Rethinking Investing: Common-Sense Rules for Uncommon Times 106 Comments
I first saw this video at the May 2nd, 2008 Berkshire Hathaway shareholder meeting. Prophetic and not to be missed.
I’ve learned quite a few things in the last 18 months of exploring—and experimenting with—the world of investing. This post is my first attempt to share the findings.
The lessons have come from not just reading books, but trial and error, and picking the brains of some diverse and fascinating people:
-Warren Buffett, the richest man in the world, and CFOs/financiers at Berkshire’s portfolio companies
-Chief economists at top investments banks
-Dot-commers who have turned $40,000 into $2,000,000 in stocks using massive leverage
-Conservative entrepreneurs (still self-made millionaires) with all-bond portfolios
-Money managers of the ultra-rich and ridiculously famous
-Ivy league professors who not only trade options exclusively but also bet up to $500,000 per night as no-limit hold ‘em poker players.
In all cases, excluding blog reader feedback (how could I know?), the principles I will offer are from people who have made millions in their respective investments, not armchair quarterbacks (advisers) who take a management fee from the people willing to take real risks…
Total read time for this post: 6 minutes.
I’ve lost a little money, made more money (with “risk capital,” about 28% annualized over the last three years), and preserved almost all of my money. I’m terrified of certain things, but I build my irrational decision-making and temporary stupidity into the planning.
To start, here is a snapshot of my total current asset allocation in retirement accounts. I’ll come back to this. Notice the dates:
Let’s start off with some smart observations from readers of this blog, who commented on my post where I described Warren Buffett’s answer to my question, which recentlymade it into Berkshire’s new annual report! Here it is:
“If you were 30 years old and had no dependents but a full-time job that precluded full-time investing, how would you invest your first million dollars, assuming that you can cover 18 months of expenses with other savings? Thank you in advance for being as specific as possible with asset classes and allocation percentage.”
The observations I have picked out for discussion follow, and I’ve tested most of them. Some will sound complex, but this series will reduce it all to simple conclusions anyone can use:
From Lee:
For someone so risk seeking in your personal life, I’m surprised at your risk tolerance rate of 10%. From reading your blog, it seems like you live your life experiences with a 50% risk tolerance rate.
[Tim: This is a common misconception. I actually consider myself very conservative and risk-averse in both life and investment, and my close friends can confirm this. As we'll see, the phrase "risk tolerance" is hugely problematic, but behind the scenes, I micro-test the hell out of options to determine what has the best chance of a high return-on-investment (ROI), but this isn't transparent to most observers, who assume I regularly roll the dice and hope for the best. Not true.]
Patrick Clark [Tim: if you take nothing else from this post, re-read the bolded portion a few times and memorize it, especially the last sentence]:
I am going to make a few assumptions here:
1. You are an accredited investor.
2. Your businesses will continue to run themselves and create cash flow income for you.
3. This $1 million is true risk capital.
That being said, I am a investment advisor. I create portfolios for clients in both traditional asset classes (stocks, bonds, cash, and real estate) and non-traditional asset classes (raw materials, energy, metals, and currencies). This provides a mix of investments that are uncorrelated to one another.
Without getting into specific investment vehicles, an asset allocation will look something like this:
US Equities - 24.5%
International Equities - 19.5%
Real Estate - 3%
Raw Materials - 12%
Energy - 12.5%
Metals - 12%
Currencies - 6%
Cash - 10.5%
The goal is to produce an absolute return. For my clients, I am not interested in having the following conversation, “The market was down 40% this year, Mr. Jones, but we only lost 18%. We did a great job!” No. A loss is a loss. By setting up a portfolio for absolute return, not relative returns, your chances of forwarding the ball every year is much greater.
Remember, a 50% loss requires a 100% gain to get back to even. Don’t lose.
Luca:
cash IS an asset during bear market.
From D:
Find an investment style that fits your personality, then backtest that strategy [Tim: for those of you mathematically inclined, search for "Monte Carlo simulation"] over long & varied starting/ending periods to see if you can stomach the maximum drop (”drawdown”). And stick with it…forever. No one can predict the market, you never know if you’re about to buy before a big dip.
It’s true that growth stocks outperform a helluvalot of other asset classes over the long haul.
But, someone who put all their money in the S&P500 index on 1/3/2000 lost about -50% (by October 2002) and is still losing money eight years later! Most might throw in the towel at that low point, when they should have been adding. The pain of losing is alot stronger than the hope of winning.
Superstar investor via phone:
92% of your return is determined by asset allocation, 6% my manager/stock selection, and 2% by timing.
Russ Thornton:
Once your target allocation among the chosen funds had been determined, I would rebalance back to your target allocation when any single asset class deviated 20% from it’s target. There is meaningful data supporting this rebalancing trigger. You could also rebalance with additional savings which is a much more tax efficient approach and will reduce your capital gains realization. Rebalancing forces you to buy more of the relatively less expensive asset class in a classic “buy low” discipline [Tim: versus selling the higher-priced asset].
That’s about it. Buy when you have money and only sell when you need the money, but not before.
Lee:
I like Taleb’s idea of 90% in government bonds and 10% in highly speculative stocks.
More conventionally, I’d follow a highly diversified strategy as suggested by Swensen (Yale) in his books, adjusting the bond percentage up or down as dictated by risk tolerance:
stock funds:
large blend index (S&P 500)
small value index
International index
Real estate Index
Commodities (PIMCO real return)
bonds:
TIPs
Short term treasuries
Bex:
You can have a pretty diversified portfolio, even if you only own 10 stocks.
Henrik:
So basically, for the most stable returns, invest in a set of assets that do not go up or down at the same time. That means you need international as well as US exposure, and debt (bonds/money mkt) as well as stocks. [Tim: these are also called "negatively-correlating asset classes," common in pair trading, which Buffett did quite a lot in the 1970's and 80's]
Oliver:
Your allocation should be approximately as follows:
90% TIPS
10% Call options on the S&P500
This means you’ll lose almost nothing if the market tanks but you’ll still get a lot of the return of the S&P500 on the upside.
The first lesson is: you don’t know what you think you know.
Think you can predict your risk tolerance? I bet you can’t.
Let’s try another question that will drive the point home:
Would you call yourself a racist? I bet you wouldn’t, and I bet you are.
Take the Harvard Implicit Association Test (IAT) for race as many times as you like. I’m not a betting man, but I’ll bet you come up as racist, regardless of race.
Surprising? Perhaps.
I’ve come to realize that the questions most investment advisers (and investors) ask are the wrong questions, or incomplete. Even if you have only $100 to invest, this is important to explore.
Most advice and decisions center on one question: what is your risk tolerance?
I had one wealth manager ask me this, and I answered honestly: “I have no idea.” It threw him off. I then asked him for the average of his clients’ responses. The answer:
“Most answer that they would not panic, down up to 20% in one quarter.”
My follow-up question was: when do most panic and start selling low? His answer:
“When they’re down 5% in one quarter.”
Unless you’ve lost 20% in a quarter, it’s hard—neigh, impossible—to predict your response. It’s not to dissimilar from a common boxing maxim: everyone has a plan until they get punched in the face.
False assumptions about your future decision making almost guarantees failure, so either 1) dial back your supposed “risk tolerance”, or 2) simulate the loss with smaller amounts but higher risk investments before betting the farm. I use angel investments in tech start-ups for this purpose.
It need not be $100,000—go to the horse track and make conservative bets (high-probability, low pay-out) at $25 a race until you lose $200 (FYI: here’s how I learned to bet on horses). How do you feel? That’s the starting point: accurately gauging emotional responses to gain or loss.
Your decisions, and investment future, depend on calibrating accurately.
—
Continued in Part II, which includes best books, redefining “investment”, and more…
Suggestions for topics in this series? Please let me know in the comments. I still consider myself a novice and this is a work-in-progress. If investment advice, please give an example from your personal experience whenever possible. Real-life anecdotes are more interesting than opinions, though opinions can be helpful.
Suggested reading:
Picking Warren Buffett’s Brain: Notes from a Novice
The Karmic Capitalist: Should I Wait Until I’m Rich to Give Back?
Lifestyle Investing: “Compound Time” Like Compound Interest?
Posted on October 21st, 2008
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106 Responses to “Rethinking Investing: Common-Sense Rules for Uncommon Times”
12:12 am
A good article
12:41 am
Bird and Fortune. Spot on as ever
12:46 am
Great post and I love your work. One small thing — I think there is a Harvard study that shows that 94% of all investment returns are determined by asset allocation (not 92% as mentioned above). This is a small difference and I’m not here to focus on that. Rather I want people to focus on how high this number is. It means ALMOST ALL of your returns will be derived by that single choice. So focus your time on make a good decision about that and far far far less time picking stocks or funds or money managers. Good luck to all and Tim, please keep up the great work!
12:52 am
Tim,
First of all, I cannot agree with you more on this post… I’m glad to see you’re not going down the road 99% of North Americans (yes I’m Canadian) are going down with: that is carrying medium and high risk funds in their portfolio on top of paying exorbitant managing fees.
If you haven’t yet read it, Daniel R Solin’s book called “the smartest investment book you” ever read is the only book one needs to read about investing. Actually, I take that back, the only thing one needs to see is the diagram he put on page 12 which basically outlines that over the last 30 years, we’ve noticed that low risk funds give you virtually the same return as a high risk fund with out the risk of loosing money!
Keep up the great work Tim and I’ll keep reading.
1:25 am
My one critique of this post is the same that I have of nearly all investment advice: it says plenty about what to invest in, but nothing about the actual act of investing. For total beginners, it is far from obvious just how to go about making investments. One of the things I loved about 4HWW compared to other “business” books was how specific it was about taking action, going so far as to recommend specific useful companies/services and provide contact information. Advice like this is great, but it’s not impossible to find; meanwhile, searching for those specific actions to take usually just leaves one lost in a sea of advertisements for various brokers. I would love to see some investment advice that takes the 4HWW route: specific steps to begin investing in addition to suggestions on investment choices.
2:41 am
My epiphany is that contrary to popular belief, Tim is highly risk-averse and micro-tests everything before trying it out. Throughout the 4HWW there were continual hints that this was the case; an adwords campaign to decide on the 4HWW’s title, praising Ed Byrd for releasing a pamphlet before releasing his product etc. It was easy to get swept along thinking that creating a successful business could be done by instinct and fearlessness. Success in anything takes, at the very least, time and hard work made obvious by superstar investor’s statement that ROI is 92% dependent on asset allocation. The investing formula seems pretty straightforward; diversify as much as possible and play the market cautiously. Aiming for a long term gain that comes eventually will leave you in a much stronger position than looking for a short term gain that could never come. Since we could argue all day about where and how to diversify; invest in something that you find relatively interesting, you will likely already be well informed about its performance.
@Tom VanAntwerp I couldn’t agree more, I have read plenty about investing but nobody has made it especially clear about how to start playing the game or investing a few hundred. I’d love to know more if anyone could make any suggestions.
@Morgan Coudray Thanks for suggesting Solin’s book, I’ll have to check it out.
3:01 am
- More important than anything else: diversify, diversify, diversify (preferably in non- or low-correlated asset classes - warning: correlation during normal times is different from correlation during market crashes)
- Only invest in stocks (and other risky stuff) if your investment-horizon is long enough to outwait the market if things go wrong (ie only invest money in it that you won’t need during in the first 5-10 years)
- “Maximum tolerable loss x 2 = Maximum equity allocation” (at least according to Adrian Nenu from bogleheads.org)
- Low cost no-load index funds are generally a good idea (they don’t underperform the market)
- Rebalance when an asset class deviates 20% or more from its initial allocation
- There are interesting non-mainstream strategies out there may or may not be good ideas: Harry Browne’s permanent portfolio (book: Fail-Safe Investing), misc momentum-based strategies (example: http://www.FundX.com), etc.
(disclaimer: I’m inexperienced. I’m still 100% cash and trying to put a strategy for myself together. Thanks for this interesting post!)
3:06 am
Tim,
I remember you posting previously about the horse races and that during your experience you got it down to winning every race? (correct me if I’m wrong, my memory isn’t exactly the best)
Anyways, I would be very interested in learning about your experiences with betting, I’d love to see the way that you approached it, no doubt there’s something to be learnt there.
Cheers,
4:01 am
I still think the best personal money management book ever written is a series of stories written from the 1920s to 1940s by George S. Clason, compiled into a single book, and published as “The Richest Man in Babylon”. You can pick it up at any bookstore for $7.
4:15 am
I just have to say Tim you are one dam inspiring guy, I love the fact that you dont just blindly follow the advice of anyone but you get to the people that count and implement solid action plans. I would say that this would be absolutley crucial in the current market and if you have no idea in investing, get one!
Rich
5:31 am
Tim,
This post is very interesting. I love the video –> “Shall I jump out of the window??” Ha.
I am a novice as well, but have been interested in learning more about the details of asset allocation. I am currently working with an advisor, who I do trust and know very well, but moving forward, I want to be more involved with and knowledgeable regarding the reasons behind what % goes where and why.
When you take a step back, it is comical to think how obvious some things are (i.e. buy, don’t sell, when the market dips), but it seems only a minority follow this practice. The balance between international vs US stocks also makes complete sense.
Looking forward to part 2.
Sheila
6:00 am
[...] Ferris and his funny video Rethinking Investing: Common-Sense Rules for Uncommon Times - The Blog of Author Tim Ferriss More of a fun video about investing. Look at the guy to the right and his eyes: "Should I [...]
6:19 am
Hi Tim,
This is a topic that I am very passionate about … trading and investing.
I’ve had my ups and downs, my bruises and my celebrations - and, through all this, I’ve survived (and thrived) as an independent stock trader.
Similar to yourself, I, too, have had the pleasure of meeting Warren Buffet and, though most people would never hear of him, Ed Seykota (who, by the way, may not be the richest man in the world - but may be the most successful trader in history earning 250,000% in just over a decade).
The first thing you must realize is that all trading and investment activities are a matter of probabilities. No forumula to date has been able to produce 100% accuracy rate - there are profits and there are losses.
People often ask me: “What’s the difference between trading and gambling?”
The answer is that people who are gambling with their trading either do not know their odds or are investing with the odds against them.
People who are not gambling know their odds.
I recommend approaching trading with a question: Do I want to trade like a casino or a gambler? Both have notable stories of making big money - but who makes the most?
If you choose to trade like a casino - then you must know and understand your odds.
There’s so much more to share but … only so much time.
Be smart. Know your odds and, though you may not “win every hand” - if you’re trading with the odds in your favor, you can reasonably expect to be profitable over the long term.
Good luck,
Charlie
6:48 am
Tim,
Another great article. I think the Havard race test is a joke though. I took it once and tried to go as fast as possible. Here’s what I scored “Your data suggest a moderate automatic preference for African American compared to European American.” I’m white. So this would mean I favor African Amercians and am racist to European Americans like myself subconsciously. I believe this test is setup to show show a preference to white people. First of all its just putting you in a pattern of matching images and words to a certain side. Then it further stacks the deck by putting the good on the same side as the European American in the second round. Next it stacks the deck even further by putting Good and European together first, so you automatically associate them together when the swap them for the next round. I still scored opposite of what they were obviously setting me up for because I was going fast and they would put so many consecutive left or right keys in a row then throw the curve and I would hit the same key I had been hitting which just probably happened to pair a good word with African Americans or a bad word with European Americans.
Back to the main topic. Yeah, I’ve taken a big hit this year. I’ll watch the video at home when I have more time. I do like the bold parts. I’ll have to think about it and talk with my planner some more once I read the rest of he series.
Joe
7:07 am
Tim, this is a great start to your series - especially in light of current events - but I’m definitely looking forward to you getting into the “philosophy” of your investment strategies a bit more.
For example, a member of the New Rich isn’t all that well served by traditional retirement vehicles. I can only stick $4000 a year in a Roth IRA and any other retirement investments penalizes the hell out of me for early withdrawal of my capital. How do I deal with that as an investor who plans to take up to 20 mini retirements before I am 59 1/2? Are there ways to do this in an intelligent and tax advantaged way? How important is traditional “retirement” saving if you never plan to traditionally retire?
Hope you can address some of these issues as you continue this series. Thanks for sharing your wisdom.
7:16 am
If you’d like to learn more about stock options, I’ve got a video blog at http://www.investingwithoptions.com/. It’s pretty informative and has great content. Let me know what you think!
7:19 am
Regardless of your investment strategy or tolerance for risk, the single biggest factor impacting your investment results will be your behavior.
In other words, do you have the discipline to hold on when everyone else is selling or the good sense to protect your gains (through rebalancing) as the market hits new highs?
Costs are certainly important — I agree. But even if you have the lowest cost portfolio available for your needs, the portfolio won’t do you any good if you don’t have the patience and discipline to let it work for you over time.
And to be clear, I’m not suggesting that I or anyone else can predict or time the markets. I believe in low cost, highly diversified asset class (index) funds and believe you should literally buy entire markets both domestically and abroad and let the power of capitalism work for you over time. It’s not particularly exciting, but it works.
But in the end, it’s all about behavior. And if good financial advisor can help you do the prudent thing even when every fiber in your body is screaming at you to follow the crowd, then I think an advisor’s fee is worth every penny.
7:47 am
I’ve recently started to max out my 401K and am now putting about as much money as I can into a well diversified portfolio with a money manager, as I realize we’ll probably never see a better time to buy in our lives. However, I’d also like to do some investing on my own with a much more aggressive approach, but not an amount that will really affect me if I lose it, so ‘play money’ if you will.
Well, I’ve narrowed it down to they TYPES of companies I want to invest in, but I don’t know where to go to research SPECIFIC companies. I’ve basically decided that I want to find some pretty speculative stocks in the Energy Technology market as well as the Biomedical markets(stem cell treatments and biologically based medicines).
So my question is where can I go to research companies in these sectors? Are there industry magazines or websites that highlights up and coming companies? This might be a stupid question, but I’m literally just starting to invest and have no clue where to look.
7:47 am
Tim,
Your allocation seems to be 180 degrees from what Warren Buffett is doing. In a recent article - http://money.cnn.com/2008/10/17/news/economy/buffett_op_ed/index.htm?postversion=2008101709 - Buffett states he has moved virtually his entire personal portfolio from treasuries to U.S. stocks.
He offers this great quote: “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors.”
8:18 am
Great article Tim, helps to show all different views of the market that aren’t as publicized. Also i took that race test and scored a no preference my first time…
8:35 am
Asset allocation is overrated. It’s impossible to measure despite fancy concepts like beta and MPT. Beta has no predictive power of returns. Read Burton Malkiel.
No strategies are guaranteed, but Value Investing seems the best approach to me. Avoid debt, pursue high ROE and lots of cash flow.
Read Graham’s Intelligent Investor if you haven’t already.
Check out the gurufocus forum and the Barel Karsan blog.
I enjoyed your book very much. I feel it doesn’t address becoming the NR while caring for very young children as much as I had hoped but I’m sure you would say it’s still possible.
8:54 am
Note that intrinsic value drives the capital allocation decision at least as much as risk tolerance.
For over a century, the S&P 500 (and its antecedents) have reverted to a mean of about 16.5 times earnings. It appears possible to somewhat predict your 20-year investment return from the current index P/E ratio. See my ancient post on the subject:
http://www.spinoffprofiles.com/proof
10:08 am
Buenos Dias! Hi everyone (I enjoy reading the blog comments)
Hi Tim, very interesting blog, the video was comical…
I broker loans and my work is derived from financing real estate/sell of real estate. Plus, I’ve taken a keen interest in mortgage-backed securities and am working on developing a REIT (Real Estate Investment Trust [huge leverage for investors], so the video was right on. This does not imply that I agree with the way things were handled in the Secondary Market.
Anyway, I understood the first lesson: 1. Assess/formulate a realistic risk tolerance 2. Form losses with small amount with high risk (similar to a REIT) 3. Entertain the advice you received and follow through 4. Determine Investment Vehicles…Gotcha Thanks!
Since you’re the point of contact to a lot sources and you ask the right questions, I appreciate your hard work and your article. Keep it up, and I would suggest a better outline to format your research on your next Investment Article.
Good luck this Saturday on your speaking engagement. As for everyone else, thanks for your comments, I appreciate those too (Gracias) because I learn so much.
Hasta luego!
Dynasty
p.s.- (off subject) for the longest I wanted to suggest EarthClassMail.com, it’s the coolest postal mail service online (online P.O. Box, etc.)
10:47 am
For most people it’s easy to understand a basic concept of investing. But to get an education of fundamentals where is the best source to turn to? text books?
10:50 am
Tim, may I suggest getting in touch with William Bernstein in regards to asset allocation. He has penned both “The Intelligent Asset Allocator” and “The Four Pillars of Investing” and is somewhat of an MVP to geeks following the asset allocation and personal finance worlds. He was a practicing neurosurgeon who started a financial consulting firm on the side, an interesting guy to be sure…and supremely supremely objective when it comes to financial issues.
11:22 am
Tim,
No I wouldn’t…and I’m not…wanna bet?
How much were we betting?….My first time through the IAT
Your data suggest little to no automatic preference between African American and European American..
One must be careful about making blanket assumptions (or bets) on such things as race regardless of the statistics behind them. One must be especially careful when using a concept as volatile as racism to drive home a point about investment risk tolerance.
This all being said, I am a huge fan!
11:45 am
Hi Tim,
Great topic. Some areas I would like to see covered:
1. generating cash flow from investments so that you can live passively off them, it seems real estate for this is best but I’m not an expert
2. how to choose someone (or multiple people) to manage your money, or doing it yourself
3. diversification - everyone seems to assume it is the best approach (which I see the logic of) but by diversifying you are basically admitting you have no idea what will go up or down.
Thanks!
Brian
11:45 am
Tim, where did you get your most valuable information about options?
What is your opinion of Taleb’s trading philosophy?
12:12 pm
“Advice for Today’s Market? Diversify Wisely”, some gold from Jack Bogle and Zvi Bodie:
http://www.businessweek.com/magazine/content/08_43/b4105073900964.htm
1:14 pm
I have a friend who tracked his investments for several years and checked to see which “source” of advise yielded the best returns.
For instance, out of the financial newsletters published by Agora, the fancy expensive ones did not do as well as the “staid” Outstanding Investments, which actually did best.
As for me, I lost tons of money in startup/investments of various kinds years ago. School of hard knocks. Now that even banks seem shaky it can be difficult to know where to place our funds. One huge bet we all need to think about is where we think the dollar is going. Assets can grow in dollars and shrink in real value.
To get an idea of how any investment class or stock is faring in real value, it may interest you to check out http://www.PricedInGold.com. It’s an idea that’s a little before it’s time.
As for me, I’m interested in keeping the majority of my “safe” money tied to currencies that are tied to metals. I’m not betting for the USD at this point, particularly if it appears that Obama’s policies will become actualized. History shows that those policies will hurt the dollar.
As for my “risk” money, I’m interested in investing in life settlements through a company that specializes in this. It is a zero coupon bond with funds held in eschrow by Wells Fargo, payment guaranteed at the end of term (which is usually around 36 months), whether the policy holder dies or not. (They can make this guarantee because they add 15 months onto the actuarial table estimate of death to determine term, and then buy reinsurance to pay out at end of term if the policy holder really beats the odds.)
Returns are11-15%, depending on the program (several offered each year), with huge upside potential. If the policy holder does die early (or “on time” actuarially, but before the end of the program), you get the entire payout you would have gotten at the end of the term. So return can be 30% or more, depending on time of death.
I also know a wealth manager who has a life settlement fund offering which has been returning 15% a year for years.
The other thing I will do with my “risk” money, is invest in websites. I’m able to manage them sufficiently, and I know how to buy them for less than 1x annual profits.
1:29 pm
Tim,
I have been studying this topic for some time now. I think the investment game works with your over all game plan. Make as much money with the least amount of time.
When the stock trading patterns are ready, you trade. When they don’t set up for you, start working on other projects. In todays market cash is king for now. The best read is going to be bill o’neils how to make money in stocks. You will love it. And if you want a history lesson read jesse livermores book “how to trade stocks. Good luck
Todd
1:47 pm
Tim,
Nice discussion of risk. Asset allocation is extremely important, but don’t forget about costs. That’s what Buffet was concerned about when he suggested that you invest in low cost index funds.
Paying your broker 1% and mutual fund manager 1.5-2% (no-load doesn’t mean free) may seem reasonable, but as the years pass those fees add up. They are in effect reverse compounding because you would have kept the money you paid in fees invested - working for you.
Be especially wary of any broker promising market-beating returns.
Check out this short article for an example of how your broker does better then you: http://www.efficientfrontier.com/ef/996/broker.htm
Also, John Bogle’s books are a must read to learn the benefits of index funds and the risks of paying your broker too much.
2:16 pm
Tim -
Great post. I would love to get your take on the question I have most often struggled with relating to investments: “How do I know when to switch allocations?”
I’ve got my retirement money in index funds right now, but I would like to switch to more conservative investments as I approach retirement.
Rephrasing the question: “Is there a generally accepted method for timing the conversion of a higher risk investment into a lower risk investment as one approaches their investing horizon?”
2:44 pm
what kind of t.v. deal are you negotiating? what would be your ideal t.v. show? upon discovering you, i thought about exactly that.
3:17 pm
Well I don’t have a solid piece of advice but have heard some good advice from some respectable experts. I will go with the latter and advise the following site: http://www.tonyrobbins.com/TVAppearance/Resource.aspx
Loggin and listen to Sir John Templeton, also another investor as popular if not more popular than Mr. Warrent Buffet.
Best,
Jose Castro-Frenzel
3:43 pm
Tim–
I think of you as someone who thinks outside the box, but in this article you’re firmly constrained within the box. For the most part, you’ve gotten bad advice and the wrong lessons. You’ve talked to people who have made their money in the postwar boom. That is, WWII to about 2000. Their responses reflect that market, but that is not the market we are in now.
We are now in a depression. We are now seeing the very real risk of hyperinflation. We are definitely experiencing very large inflation– about %20 a year (this was the rate before the recent “crisis”).
Thus putting your money in the US Dollar *is* an investment. Its not keeping money on the sidelines, its putting your wealth into an asset– a form of debt– that is currently being devalued.
My personal investment strategy is %30 Warren Buffett, %60 Ludwig von Mises et. al, and %10 myself. I used to think of investing much the way you are here– but that was the 1990s. That was boom times.
Ludwig von Mises is not an investor, he was an economist. You can learn anything you want to about the school of economics he founded at http://www.mises.org
This school accurately predicted the housing crisis, the CDS crisis, the failure of everything we’re seeing fail right now.
Investing without a solid foundation of economics is just as bad as investing in an asset class you don’t understand the fundamentals of– because the dollar is an asset class and buying any stock denominated in dollars involves dollar risk.
Most of the time dollar risk is negligible, but that is not the case now.
For a good introduction to money, I recommend Murray Rothbards book at http://www.mises.org/money.asp Its a short book, a quick read, and its free.
You’re a worldly guy, get your assets out of the dollar– some other currencies aren’t being debased, but buy precious metals as an inflation hedge.
Ignore anyone who tells you to “allocate” your assets. What did Buffett do? Did he buy companies based on which “category” they were and then shift that around every few years based on what was in fashion? Of course not. He bought good individual companies.
Maybe its because my strategy is a split of Buffett and Mises that I’m recommending them to you, but I think you– and your readers– are going to be painfully surprised in the next 5 years if they don’t recognize the nature of the dollar— and I think you would be well served by better understanding Buffett, and listening to people who make their money managing *other* people’s money less.
I was making %80 a year until 2006, when I decided the housing bubble was going to pop and then start the dollar bubble, and that I needed to get money out of the US dollar and denominated assets. At that time I was investing in canadian royalty trusts– returning around %10-%15 a year in dividends, which covered my principle, and then taking aggressive positions in using options spreads– where the odds were in my favor and the pricing was right. If all the options investments had been a total loss, I would have only been down about %10-%15. As it turned out, about %50 of the options investments paid off- returning %300-%500 each, and then the ones that were losses returned %0-%50. That was very profitable, and I was betting on clear and obvious trends, hedging by using a spread, and my downside was covered with the more conservative investments.
But all of my money was in the sector that was performing at the time- commodities. No point in buying REITS in a real estate boom because the real estate bubble was obviously going to bust.
People act as if you can’t predict the future. And you can’t precisely, but you can see risks in an economy and the direction the market is going. People who were buying real estate in 2003-2006 were gambling because they knew what was happening *then* but no clue about the future.
Investment wisdom can be gotten from Buffett, and he uses a different method than me, but his perspective is sound.
But economic wisdom is the thing that would really set you apart from the mainstream as an investor. Virtually nobody really has it, and even Warren Buffett hasn’t quite got it. (notice his silver purchase– it was the right move but rather than holding it like he should have he sold out around $5/ounce. He lacked the economic perspective to know that silver was (and still is) a long term investment.
Its hard to get a whole worldview into a comment box– but I think that you will find that good economics is not dry, it is very rewarding, and it is very profitable.
Check out the Mises Institute website at mises dot org, and read whatever catches your fancy– want to know the reasons behind the great depression? Read “Americas Great Depression” — they have many books for free on the website, and the others are well worth the money.
So, why did I say we are in a depression right now at the outset of this comment? Because economic growth is under %5 a year…. yet inflation is %20. (Even using government figures its over %12). This means that the seemingly positive return in the GDP is more than offset by the devaluation of the US dollar— which the GDP is denominated in.
Thus the economy is contracting, and actually has been for several years. (High tech is still expanding, but the manfuacturing base of the country is still collapsing, and more than making up for it.)
Would your investment thesis change if you recognized we were in a depression rather than a short recession?
3:45 pm
Options are interesting. I don’t diversify. I keep a lot of powder dry and try to pick winners or losers and play it that way. This takes a lot of time and study so I wouldn’t recommend doing it if you just want to buy, hold, and “invest.”
In 16 months of doing this I’ve made about 120% annualized on the money I play with. Thats through all the big gain days and big losing days. I keep a lot of it out of the market on a week by week basis, then jump in when I think it is about to move. After it moves, I sell, regardless if it moved my way or not. I’ve taken some losses but my winners hit big. With options, if you can call it right more than 50% of the time, you are golden.
3:45 pm
[...] Source: http://www.fourhourworkweek.com/blog/2008/10/21/rethinking-investing-common-sense-rules-for-uncommon... [...]
4:17 pm
Hi Everyone.
Judging from these comments here, there is probably only one person who really knows how to make money trading and that’s the guy in the comment section named “The Trader.” Tim, in your blog, your guru Patrick Clark’s portfolio has been decimated in this market because all of his “diversified” investments like energy & materials have been falling dramatically, equally as much or more so than the stock market. Diversification is useless if you’re diversified into all the wrong areas.
A skilled trader does not fight the markets…a skilled trader can make money in all types of markets..up, down or sideways markets…in equities, currencies, futures, etc. Ultimately, all these markets behave the same because human emotion drives all of them.
Investing IS only about probabilities when it’s done right. When it comes to investing, you want to be “the house”. You want odds in your favor. How do you do this? First off, you must cleanse yourself of old Wall St. “conventional wisdoms” like “Buy & Hold”, “asset allocation” and such. These are institutional biases that are intended to keep you sitting at the craps table, as a gambler. You also need to disconnect from the mass media, CNBC, etc, whose financial interest is to keep you watching, not to build profits in your portfolio.
Secondly, you need to approach the market like a scientist with an open mind, as it seems that you are currently doing.
Don’t bother reading books like “the intelligent investor” unless you need something to put you to sleep. I manage a 9-figure portfolio and I still can’t get through that one without dozing off.
DO read “The Successful Investor” by William J. O’Neil…this book will change your entire investment philosophy as well as your results. Widely regarded as one of the most legendary investors, O’Neil also publishes Investors Business Daily. Decades ago he created the first ever computerized database of the stock market, and did an empirical study of the traits that the most successful stocks had. He also was able to devise a method for determining market direction, so that you know when it’s safe to invest in stocks. The past few months have NOT been safe, and everyone following this strategy has either been completely out of the market, or shorting stocks to profit when they drop. I view this book as the Bible of stock investing, since it’s highly pragmatic and delivers a rules-based approach. Having a rules-based approach is absolutely critical since opinion and emotion will always cause you to do the wrong thing.
Further, you can read about other legendary traders in the book “Market Wizards” by Jack Schwager. This book was transformational for me. It made me realize there were people out there making serious money in trading, and that I could do it too.
Finally, “Reminiscence of a Stock Operator” by Edwin Lefevre chronicles the life of Jesse Liverpool, one of the most legendary traders of all time. This is a novel, with nuggets of wisdom woven in.
Cheers,
Ben
5:35 pm
Hey Tim,
I think this is consistent with the NR philosophy of Cash Flow First and big pay day second. I’ll make sure that I pass this strategy over to the New Jet Set. Look forward to the next post in the series
Best,
Rob
5:40 pm
Joe M: Actually, the IAT is set up randomly so that sometimes black is associated with good and white with bad before vice-versa, and the supposed priming doesn’t make any difference (or at least statistically accounted for).
That’s why you’re invited to take the test more than once.
However, I’d be surprised if there were actually a bet on it–12% of the pop. come out as non-racist. And now that I’ve got my similar results, I feel like there should have been money on it. =P (also came out as a reverse sexist)
Oh… and there was an article too? Ooops. I’ll leave commenting on that to people with financial experience.
5:41 pm
The first book any investor should read is Swensen’s “Unconventional Success”. Swensen is all about allocation rather than stock-picking, and the book debunks the hyped alternatives to his core portfolio - methodically dissecting the returns and the fees, showing that the extra returns to those alternatives (if any) never make up for the additional risk you incur:
http://www.islandersoftware.com/weblog/2008/08/01/unconventional-success-swensen/
Also there is a site dedicated to value investors you might be interested in:
http://libertyvalley.com/
5:52 pm
Tim,
I suggest that you drop whatever you are doing and read Worry Free Investing by Zvi Bodie, Graduate Finance Professor at Boston Univ. see http://www.amazon.com/Worry-free-Investing-Bodie-Michael-Clowes/dp
/0130499277/ref=sr_1_1?ie=UTF8&s=books&qid=1224722182&sr=8-1.
Bodie will change the saving/investing world with these concepts about stocks and risk (yes equities ARE risky even in the long run.) Using your approach on contacting important people I have recently been in touch with Dr. Bodie and will be part of a beta test of an on line Q & A.
Get acquainted with “consumption smoothing” Laurence Kotikoff (another BU prof) and Scott Burns - see their book Spend Till The End.
Consider subscribing to Grants Interest Rate Observer - the fastest way to get MBA level credit markets information without grad school. Consider attending a bi-annual Grant’s conference in NY.
I was once a typical asset allocator just like everybody else. But stocks get more risky, not less so in the long run. While the probability of a shortfall diminishes over time the size of the shortfall increases (a 40% loss on a 1M stock portfolio is real money). If we have such a large meltdown the year before I plan to retire then retirement is not an option.
I lost 1/3 of my portfolio during the tech wreck of 2000. I said, “never again” and studied Bodie’s work. Thanks to his concepts the current wreck has not hurt me at all. With no risk I am up approximately 3% this year. Lao Tzu said, “if you have enough, the whole world belongs to you”. Read Bodie then let’s get him to help the 4HWW community. He can dial us in with his grad students. Maybe we will sit with him some day as he testifies before the Senate Finance Committee.
You have hit a home run with 4HWW. Your ideas have certainly changed the way I do business. And, it helped change the way I invest. Do not lose what you have earned with your incredibly creative work. Study Bodie.
Good luck,
Greg
6:00 pm
[...] do you feel? That’s the starting point: accurately gauging emotional responses to gain or loss. [Tim Ferriss' Blog] SHARETHIS.addEntry({ title: “What is your ~real~ risk tolerance?”, url: [...]
6:07 pm
Jay,
All in all there is not one strategy that beats them all. As history does repeat itself we lend your ideas and strategies based on the past. There is not one person who can predict the future and investing is more simple than what so many people try to make it out to be. Reselling is the same as an investment, let’s not complicate what needs to stay simple.
Jose
6:29 pm
Tim - I am excited to read this series of posts by you. I previously was a corporate guy working in the consulting & IT sector and gave that up to trade commodities, stocks & options full-time. I’m now 27 & supporting myself in my own way by trading. Its an odd combination to have my own version of the 4 hr. work week & be in the finance industry.
I hate to say it, but I think you really limited yourself and what you’re capable of in this post. By the words used in it, it looks like you interviewed a lot of long-only mutual fund managers that do well in a bull market but get smoked when the market changes. ‘Diversification’ is all well & fine but I think you can do a lot better given your ability to understand more complex ideas that you have demonstrated in other posts. Watch how the correlation in uncorrelated items goes to 1 when things get ugly out there (which happened the past month or so). A sinking tide sinks all ships, whether they are red, blue or green. The majority of a stock or mutual fund’s returns are related to the overall index anyways.
I think you can do MUCH better using some more advanced techniques than long only stocks & sitting out the times that are too volatile.
Long-only funds rely on ‘hope’ that something increases in value. Warren Buffet is amazing but 99% of the people that try & imitate him cannot as they don’t have the discipline to follow his method. Also, a company is a GREAT value on paper right before it goes bankrupt & is de-listed.
I do a lot of long-short active strategies that do not require me to be in the market all the time, but rather I am only in the market when I have an edge. The edge is roughly defined as: (% Wins x Avg. Win Size(as a ratio of win/loss)) - (% Losses x Avg. Loss Size). If this number is positive over a valid set of trades (50 or so), you will make money assuming you risk at most 1-2% of your capital on a trade. Last year my win % was about 35% and I had about an 85% return on my account. I control my ‘risk’ based on how much I buy or sell (how large of a position I take). The role of the investor or speculator is to exploit this edge as much as possible.
I think that it would give you a better perspective if you tried to chat with anyone mentioned in Jack Schwager’s ‘Market Wizards’ or ‘New Market Wizards’. Also, any of the old pit traders that did NOT manage money or collect fees from anyone else will have good advice. Besides, they have great stories about fist fights and other stuff in the pits too.
I look forward to the other posts in this series.
Regards,
Eric
8:26 pm
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There are only three ways to make money in stock market:
1: Trading
2: Value investing
3: Index investing
Nothing more.
1:Trading is like someone who tries to time the market (buy low, sell high),
it’s same as gambling. You may make money in short period of time
if you are lucky, but in the long run, you’ll most likely lose.
It’s just that we still cannot see the future.
Pros: It’s exciting, for some people. Just like gambling.
If you like taking risk and have a lot of time staring at the monitor,
and you enjoy it, then you may try trading.
Cons: 98% of time you will lose money. I hear many people
bragging how much they made in trading, but they are not
talking about their 20-30 years long experience. Don’t think that
just because someone has jumped off from 8th floor and survived ONCE,
and it was fun, it means you should try jumping off and survive and feel
excitement out of it.
Advice: Do it for fun. Do it with other peoples’ money not your own.
(Trading with other peoples’ money, you will always win. (with commissions)
2: Value investing is like Warren Buffett style investing.
You pick the market you’re VERY VERY knowledgable in.
And FIND the company you BELIEVE that it will grow steadily for
more than 20 - 30 years.
Pros: You will make the most money in this style in the long run.
Just look at Warren Buffett’s net worth.
Cons: It’s very hard to Analyze the company. There are many ways to
check if the company has the most potential, but it requires tremendous
amount of research, and intelligence. W.Buffett started reading
company’s annual report since he was 11 or something, he just enjoys
doing it. He said once that he read annual reports of almost all of the
companies when he was 20 something years old.
If you don’t have passion/intelligence like Warren Buffett,
then you will most likely pick the wrong company.
3: is simply investing in index fund. (like S&P 500/1500 index fund).
Pros: Easy. You don’t have to think. There will be an up and down, but in the long run you’ll most likely get 10-11% annual return, as long as there are more people in this planet who think positively about future than negatively, you will be profited in the long run.
If index fund investing doesn’t work, it means that having money in cash
doesn’t mean any better either.
Cons: It’s boring. Nothing to analyze, boring return.
My opinion from my experience:
- If you like having fun with taking risk with your money, then
use your 100% money to trade, it should be very fun.
- If you want to be the wealthiest man just like Warren Buffett,
then be just as intelligent, passionate like him, and pick few
companies that you are SOOO sure will grow, and invest 100% of
your money, and also ask other people to believe in your ability to
invest, and invest other people’s money as well.
- If you just don’t wanna think about it, and want to keep on doing
what you are doing right now, BUT you don’t wanna leave your
cash uninvested and lose value every year of inflation, then
invest it in low or no load index fund. And forget about whole thing.
As for bond/equity balance:
If you are VERY worried person, then go for 100% bond.
If you are NOT easily worried person, then go for 100% equity.
If you are little bit worried person, then go for 50/50.
If you don’t really care about whole thing, then keep it 100% in cash.
Keep it simple, don’t think too much.
You will die anyway one day. Who cares.
You are intelligent enough, so even you are so broke in 60s, then
you will find the way to make money and enjoy.
My advice to younger people:
Don’t think about investing in stock unless you have at lease 1M bucks
to invest. Till that mark, just invest in knowledge, skill building.
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