other Things · Collaborative Fund

Life guarantees: 1. A perpetually moving goalpost Median family income adjusted for inflation was $29,000 in 1955. In 1965 it was $42,000. Today it’s just over $62,000. There’s widespread belief that the 1950s and ‘60s were peak time for middle America to secure a good-paying job. But it’s a quantitative fact that the median American household earned more in 2018 than they did at any point in the 1950s or 1960s, adjusted for inflation. That’s true for hourly wages too. Part of the disconnect between feelings and reality can be explained by the shift in expectations over the last 60 years. To generalize only a little: In the 1950s camping was an acceptable vacation. Hand-me-downs were acceptable clothes. A 983 square foot house was an acceptable size. Kids sharing a room was an acceptable arrangement. A tire swing was acceptable entertainment. Few of those things would be acceptable baselines by most households today. But – and this is the important part – they were acceptable back then because other median households accepted it. John D. Rockefeller never had penicillin, sunscreen, or Advil. But you can’t say a low-income American with Advil and sunscreen should feel better off than Rockefeller, because that’s not how people’s heads work. People gauge their wellbeing relative to those around them. Everyone does. And goalposts move both ways: Sebastian Junger’s book Tribes details the long history of comradery during shared disasters, like soldiers during war and neighbors during natural disasters. Hardship is more palatable when everyone around you is in the same boat. You can be an optimist and say living standards will keep improving, which I think is likely. But you can’t say that people will feel proportionally better off, because the goalpost will always move up with improvements in living standards. There is a correlation between money and happiness, but it diminishes with each additional dollar gained. This is especially true at the micro level where people live their day to day – the hedge fund manager who makes $100 million a year compares their life to other hedge fund managers who make $100 million per year, so their life doesn’t feel nearly as amazing as others imagine. Their goalpost moved to the next town over. If the 1950s and 1960s felt like a better time, it’s because there was less dispersion between income groups, with fewer extremely wealthy people inflating the lifestyle aspirations of everyone else. But that highlights the point here: when you watch other people live a better life, your benchmark for normal and acceptable rises. The goalposts moves. This isn’t necessarily bad or good, and I don’t have a solution; it’s one of those things that just is. Like death and taxes. 2. Periods of excess After each bubble there’s well-meaning attempt to ensure it never happens again. Governments make new regulations, and individuals say “I’ve learned my lesson and I’ll never do that again.” But you will do it again. Maybe not you. But the drive toward financial excess is an inevitable part of how markets work. There are two reasons why. One is that the most important variables of investment returns are unknown. How much will investors pay for this asset? How much debt is too much? How high do interest rates need to go before businesses stop investing? These are more psychological than analytical, so there are no predictable answers. And when there are no predictable answers the only way we can identify the “breaking point” is to go beyond it, then look back and say, “Oh, OK, apparently 50 times earnings was too much,” which is something we didn’t know at 49 times earnings. The only way to know how much food you can eat is to eat until you’re sick. Same for markets, which occasionally vomit. And we have to find that breaking point because until we find it there’s potential profit on the table, and market potential will always be tested. Put up a sign that says “There’s potentially a prize in this box” and someone will eventually open the box. Human nature. The second has to do with volatility. If returns came at predictable times there would be no risk, because you could just show up, collect the prize, and go home. If there’s no risk, investors will bid up the price of an asset until there’s no reward, because free money on the sidewalk is always picked up. Then, once there’s no reward, the people who show up to collect their predictable prize realize they’ve been stiffed, so they get mad and storm off and the asset price falls. Which is to say: If markets weren’t volatile, prices would rise until volatility is triggered. Which is why there’s volatility, and always will be. As certain as death and taxes. 3. Intense debate about economic policy In late 2009 the unemployment rate for African American males age 16 to 19 without a high school diploma was 48.5%. For Caucasian females over age 45 with a college degree it was 3.7%. That’s the most extreme unemployment skew you can find. But the point is that when there’s such a wide disparity of personal experiences it’s very hard to get everyone on the same page about economic policy, financial goals, or philosophies around things like risk-taking and opportunity. Some argue certain economic policies with bad faith, knowing they’re talking their own book. But more common and potentially more dangerous are those whose personal experience makes it hard to even fathom those who have experienced a different world, in a way that innocently makes their arguments oppose huge groups of other people. Empathy and putting-yourself-in-others’-shoes only go so far. Daniel Kahneman put it recently, “Anything you experience is so much more vivid than if you’re just told about it.” This is not the case for something like, say, physics, which everyone experiences more or less equally. There are physics debates, down to the Flat Earthers. But they aren’t as widespread or passionate as economic debates, which can rival religious debates. There is an implicit feeling by many that if you can just get the other side to hear you out, listen to your story, look at your data, they’ll be able to agree with your economic view. That’s sometimes the case. But as long as people have wildly different economic experiences there will be wildly different economic views. As reliable as death and taxes.
— Read on www.collaborativefund.com/blog/death-taxes-and-a-few-other-things/

No Pain, No Premium

Summary

  • In this commentary, we discuss what we mean by the phrase, “no pain, no premium.”
  • We re-frame the discussion of portfolio construction from one about returns to one about risk and argue that without risk, there should be no expectation of return.
  • With a risk-based framework, we argue that investors inherently act as insurance companies, earning a premium for bearing risk.  This risk often manifests as significant negative skew and kurtosis in the distribution of asset returns.
  • We introduce the philosophical limits of diversification, arguing that we should not be able to eliminate risk from the portfolio without eliminating return as well.
  • Therefore, we should seek to eliminate uncompensated risks while diversifying across compensated ones.
  • We explore the three axes of diversification – what, how, and when – and demonstrate how thinking in a correlation-driven, payoff-driven, and opportunity-driven framework may help investors find better diversification.

Read the full article right here: https://blog.thinknewfound.com/2019/02/no-pain-no-premium/amp/

Seek Wealth, Not Money or Status

This is a transcript of Seek Wealth, Not Money or Status. Summary: Wealth is assets that earn while you sleep: businesses, products, media, robots, investments, land. Wealth is for freedom, not conspicuous consumption. // Money is how we transfer wealth; it’s the social credits and debits of other people’s time. Money isn’t going to solve all…
— Read on startupboy.com/2019/02/28/seek-wealth/

The Four Fundamental Skills of All Investing · Collaborative Fund

In his book Succeeding, John Reed wrote one of the smartest things I’ve ever read: When you first start to study a field, it seems like you have to memorize a zillion things. You don’t. What you need is to identify the core principles – generally three to twelve of them – that govern the field. The million things you thought you had to memorize are simply various combinations of the core principles. This extends beyond those learning a new field. I think it’s most relevant for those who consider themselves experts. The root of a lot of professional error is ignoring simple ideas that seem too basic for those with experience to pay attention to. Having seen the investing world from several different angles, four skills stand out as governing most of outcomes. 1. The ability to distinguish “temporarily out of favor” from “wrong.” The two strongest forces in investing are “This investment looks broken because that’s how opportunity presents itself” and “This investment looks broken because it’s actually broken.” It’s hard to tell the difference in real time. Distinguishing between the two relies on accurately calculating the odds that something will eventually come along to heal or promote the market or company that looks broken. And since those odds are always less than 100%, it can take a while to tell if you’re any good at it, because even when the odds are in your favor the outcome can go the wrong way. It’s hard to do. But worse, and more common, is forgetting that a distinction needs to be made in the first place. 2. The willingness to adapt views you wish were permanent. Economies grow because businesses, consumers, and technology change and adapt. It’s ironic how many investors attempt to ride this wave of change with rigid beliefs. There are a set of truly timeless investing ideas. But most of what guides us are beliefs that reflect what we’ve happened to experience in the narrow view of our own lives. Even when investors study history, they put more weight on stories that align with their own experiences, because those stories are easier to understand and confirm their beliefs. It’s painful to contemplate, but a lot of what all of us believe about investing is either right but temporary, or wrong but convincing. If you’re unwilling to update your views when the world changes, or be open-minded enough to realize that some of your views were anecdotal to begin with, boy, you will be eaten alive in this field. 3. The ability to be comfortable being miserable. This is the most fundamental of all investment principles. You can’t enjoy the benefits of exercise without some sort of discomfort, because being out of breath, sore, or tired is the sign that you’ve put in enough effort to deserve a reward. Same in investing. The financial rewards for being comfortable as an investor are the same as the physical rewards for sitting on the couch. Returns do not come for free. They demand a price, and they accept payment in uncertainty, confusion, short-term loss, surprise, nonsense, stretches of boredom, regret, anxiety, and fear. Most markets are efficient enough to not offer any coupons. You have to pay the bill. There are four psychological states of investing, in order of lucrativeness: Miserable but confident in its eventual rewards. Miserable and giving up. Comfortable and accepting of its future downside. Comfortable and oblivious of what’s to come. Some are better at coping than others, but that’s the complete list. 4. The ability to distinguish when analytics vs. psychology is necessary. If investing were only about numbers, no one would be good at it, because computers would arbitrage away all opportunities. And if it were only about psychology, no one would be good at it, because every investor has different, arbitrary, goals and markets would never coalesce around something objective. Good investing is some part analytical and some part psychological. An art and a science. The trick is knowing when which skill is necessary, and how one affects the other. Parts of investing are counterintuitive – like the prevalence of volatility, margin analysis, or moats repelling competition – and require data to understand. But there are things data can’t help with, like the tendency to embrace false narratives that justify your actions, or your willingness to throw your strategy out the window after the emotions of a big win or loss. Data doesn’t teach you about fear or patience, and psychology doesn’t teach you about discount rates and EBITDA. The hard part is that analytics and psychology couldn’t be more different. One is rational and stable, the other makes no sense and changes all the time. One is numbers you can see, the other is emotions you can sort of feel, sometimes. Attacking a problem with two different skills is hard. But attacking a problem with two conflicting skills can make you question what you’re doing. And even harder is the frustration that comes from attacking an analytical problem with psychology, or vice versa.
— Read on www.collaborativefund.com/blog/the-four-fundamental-skills-of-all-investing/