Principles of Wealth #22*

Tuesday, November 13, 2018

The efficient market hypothesis is bogus. The stock market, its sectors, and its individual stocks are often mispriced. But that doesn’t mean speculating on those errors makes sense.

Speculation is at best an intellectual form of gambling, like playing blackjack rather than roulette or craps. But all forms of speculation are likely to decrease one’s wealth over time. And every experienced speculator, in his heart, knows this to be true.

Selling speculations is not speculating. It is a form of business. And for some, it is a very profitable business.

 The prudent wealth builder that speculates treats his speculations as spending.

Delray Beach, FL.- In an essay published in Investopedia, Tim Parker writes: “Whether speculation has a place in the portfolios of investors is the subject of much debate. Proponents of the efficient market hypothesis believe the market is always fairly priced, making speculation an unreliable and unwise road to profits. Speculators believe that the market overreacts to a host of variables. These variables present an opportunity for capital growth.”

The argument Parker attributes to speculators is correct. The stock market is often inappropriately priced. And sectors within the stock market are badly priced even more often. Not infrequently, market sectors are grossly mispriced. The same is true for individual stocks.

I am always astounded when I think of how quickly and widely accepted the thesis of the efficient marketplace came to be. The logic, simply put, is that the big financial players – including institutional investors, hedge funds, and the like – have, through internet communications and computer technology, access to all of the key financial data they need to value stocks. They even have access to indices of public sentiment. With all that knowledge available and updated in nanoseconds, the price of any stock, any sector, and even the market itself will of necessity reflect the correct pricing.

This doesn’t make sense on several levels. For one thing, it is impossible to measure consumer sentiment or to predict its ebb and flow. More importantly, raw data (such as history of earnings, revenue growth, P/E ratios, etc.) cannot possibly give a reliable view as to the value of a company in the future.

I cannot tell you with any accuracy the true value of the equity of any of the companies I own and control. And I certainly could not predict what the value will be in six months or a year. So how could these data-crunching investment behemoths know?

But forget about the logic. Take a look at any 20-year period of stock market valuations and you will find moments when the market “corrected” itself, sometimes with a fall of 10% or more. What is happening there? There can be only one answer: irrational exuberance. And as I have already pointed out: You cannot measure accurately, let alone predict, the fluctuations of investor sentiment.

But that doesn’t mean that speculating is a reasonable way to accumulate wealth.

(Note: Hedging and arbitrage are not necessarily speculating. If done properly, they are the opposite. We will talk about them another time. This is about speculating and only that.)

What is speculating? John Maynard Keynes said it is acting as if one “knows the future of the market better than the market itself.” I like that definition because it emphasizes the core problem with speculating. It is fundamentally a bet on the future. And betting on the future is betting on something that is largely unknowable. Why bet on future possibilities when you can make good money investing in the known facts, the realities, of the present?

Professional speculators use sophisticated strategies such as swing trading, pairs trading, and hedging along with fundamental analysis of companies/industries and macro analysis of economics/politics to place their bets.

Just think about what I just said. The best speculators are crunching numbers from all these realms and using complex, technical strategies to make their decisions. And it is all done in the hope of getting way-above-average ROIs. It’s a whole lot of work. And at the end of the day, success depends on thousands of uncontrollable and even unknowable details. Where is the reasonableness in that?

John Bogle, bestselling author and founder of the Vanguard Fund, wrote a book called The Clash of Cultures: Investment vs. Speculation. In it, he demonstrated that individual investors almost always lose big when they speculate. He says that speculating is an “unwise” strategy for ordinary people whose goal is to safely accumulate funds for retirement.

“The internet and financial media may encourage speculation,” he says. “But that doesn’t mean you should follow the herd.”

Indeed. The reason the financial media and the brokerage community promote speculation is because they benefit from the fact that most speculators lose and lose big. And all those losses end up in the pockets of the brokers and the bankers and also the prudent investors that would rather invest their money safely for reasonable gains than gamble for big wins.

* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost.

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A “Simple Question” With a “That Depends” Answer

Monday, November 5, 2018

Delray Beach, Florida.- “I have a simple question,” RS wrote. “How can you calculate the odds for losing your money before you start a business or invest your capital? I’ve read what you said about it, but I can’t figure out how to do it! (I can, though, tell you that the odds to roll a 6:6 with two dice is 2.77%.)”

I like the critique implicit in RS’s question. The answer is that you cannot mathematically calculate the odds of losing money in a business. But you can figure out if the odds are in your favor.

I told him to start with this:

* Have you ever started the same or a very similar business before?

* If not, have you worked as a senior person in the same or a very similar business?

If the answer is no to either question, the odds are against you.

If I feel the odds are against me, the only way I will invest in a new business is if I can do a series of marketing tests to identify its optimal selling proposition within a timeframe and a budget that I can afford.

That will be different for everyone. For me, the timeframe would normally be up to but not more than 2 years. And the dollar limit would be $50,000 to $100,000.

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What Am I Doing Here? What Can I Say?

Saturday, October 20, 2018

Bermuda –I’m in Bermuda this weekend, speaking at an investment conference. I’m here to talk about money — making it, growing it, protecting it.

I came in Thursday night at about 10:00 and taxied to the hotel in the dark. I hadn’t been here for 30 years and had only a few very fragmented memories — pretty, pastel-colored buildings and a beautiful sea. In the morning, those images were confirmed by a look out my balcony.

Indeed, Bermuda is an attractive place to spend a few days. As you can see, the scenery is beautiful in the usual tropical island ways. But Bermuda has its unique architecture and it has rolling hills and little cliffs and thousands of tiny islands along its shore, which gives one the feeling that there is more to be discovered here as opposed to, say, Grand Cayman or the Bahamas.

I wasn’t looking forward to the two presentations I was scheduled to make on Friday. I was exhausted after a week of meetings in Berlin, the Liverpool film festival, and three days of crushing attention at AWAI’s “Bootcamp.” (This year, there were more than 500 attendees.) I hadn’t prepared my comments and I didn’t want to. I felt like I didn’t care about investing anymore. The only thing I wanted to tell these investors was to stop worrying so much about money and spend more time with their grandkids.

So I spent the first part of the morning writing an essay on a new idea I’m working on: that the greatest danger we face in the USA today is not an economic one but a cultural epidemic. I am tentatively calling it the “culture of blame.” I haven’t yet looked that up yet to see if it’s an idea that’s already out there. It probably is. But I wrote the essay anyway. (You will see it here soon.)

My first obligation was at 10:00, a panel presentation on “investing outside the stock market.” It was me and two financial specialists and an economist. The emcee started the discussion by asking me for my “general thoughts” on diversifying.

I don’t remember what I said, but the audience was engaged. They sat upright, asked questions, and even laughed at a few of my jokes. It went by, as every presentation I’ve ever done has, in a flash. It was over and I wanted to keep going.

I went upstairs to my room to actually prepare for the 2:30 breakout session. This time, I would be presenting all by myself, and I couldn’t just wing it. I needed to do some thinking. I needed to create note cards or, at the very least, a crib sheet of topics. But I decided to close my eyes for a quick rest before I got to work… and I nodded off.

The phone rang. I was “on” in 10 minutes.

I got to the room exactly one minute early. No one was there. “Cripes,” I complained to someone who looked like he was in charge. “I said I wasn’t going to come unless there were people that wanted to see me. “The general session is running late,” he said. “They’ll be letting out in a few minutes.”

I heard the doors open and a steady stream of people began walking towards us. There were three workshops scheduled for 2:30, mine and two others. I knew and liked the young analysts heading up the other two, but not enough to feel okay about it if they had full rooms and I had only a few people. So I stood in front of the door to my room, urging people to come in like a Greek waiter in front of a cheap Parisian restaurant.

Five minutes later, my room was full.

I began by telling them a story about how my advice cost a colleague of mine $15 million. “I thought you should know that before you take anything I say seriously,” I said. They laughed. I relaxed.

We talked about “investing” in gold. I explained that I don’t see gold as an investment but as an insurance policy – insurance against financial Armageddon. I told them that bought a lot of it from 2001 to 2005, when it was trading between $250 and $500. “Since the price is now $1,200 and has been at this level for some time,” I said, “I feel like I have too much of it. I’d like to get rid of about half of it, but I don’t know where I’d put the money. “I know what you can do with it,” a lady in the back said. Everyone laughed. I did too.

I talked about real estate, and I gave them my magic formula. “If you invest the way I do,” I said, “you don’t need to pay attention to the general economy or the state of politics or price fluctuations. All you need to do is buy in the recommended range, have someone competent manage the property for you, and then keep on buying.”

Then I talked about art and I explained my scheme for cornering a certain market. They seemed to enjoy hearing about it, though I doubt that any of them will ever do it.

They asked a lot of questions and I answered most of them by telling them stories. They liked the stories. Most of them understood the implicit messages.

Then it was over – faster than I wanted it to be. I signed some books, took some photos, and went back to my room.

I had come unprepared – except for 35 years of experience – and I had told them the truth as I know it. Once again, it was “ready-fire-aim.” And once again, it worked out pretty well.

I’m looking forward to the cocktail party tonight so I can keep on talking.

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Principles of Wealth: #21*

When the odds of a particular speculation are extremely long, we refer to it as gambling. And gambling, most sensible people would acknowledge, is a foolish financial activity. Unless, of course, the odds are in your favor.

It must have been 40 years ago. I was a young man, returning from my first trip to Las Vegas. The man next to me was an architect. His specialty was high-end hotel-casinos. His favorite part of the job, he told me, was designing the VIP suites. They were immense pleasure domes, featuring every imaginable luxury, including gilded furnishings and indoor pools.

“How much would one of those go for?” I naively asked.

“Oh, they never charge for those rooms. They give them away to high rollers for free.”

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Principles of Wealth: #19 of 60*

There are two ways that investments can build wealth. One is by the generation of income. The other is through appreciation – an increase in the value of the underlying asset.

Certain asset classes are inherently structured to increase value by generating income (e.g., bonds, CDs), while others increase value through appreciation (e.g., “growth stocks” and entrepreneurial businesses). But there are also many asset classes that provide both income and appreciation. The prudent wealth builder will likely have all three types of assets in his holdings, but he will favor those that provide both income and appreciation.

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Notes From My Journal

Does the SEC Really Give a Crap About Small Investors?

Delray Beach, FL– “The private markets are awash in capital these days,” Jay Clayton, Chairman of the SEC, told entrepreneurs and business-school students in Nashville recently. “The question is, who is participating?”

For decades, regulators have walled off most private deals from smaller investors. Because of the added risk of private investing, they must meet stringent income and net-worth requirements to participate. As a result, small investors never had access to companies like Uber Technologies and Airbnb.

Mr. Clayton wants to change that.

“This is good news,” TM said in a memo to my partners. “And it would be no small potatoes as it would open a big line of biz. Early Seeds.”

TM was talking about the opportunity for businesses like ours, publishers of investment advice, to sell more newsletters and other advisory services focusing on this newly opened and quite exciting topic.

Here’s what I think: Yes, it will be good for financial publishers like us. And it will be great for financial advisors and brokers and all the guys with suits that live off Wall Street. But it will not be good for ordinary investors, particularly the elderly and vulnerable. This change will make the sum of them poorer. And I’m pretty sure Mr. Clayton knows that.


From My “Work-in-Progress” Basket

A Serious Answer to a Dumb Question

 “What habit made the biggest difference in your life with the least effort?”

This is the sort of question you see on Quora – ultimately dumb but superficially interesting. I rarely open the links because I know the answers will likely be as silly as the questions.

That’s what happened when I saw this one.

But then I thought: If I am taking questions from an audience and someone asks this one, how would I answer it? I couldn’t dismiss it as a stupid. What would I say?

Hmmm… the audience is waiting. Clock is ticking…

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Wealth Building for Beginners (Even if You Are Not Young Anymore)*


3.-Your Invitation to the “$150,000 Club”

In the last installment of this series, I told you how I got started on my own wealth-building journey. I hope it amused you. Looking back at it now, I can see that the ratio I kept between foolish and sound habits was about 2 to 1. But that was enough. I hope it comforts you to know that you can do most things wrong (as perhaps your parents and teachers always reminded you was your habit) and still become as wealthy as you need to be!

The second thing I did was to introduce you to a very simple and crazily powerful wealth secret that most high earners never follow: As your income increases (and it will!), you must resist the urge to ratchet up your spending accordingly.

And thirdly, I shared with you one of the most important insights about wealth that I ever learned. Luckily for me, I learned it when I was still relatively young. (In my early thirties.)

That insight was this: You need a lot less than you probably think to live a rich life: A lot less wealth. And also a lot less yearly income to acquire that wealth.

As for income… If you can get your income above $150,000 a year and simultaneously curb your enthusiasm for expensive toys, your chances of one day retiring wealthy are about 99.9 percent.

As for how much “money” you’ll need to sock away… A very rough number would be about 12 to 15 times the amount of money you’d need right now to lead a rich life.

If you can get your income up to $150,000 or beyond (and as I will show you that is quite easy to do if you are willing to put in the right sort of time) and if you can save 20 percent to 30 percent of that (which is very possible if you manage your finances as I’ll suggest), you will arrive one day at a net worth of between $3 million and $30 million.

And that – if you know how to spend your money – will be enough to provide a great, rich life for you and your family.

Before we move forward on that, you have to answer one question…

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What I’m Doing With My Money Now and for the Rest of 2018

Consult an expert, if you like experts. Talk to your broker. Read your broker’s “research” recommendations.

But don’t ask me what you should be doing with your money right now.

I have no qualifications as a financial advisor. No certificates. No degrees. I’ve never taken a single class in economics or accounting…

I’ve read a few books – ones that came highly recommended.

And yes, I was an advisor to and publisher of investment advice for nearly 40 years….

Which gave me an inside view on how the business works and a contact list of several dozen of the best-known stock analysts in the world. I know how they work and I’ve seen the results of their work, good and bad.

I keep tabs on the best of them. And incorporate the recommendations of a few. But when it comes to making decisions about what do with my (now my family’s) money, I follow my own rules.

My rules are not for everyone. So you may decide that they are not for you.

But if, like me, you are a timid investor…

If, like me, your fear of losing money is greater than your greed…

And if you are willing to work hard to make sure your active income is always increasing… every week and every month and every year…

Then you may be interested in knowing some of these rules that I follow and what, in particular, I plan to do with my money this year.

I have several dozen rules. Here are 10 of them:

  1. I don’t Invest in anything I don’t fully understand.
  2. If I am determined to break rule number one, I admit to myself that what I’m doing is gambling, not investing. And I proceed fully expecting to lose every penny I put on the line.
  3. I would never put all my savings into stocks or even into a portfolio of stocks and bonds. I have my money allocated in at least a half-dozen asset classes at all times.
  4. I don’t try to get from any asset class (stocks, bonds, real estate, commodities) or subclass (blue chip stocks, growth stocks, etc.) more than 10% to 20% of its natural (historic) rate of return. When someone recommends an investment “sure to” do much better than that, I steer clear.
  5. Before investing in anything, I have a Plan B in place. A proper Plan B is a pre-set (and if possible automatic) protocol that cashes me out of the deal as quickly as possible and with the least amount of damage.
  6. As a rule, I don’t invest in growth stocks. I prefer buying shares of world-class, income producing, Warren Buffett type companies that I feel confident will still be strong in 20+ years. And I do not sell these stocks in market downturns. I often buy more of them in order to “average down” my buy-in price.
  7. I devote the largest portion of my portfolio to income-producing real estate properties and use a trusted partner to manage them.
  8. The next largest slice of my investment pie goes to private businesses – either in stock or debt or convertible debt. When considering such investments, I ask myself how well I understand it and whether I have some control or at least influence on management should they take actions that seem wrong to me. (And I have my Plan B.)
  9. I don’t “invest” in hard assets or currencies because I don’t consider them investments. (They have little or no intrinsic value, do not produce value, and do not earn income.)
  10. I never invest more than a very small portion of my net investible wealth (net worth minus my house and other things I don’t intend to sell) in any single investment. (Long ago, my limit was 5%. Now it’s 1%.)

Now it’s time to tell you what I’m doing with my money this year.

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Investing and Wealth Building: Don’t Confuse Them! The Five Key Financial Strategies You Need to Create Wealth

This essay first appeared in The Palm Beach Letter

In my ongoing effort to shock and awe you with contrarian (and sometimes counterintuitive) truths about building wealth, I give you this little nugget to chew on today:

You cannot become wealthy by investing.

Please don’t tell anyone I told you this. If any of my fellow investment newsletter publishers knew I was saying such things they would have me tarred and feathered.

The investment advisory business – and in that I include brokerages, private bankers, and insurance agents, as well as investment newspapers, magazines, newsletters, and Internet publications – is a huge, multibillion-dollar industry based on lots of hard work, clever thinking, sophisticated algorithms, and one teensy-weensy lie.

The lie is that you can grow wealthy through investing.

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