Rethinking Investing – Part 2 (Plus: Election Thoughts)

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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.

###


I get really, really pissed when smart people don’t speak out. (Photo: Me at Burning Man ’08)

Odds and Ends: The Presidential Election

I’ll keep this short and sweet. Regardless of whom you’re voting for, get out and vote tomorrow, Tues. Find your closest location here.

If you care about your future and believe in a democratic process, it is your DUTY to get out and vote. I voted last week in San Jose, and — to be honest — I was not overwhelmed by the brain power I saw around me, all due respect to those who actually made the effort.

The best-informed people, for some reason, seem to sit on the sidelines playing armchair critic while elections happen. That’s bullsh*t.

This country is hanging on by a thread.

Make it a priority and vote on Tuesday. No excuses. Let the boss get a little pissed, let the co-worker whine for a few hours. Screw ’em — they’ll get over it within 48 hours. The future of this country, and every person you know in it, is at stake. Gird up your loins (metaphorically) and get to your closest voting location.

Who am I voting for? Since the word got out last week, here it is: Barack Obama. I’m not an Obama maniac, and I don’t think he is a panacea. I think all politicians are liars — it’s in their job description to win public office. Either candidate will get more things wrong than right.

I actually agree with McCain on many issues, but this is an A-or-B choice. Despite some misgivings, I am certain Obama is far better than McCain for the long-term prospects of the US, and I know advisors to both candidates.

The minds I most respect, including people like Warren Buffett and Marc Andreessen (his reasons here) and those who will be taxed most under his administration, all support him. If you want to see a video where I explain some of the reasons, here it is. Disagree if you will, but make no mistake: I’ve done a lot of homework.

Here’s the point, though: I don’t care much who you vote for, despite my preference. But I do care that you vote.

Get out and make yourself heard. Find your closest voting location here. No excuses. What could be more important?

DonorsChoose winners:

I haven’t forgotten! Lots of good news coming soon on winners and even more winners…

Posted on: November 3, 2008.

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126 comments on “Rethinking Investing – Part 2 (Plus: Election Thoughts)

  1. Wow, really liked both parts of this post and the photos too. Hearing Mark Cuban’s quote is an echo I have heard from other billionaires and I appreciate the reminders. I also like your responsible approach to the vote and I agree: people with a bright brain need to get out, vote and excercize the right people have died to give them!!!

    By the way, I am new to blogging and how it all works. Not sure if you saw my previous post, I just had a quick question about your biz: why is it not “sellable” as you said in your book? Is because it is an internet based biz, or some other reason? Thanks for your time, all the effort you put into coming up with interesting blog topics and for your being as specific as possible with your answer.

    Loved the book, told everyone about it and gave another copy to a friend today!

    Tim B.

    Like

  2. Totally agree!

    I think some people like to “invest” because they like to feel that they’re “doing something” to improve their net worth. It’s nothing more than an extension of the gambling reflex.

    You’re right that you have to have some edge, informational or otherwise, and if you don’t know what it is, you don’t have one.

    Two other books I thought I’d throw in are:
    Why Smart People Make Big Money Mistakes And How To Correct Them
    The Zurich Axioms.

    Sorry no links, I’m a bit of a net noob so I haven’t figured out how to put them in yet. Those books give you some idea of what to expect but better yet, give you some inkling if you’re cut out to actually engage in the activity of investing!

    Like

  3. After a tip from a friend I read your articles on investments and think you have come to the correct conclusion.

    A lot of the strategies that hedge funds and banks use to trade their own assets involve beliefs about valuation models, distribution assumptions, correlations and so forth. For them, arbitrage is much more important than stock picking.

    Furthermore, banks and bigger institutions can leverage their bets, i.e. they can lend money to invest it and, with that, multiply their original returns. Also if you have a very high risk appetite, the concept of doubling down is widespread (If one bet goes array, just double your bets on the next one – you probably won’t make a wrong guess 1000 times in a row). If you had unlimited capital – you could never lose. This is what some (rogue) traders forgot.

    Your quote from liar’s poker might sound like some traders run wild and manipulate the market day in and day out. But over the last decade their influence has dwindled. There are now many powerful players that use similar models and spot each others movements fairly well.

    The old angst that brokers would systematically screw you on your orders has also been largely mitigated by modern trading systems with realtime orderbooks and automatic execution etc.

    A note of caution though – every successful investor might have a good story of why he won. But if you think about investment success as normally distributed (with a weak form of the market efficiency hypothesis) then, by design, there will be a few very big winners and a few very big losers and lots in between. (the same happens if you let apes throw darts at the investment page of the WSJ to find your portfolio or do some coin tosses).

    Warren Buffet, Peter Lynch, etc. are beyond a shadow of a doubt very intelligent. However, they might just be lucky after all- as far as their stock picking is concerned.

    As for angel investing – this is a far better field for people coming from the “real world”. However, keep in mind that everywhere where there a great returns promised there is bound to be high risk. Your competitors for “insider” information are on a very high level and companies are often searching for the big brand angel investors to attract new ones (“If Larry Page/Goldman Sachs/KKR/… gives them money…”).

    Anyway, good luck with your ventures!

    Like

  4. I believe as long we know what we are doing, that should be all right regardless we allocate our money in stocks, bonds or currency.

    Cheers
    Vincent
    Personal Development Blogger

    Like

  5. Hey Tim,

    I think this falls into your category of do the opposite of what every one else is doing. I have only a few friends who are Angel Investors- and they all do quite well. I have many many friends who invest in stocks and well…there not. It makes total sense to me that if you don’t have an ‘information advantage’ stay out of it. On another note- Burning man looked like it was off the hizzay!

    Best,
    Rob

    Like

  6. But why vote? Nobody seems to have a reasonable answer to that question. If the world ended tomorrow or in a week or in a month, i wouldn’t go and vote. So it can’t be that important…

    Like

  7. Hi Tim,
    interesting that investing is your new interest. I started investing some 8 years ago when I was in new economy venture cap firm. And it was easy: the guys from forrester research & co. made a prognosis mistake on which all nasdaq valuations were based on: the mistake is the same over and over again: people, especially expert people think that patterns from the past last eternally – in that case it was the exponential growth of internet usage. they simply forgot that internet usage was dependant on pc usage or as it was called at that time – internet and pc penetration. and so it was a typical value-price difference. and it was in october when I former colleague of mine, formerly a mc kinsy consultant asked me: …but this now must be the floor, isn´t it. My response question was: do you really think that a company like yahoo will grow as much in future that a price / earnings ratio of 890 is justified. the answer to my question was a clear no! So I think people can think but when it is about stock exchange they often forget that. So may be investing is just finding differences between true values and prices on stock exchanges or other markets (so this is the simple basic idea of value investing). And isn´t it so that the simpliest ideas are often the best?)

    But Tim, my question to you: You write in your book that you spent some time in Berlin. So could you please help me with a short answer. Do you know VA Virtual Assistant agencies in Germany? Or German speaking ones? Or could you recommend something else for executing the VA concept in Germany? Would be nice if you could help me.

    And here an invitation: As I am working on an internet platform with german hiking trails: if you ever feel like hiking in wonderful german nature –> please feel free to tell me. I would find best hiking trail and hotel for you, pick you at the airport in Berlin and fly with you on one of the German Autobahns with over 200 kilometers per hour (proposed vehicle: Jag XJ 8). Speed & Nature, could be fun for you. Just let me know… best wishes from Berlin, Germany, HM Weiss.

    P.S. Shares of German carmakers BMW and Daimler are sinfully cheap at the moment! Price / earnings about 7! BMW significant under equity!

    Like

  8. Good post. I think most people think they’re investing when they are in fact gambling. Especially those early twenties day trader types (who aren’t looking quite so pleased with themselves right now). Mind you, so is putting your money in the bank if you choose the wrong bank!

    Like

  9. Information advantage is a crucial component in earning money anywhere. One book that I really enjoyed reading is similar to Liar’s Poker, it’s called Trading With The Enemy and it’s about the experiences of someone who worked at Jim Cramer’s hedge fund.

    One of the best stories in there is about how analysts would sometimes tell Cramer about a downgrade a few minutes before their official announcement. Cramer paid 6 cents a share on trades, way more than regular investors, but he was given an information advantage that was impossible to for the SEC to track and gave him a serious leg up.

    Like

  10. Tim – Thanks for another thought-provoking post on investing.

    I agree, investment assets are ultimately a currency that can buy (or help subsidize) your goals, hopes and dreams for the future.

    And while many spend a lot of time and money trying to “beat the market” in this pursuit, I think many could “allocate their resources to improve their quality of life” by taking a more simple approach the seeking an information advantage or wading into angel investing.

    The 2 key ingredients are: 1) a low-cost, highly diversified portfolio of index or asset class funds. Bottom line: buy everything. and 2) Good behavior over time. This is the key to successful investing IMHO.

    To be clear, this isn’t a “set it and forget it” strategy. There will be opportunities to rebalance the portfolio, harvest short-term tax losses and other strategic activities that can simultaneously add incremental returns while better controlling your ongoing risk exposures.

    Thanks again for the post — look forward to seeing more on this topic.

    Like

  11. Tim,

    Thank you. Read your post and felt dread when I heard the “information advantage”, and about the fixing. The way you structured your argument was likely sound, but it had the affect on me of avoiding investing in the stock market at all, so then any interest in the reading the books you suggested seemed lost. I will do my part on examining your post again later. Apparently, my flight response was triggered. You content is usually very informative, so forgive me for suggesting that when it comes to a sensitive subject like this, you might want to define who your target audience is. I am an educated, intelligent, positive and energetic 40 year young entrepreneur, but you scared ME into really thinking about slipping out of the stock market entirely.

    Like

  12. Sorry Tim,

    You put politics into a good blog, now I am gone. This was one of the last places to go without all the election nonsense being shoved at us. I guess you are just like the local business that sticks a ******** for president sign in the window and then wonders why half its customers seem offended and stop spending money there.

    Funny thing: Funds race did not show you making a $200+ donation to either candidate.

    Like

  13. 3rd Strike Tim – you’re out. I’ve read your book…I’ve read this blog…and I’ve commented here when I see you state something that is completely out of line with my own experience, with historical experience and with experience of people who have authority on the given matters you are commenting on ..and lastly – with overall results and good judgment.

    That you, who supposedly understand our enemies, understand entrepreneurship, and understand the marketplace are supporting Obama is utterly and completely ridiculous – and here’s why: Either you don’t understand these things or you’re concerned what those in your marketplace believe and you’re playing to them. Let me expand on this…

    …In order to get a firm grip on reality in the world and in the marketplace to understand what’s actually happening (not what people are just telling us in order to influence our decisions and perception) it’s important to watch what people do – NOT what they say. Tim – you made a # 1 NY Times Best Seller. What people who make that list have done is pretty amazing; they’ve mastered an art in telling people what they want to hear. Rarely – that book/author may also have imparted words that tell the reality of the world and marketplace also. I gave you that benefit of the doubt as you had some great advice and commentary. So the question came down to – are we listening to someone telling us what we want to hear – or is this a watermark as to what’s actually happening out there? There are several statements from your book and blog that made me take that step back ..and this one (plus 2 others in your blog) have cemented the reality that you’re telling people what they want to hear because results simply don’t mete out what you’ve stated as fact… I’ll let the readers of this blog figure out what and where …and just do a search on my posts and you’ll see what I’m speaking of… but further, our enemies around the world are hoping we elect Obama …because it will play into their favor. You can talk all you want about how we’ve suffered in the eyes of the world – but our enemies are all that matters. It’s like poker – people love you when you’re losing – but they hate you when you’re winning. So if our enemies hate us – and the world hates us …it’s because they want what we have (and it’s the reason why so many people are trying to get into the country – they want a piece of that same pie.) … so electing a patsy into the game, telling everyone what our cards are – plays right into what “the world” wants …enemies, friends ..you name it. Tim – you either know this or – if you don’t – then you simply DO NOT have an understanding of the world and how it works (and my guess is you lose at poker quite often)… or, as I believe, you’re just a guy who figured out a marketplace of guys like me who get technology, get a simple lifestyle of experiences (not possessions) and get freedom overall… and my guess is – guys in my lifestyle don’t get poker and how it works in geopolitics … and your’ just telling them what they want to hear. If that’s what my “demo” is … deal me out of it and I wish you fools well. And fools you are – you’ll soon be parted from your money.

    One last thing – when an elected official is in line with a propaganda cabal (read: the media) – and an average citizen is investigated and attacked for ASKING THAT OFFICIAL A QUESTION – then it is your duty as a citizen to vote against that party/official as a referendum against the media cabal. To not do so is complicity in creating a juggernaut-structure that is unstoppable… just as the German people did that elected Nazis to power.

    I wish all of you well – and never forget – the moment you start buying into the hype of those you follow – is the moment you’re lost.

    J.

    Like

  14. Investing = “Allocating resources to improve quality of life.”

    Interesting definition. One of the implications of this is that “quality of life” extends beyond you to the rest of the world.

    In other words, only invest in companies that are changing the world in ways you agree with. To me, that’s the ultimate in socially responsible investing.

    Like

  15. My attitude to public stocks has been to not invest because:

    1) I’m not going to kid myself that I understand enough about the markets any time soon

    2) I’d not want my investment to be vulnerable to something so sentiment-led

    3) Once invested, my investment is out of my control beyond the ability to buy and sell

    I’m all for Mark Cuban’s comments.

    Like

  16. Hi Tim,
    Great post as always and I agree – every eligible person must vote tomorrow – democracy is NOT a spectator sport.

    I also urge everyone with children to take them to the polls with you and explain what is going on – and tell them their duty to vote. I’ve done this since my kids were born – and why I have not voted early. I’m taking my 2 boys to the polls tomorrow to impress on them the importance of our responsibilities. Not only should you vote tomorrow, but you need to pass the practice on to your children/grandchildren etc.

    Also, if you have an enlighten manager – he/she won’t be pissed, but will give you time to vote. Back when I was working for the ‘man’ (alas, now that I’m the co-founder of my own company I find myself the ‘Man’ and its quit irksome to wail against myself :-) ) I always gave my folks either time in the morning, at lunch, or let them leave early to vote. A few took advantage of that (of which I always knew) but for the most part it got people who normally would not have voted out to vote.

    best,
    –Jack

    Like

  17. Buenos Dias, Hi Everyone!

    Tim,

    Wow, seems like the other post helped to clarify your take on investing. Sure, invest where you have insider knowledge and connections that others don’t (it isn’t the path of the least resistance, but rather a path which can strengthen your confidence in decisions). I agree, what is important is having information advantage and even if we don’t have it all the time, one can be wise in teaming up with the right people to have that information advantage.

    It was interesting to read some blog comments in your first investment article, the term “investing” was interpreted in so many ways, I admit it was a bit overwhelming but insightful. At the end of the day, investing in general is best distinguished over time and at the preference of everyone’s taste. Overall, it’s an awesome thing to keep to our commitments when playing hard ball and not lose credibility.

    From my perspective, the sweaty palms at night isn’t always a wrong choice, it comes with territory and the learning process, whereas we grow from new challenges (possibly in a known territory) and extend ourselves to new heights. You do a lot of that…at some point, sweaty palms might come to some or not (from experience) at other times. My personal feelings about that, I feel it comes down to the degree of confidence one has and whether one can accept the consequences of a particular decision.

    But I get what you mean when you insert a comment about the sweaty palms. And yes, I like that you make it a point to have us think about our values in connection to the degree of work we do.

    I saw this cool comment on a guy’s shirt in one of my business classes, it said “Don’t sell your liberty to gratify your luxury”. It’s something to ponder about, just putting that out there.

    You’re doing a great job!

    Thanks for the list of book recommendations.

    ¡Buena suerte!
    Dinastia

    Like

  18. Tim, great post, very good advice and some wonderful books for me to fill my time with. To be honest, I’m not going to vote tomorrow, a) because I am recovering from surgery and physically cannot, and b) because I can’t honestly cast my vote for any candidate and feel like I have truly voiced my opinion. I have considered write-ins, voting for no one, etc, but all of the other options just seem like a waste of time. Instead, I’ve committed myself to making the country as good as I can under any President there is, and hoping in 4 years I’ll have a much better choice to vote for, either from a new candidate, or one of these ones surprising me.

    Like