Successful “investing” requires some uncommon questions. (Photo: Me at Burning Man ’08)
“If the market felt fidgety, if people were scared or desperate, he [senior Salomon Brothers bond trader] herded them like sheep into a corner, then made them pay for their uncertainty.”
–Liar’s Poker, Chapter: A Brotherhood of Hoods
Connecticut, 2003
There were 4-6 screens per person, and chairs were lined up at a single 30-foot desk in hierarchical pecking order. Commands would come down the line and trades were made.
“Who the f*ck are you?” asked one of seniors, swiveling back to his glowing screens before I could answer.
It was my first time inside one of the largest investment banks on the planet, and I was just observing a friend in the hopes of learning something. Before I knew it, lunch had arrived and a 20-minute break was announced in a poetic slew of 4-letter words.
“Name a company.” It was a voice I didn’t recognize, but it was clearly directed at me.
“Uh… sorry. Excuse me?” I asked to the room and no one in particular.
“Name a company.”
“Uh…”
“Any company — doesn’t matter.”
“OK. Ah… Genentech.” It was a shot in the dark with no rhyme nor reason.
“F*ck Genentech!!!” came the chorus.
“OK, we just sold 100,000 shares of Genentech. F*ck those guys. Lost a ton on them last week.”
100,000 shares of Genentech sold because a no-nothing guest had pulled the name out of thin air.
That was my introduction to how truly rigged the stock market is…
Information Advantage
“One trader remembers that Lewie [head of Salomon Brothers’ mortgage department] would say he thought the market was going up, and buy a hundred million [dollars’ worth of] bonds. The market would start to go down. So Lewie would buy two billion more bonds, and of course, the market would then go up. After he had driven the market up, Lewie would turn to me and say, ‘See, I told you it was going to go up.'”
–Liar’s Poker, Chapter: The Fat Men and Their Marvelous Money Machine
I currently have less than 10% of my net-worth in stocks. Why? I don’t have an “information advantage”. If other words, I’ve seen the sharks in this ocean, and I want no part of it. They’ll eat my Barron’s-reading ass alive. I’d rather put my capital in angel investing and the few industries I understand, two areas where I have insider knowledge and connections that others don’t.
To quote billionaire Mark Cuban (great blog here) in his short interview with Young Money (YM) magazine:
YM: Do you have any general saving and investing advice for young people?
CUBAN: Put it in the bank. The idiots that tell you to put your money in the market because eventually it will go up need to tell you that because they are trying to sell you something. The stock market is probably the worst investment vehicle out there. If you won’t put your money in the bank, NEVER put your money in something where you don’t have an information advantage. Why invest your money in something because a broker told you to? If the broker had a clue, he/she wouldn’t be a broker, they would be on a beach somewhere.
Here’s the deal — to beat the market consistently, you have to: 1) have better information than most people, 2) have superior analysis of the same information, or 3) have better luck than a Leprechaun.
Discarding luck as a strategem, and personally discarding better analysis because I don’t want to spend my life poring over annual reports or evaluating algorithms, there is a simple conclusion: don’t invest in anything that you don’t know inside and out better than most of the world.
From David Swensen, who ended 2007 up 28% as the investment manager of the Yale University endowment:
“You have to diversify against the collective ignorance… I think nobody is in a position to react to these big macro-issues. Where is the dollar going to be or what is G.D.P. growth going to be in China? For every smart person on one side of the question, there is another smart person on the other side.”
Having come out of Princeton and the land of Burton Malkiel, I agree with efficient market theory insomuch as “information advantage” is a prerequisite to consistently getting better returns than average.
If you don’t know something the rest don’t, don’t gamble.
Period.
The Weasel Word: “Investing”
In part 1 of this series, I promise my favorite picks for investing books. Though I’ve read several dozen based on recommendations from self-made millionaires (I try not to take advice from speculators), here are the few I’ve found most useful:
The Essays of Warren Buffett: Lessons for Corporate America (Buffett)
The Smartest Investment Book You’ll Ever Read (Solin)
Liar’s Poker (Lewis)
Seeking Wisdom: From Darwin to Munger (Bevelinl; Parts 2-4)
Less is More: An Anthology of Ancient and Modern Voices Raised in Praise of Simplicity (VandenBroeck)
What?! It seems like philosophical books have been mistakenly put on this list, no? Here’s the rub: after all the research and mind-numbing number crunching, I’ve decided that the philosophical decisions take precedent over the tactical ones. For me and those whose lives I most admire, at least.
One qualified commenter on the last investing post said:
“I don’t think you’re going to figure out investing in a matter of weeks or months.”
Well, this brings up an interesting question, doesn’t it. What the hell is “investing”, exactly?
If you have the potential to make 30% per annum in a given stock, but it keeps you up with sweaty palms at night, is that a good “investment”?
Is a stock with a projected 25% annual growth rate over 10 years a good “investment”, even though it will lose value every year except for one undetermined year with a 259% increase?
I sat in on another friend’s job once. He was a day trader, and his boss made more than $50,000 per day in most cases. But, this boss also carried divorce papers in his briefcase 24/7 “just in case he’d had it with the bitch.” Do you want his life? Is he a successful “investor”? Be careful with that term.
In the 100+ comments on the aforementioned post (some of the commenters manage 9-digit funds–hundreds of millions of dollars), definitions of “investing” range from “gambling” to “asset allocation.” In other words — “investing” as a term is so overused as to have become meaningless.
I propose that we define investment as a broad concept and then separate it out. First, the broad definition:
Investing = “Allocating resources to improve quality of life.”
This applies to financial investment as much as it does time management and all other resources. How much would your behavior and results change is you just replaced the concept of “time management” with “time investment” in your head?
Using this definition of investment, I would not chase the moving target of pure ROI (after all, there is always a more speculative vehicle with potential higher gains), but choose the vehicles that offers the greatest ROI with the least insomnia. More cash with constant sweat in the palms is hereby defined as a poor “investment.”
Moving from conceptual to tactical, we can also separate “investment” into three categories of actions, which I’ve found useful:
Investment =
-Asset/wealth creation
-Asset/wealth allocation
-Asset/wealth preservation
[To be continued…]
Did you miss Part 1 of the “rethinking investing” series? Read it here.
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I get really, really pissed when smart people don’t speak out. (Photo: Me at Burning Man ’08)
The Tim Ferriss Show is one of the most popular podcasts in the world with more than one billion downloads. It has been selected for "Best of Apple Podcasts" three times, it is often the #1 interview podcast across all of Apple Podcasts, and it's been ranked #1 out of 400,000+ podcasts on many occasions. To listen to any of the past episodes for free, check out this page.
Comment Rules: Remember what Fonzie was like? Cool. That’s how we’re gonna be — cool. Critical is fine, but if you’re rude, we’ll delete your stuff. Please do not put your URL in the comment text and please use your PERSONAL name or initials and not your business name, as the latter comes off like spam. Have fun and thanks for adding to the conversation! (Thanks to Brian Oberkirch for the inspiration.)
Apparently, the SEC has charged Mark Cuban with insider trading.
http://ca.news.yahoo.com/s/capress/081117/sports/mark_cuban_insider_trading
The SEC has apparently charged Mark Cuban with insider trading….check it out online…
Investing, speculating, gambling.
Investment is an activity that provides safety of capital with a reasonable expectation of return. Because “safety” and “reasonable expectations” are defined in terms of one’s information advantage and world view, one person’s investment can be another person’s speculation or gamble.
Speculation is an activity where you know, statistically speaking, that you can win more than you lose (#wins * size of wins concept), BUT there are not enough bets available to you to virtually guarantee a final winning outcome. In angel capital if you have enough speculative opportunities available, which suit your special knowledge, and you hedge out relevant market and economic risks, then you can turn a speculative enterprise into an investment enterprise.
A gamble is an activity where you know, statistically speaking, that you will lose more than you win – as long as you place enough bets.
Tim, I just found your blog and have read your two recent investment blog posts, you have interesting ideas and an engaging group of readers. In your last post you asked readers to share life experiences: I am 26, an electrical engineer, married w/ 1 child. I am not wealthy. I have read shelves of investment books containing diverse viewpoints. For the past few years I have been carefully and introspectively investing, and learning about investing.
Someone who accepts your definition of investing: “allocating… quality of life” would probably want to avoid destruction of quality of life even by factors beyond our control. If you assets are: cash, angel capital, and private businesses then you are still at risk to other systematic shocks. Consider what happened to cash in the 1970s: it was hugely devalued by inflation, at the same time bonds were devastated by rising interest rates, and businesses/stocks tanked due to stagnant growth. The one bright spot was gold. In other economic circumstances gold has tanked, but the other assets have more than made up the difference.
I want to add another vote for consideration of Harry Browne and his permanent portfolio / variable portfolio concept. His philosophical approach to money seems very compatible with yours. His idea is to preserve wealth through the 4 economic environments you and I will face. Browne makes a good case that there are only 4 economic environments.
The reason to do this is to provide peace of mind and to allow you to live your life. Your previously suggested exercises for determining risk tolerance is similar to what Browne would suggest for determining how much money you should put into your speculative variable portfolio.
The permanent portfolio is designed to hold value for the long term in even unlikely circumstances, while earning more than inflation. The allocation he suggests for this is 25% each in of cash (T-bills), gold (preferably mostly physical gold under your control, and some in foreign trust accounts), stocks to take advantage of times of prosperity, and long bonds issued by your country of residence to guard against deflation/depression.
The permanent portfolio allocation is static to avoid the risk of you mis-timing the market. The stock investment is indexed to avoid the risk of an active manager blowing up in one way or another. (Actively managed funds go in the variable portfolio.) Browne also suggested setting up your own portfolio instead relying on the mutual fund that more or less follows his portfolio allocation ideas.
Since you own stakes in your own businesses and early round start-ups, you are most likely positioned to profit from prosperity. This means that you need to think through how to guard your assets during runaway inflation, deflation, and recession.
Many people have asked “how do I get started”, this is more for their benefit than for Tim Ferris’s. Here is an example ETF portfolio similar to one I hold in an IRA at an online discount broker:
20% TLT (long US bonds)
10% DGP (2x gold futures) – I also have some gold coin
10% UVT (2x US small value)
20% SHY (US treasuries)
20% money market sweep account
20% absolute return strategies
Notice that leverage is judiciously used to reduce risk by buying short term bonds with the “extra” leveraged funds. (Read about Risk-Parity portfolios and Taleb’s views on leverage for two different takes on this concept.) Do not blindly implement this portfolio without taking the time to understand how it works and what it is supposed to do – that would be a gamble or a speculation not an investment.
The last 20% would roughly correspond to Browne’s “variable portfolio”. This could be the bankroll for a day trader, or the capital for a real estate investor, active managed funds, or in my case it is in strategies such as debt abitrage, managed futures, and long/short equity. Depending on your own position in life you may put more or less money, percentage wise, into your variable alpha seeking portfolio.
Guard the money you can’t afford to loose against every risk you can. Then relax, live life, and if you feel like doing the necessary research you can speculate with money you can afford to loose.
I hope this post is helpful to someone!
-Matt
“Do not believe that it is very much of an advance to do the unnecessary three times as fast.” -Peter Drucker, management consultant, professor and writer (1909-2005)
You voted for someone because a few rich people think it’s okay their taxes are going up? Are you serious? Oh dear, this country IS holding on by a thread.
It amazes me that when the market tanks, people like to call the stock market “gambling.” But when you look at it, it’s clear that there is a difference in strategy.
Gambling: If I give 100 people in the casino floor $100 in the hopes that one of them hits the jackpot. That is gambling.
Investing: Putting my money on the house/being the house. Yes, there will be a jackpot payout every so often. Yes, that jackpot feels painful, and watching that money go out the door might feel like we’re gambling, but we aren’t. Now, if I time when my money is on the house and when it isn’t to avoid the jackpot? THAT is gambling.
Oil trades at $50 today. If i asked 1,000 people if oil is likely to hit $100 again in the next 5 years, I bet 95% will tell me it will. I’d also guess they will be right. I also bet that 95% of them aren’t buying oil right now even knowing a 100% gain in 5 years would crush their other investments.
Why won’t they invest in a likely outcome? Well, its a whole lot more fun to stay at the casino and gamble than run the casino. If you want to stay at the Casino and gamble, than gamble away, just don’t look at us Casino Owners and think we are playing the same game.
I think that successful investing is about knowing the level of risk that you are willing to take and then going for it. Love the photo it just sums up that you truly do have to speculate to accumulate and investing is about step outside of your comfort zone
Late note, but I would suggest NOT voting if you have not done your research. Tim, you rock
Zack
Hi Tim,
Another analytical Tim here. I enjoy your book and blog and refer to both often. I was not particularly happy with your political comments though. You say you have done a great deal of homework on the subject but your article and supporting articles sound much more like a school girl in love than your normal informative posts. I myself an not a very political person but most of the details I can find about Obama are too idealistic. I think this country has been seduced on a grand scale, but time will tell. We will have change no matter who the president is. “Change” is to arbitrary it means whatever you think it means. You have only yourself to blame if the change is not what you imagined it would be.
I am much more interested in your homework than your opinions and would prefer that you stick to those type of posts in the future.
Don’t worry Tim. I’m still a big fan. I’ve just been maximizing my personal efficiency by not posting too often. Thanks for all the great info you have shared.
[…] to keep things interesting and balanced in perspective, here’s a post from out of left field by Tim Ferriss. He basically says his life is already risky, so his […]
[…] Discarding luck as a strategem, and personally discarding better analysis because I don’t want to spend my life poring over annual reports or evaluating algorithms, there is a simple conclusion: don’t invest in anything that you don’t know inside and out better than most of the world. Full blog entry […]
[…] can view the Tim’s full post on his […]
Obama gave you a blank canvase and you painted your dreams upon it.
Now, before he is even sworn in, the scandals start. Earliest in my memory!
If you think that Obama is the virgin in that political whorehouse, you are mistaken.
Get ready for the biggest case of buyers remorse in the history of the USA.
I really hope I am wrong, country first! If Obama does a great job I am with him 110% as that would be best for America.
Tim, you need to include “time frame” in your definition of investing. When you get an education, you retain it for life, you never sell it. When you invest in fitness skills you plan on keeping it for life.
When buying stocks you really need to plan on keeping it for life, anything less is not investing but trading / speculating.
This simple point is what most people just cannot understaind about investing. If you plan on selling your stock for a profit in 10 years then you are trading or speculating and will get your clock clean by the pros.
It does not take “special information” to invest in an education or fitness, nor does it take special information to invest in stocks.
You simply save cash for years and years and years and years and then magically the great investment opportunity(s) will present themselves and you buy. Simple as that.
Another misconception is that due to structured finance and leverage, there really have been almost zero good investments during your adult lifetime. I believe there soon will be if your are patient and think investing rather then trading.
[…] about the strategies I will describe. Specifically, two successful business-people and bloggers Tim Ferriss and Marc Cuban both discuss the issues with buy and hold investing and the equity market in […]
Well, your guy Obama yesterday proved he’s all talk and no action. Forget about the near $200 million tip of the iceberg cost of the innaugeration tath the tazpayers will mostly carry; let’s talk about the not using technology and the environmental impact of millions descending on DC. As I recall he ran as the technology savy and pro-environment guy. He should have had a simple inaugeration streaming it using web technology. All of those that say they needed to be there so that “they could be a part of history,” I say, how does sitting on the sidelines watching someone else make YOU a part of history. As for the impact to the environmnet, I am not talking about trampling the vegetation of DC, I am talking about the polluting buses, trains, and aircraft used to get there by all of those folks. The carbon credit costs must be in the $billions, how will Obama ever repay that?
[…] Brain: Notes from a Novice Rethinking Investing – Part 1: Common-Sense Rules for Uncommon Times Rethinking Investing – Part 2: Information Advantage, Best Books, and More Things I’ve Learned and Loved in 2008 – Recouping Losses, etc. digg_url = […]
@Ferriss, what do you think of currency trading. It looks difficult and complicated attached with a lot of risk.
I tried it, because I was receiving a special offer ( I received an amount without the need of any deposits at a forex trading site) and I GET HOOKED.
I was trading every evening a couple of weeks. i was focused on following the trend, I was buying when it was going up (with a stoploss!!) and selling when it was going down (or hitting my stoploss).
Without any thoughts but with a simple rule: Let my profits run or cut my losses immediately!
So I managed to make from my free received $20 ( the ‘bonus’, only one per new account, instantly on your account) a reasonable $2334 in almost 3 weeks.
And the magic: It was without any deposit. I just kept my creditcard in my pocket. SO I couldn’t lose any money at all.
What do you think of this? Of course you’re readers are interested in this, most of them would make some money. And Tim, it is intellectually so stimulating, it’s like dopamine mixed with the smell of crispy dollars.
Hi August,
Forex trading is very fascinating and very addictive, which is part of the reason I’ve avoided it to date. It’s true you can make some serious gains in short periods of time, but the flipside is that you can also use leverage to get yourself in a hole you lack the capital to dig yourself out of.
Dopamine is great, but addiction to any behavior can spell poor decision-making. I’ve been there with some of my projects, and it’s important to be aware of the validation/excitement addiction all of us are prone to with different activities.
Tim
[…] in the stock market resembles letting go of the wheel. You have surrendered control of your money to the whims of the market and […]
Hi Tim,
Great thoughts and insights into an often complex subject.
Personally, my bosses, mentors and myself are actively involved in startups as our main source of business activity. Many of them seem to be involved in more than one (usually in similar fields or industries however) which is how diversity occurs.
Cash flow generated from business activities is allocated and invested in one of three ways:
1: Back into the businesses, or in starting new opportunities (if the number of involvements is manageable)
2: In reducing living expenses and increasing simplicity.
3: In building cash savings (most liquid).
Long term investments and capital growth is achieved by building a share portfolio surrounding these ventures, each of which has a plan and a planned exit.
The concept (as explained by one of my mentors) works as follows:
“We are actively involved as investors in startups, where we invest time, effort and experience into the business rather than capital (aka Entrepreneurs and Advisers). These businesses are high risk businesses, so any cash flow taken from them is best stored into low risk, high liquidity options for future use and survival during lean times.”
Investing in yourself is highly recommended, and many of my bosses heavily invest in education (both formal, informal and ongoing learning).
This ties in efficiently with the principle of having an information advantage. If you are continuing to learn in your field and have studied and applied more than your peers, your chances of success are much higher.
I wouldn’t recommend this path for everyone, but since it is something I am continuing to educate myself in and enjoy, I find it a rather viable option for my long term success.
Investing = “Allocating resources to improve quality of life.”
Staying true to that quote will minimizes ones exposure to the risk of collective ignorance.
That quote puts into context the true essence of lifestyle design. I have transformed my practice and continue to transform my practice to focus on helping my clients allocate their resources to improve their quality of life.
I am in the process of doing so myself and if there are any resources in addition to your book that you can suggest, they would be gratefully appreciated.
Sincerly,
Kumbie
I have two comments here.
1st- You can’t be a Warren Buffett devotee and an efficient market theory proponent. They are opposite in nature. Buffett is a value guy who believes that the market is not efficient. He buys stock when the market prices it inefficiently. The reason he said to buy index funds was in response to your statement that you couldn’t be a fulltime investor. I agree with this point, but only because you wouldn’t have the time to do adequate research on a company, not because the market is efficient and you can never beat “the man”. Buffett=value. EMH=indexing. If you can’t allocate your time to investing like Buffett, index funds give you the average market returns.
2nd-Concerning the election and getting out to vote, I see two sides to this argument. On the one side, I agree with you that by voting, we keep a democratic process alive, something that we all take for granted. On the other side, most people do not do adequate research on a particular candidate so I see problems in voting for, or supporting a particular agenda that one has not done appropriate reseach on. A very glaring example is the Howard Stern radio segment where his guys approached people on the street and asked how they liked the Obama/Palin ticket or the Mccain/Biden ticket. People simply follow the herds and like lemmings to the ocean(a misconception but you get the point), vote or support a cause because everyone around them is too. Yes, write an article about the importance of elections, but please emphasize the research into a candidate more than simply voting because “Obama will pay my gas and mortgage”, or Obama wasn’t born in America, so I’m voting for Mccain. These people would do better to not vote.
The four hour martial artist next – its time
Tim, thanks for posting. I’m late into this thread but thought I’d share a couple of thoughts. What you are saying here is a contradiction. You can’t partly accept the efficient market hypothesis It’s like gravity – it doesn’t only work for stuff falling down, so to speak, but applies in all directions. Same with EMH. If you say you believe in it then you also assume, by definition, that all market participants have the same information. But the rest of what you’re writing points to that investors have different access to information. This means that you’re actually saying that markets are NOT efficient, and this is the same as saying that there are opportunities for people like Buffett (of whom I’m also a great fan).
There’s definately a lot to learn about this subject.
I like all of the points you made.
Bet you’re glad you stayed out of the stock market in Dec. 2008! However, I’m sure you were in the best investments coming out.
Tim – I just read through this blog post and was wondering if you had comments about your vote in the 2008 election. Meaning, do you stand by your vote or do you have any buyer’s remorse? BTW – I too, voted for Obama in 2008. Thanks!
Who said anything about beating the market?
You never continued this, Tim. Super useful.
Rick