Author: OnceUSave

Gary Smith in his book, Standard Deviations talks about the evolution of peppered moths, usually found in nature as light-colored creatures. But that was not always the case.

A trickle of dark-colored moths started appearing in 1848 England but by 1895, ninety-eight percent of the peppered moths found there were dark-colored.

But by the 1950s, the pendulum started to swing back towards light-colored moths, and it swung back to a point that dark colored moths today are so rare that they may in fact go extinct.

So why this back and forth? The evolutionary explanation for that is that the rise of dark-colored moths coincided with the pollution spewing Industrial Revolution. The blackening of trees from soot and smog gave dark-colored moths an ability to camouflage themselves better and hence were less likely to be noticed by predators.

And since they were more likely to survive long enough to reproduce, they came to dominate the gene pool. England’s clean air laws reversed that course as pollution-free trees allowed light-colored moths to blend in better with their environment. That is nature and evolution taking its course with a big help from humans, allowing the fittest and the most adaptive to flourish and thrive.

We are here today because our ancestors, since the hunter-gatherer days, did all they could to fight and survive the many existential threats they faced. Life in those days was short and fragile. The availability of resources like food, clothing and shelter was unreliable. Life shortening hazards lurked everywhere. As a species, our strength lay in our minds. The instincts and the traits that helped our ancestors survive and thrive are still hardwired in us today.

And one of those traits is the fear of an impending loss. We, evolutionarily, are designed to take flight even at the slightest inkling of a loss. That is because when you were living on the edge as what life was like in times past, to lose even a little meant your very existence was at stake.

So quite naturally, the human beings that are with us today are here because their ancestors did everything they could to protect themselves from danger. The gene pool hence is designed with loss aversion as a primary mechanism for survival.

Amos Tversky and Daniel Kahneman in their work on Prospect Theory demonstrated that people react differently to positive and negative changes to their status quo. The pain of losing is psychologically twice as powerful as the pleasure of gaining, so the theory goes.

And hence we quiver at the prospect of a headline like this…

That 508-point drop might appear like a run of the mill drop these days until you realize that that is a 23 percent drop in a single day. But that was in 1987.

The real shocker though is that had you Rip Van Winkled from the start to the end of that year and remained invested, you didn’t feel nothing. The stock market was in fact up for the year.

So, you didn’t lose any money had you not sold. And that is the key thing to remember about stock market downturns. Once you’ve bought right, you don’t have less until you sell.

And what worked for us evolutionarily to survive as a species turns out to be a disaster when applied to our modern-day world of money. It leads us to precisely do the thing we should not be doing and that is to panic sell out of fear of losing all our savings.

But what if you could dance in and out of the markets to circumvent the pain of a loss? Glad you asked and it doesn’t work. Miss a few of the best days when the markets violently turn, and it is game over.

But can you capitalize on this up and down and then up in the markets? Yes, you can, and you do that by being strategic about how you invest.

Strategic investors are plan-focused on how they deploy their savings. Tactical investors on the other hand invest based on whims. They invest based on what they feel is going to happen next in the markets. Or some try a mix of both as I ultra-sparingly do with my own money just to see what an occasional self-flagellation feels like.

Tactical investors are constantly changing their portfolios. There is no process. They watch every move the markets make. They are always on the hunt for something ‘better’ than what they already own.

Tactical investors feel like they are ‘in the game’. They are making decisions all the time which they think will get them closer to their goals. And it is supposedly fun. It is fun to be ‘in the game’. It is fun to make things happen than it is to let things happen.

And it gives them something to brag about to whoever cares to be bragged about on. They of course only brag about their winners.

Strategic investors do not play any of those games. They set out with a plan designed around their goals and populate their plans with investments that are statistically likely to get them to meet those goals. They invest like how pension funds invest – matching assets (the investments they own) with liabilities (expenses they’ll incur) to make sure they won’t run out of money before they run out of time.

Strategic investors take a long-term, process-oriented approach to investing, centered around prudent asset allocation, opportunistic re-balancing, and tax efficiency.

And most importantly, strategic investors act based on what has already happened whereas tactical investors act in anticipation of what is going to happen. Think about it for a moment. By being strategic, you act based on facts and data. By investing tactically, you act based on hunches. Do you really want to manage your life savings based on hunches?

If you believe in astrology or tarot card reading, you might be more of a tactical investor. For all others, take a strategic approach to managing your savings and sleep easy. Market declines will come and go but you will still have to send your kids to college and plan to retire someday. A solid plan with the right mix of investments with lots of tuning along the way is how you get there.

Thank you for your time.

Cover image credit – Cottonbro, Pexels

Stocks are volatile. And a big reason they’ll remain volatile is because of where a stock’s value comes from.

The value of a stock today is the sum of all the cash flows (dividends) a business (stock) will deliver to its shareholders in perpetuity, discounted to the present at the appropriate discount rate.

Not to get fooled by this apparently trivial setup, small changes in i and r can have profound implications on the value of a business.

Every business returns profits to its shareholders in the form of dividends, D.

Not all businesses will. Some won’t be able to get to profitability but hold a decent number of them spread across industries and the dividend stream continuing in perpetuity is a given.

r defines the growth rate of those dividends. That is tied to business profits and profits tend to grow long-term. They don’t grow in a straight line and hence the implied volatility.

The discount rate, i quantifies risk. The greater the risk to profits, the higher the rate of return you’ll require. You expect to get paid for the extra risk you are taking with a riskier investment. Your expected rate of return hence rises for that investment.

Expected rate of return is the discount rate. So, when the discount rate rises, the value of a stock falls because the discount rate is in the denominator. And when the discount rate falls, the value of a stock rises.

That is why small changes in interest rates cause stock prices to change. Because discount rates are not derived in a vacuum. They rely on prevailing interest rates and if they rise, discount rates rise as well. If you can safely earn eight percent on a Treasury bond, why would you buy stocks? Stocks, hence, have to offer better than eight percent.

So, when interest rates are higher, discount rates are higher, and stock prices are lower. That is how you get the higher rate of return when you buy stocks because you get to buy them at the cheap.

So, with r and i constantly changing, the intrinsic value of a stock changes too. And hence the inherent volatility with stocks. There is no way to avoid it.

That makes up the growth side of your portfolio.

With bonds and using the same equation above, cash flows from bonds are the interest payments you receive. We’ll continue calling them D.

But D for bonds is fixed. They don’t grow once a bond is purchased (r = 0).

The discount rate i for a bond is the interest rate set when you purchased that bond. Unless you decide to sell that bond before it matures, the discount rate doesn’t change and so doesn’t the bond’s value.

Bonds preserve capital. They hence make the capital preservation part of your portfolio.

If you want complete preservation of capital, growth cannot come. If you want growth, you must accept volatility. You must accept it because that is the only way to outrun inflation in the long run.

So why do we see investments that claim to preserve capital but also provide growth? LJM Preservation and Growth Fund was supposed to do that. Then it went belly-up overnight. Jeff Malec in a piece at Seeking Alpha, LJM – The Autopsy does a great job describing what happened and leaves us with this excerpt.

In the span of 48 hours in and around that spike, LJMIX had lost 82% of its more than $700 million in investor assets, failing to strike an NAV for several days as the manager, clearing firms, the exchange, and regulators tried to sift through the trades. It was the investment manager equivalent of a suicide, overdosing on the tempting drug of an investing free lunch.

Free lunch? Capital preservation and growth doesn’t exist. It is an oxymoron. Capital preservation means eliminating downside. Eliminating the downside means eliminating volatility but then you don’t get the upside. We just did the math.

Risk and return are inextricably intertwined. In almost every country where economists have studied securities returns, stocks have had higher returns than bonds. Further, if you want those high stock returns, you are going to have to pay for them by bearing risk; this is a polite way of saying that in the course of earning those higher returns, your portfolio is going to lose a truckload of money from time to time. Conversely, if you desire perfect safety, then resign yourself to low returns. It really cannot be any other way.

William Bernstein, The Investor’s Manifesto

One way I don’t see volatility with my own money is that I don’t peek at my accounts as often. It is not easy these days. That stock market app on your phone is the worst thing that will happen to your money.

Yet not everyone can take the stock market heat. So, we bring some bonds into the mix to turn down that heat. The right ones in the right proportion act as ideal ballasts against stock market volatility. They won’t make you the same money, but they’ll help you remain at peace.

Because what you don’t want to have happen is that you abandon your plan at the worst possible times. And worst possible times will come.

The stock market people haven’t seen them lately, but times were rough after the Dot-com crash. It took 15 years to get back to breakeven and let me tell you, it was not an easy ride.

So, you don’t need the craziness if you don’t need it. Because the goal in the end is not to die rich but to have lived a great life. And if stock market volatility interferes with that, that is no good.

Thank you for your time.

Cover image credit – Mike, Pexels

Recessions are necessary to clear out excesses. They are part of the growth cycle. They make sure that our savings get re-channeled into the right investments. They cause pain. They are supposed to cause pain.

But that is a transitory pain. The world has endured recessions and depressions. A decent number of them will occur in your lifetime. You must get used to them because you won’t know them coming. You can feel them coming but you can never be so sure. Nobody is.

So never act on your feelings and commit the cardinal investing sin of giving up and sell. Use your plan that you put together in saner times as a guidepost to navigate through bad times.

The default state of our economic order is progress. Bad times lingering for long is not.

The best way to own a piece of that progress is through the stock market. Stocks are ownership stakes in businesses.

Businesses like these…

…and thousands more.

You know about the Apples and the Googles of the world, but did you know about ASML holdings, a Dutch company without which it is near impossible to build a semiconductor chip.

Or Denmark-based Novo Nordisk, the biggest maker of diabetes and cardiovascular drugs.

Or UK-based Diageo, the largest producer of alcoholic beverages.

Or BHP Billiton, the Australia-based mining giant that will become ever more relevant as the world transitions to green energy.

You own them all. You own their machines, you own their buildings, you own their patents.

Taken together, stocks represent the collective wisdom of the business world. They represent the promise of future technological advances.

Not all businesses will survive. The weaker ones fail and get replaced by newer, better and more efficient ones. That is creative destruction, a powerful force for societal good.

But the inherent direction of the value of a portfolio filled with businesses is up. How do I know? Because businesses are profit-driven entities. What do they do with that profit? They invest part of it back into the business to earn more profits. What remains gets paid out as dividends.

The real magic happens when you reinvest those dividends into buying more shares of those businesses. Which then pay their own dividends and the snowball starts to build – imperceptible at first and then boom.

So, owning plenty of stocks should form the backbone of any financial plan worth its salt. You cannot make the math work otherwise.

But when you own stocks, you have got to accept the occasional declines. What else are you going to do? Dance in and out of the markets?

Enduring through declines is the price you pay for that golden ticket of financial independence. There is no other way out.

Markets often sway from one extreme to the other. One moment, the times are as happy as ever. The next moment, they turn despondent. Markets overextend on the way up and overextend on the way down. It is in their nature.

But things are never as bad as they seem when all hell is breaking loose. And things are never as good as they appear when everything is going great.

So, plan for things to go bad when things are good. And when things turn miserable, know that it is going to eventually get better.

The pension systems of the past really did work. They took the burden of saving for retirement away from us. And it is a burden. Imagine not having to acknowledge that the markets even exist. You did not have to deal with discount rates or PE ratios or life expectancies. Imagine spending more of your time doing what you are good at instead of worrying about what the markets did on any given day.

Pension plans unfortunately are history. You are your pension fund manager.

And that means investing like a pension fund. Matching assets with liabilities. Assets are your savings and investments. Liabilities are the expenses you will incur during retirement.

The alternative is trying one crackpot idea after another hoping to make it. And then suddenly you are 50 and then you get scrambling.

If you manage your own money, you are potentially vulnerable to every crackpot investing idea that comes along. It only takes one.

Phil Demuth, Author & Founder, Conservative Wealth Management

I have seen folks make $25,000 mistakes in their twenties thinking it is no big deal. It is a big deal. That is a million dollars in future buying power that you just wasted.

I’ve flown airplanes, and as a doctor, I’ve taken care of kids who can’t walk. Investing for retirement is probably harder than either of those two activities, yet we expect people to be able to do it on their own.

William Bernstein

And if this was all easy, we wouldn’t have 65-year olds with a mere $88,000 in retirement savings. Hope there is more to that story but if that is all you’ve got, it is going to be a struggle.

Some parting thoughts on navigating downturns…

• Keep plenty of cash reserves. You won’t earn much on them, but you won’t be forced to sell investments at inopportune times.

• Lifestyle bloat kills. The right amount of house, the right amount of car, the right amount of stuff and not an ounce more.

• Leverage also eventually kills. Never borrow and invest, ever.

• Avoid fads and frauds. No SPACs, no meme stocks, no crypto. Never make hasty money decisions. There is no rush.

• Last, there are no certainties in investing in the short term. Not even with Treasury bonds. They even lose value from time to time. So, you must rationally assess those chances when building your plan. But once you have a good enough plan, the only job of yours that remains is to dollar-cost average into it with all that you’ve got, and then let the markets do their magic.

Thank you for your time.

Cover image credit – Gerd Altmann, Pexels

What if there was an account to which you can contribute money to before tax, invest and let the money grow tax-free and then spend that money tax-free? This looks like a fantasy setup but it is not, and you should know about it.

Consumer-Directed Health Plans (CDHP) combine a High-Deductible Health Plan (HDHP) with an investment account, also called an HSA or a Health Savings Account.

Confused? I know but that is our health insurance system, though I’d try to simplify as best as I can.

With traditional employer-provided health insurance plans, you’d pay a $20 or $30 co-pay every time you go see a doctor.

But with CDHP, you pay the full retail cost as if you do not have insurance. That is, the insurance company does not come to your rescue until you have paid say about $3,000 out of pocket total on medical expenses for you and your family in a given year. Once that limit is exhausted, another slab kicks in for say the next $2,000 where you split the cost with your insurer. The amounts can vary from employer to employer but that is the general theme.

But once the $5,000 total annual limit is reached, you have no more healthcare-related expenses for that year. The insurance company picks up the entire tab from that point on.

So, what made these plans (CDHP) come about? Choice and to some extent, necessity. They are a great deal for the employer, almost always a great deal for you and certainly a decent deal for the health care system in general.

Because with CDHP, you are signing up to take the initial cost hit which then means insurance premiums are lower as compared to traditional health insurance plans. And since employers split the cost of insurance with you, they love you for that even more.

But because you are willing to take the initial cost hit, you are more likely to price compare. Or at least be aware of the grossly inflated costs you pay for pretty much everything healthcare so there is this vague promise that this will somehow instill some cost discipline in the system.

And you’d tend to use healthcare less when you know you are going to incur that gigantic cost hit every time you go see a doctor. That even knowing that your total all-in cost in any given year is almost guaranteed to be lower with CDHP than with traditional health insurance.

But using healthcare less is both good and bad. Good because you won’t be going running to your doctor for every itty-bitty stuff. Bad because who knows whether that itty-bitty stuff that pains you is truly itty-bitty.

We use CDHP in our family but of all the things that we economize on, this is one thing where we try not to. If it pains, it is time to go get it checked.

Talk about checkups, preventive services are covered at no cost with CDHP, so it is dumb to skimp on things like annual physicals etc. I’d check with your employer though to get a rundown on what is covered and what is not.

What else is in it for you with these plans besides lower premiums? Access to an HSA, an account to which you contribute money every pay period before any taxes are taken out. You can then use that money to pay for qualified medical expenses.

But the money went in pre-tax and when you spend it on healthcare, you get the entire amount back. So, in theory, the money never got taxed.

Plus, to incentivize participation in these plans, your employer might match your contributions to the HSA so more tax-free money to spend.

But it gets even better. Say you contribute $3,000 to an HSA in a given year but only end up spending $1,000. The $2,000 that remains can be invested in a portfolio of stocks and bonds just like you’d do in your 401(k).

Do that for a few decades and you’ll be sitting pretty with a nice pile of stash, right in time for retirement when you’d need healthcare the most. And all that growth happens tax-free.

The money hence went in pre-tax, grew tax-free and is spent tax-free when used for healthcare. This money is the only money in our system that never gets taxed.

There is of course a limit to how much you can contribute to the HSA account each year but it is high enough to accumulate a decent chunk (if not spent) to cover most or all your healthcare-related expenses in retirement. And you know those expenses are coming.

In fact, we don’t spend any money out of our HSA accounts for our day-to-day healthcare needs. We pay out of pocket for now to let the money compound for later years.

But what if that later never comes? I mean what if you end up not needing as much healthcare and have a large balance that you will not use?

Remember all those expenses you paid out of pocket over the years? You can claim all of them whenever you want. There is no time limit of how old those expenses must be. I maintain a digital folder where we dump all our receipts in. If we never end up using the money in this account, we will use these receipts to get reimbursed for expenses of years and decades past.

But what if you die with leftover money in your HSA? The money then goes to the named beneficiary of the account. If there is no beneficiary, the money then goes to your estate. But it is treated differently depending upon who that named beneficiary is.

If that beneficiary is your spouse: If you name your spouse as the beneficiary, it becomes their account and the same set of rules apply. The money in the account must be used for qualified medical expenses. If it is used for anything other than that, withdrawals become fully taxable at the spouse’s income tax rate.

Moreover, if the money is withdrawn or spent on non-qualified medical expenses by the surviving spouse before they turn 65, there is an additional 20 percent penalty on top of the taxes due. There is no such penalty after age 65 though but taxes will still be due if the money is spent on non-qualified healthcare expenses.

If that beneficiary is someone other than the spouse: The account closes on the day of your death if you name a non-spouse as the beneficiary. The value of that account then becomes taxable income for the beneficiary in the year of your passing.

And since taxes must be paid as if it is income for the non-spouse beneficiary, the stipulation to spend that money only on qualified medical expenses go away. And there is no 20 percent penalty for withdrawals before age 65.

The non-spouse beneficiary can be a person or an entity like an estate or a trust.

The non-spouse beneficiary can lower their taxes if they use the HSA funds to pay the original account owner’s medical expenses. Only expenses incurred within a year of the HSA owner’s death qualify though.

So, keep an eye out for this the next time open enrollment rolls around and jump all in.

Thank you for your time.

Cover image credit – David Peterson, Pexels

You want to feel inflation? Try visiting a country like India every other year. I mean you are gone a while, but you only remember the prices of the past. Then you go there again and get price shocked everywhere you turn.

Inflation, an ever-present tax on us, is structural in most emerging economies. They import more than they export, which creates a deficit. But that deficit seldom gets plugged. So, they print more currency to replace the currency that left the country which then dilutes the value of that currency in relation to others. The stuff you import now costs more in your local currency, which is the definition of inflation.

But then Covid happened, governments panicked and pumped a lot of money into the system while factories remained shut and we got to feel inflation firsthand in a supposedly efficient economy like that of the United States.

Some amount of inflation in an economy is by design but a big amount is unwarranted. And when it flares, it is hard to put a lid on it without causing pain. The last time United States experienced a major bout of inflation was in the 1970s but not many are around to remember it. But it took an economy-wide pain (double-digit interest rates and ensuing high unemployment) to bring it back down.

Inflation as always is too much money chasing too little goods. Either we reduce the supply of money, which means raising the cost of money, which means raising interest rates, which in turn reduces demand. Or we produce more goods.

But if producing more goods were as easy, we wouldn’t be in such a mess. Take housing for example, a big component of inflation that feeds into the data the Bureau of Labor Statistics collects. There are not enough homes to go around, we all know that.

Yet, it is not like we can flip a switch and make shelter abundant. It takes time but, in the meanwhile, raising interest rates is the only weapon used to temper demand for shelter.

Raise interest rates so it costs more to buy a home, so folks instead rent. But then rents shoot up so folks who’d be loving living alone are forced to double up. That new college grad of yours, ready to go out in the world, will be stuck at home a tad bit longer. Demand for shelter hence falls and with it, a big chunk of inflation.

Raising interest rates also raises the hurdle rate for businesses. Projects that were feasible when interest rates were low suddenly don’t pencil out. Projects get cut, jobs get lost. And without a job, you will not be buying as much stuff which reduces demand for that stuff which then lowers inflation.

Inflation is what author and investment advisor William Bernstein calls one of the deep risks to our financial plans. It is not volatility; it is not temporary declines in asset values that you should fear. Those are what he calls shallow risks. It is the long-term loss in purchasing power that you should fear much, much more.

Inflation most affects cash, bonds, and other fixed income investments so exposure to them beyond what is reasonable for your situation is going to cost you. Instead, you need a big chunk of your portfolio working to fight inflation. And stocks have historically proven to be the asset class of choice at doing just that.

And why not? Stocks represent ownership stakes in real businesses and businesses don’t just sit around and eat up the rising costs of their input. They will pass down those cost increases to you and me through price increases for the stuff they sell. Not all businesses will be able to do so. Those that cannot wither away and get replaced by the ones that can.

But adjusting to rising prices takes time so in the short run, there will be pain, even for stocks.

With bonds, you become a lender to a business. Even if that business were to go on to become the next Microsoft, your share of the profits is capped at the interest rates negotiated when you bought those bonds.

But in the event of bankruptcy, payments to bondholders come first before the stockholders get anything. Plus, interest income from bonds is much more predictable than profits from stocks. So, investing in bonds is supposed to be safer than investing in stocks and it shows up in the data.

Treasury bonds have longer maturities than treasury bills but, in both cases, when you buy them, you are lending money to the United States government. With treasury bonds, you are lending money for seven to ten years and treasury bills have maturities of less than a year.

Treasury bills or bonds can be used as a proxy for lending money to rock-solid businesses, but businesses carry a non-zero default risk so to get compensated for that extra risk, you will expect to earn more by lending money to businesses than to governments.

The apparent safety of bonds and bills over stocks is clear from the data above. The value of stocks sometimes gets cut in half. Bonds have had some negative years but not as many and their values don’t decline by as much as for stocks. Bills have been the safest with no declines at all.

But there is an enormous cost you’ll pay for the perceived safety of bonds and bills over stocks.

Granted, not many have 100-year timeframes to invest but maybe you do if you intend to invest with the next-gen in mind. The difference in outcomes though is as stark as it gets.

And log scales (in the plot above) tend to surreptitiously hide pain so do not be fooled by the apparently ‘small’ declines you see in the dollar amounts with stocks. Those declines are huge, but you must learn to live through them to deserve that favorable outcome.

And stocks must return more than bonds and bills because stocks represent business ownership while bonds and bills in a way represent the cost of financing those businesses. Businesses won’t exist if over time, they don’t earn more than the underlying cost of financing them so stocks outperforming bonds and bills makes sense.

But if you think bonds and bills are safer than stocks, let me introduce you to their arch-nemesis, inflation.

Inflation-adjusted return is what counts because that is the real growth in wealth.

The returns of bonds and bills no longer appear as safe once inflation is taken into account. And that is how it should be. You can’t be rewarded for sitting on cash. There is no free lunch in investing.

So, in inflation-adjusted terms, your purchasing power with treasury bills stayed flat, was up 4x with bonds and 440x with stocks. Stocks did win.

That win of course didn’t come free. You’d have to wait, sometimes for years, to experience the magic of compound returns but wait you must.

Thank you for your time.

Cover image credit – Pixabay

My daughters each have their own investment accounts, funded with a little bit of money they receive from allowances and gifts. And regardless of how disinterested they appear or seem to appear, I talk to them about the world and the goings in the markets at every chance I get. I am the boringest dad of all, just like the rest of you.

And I do it because this is the only chance I have while they are still under my roof. I want them to understand how our economic system works. I want to empower them with the tools needed to help them make good life decisions. I want them to know about credit cards and credit scores. I want them to know about stocks and bonds and that they get to own tiny pieces of some of the world’s best businesses at the click of a button. I want them to know how the business world works and that nothing happens in the quick.

But greed and the sight of easy money are such strong emotions that it is hard for anyone to not succumb to them, let alone kids who have yet to know how to separate the wheat from the chaff. Mix in envy and now we have a potent combination that can lay waste to the best of plans.

Nothing so undermines your financial judgement as the sight of your neighbor getting rich.

J.P. Morgan

I want my daughters to succumb to those emotions. I want them to make mistakes, lots of them. In fact, I want them to completely ignore what I have to say and do something really dumb, like buy penny stocks. I want them to follow some rando on the internet and act on it.

And I hope they lose all their money in that process. Because it is so much better to make mistakes and they are mistakes and learn from them with a small amount of money than to lose it all after a lifetime of diligent savings.

Because it happens. I have seen it happen. Folks, literally about to retire, having to start all over again. It does not take much in this trigger-happy world.

But I know my kids would do fine. With all that brainwashing I have done to them, they ought to do fine.

Stock price changes over the short run is all noise. Stocks represent business ownership. Nothing much changes for a business in a day, a month, or a year. It takes many years for decisions made today to show up on a business’s bottom-line.

Jeff Bezos, in one of Amazon’s earnings calls, said this upon being congratulated for reporting great numbers.

When somebody…congratulates Amazon on a good quarter…I say thank you. But what I’m thinking to myself is…those quarterly results were actually pretty much fully baked about 3 years ago. Today I’m working on a quarter that is going to happen in 2020. Not next quarter. Next quarter for all practical purposes is done already and it has probably been done for a couple of years.

Jeff Bezos, May 8, 2017

So, reacting to market events that are short-term in nature is of course dumb. And the many brokerage apps with video-gamesque features enticing you to “play” don’t help either.

In fact, if I were running a well-meaning investment business (I am), I’d charge a toll every time you’d try to log into your accounts. We have turned what should be a well thought-out, long-term process of business ownership into a game.

It is not a game. When you buy stocks, you buy pieces of real businesses – with employees and buildings and factories and machines, all working in tandem to make life better for all of us. There are exceptions but the market corrects for them with time.

Real money is not made in exchanging pieces of paper with your neighbor or with those traders at Goldman Sachs. Because that is what you are doing when you buy and sell and then buy again and sell again while your money bleeds to taxes and fees.

The real money in investment will have to be made – as most of it has been in the past – not out of buying and selling but of owning and holding securities, receiving interest and dividends and increases in value.

Benjamin Graham, The Intelligent Investor

Real money is in the holding. Real money is in building the conviction to double down when opportunities present themselves.

Investing should be boring, as boring as watching paint dry. The more exciting you make it and the longer you play at it, the more you’ll lose. That is like going to Vegas but without the Vegas fun.

I’ll leave you with this conversation between Bezos, Buffett and Brian Chesky, the founder of AirBnB that took place sometimes in 2013.

Chesky to Bezos: “Jeff, what’s the best advice Warren Buffett ever gave you?”

Bezos: “[I asked Warren,] your investment thesis is so simple…you’re the second richest guy in the world, and it’s so simple. Why doesn’t everyone just copy you?”

Buffett: “Because nobody wants to get rich slow.”

Nobody wants to wait from years one to ten to see the wealth snowball start to roll up the hill from years eleven to twenty, accumulating more powder on an ever-larger surface area as it rolls along, getting bigger and bigger, with no help from you.

That is too bad. Nobody wants to get rich slow and that is why many never get rich.

Thank you for your time.

Cover image credit – Jeswin Thomas, Pexel

Up until the 1890s, horses and buggies ruled the land. There were incremental innovations within that ecosystem but nothing transformative. Then Henry Ford came along with the Model-T car and the buggies were history.

Gutenberg’s invention of the printing press in the 1450s drove the manuscript writers out of business. I mean before that, you’d have armies of people literally writing pages by hand, one book at a time.

But once we could print stuff en masse…

Something similar transpired with the advent of electricity, the light bulb, the telephone, the internet and a million other big and small inventions that rendered the old way of doing things useless.

Joseph Schumpeter, the Austrian-trained economist, called this the process of Creative Destruction. Capitalism and creative destruction go hand in hand. They kill the inefficient to reallocate resources to the efficient.

Take manufacturing for example. United Sates is a powerhouse in manufacturing, second only to China. And that with a mere ten percent of its workforce employed in that sector.

Less labor required to produce more stuff is a great thing for the economy but not so for the workers being impacted. There is hence a need for a strong safety net to catch these people when they fall but progress should not be allowed to stop.

Because all net wealth created in an economy is due to increases in productivity. And wherever capitalism’s forces of creative destruction remain unleashed, productivity growth follows.

Business values rise, shareholders get rich, and everyone benefits when the economy produces more output with fewer inputs.

To comprehend how good we have it today, let me take you to the good old days of the early 1900s when John D. Rockefeller was the richest man around. Yet he had no TV, no internet, no air-conditioning, no airplane travel, no mobile phones and not even penicillin¹. That was life for the world’s richest.

Or take Calvin Coolidge, President of the United States during the 1920s. His son died due to an infection caused by blisters that he developed while playing tennis. A President’s son dying from blisters, an implausible likelihood these days for literally anyone, anywhere¹.

Or take Maria Theresa, head of the Habsburg empire in the 1700s, who saw six of her 16 children die before reaching adulthood². Even the poorest regions of our planet have a higher survival rate today.

Life is so good, yet we feel inadequate because we compare and contrast, especially when it comes to money. And then we get sad. It is hard to find perspective but find we must. Each one of us is way richer than we think we are.

But back to capitalism’s forces of creative destruction, they are alive in our portfolios as well. And what better way to demonstrate that than to take a look back again to the 1960s world of stock portfolios where if you didn’t own Xerox, you were a loser. If you didn’t own GE, the General Electric, you didn’t know what you were doing. Same for IBM, Eastman Kodak, Polaroid and on.

We know about the Dow Jones Industrial Average, an oft-quoted stock market benchmark that is supposed to measure how our economy is doing. Stock markets are not everything, but they have become everything and that is a good thing.

So, imagine you are in 1965 trying to build a portfolio to invest your savings into and you’d of course be looking for the bluest of the blue chips. And what better way to populate your portfolio with than to just buy what the Dow owns.

And these were the companies it owned…

But then Schumpeter‘s forces of creative destruction kicked in, and this is what that same Dow owns today.

So, if you held onto the businesses of 1965 beyond their useful life and made no changes, you could be hurting. I don’t know for sure as it is hard to crunch the numbers as businesses get merged or get spun off or go extinct.

But what I do know is that a single $10,000 invested in 1965 would be $2.5 million today even in this relatively dumb way to build portfolios and that is by owning just the Dow. And that is because the Dow kept on evolving as the economy evolved.

John VanGavree, a U.S. State Department analyst put together a dashboard that highlights the changes in the top 10 holdings in the S&P 500 index in five-year increments. Even in such a short period of time, the index components change and sometimes by a lot.

This mostly happens because large companies become slow and bureaucratic, and difficult to navigate for employees who want to break things.

So, they leave, picking up venture capital on their way out and starting new disruptive businesses.

So too top-heavy a portfolio adds this extra layer of large-company disruption risk that should be designed around.

Plus, data going back to 1970 show that companies that finished in the world’s top 10 in terms of market value had less than one in five chances of finishing the next decade there.

And in the decade after companies reach the top 10, they typically see earnings growth fall and profitability decline. Investment performance of course always follows so they end up giving back all the excess gains they made in their run up to the top³.

Competition and churn lie at the heart of a functioning capitalist system. That is why the giants of one decade so often deliver such underwhelming returns in the next one, and shrink in the popular imagination. Expect that pattern to recur unless capitalism is truly broken.

“How the US tech giants could fall” by Ruchir Sharma, Financial Times, August 15, 2021

And competition is always there, waiting to gobble up any edge a business has, and disruption happens these days at a pace never seen before. There is no way to tell if the stock of a business you own today which is at the top will stay there a year from now, forget a decade.

So, some takeaways…

• The darlings of today may appear invincible. They always do. But unless capitalism is truly broken, they will be replaced. They must be. So, if your portfolio is overly concentrated with these darlings, you must plan to un-concentrate before it is too late.

• And the fact they are the darlings today means everyone knows about them. And when everyone knows about them, everyone wants to own a piece of them. So, more demand with the same supply of shares means price inflation. And you pay for that by paying inflated prices. Yes, markets are supposed to be efficient, but they seldom are in the short term.

• You might be unknowingly concentrated in some of the top names with no fault of your own. Maybe you work for one of these businesses and you acquired shares through employee plans over time. As much as you hate letting some of your shares go, let go you must because history is not on your side. The way to do it is to build a plan that errs on the side of conservatism and use that plan as a guide to trickle out of your shares. Let the plan dictate what you should do mechanistically instead of using emotions to guide your decisions.

• And last, design a portfolio where you get to participate in the rise in the value of a business from small to mid and from mid to large. That is an extra value capture that you can extract through portfolio tilts towards different segments of the market. Some will complete the full cycle from small to mid and from mid to large and eventually to extinction. Others may get acquired halfway through that process and some may flame out prematurely. But owning a broad enough basket of them, spread across the size spectrum means you’ll get to own a turbo-charged version of all that capitalism has to offer.

Thank you for your time.

¹ David Henderson. “Richer than Rockefeller“, Econlib. February 8, 2018.

² Laura Vanderkam. “All the money in the world“.

³ Ruchir Sharma. “How the US tech giants could fall“, Financial Times. August 15, 2021.

Cover image credit – Smithsonian Institution

Investing is like planting a tree. You put in the effort once and then the fruits keep on coming. That is akin to buying stocks. Dividends are the fruits, and the tree is the business behind the stock that pays those dividends. Stocks are deemed as perpetuities (dividend stream continues forever), but we all know nothing lasts forever – not the trees and not the businesses.

But the present value concept for valuing stocks takes business survival into account, which then gets reflected in the prices we see quoted on the stock exchanges each day.

Bonds are the same but with a defined term (not perpetual) and with deterministic cash flows (fixed interest payments). The same can be said of investment real estate and rents.

So, stocks pay dividends, bonds make interest payments and real estate pays rents. These cash flows are what we use to value each one of these investments.

There are no cash flows with commodities. They don’t return anything.

Take oil for example. It costs money to buy and then it costs more money to store. Same goes for gold, soybean and corn.

So why buy commodities? To use them in some form or the other and to make something out of them.

It is dumb to buy them as investments because they are not investments. They cannot be investments because they don’t produce cash flows.

The only way you’ll make money “investing” in say oil is if you sell it to someone at a price higher than what you paid for it. That is the definition of speculation. You may get the trade right one time. You are not going to get it right every time. Because you are playing a zero-sum game. For you to win, someone else has to lose.

And every once in a while, the price of any one of these commodities would go through a speculative boom.

But these things go in as raw materials in the stuff we buy and consume. And whatever we buy, it takes a business to produce.

The cost of a commodity hence is a line item on the profit and loss statement for that business under the big bad term called EXPENSE.

So, what does a business do if the price of a commodity causes its input costs to rise beyond what it can afford? It uses less of it. Or it finds a replacement for it. The demand for that commodity eventually wanes. Its price then falls back down to earth.

Here’s an example. If you were to peer into any one of the semiconductor chips that were the brains inside the gadgets you bought in the past, you would see connections made out of gold.

Then the price of gold spiked so what did the businesses making these semiconductor chips do? They replaced gold with copper. Not as great of a material as gold but businesses found their workarounds.

Here’s another example; the world population in the 1950s was two and a half billion people. Economists were predicting all sorts of shortages for many of the commodities we use today if the population were to rise even more. The term ‘Peak Oil’ had a similar premise.

What really happened? The population has more than tripled but the inflation-adjusted prices for many of the commodities we use today have never been cheaper. That is because as Allen Mattich of the Wall Street Journal puts it, when you buy commodities as investments, you are shorting human ingenuity.

Human ingenuity is the ultimate resource that makes all other commodities more plentiful. It may not happen overnight, but it will happen over time.

So, if you are investing in commodities, you are making a mistake. Because in this race between speculators expecting the price of a commodity to rise and human beings trying to survive and thrive, human beings will win. They must win.

Thank you for your time.

Cover image credit – Michael Steinberg, Pexels

JFK‘s father, Joseph “Joe” Kennedy, exited the stock market right before the 1929 crash when he heard his shoeshine boy give stock advice. He figured that if a shoeshine boy is giving him a rundown on what stocks to buy, the market has become too popular for its own good. That was during a time when most did not invest in the stock market but at that euphoric peak, everyone wanted in. And the rest as they say is history.

And it is not partaking in the stock market that is the problem. It is partaking in extreme speculation in a herd-like manner which becomes a problem. It causes bubbles and the follow on bust causes a lot of grief and pain.

Bubbles occur because we are a jealous, envy-laden bunch. We see our neighbor get rich on some dumb investment and we say, why not me? It is ingrained in us, so we chase the same investments which then causes their prices to detach themselves from reality until they eventually crash back to earth.

Nothing so undermines your financial judgement as the sight of your neighbor getting rich.

J. P. Morgan

People start being interested in something because it’s going up, not because they understand it or anything else. But the guy next door, who they know is dumber than they are, is getting rich and they aren’t. And their spouse is saying can’t you figure it out too? It is so contagious. So that’s a permanent part of the system.

Warren Buffett

Bubbles hence are inevitable. But how do we know if we are in one? William Bernstein, neurologist turned investment advisor and a writer par excellence, lists these four signs…

• Popularity – You go to a party, and everyone talks about the killing they are making in tech stocks or in flipping real estate. Your Uber driver talks bitcoin and Ethereum, those are signs of a bubble.

• Job quits – When people quit their stable professions to day trade or to flip houses, that is a bubble.

• Skepticism met with anger – You express skepticism on investing in something that has been popular, and you’re not just met with disagreement but also with anger, that is another sign. You see that in the crypto world where even mild questioning of their thesis is met with resentment. That is a bubble because who does not want to effortlessly get rich.

• Extreme predictions – The last feature of a bubble is extreme predictions. Bitcoin is going to a million. When you see such headlines, you can be sure of a bubble.

One more thing I would add to the list is when you see Wall Steet launch products around themes that are currently in vogue. Because Wall Street will sell anything people will buy. So, when you see things like an AI-focused fund and gold and uranium mining ETFs being marketed, you know that is a bubble.

The unfortunate problem with bubbles is that they can go on forever. Alan Greenspan, the then Federal Reserve chair, in a speech he gave at the American Enterprise Institute in December of 1996, warned that the stock market is in a bubble. Yet, the tech-heavy Nasdaq went on to quadruple in four years before the bubble eventually burst.

So even knowing that there is a bubble did not help. What do you do then? A few takes…

• Know why you are investing and for how long you are investing for. Build a plan around that using reasonable investments and you’ll do fine.

• FOMO is real but free lunches are few and far between. Be wary of hot tips and know that you’ll never see the full picture of other people’s finances.

• Expected return from any investment should make sense. I use the yield on the 10-year Treasury bond as a guideline. And ten years roughly matches the duration of any long-term investing. So, if that bond, the safest of all investments, yields four percent and if something else yields five, there is a risk. Understand that risk and invest accordingly.

• An investment today means cash flows now or in the future. Steer clear of investments that will never produce cash flows. You don’t have to know as much as Aswath Damodaran but understanding some basics on how business valuation works will save you from a lot of heartburn.

• And knowing some history only helps. It gives you the context on what to expect from real investing. You can deviate from what works but understand the risks before you deviate too much from it. Blowing up your life, taking chances, is never worth it.

Thank you for your time.

Cover image credit – Andrea Piacquadio, Pexels

Abraham Maslow describes in his groundbreaking 1943 paper a pyramid of needs that must be met in more or less a sequence before human beings can realize their full potential.

Food, clothing, and shelter form the base of that pyramid.

Friends, relationships, self-esteem, and a need to belong form the next set of rungs.

The tip of that pyramid of needs relates to self-actualization, a process by which we achieve our full potential. That comes with honing our craft, that comes with spending our time doing what we love, that comes with spending our life’s energy in pursuing what we are here on this planet for.

Self-actualization takes a backseat when you are merely trying to put food on the table or a roof over your head. Maslow summarizes it with this quote on what an ideal society should look like…

What a man can be, he must be.

Abraham Maslow

Scandinavian countries have taken this to heart, and they actively work to get their citizens to that self-actualization phase. The rest of the world, not so much.

Take Norway, for example, and compare it to say the United Arab Emirates. Both big exporters of oil with about the same per capita production rate.

But Norway along with the rest of Scandinavia come out at the top on any measure of happiness there is because the governments there actively work to make life better for their citizens.

And Norway is as prudent as prudent can get. They have seen the future. They know this thing (oil) will someday run out so what do they do with all that oil money? They deploy it into a sovereign wealth fund for their citizens which as of the day of this writing¹, is the largest in the world. The fund invests in stocks and bonds of businesses around the globe.

And because of that, a child born today anywhere in Norway is entitled to a quarter million dollars to his or her name. And that amount keeps growing. Those babies are set and so is the rest of the citizenry that are afforded a quality of life that only millionaires in America can afford. You can read about it more here.

But back to the topic at hand, the economy has its own version of the pyramid with businesses, both public and private, forming the top of that value chain.

Without businesses, there is no economy. Without businesses, there are no jobs. Without businesses, there are no productivity gains. Without businesses, there is no innovation.

Yes, you can make it work through a patch work of government-run enterprises as has been tried in the old Soviet-bloc and in what we see today as a ‘shining’ example of running its course in countries like Venezuela and Cuba, but they don’t work.

They won’t work because there is no profit motive. Human beings are not designed to work without a profit motive.

And without a profit motive, there is no business. And without a business, there is no economy.

Businesses hence form the top of the economic value chain and the stock market, as flawed as it is many a times, is the best way to own a piece of that value chain. Lucky for us. Imagine clicking a button and being able to own a piece of Apple or Google or ASML – all through the wonder that is the modern-day stock market.

The next rung in that value chain is occupied by bonds. When we buy bonds, we become a lender to governments and businesses, but ultimately, still businesses. Governments rely on tax revenues to pay back the money they borrow and without jobs, there are no tax revenues and it’s the businesses that ultimately create those jobs.

And you lend money to a business with the expectation of getting paid interest as well as a return of your principal at the end of the loan term.

But if that business does not make money, you are not getting your interest or your principal back. That business, hence, must out-earn in profits what it pays in interest to the bondholders, or it does not survive.

And because you own a piece of that business through the stock market, the stock of that business must out-earn the interest paid by the bond issued by that business.

So why would we then own bonds? Because they are short-term safer (less volatile). Bond investors get paid first regardless of the goings in the business before stock investors get anything. Bonds are less risky than stocks by design, but they won’t earn you as much as stocks.

Then there is real estate. Now in theory, it must earn even less than bonds. I am talking about real estate in aggregate, not one specific piece of property in San Francisco.

Employees make money for a business, but they also cost money. You can only afford that rent or that mortgage on that home because the business you work for clears enough profits to pay the bondholders a little, the stockholders a big chunk and then whatever is left is what eventually flows to the owners of real estate through your paychecks.

And businesses in general tend to cut the employee slice as thinly as possible. That is by design.

So, you better hope that the city you work in does everything possible to make sure the cost of living remains as reasonable as possible. Raise it too much and businesses will actively work to reduce the impact of that cost by moving jobs around. They might not say that in your face, but they are working behind the scenes to make that happen at every chance they get.

This is of course thinking in aggregates but when you own a portfolio of businesses spanning the globe, you must think in aggregates.

So, if you want to own the top of our economic value chain, stocks are it. They’ll give you ulcers from time to time but that is the price you pay to own the profitable top.

Stocks are indeed for the long run. Not every stock but stocks in aggregate.

Thank you for your time.

Cover image credit – David Mceachan, Pexels

¹ December 31, 2023