When Not To Defer

Real names eliminated to protect the guilty.

In high school. my brother and I each had our own friends, but we also did a fair amount of sharing them, which worked out well for me, since he had more of them. Once, our friend "Chewy" had a broken stereo in his Fiero. Our other friend, "Shabba", who lived across the street (both nicknames are distant derivatives of the last names), was handy, relative to the rest of us, and offered to fix it.

We’ll never know if he fixed the radio or not, because, after he worked on it, the car wouldn’t start at all. At this point, my brother went inside to field a phone call. Shabba suggested we try to roll start it in front of our house, as we were on a slight incline, which might have been a valid idea had the car not been an automatic. But, in the land of two burnt-out headlights, the one-headlighted man is king, so Chewy and I went along with it, not knowing any better.

Predictably, the roll starting didn’t work and the Fiero set inert at the bottom of the hill. Shabba suggested pulling it back into my driveway using his Bronco II. Again, this might have worked had he and Chewy not insisted on pulling the Fiero by its spoiler. I objected, but Shabba said, “Don’t worry. It’s a strong spoiler.” In retrospect, my actions betrayed more trust than my words because, like a fool, I got behind the car to push it. In the end, Shabba and Chewy were right, the spoiler was strong, but whatever attached the spoiler to the car wasn’t. As I pushed, I heard a loud “Clang! Clang!” as the spoiler ripped off and  dragged along the street behind the Bronco. It likely worked out for the best, because the spoiler also probably represented the limit of the its towing capacity.

Chewy rushed to get the brake on, leaving me to support the Fiero by myself, which, actually wasn’t too hard, since, well, it was a Fiero. He and Shabba ran to the spoiler and both began to fumble with it, like cavemen  with a Rubik's Cube. Chewy said frantically, “Untie it! Untie it!” and Shabba said (in an excited voice that somehow uncharacteristically suddenly sounded like a cross between Yoda and Harvey Firestein), “I CAN’T! IT’S A SAILOR’S KNOT!”

At this point, my brother stepped outside into the dusky evening, about to discover that one of the side effects of talking to girls on the phone is missing out on your friends and brother doing stupid crap. We were all still out in the street and Chewy told Shabba, “Don’t tell him”. This was pointless advice because it wasn’t so dark that my brother wouldn’t either notice a) the spoiler on the pavement or b) Chewy’s attempts to stuff said spoiler into a backseat with the capacity of a mini-fridge.

Shabba said, “Ok. I won’t.” Then he proceeded to run up to my brother on our porch, murmur a few sentences and the darkness was pierced by my brother’s cackle. Chewy said to me, “I’m gonna kill him.” I still don’t know if he was talking about which of them he was talking about.

The purpose of the story isn't to bag on my friends, but that's a nice side effect. Not much point in piling on too much, though, as both of them (and my brother) have grown up to be respectable parents/citizens/professionals. But the real point about this story is about knowing when to defer to the "experts".

Now the story is a little disingenuous. Shabba really did know more about cars and car audio than the rest of us, so maybe some degree of deference was in order. But, you don't need to be a mechanic to know that you can't tow a car by its spoiler, either. And as for the attempt to roll start an automatic? I have no idea what was going on there.

We live in an age  when expertise is under attack. And I can see the experts' point. It must drive doctors nuts when they see a people armed only with Google debate the merits and drawbacks of things like vaccines and diets. But, this isn't just a tale about the masses being uppity, as the experts cracked that door open by being wrong about some very key things (the 2016 election, whether fat is bad for you, the subprime crisis, etc.). And of course, generally mistrust is amplified with the related problem of governments and corporations repeatedly lying to us.

It isn't that expertise doesn't have value, but it doesn't carry the same weight across all domains. When it comes to technical skills (programming a computer, inventing new gadgets, performing sleight of hand, hand-to-hand combat, etc.), the experts keep getting better and better and the limits of human ability keep boggling the mind. When the systems become more dynamic, though (elections, investing, geopolitics), the value of expertise seems to degrade a bit. Partly because expertise in these fields often involves predictions, always a risky proposition.

It’s clear to some people why political and economic domains (in short, the social sciences) might be tougher to get a handle on. But the problem exists in the hard sciences, too, as the “Is fat bad for you?” debate proves. I don’t want to come down too hard on science. It’s not a religion, it is a method of discovery, which means it is sure to make a lot of mistakes by definition. So, I’m not implying that an actual physicist doesn’t know more than some guy who just read some Neil deGrasse Tyson books. I’m just saying that even the expertise in the hard sciences is undercut severely once scientists start exhibiting hubris about what we don’t know. The history of science is littered with ridiculous statements saying we have reached the limits of knowledge, which makes people like Thomas Edison look all the wiser when he said, “We don’t know one millionth of one percent about anything.” Though I’m still wondering if he gave us too much credit.

The problems and limits of expertise might be no clearer than in the domain of investing. The correlation between knowledge and performance in investing is sketchy at best. Someone can have the facts down cold, but constant messing with with their portfolio will likely result in worse results than someone with no knowledge whose internet is down for ten years, rendering tinkering impossible.

This isn’t to undercut my own profession by saying advisers don’t add value. It’s just that their value often takes the form of three things:

      1)  Identifying holes in the client’s finances in areas like insurance, taxes and estate issues, while acknowledging that financial advisers aren’t CPAs or lawyers. When push comes to shove, only lawyers should law and only accountants should account.

      2) Helping the client determine their risk tolerance and crafting an investment plan appropriate for that tolerance.

      3) Enforcing good behavior on the investment piece by executing the plan faithfully and being choosy as to when changes are made.

And a big part of the third point is having a solid appreciation for what we don’t know and just how hard investing is.

As to when to defer and when not to defer? An adviser might have more general knowledge than the client, but the client should know himself and his money better than the adviser. This is true in the same way that a doctor will know medicine better than the patient, but, if the patient is paying attention to themselves, they should know their own body better. A big part of knowing yourself is knowing your risk tolerance and what you can handle. If you adviser is pushing you into things that make it hard to sleep at night, maybe it’s time to push back.

As for listening to the “experts” about the economy who give either excessively rosy or gloomy predictions? All I need to do is look at the college football scores from last weekend (4 top 10 teams lost to unranked opponents) to be reminded that no one can see the future. And if you listen to people argue about economic history, you will realize that a lot of them can’t even predict the past, let along the next 5 years.

Hate Economics? Read These Books

In these days of iconoclasm, I'm not sure I have any heroes left, aside from the saints or near saints like  Fr. Emil Kapaun , G.K. Chesterton, and maybe Jack Pearson from This Is Us, but he has the double whammy of being both fictional and dead, so that might not count. And as much as the fields of investing and finance interest me, it's the ideas, not really the people. that inspire me. I've met many people from the world of money and economics that I could learn from, but not a ton that I would say I call heroes, if any.

So, in a way, it's a backhanded compliment to many of the authors listed below that I find these works so important. On a lot of the issues of the day, I'm probably at odds with them, but I can't deny the level of their work or their ability to provoke thought in an accessible manner. If you aren't a fan of economics as you learned in in high school (or didn't learn it), you might find these books interesting primers on the field of behavioral economics, which is the study of decision-making. Maybe they aren't always right, but they are asking some good questions.

The problem with the field is that many of the same studies or concepts are bandied about in a variety of books, so it can start to seem a little pseudo-intellectual and repetitive to the cynic. But, that shouldn't denigrate the quality and imagination of the research, much of which was counter-intuitive when it was first uncovered.

So, in celebration of Richard Thaler's Nobel Prize, here are a list of very readable and enjoyable books to stoke your cocktail party (or Pabst Blue Ribbon party) conversation.

1) Misbebaving by Richard Thaler-A great account of the history of behavioral economics, from a guy who lived it.

2) Thinking Fast and Slow by Daniel Kahneman. Dense, informative, essential.

3) Anything by Dan Ariely. He's made a nice career out of studying lying, cheating and irrationality.

4) The Signal and the Noise by Nate Silver. Not technically economics, but some good background on statistics.

Another good option who often dissents with popular behavioral economics  is Nassim Taleb. I love all of his books.

Also, though I haven't read it, The Undoing Project by Michael Lewis is about the work of the above-mentioned Daniel Kahneman and the late Amos Tversky. Lewis made subprime mortgages interesting in The Big Short, so I'm betting it's a solid effort.

Remember, reading is a great way to learn from the mistakes of others, as opposed to making your own.

 

What Could Go Wrong In Real Estate? Just About Everything

The title actually just means real estate is like every other kind of investing, so don't take offense, RE gurus. It has its pluses and minuses. But, the first step towards inviting financial disaster into your life is thinking it can't happen to you. This leads to hubris which leads to risky behavior which leads to the aforementioned financial disaster. So, consider the costs and remember that as author/financial planner Carl Richards said, "Risk is what is left when you've thought of everything."

Buying real estate for cash sounds like a pretty safe and conservative way to go. No danger there, right? But what if the real estate is new construction townhomes? In Vegas? In 2004? Check out this second hand story from Financial Samurai about how the deal went south. Gangs, section 8 tenants, a flaming bathroom. This story has it all. It's evidence that a deal isn't bulletproof just because it was done for cash.

Before further commentary, I should make it clear that I am no real estate professional. I am merely a financial adviser who has done some real estate investing. My biggest assets in the field are 1) I'm perfectly willing to chalk up our modest successes to a great deal of luck, 2) an appreciation for what I don't know and 3) having a decent idea of where to find people who know more than I do. 

It seems like real estate is one of those things that everyone either thinks is really easy or really hard. And the fact that many of the people who think it is hard are the ones who have actually done it may speak volumes. The people with experience talk of middle-of-the-night toilet uncloggings and tenants late with the rent. The people who haven't done it, on the other hand, too often have the vocal confidence normally reserved for the truly ignorant. 

Note, that oftentimes, the people in the first group started off in the second group. Passive income sounds great, but then they find out it isn't so passive. What's going on here and are there ways to invest in real estate and insulate oneself from disaster?

In a word, I would say "no", because remember, to think that you could wall yourself off from the world is to invite Mr. Murphy ("anything that can go wrong, will go wrong") to come knocking. But, I believe there are some things you can do to set yourself up for success...or at least, a greater chance of success. Real estate can be a great way to invest, but there are some caveats and things to consider. Here are some suggestions that I have gleaned from a little experience and a lot of listening to other, smarter people:

1) As is the case with all matters financial, never stop learning. If this blog post (or any one blog post) is the lion's share of your education, I will pray for you, as you will need it. The best single online resource I know of is probably Bigger Pockets. But, also, read some books. Whether the subject is religion, exercise or money, I'm amazed by the amount of people who want to improve a key area of life but can't be bothered to even read a book that a dim high school student could understand. Because those Luke Cage episodes won't watch themselves, I guess.

2) Set expectations accordingly. From what I know, most expert real estate investors don't count on appreciation, they consider that gravy. Most likely, if a deal doesn't cash flow from the start, it doesn't make sense.

3) Train your tenants. There are a lot of great reasons to stay away from real estate, but dealing with the "middle-of-the-night-clogged-toilet" is not one of them. I wouldn't even unclog my own toilet in the middle of the night, let alone drive over to someone else's house to unclog their's. And I wouldn't expect a landlord to do it for me, especially considering 95% of toilet clogs are user error. Very few maintenance issues are true emergencies. Set ground rules and boundaries. The fact that a tenant takes the claims of flushable wipes at face value doesn't mean I need to lose sleep.

4) Think scale. Even if you plan on managing your property yourself, include paying yourself a management fee in your profit and loss considerations. Why? Because the business can't grow if you can't scale and chances are, as you get more properties, you will find more important things to do, either outside of real estate (like your day job) or inside of real estate (like finding new properties).

Another reason to get a property manager is tenant selection and rent collection. It seems to me, based on some anecdotal evidence and war stories I've heard, that a seat of the pants operation is more likely to let tenants slide on rent than a professional manager will. This is less about how good property managers are than it is about how sloppy most mom and pop real estate operations are. A true professional simply doesn't have patience for late rent, because they've seen a week turn into four months too many times. Rookies often don't realize they are getting scammed until a few months have slipped by. And, to create some separation, I even know of people who self-manage their properties, but present themselves to the tenants as only the manager and not the owner. This is like the episode of Cheers where Norm created an alter ego to be the bad guy to manage his painting crew.

5) Include capital expenditures in your profit and loss assessment. Things break down eventually, so set aside an appropriate amount of money each month to pay for them. New properties take less money, old properties take more. I am not aware of the property that cash flows 100% profit, even if it is paid off. Have the money set aside and growing for things like a new roof and AC.

6) Don't forget property taxes and HOA fees. These can turn a profitable property into an unprofitable one. And speaking of HOA fees, if you own a single-family residence with a relatively innocuous and inexpensive HOA, that's one thing. But, I would think strongly about investing in anything with an active/expensive HOA. This would rule out a lot of condos and townhomes. Life is complicated enough. I don't need to add the board at Del Boca Vista to the mix.

7) When possible, I would say to own actual land and own directly. This is related to the above point. Many people choose to get real estate exposure through stock-like instruments such as real estate investment trusts. Those involve owning a share of a large fund that trades on an exchange like the New York Stock Exchange, as opposed to owning actual sole direct ownership. There are a lot of different kinds of these "REITs", but they spread your exposure over the broad real estate market. As real estate investing is, at its core, local, this is a very different animal than, say, owning ten single family homes in Jackson, MS. There is a time and a place for partnerships and syndicates (they are like small private funds that don't trade on exchanges), but tread carefully and maybe wait until you are experienced.

I would say things like condos and townhomes have some of the same problems as the funds (large or small). Namely, what you own is tangled up with the interests of others. When it comes to real estate, I personally want as little interaction as possible with by-laws, lawyers, common areas and voting rights. The hassle of an effective permanent lien on your property in the form of taxes is more than enough for me, not to mention local codes and ordinances. This doesn't always mean that owning the actual dirt is always a better investment (would you rather have a single family home in Detroit or a co-op in Manhattan?), but speaking broadly, I want something I can have total control over and at least fence off if I don't like my neighbors.

8) Beware turnkey investing. For people with money but no time, turnkey investing can be a good option. This involves buying rental ready properties (often bundled with property management) from a company that specializes in this space. There are just a few catches. First, you often pay a premium for good properties and second, this corner of the industry is full of snake oil-salesman, especially at the lower price points.

Reputation matters so much that, when I went looking at turnkey companies recently, finding an honest company was as important as the market.  Jay Hinrichs at Turnkey Reviews is a pretty good place to start your investigation. He's also very active on the Bigger Pockets forums.

9) Use debt wisely...or not at all. There is no doubt that the best potential returns come with using debt. So can the greatest potential disaster. The positive about buying for debt is that it can take a long time to save up to buy a property for cash. Debt ( or "leverage", in the industry parlance) speeds that up. But, in a bad market, I believe owning outright with no mortgage is, if nothing else, a huge psychological advantage. If rents are falling, the person who owns free and clear can always slash prices and still get a modest cash flow. But the person with a $1000 a month mortgage has to decide whether to take the renter in front of them offering $900 for a 12 month lease and go underwater or instead hold out for prices to improve in the short term.

Just some thoughts from a fellow traveler. I hope that helped!

The Tao of George Costanza

Recently, I heard it said that the market exists to cause the maximum amount of people the most pain. It wants you to mess up. 

One way to think of it is like "The Nose Job" episode of Seinfeld. Long story short, George is going out with an otherwise great girl with a big nose named Audrey (the girl is named Audrey, not her nose). He and Kramer guide her into getting a nose job that goes bad. George ends up being so repulsed by it that his treatment of her   compels her to  break things off with him. Then, she gets her nose fixed, becomes beautiful and starts dating Kramer. So, he switched things up right before they got better.

Or, perhaps even more directly, maybe the market is more like "The Opposite", an episode almost needing no introduction. But, for the Philistines who don't know, here's the rundown. George, realizing that his impulses lead him nowhere, starts doing the opposite of his natural inclination. This results in him meeting a great girl, getting a job with the Yankees (as the ever-important Assistant to the Traveling Secretary) and facing down some loud goons in a movie theater.

So, Seinfeld can explain a lot about the stock market. Maybe next week, I will explaining the 1970s energy crisis using Boy Meets World.

The point is that, in investing, doing what feels good and comes naturally can get you creamed. Persistent periods of underperformance are sure to happen, and occasionally, they are due to fundamental changes in how the markets operate. I don't care how much you pray, those typewriter stocks aren't ever coming back.

But, more often, it's merely the natural ebb and flow. And if you just follow the ebb, you will likely see money flow away from you. I've talked about this before, but there was a very famous magazine cover story detailing the death of equities in 1979. It's one thing for that Chess King stock to be permanently in the tank,  it's quite another to throw dirt on the very idea of equity investing. Listening to that magazine cover would have resulted in missing out on the incredible stock market run up of the 1980s and 1990s.

The same "Is it dead yet?" question has come up with value investing (which means basically owning assets that the market has beaten up). There's a few ways to skin a cat in the markets and using value is one of them. As more and more research gets out to the general public, it's likely that the benefits of any particular type of investing (including value) will decrease, as there will be too many mouths at the trough to keep the returns high. But, the opposite holds as well: once a method loses favor with the general public, it often makes a comeback.

It's a constant seesaw. Maybe value investing will never quite be as good as it was in the good old days of the 1930s, 1940s and 1950s, when the legendary Ben Graham was doing his thing and others like Warren Buffet were getting started. But, that doesn't mean it is dead, and what is certain to fail is following the headlines and fads.

Whether you are talking about a general asset class, like equities or housing, or just talking about an investing school of thought, like value investing, beware the conventional wisdom. If you can't stick something when the pundits and your reptilian instincts are telling you to run away, you shouldn't be in it to begin with. Like with George Costanza, doing what feels "good" in the moment can lead you watching your unemployed friend get the attractive girl.

Simple Advice for a Groom

I've heard some bad wedding toasts. Admittedly, a lot of them were by me, as I have been a best man three times and given speeches two other times at the grooms' request,  I've done it at Catholic, Muslim and fundamentalist Baptist weddings, so I have a rainbow coalition of offended guests under my belt.

The best advice I ever heard from  a toast, obviously, wasn't from me. It was June 1996., a simpler time. The Atlanta Olympics were weeks away, the full sin potential of the internet hadn't been exploited yet and George Clooney was still on ER. The best man said this to the groom (his brother): it's not what happens to you that makes you a man, it's what you do about it.

I'm pretty sure this guy didn't invent that advice, but correct application and selection are half of creativity, so I give him  heap of credit. So often, we seek to control outcomes as opposed to managing our response to them, which is time better spent. It's true across domains, including money.

If you bought into the stock market at the worst possible time (Oct 2007), congratulations, as you just doubled your money. That's good for about a 7% annual return, and if you were dollar cost averaging by buying in regularly during that time, you are very possibly doing much better that. So, even though you picked the worst possible time to go all in, patience won the day.

I hate market downturns as much as the next guy. And maybe someday we will reach the point where the market stops bouncing back from these bubbles. After all, one thing about the world that most people agree on is this: it's going to end someday, and our stock market will go with it.

But, before it does, there are lives to be lived and risks to be mitigated. And one of the biggest risks is that your money won't grow because it's on the sidelines as you wait for the perfect time to invest. As an investor, you job is to follow a plan, regardless of market fluctuations. If you do that, you will probably be ok. If you don't, you will become intimately aware of what regret feels like.

 

 

Change For Its Own Sake

In another life, before I discovered my current vocation, I was a middle school teacher. It messed with my mind a good deal. I knew it was time to leave when I was watching The Breakfast Club and found myself rooting for the principal. During a particularly bad stretch of behavior by the students, I said half-jokingly, "I've tried everything but consistency!"

Apparently, Harvard's endowment is having the same problem. From the early 1990s through 2005, they were at or near the top of the endowment game in terms of performance. Since 2005, they have had four different management companies and, by extension,, four different investment philosophies. Not surprisingly, performance for the last 10 years has lagged that of a basic mix of 60 percent stocks and 40 percent bonds, let alone that of other endowments.

The lesson here? A good plan faithfully executed is better than a series of perfect plans that are switched when the going gets tough. A basic index investing plan (like the above mentioned 60/40) is perfectly fine if it matches the clients risk profile and expectations, and if the fees are in line with what is appropriate for that hands off approach. Harvard isn't content with index-like returns (nor are paying so much money for "mere" index-like returns), though, and it's causing them to cycle through managers quickly. Now, maybe the investment methods of these managers are good, and maybe they aren't, but it doesn't really matter if they are changed up that quickly. Anyone's portfolio would lag after that kind of constant re-jiggering.

There's a time to switch things up, but that's where art meets science. Sometimes, you realize that your current method doesn't fit your personality, or maybe it isn't sustainable (too much screen watching) or it is too-complex, or maybe you realize a flaw in the reasoning or assumptions that led you to choose that method in the first place. Those are valid reasons to make a switch.

I jealously guard against changes in both mine and my clients portfolios (especially my clients'). But I plan on being in this business a while, and it is simply not realistic to think that my thinking won't evolve over a career that I hope spans many decades. So, I have had to make some changes, and when I do, it's generally after some careful thought. And,  when I do change things, it's  in the name of making things simpler, getting behind better research or reducing fees, and not merely because I'm not happy with current returns. And, also, it isn't just based on a gut-level prediction. Lastly, I brace myself for the fact the next big move I see in my portfolio after the change could very well be down and not up.

One of the more recent tweaks I made involved my own portfolio. I was previously doing a very well-researched method that resulted on about 1 or 2 trades just about every month. It doesn't sound like much but, I hate making trades (ironic considering that I initially got into this business because I thought I wanted to trade).  After attempting this method for a period years ago, I was determined to stick with it this time, but just hated the activity it required. Plus, that amount of trading just didn't feel right to me. I was like watching a pot waiting for it to boil. Also, I was so focused on my clients portfolios and managing them correctly that, oftentimes, these type of trades in my account would slip through the cracks.

In the meantime, I got access to a family of funds that I previously couldn't invest with. Investing with them would be about as cost-effective and would probably result in more portfolio volatility, but it was a lot simpler and more hands off. After some thought, I made the change. 

It's also worth noting that I didn't have any clients in this strategy that I scrapped. On some level, I doubted its ability to scale and didn't trust myself to execute it for them. I probably should have listened to my gut on that one.

The lure  to monkey our investments  can be very powerful. Especially in a long bull market such as this when the stock market has gone up for so long and everyone appears to be an investing genius.  And this is doubly true if you are invested conservatively and are seeing aggressive investing rewarded. Activity feels like you are being productive, it feels good. The problem is that this is largely an illusion, as the "set-it-and-forget-it" tends to work the best. Activity doesn't equate to results.

Helicopters, Easter Eggs and Classic Sitcom Episodes

Around 2009, I was on the beginning of my re-entry in investing and on the tail end of working at a mega-church. I attended a conference at my-then church that was more about leadership than faith. This particular year, I believe  Gen. Tommy Franks and our governor were speaking. I am sure both were honored to have me in attendance.

But another speaker was a hip pastor at an extremely dynamic and fast growing church in the southeast part of the country. He was young and doing great things, and in certain circles, was more revered than the general or the governor. And his untucked plaid buttondown shirt was cooler than anything they were wearing.  He told the story of his church's first Easter. They were small, virtually broke and they decided to go all in on marketing for an event involving a helicopter and a bunch of Easter eggs. By a year later, attendance was up tenfold. The point of his message, as I remember it, was "Go for broke" (or maybe, since he was a pastor, it was more like "Trust God and go for broke".)

Now, the issues of mega-churches , whether they should use gimmicks, and when to take a leap of faith aside, this didn't sit well with me. Sure, it worked for him, but every year, churches (and other businesses) start up and a lot of them fail. And blowing the entire budget on a single marketing campaign is probably not the recipe for success writ large. It worked for him. Great. I want to hear about all the ideas that didn't work, both for him and for others. Like the Thanksgiving helicopter live turkey drop on WKRP In Cincinnati.

Here's the same point about "survivorship bias", in single-panel comic strip form.

It's not a leap to apply this to investing. We can always talk about the ones that got away that seem so obvious in hindsight: putting our money into Amazon, Apple, Facebook, etc. I mean, in fairness, people could have made good money on those stocks even if they got in long after they were household names. You didn't have to get in at the basement at the venture capital level in Silicon Valley in order to get rich on those guys. They were all well known and trading on the exchanges, in the headlines and ripe for the taking. I could understand the desire to kick oneself.

But, how well would that "I only invest in obvious successes" strategy have worked overall? Would you have been all in for Worldcom and Enron in 2000? Or what about getting into Tesla in 2014 and enduring 30 months or so of poor performance as the rest of the market ripped straight upwards? And listening to your gut might have also resulted in an outsized bet in real estate in 2005...which might have played out well, but only if you could have held on for 5-7 years. And, in certain markets, much longer.

So, anytime someone shows you a good idea, I want to see what the corpses of the bad ideas related to it look like. And also, I want to know how many corpses there are. If they exact same investment method that led you to invest in Facebook in 2012 also led you to invest in Enron in 2000, you probably wouldn't had any money left over for Facebook in the first place.

Economic Myths?

I stumbled across an old post at Pragmatic Capitalism about persistent economic myths. I don't know if I agree 100%, but it would be unwise to completely dismiss it. Cullen Roche has a good working knowledge of money and banking and recent events have largely played out per his economic worldview. And it sure hasn't played out the way the perma-bears thought it would during 2007-2008. Does that mean it  we couldn't find ourselves someday having to pay the piper for a smoke and mirrors economy ? No, but we can't overlook one basic fact: our economic system has largely rewarded optimism. And while Roche's worldview isn't officially "optimistic", I would say it leans closer to that than it does pessimism.

A few highlights:

-Point 6- Cullen's belief is that hyperinflation isn't really a money printing phenomenon (though he believes the term "money printing" is a misnomer). He contends it's normally due to exogenous factors such as losing a war or rampant corruption. He certainly has a point here. Because, I'd have to think that if simply printing money caused it, the U.S. would have seen it by now.

-Point 8-He argues that the Fed wasn't really formed by a secret cabal of bankers to control society. I don't know here. I read The Creature from Jekyll Island (about the creation of the Fed), so I've got a conspiratorial streak. Here's my theory: maybe it was started by a secret cabal of bankers bent on controlling the economy, but also, maybe they needed to do it. When the Fed was founded circa 1913, severe economic panics were happening every 15 years or so, and that doesn't even include recessions or the Civil War. Greed meets the public good.

-Point 11-Roche states the economics isn't really a science, it's just "politics masquerading as operational facts". I think there is a lot of validity to this argument. Economists can't even predict the past, let alone the future, as they can torture the data to fit any worldview.

There is a host of thought provoking stuff there. But one point I have to make is this: you don't have to have the correct economic model in order to invest wisely and profit. You need discipline, excess income and faith in our capital markets...or at least just enough optimism to recognize that doing nothing also carries a big risk and generally isn't the wisest choice.

Another Breach, But How Much Does It Matter?

I was talking about the data breach with another adviser who I am close to and we discovered that we were both a little cynical about it. There's a certain fatalism about how it plays into the modern world. These breaches have sadly become the cost of doing business in 2017. And pretty weird thing that happened to another friend's digital life has me thinking we are all targets and it is very possible that the things we are doing to prevent the theft of our data are just window dressing.

I'm no digital expert, so don't take my word for it.  But it seems like, if you catch someone who is "in the know" about these things during a candid moment, they will lay out a pretty bad scenario and suggest that, if we knew as much as  they did, we'd never leave the house.

While the details are obviously still forthcoming, in fairness to Equifax,  I have to wonder how much they could have prevented this. I mean in the long run, as it almost feels like things like this are bound to happen. Maybe the problem isn't negligence,  they just got outmaneuvered.  Maybe the real problems are: 1) they are so big and 2) they exist to serve the financial institutions, and many of us never gave them explicit permission to have our information.

This is really just another angle of "too big to fail" . As capitalism grows, it becomes becomes more about corporatism as the concepts of the free market begin to cannabalize themselves. Today's plucky free market competitor is tomorrow's competition-stifling monopoly. Problems such as these explain the genesis of the economic idea of  distributism more than 100 years ago. This is the idea that, since socialism and capitalism are equally exploitative (not exactly my belief, but stay with me), property ownership should be a fundamental right. This was largely espoused by Catholic writers such as G.K. Chesterton and Hillaire Beloc, who both felt society would be best served by workers owning their own means of production. In short, there would be more owner/operators.

Criticism of capitalism may sound unusual coming from a financial adviser, but I have to call them as I see them.  As overhauling the financial system is a tall order, I'm not planting my professional flag firmly in the distributist model. But, if I'm criticizing capitalism, it is partly because capitalism is in danger of no longer being capitalist. We can't deny the prosperity that free markets have brought the world, but they've also come with a heavy price, as people and information run the risk of becoming commoditized. Furthermore, corporations are having an outsized role in politics, society and the hoarding of information.

The current economic model we operate under isn't likely to change any time soon, and my objections to the present reality certainly aren't so great that I can't  see the good it brings or  serve my clients under it. But, this particular avenue to prosperity has a cost, and we've been paying that in the form of giving up some of our humanity and our privacy. This latest data breach is just another brick in the wall of that argument.

Life Insurance and You: The Fast Version

1) If you have people who depend on you financially, you probably need some form of life insurance. If you need it, get it. Somewhere and somehow, get it.

2) People make money selling life insurance (myself among them). If you buy a policy, chances are some adviser/agent/broker is going to get a commission.

3) Historically, many people have been oversold life insurance policies or have just plain been sold the wrong policy. But it doesn't have to be expensive. You just must know  enough to know what you need.

4) That being said, see point 1.

The Meta-Post

I won't dance around it: writing a financial blog is hard. One has to be welcoming while avoiding being too much of a salesman, and convey information without devolving into nerdiness and boring people.

With that in mind, frequent readers of this blog and my newsletter might notice a certain amount of repetition. This is largely by design. The most important parts of personal finance and investing are pretty simple, it's basic blocking a tackling (admittedly, sometimes, the basics are hard, just ask many of my favorite college football teams).

But, my mission is a matter of constantly driving home certain points because we all need to be reminded. And I am no different. While I am always on the lookout for new ideas, many of the money-related books I read for education and fun are simply novel ways of saying tried and true ideas.

So, buckle up, here's my full disclosure. If you read my writing more than a handful of times, here are some themes you will see repeated.

1) Stick to a plan. In investing, a good plan followed consistently over years is better than a series of great plans that are changed frequently.  There will come a time to change and tweak, but try to minimize these and it is best if your reason for doing so isn't merely because you want better returns. The market's job is to fool you with the old "okey-dokey". You change from plan A to plan B out of frustration and that's when plan A starts working. On that note, never changes lanes at the grocery store checkout.

2) Underperformance is going to happen. When it does, see above.

3) Keep fees low. High fees cripple returns. And an adviser who charges 1% plus may or may not be worth the money. The more they charge, the more I would ask them to justify that fee. They may be able to, but likely even if they could, it would not be based on returns alone. Also, remember, the funds you use have fees on top of the adviser's. These things add up.

4) Keep taxes low. On a regular old taxable investment account, it can be very hard to get ahead, especially if your hold times are less than a year, thus ensuring that your gains are short term and taxed higher. Consider diverting these assets to retirement account, or more tax-friendly assets such as real estate (if you have the desire, risk tolerance and ability) or even cash value life insurance (if you are comfortable with lower returns than stocks and can get a good policy). Yes, I now a certain radio host would hate me right now  for suggesting that.  Just like I hate his overly-optimistic stock market return assumptions.

But, don't get so tax conscious that you cut off you nose to spite your face. Like it or not, Uncle Sam is your partner, he's just a silent partner who doesn't do anything but use up all the Keurig coffee in the break room and has a gun he's ready to point at you if you don't give him his share. But, the only way to cut him out completely is to not make any money. In the situation, he'll still be ok, but you won't.

5) Predictions stink. Hey, remember when we were all sure that the Patriots were going to beat the Chiefs in the NFL season opener? Me, too. There is evidence that investing based on simple rules that react to current market conditions can work. However, this is very different from a prediction/stockpicking style of active management. Odds of success with that are low, as it relies on being able to see the future. Guess what? You can't. And neither can anyone else.

6) Knowledge can be dangerous. I know people who have amassed quite a war chest because they knew enough to save and invest...and nothing else. They are much better off than people who follow the latest financial news and then act on it. Having enough money to invest and being bored by following the markets can create awesome synergy in one's  investment returns. People who ignore their investment accounts normally avoid shooting themselves in the foot.

7) You have to earn and save. If there were a way around this one, I would have found it by now. Trust me, I've looked.

8) When all else fails, go "passive". If you are tired of advisers, fees, research and everything, just put them in a passive, low-fee fund (or funds). The only problem is that, you still need to pick your funds (as they are broken down by country, company size, asset class, etc.), so even "passive" isn't completely passive. Also, if you passive investing is equity-heavy, be ready for a wild ride.

See you next post. Odds are, it will touch upon one of these items, but no promises.

 

Individual Results May Vary

Another great post  by Ben Carlson. This time, it's on "sequence of returns" risk. In short, this risk involves the fact that the timing of the market's ups and downs matters in relation to your additions and subtractions to your investments.

If you start with $10,000 and let it sit for 30 years, the mix of returns won't matter, it's an extension of the fact that 2 times 3 equals 3 times 2. So, as long as you are dealing with two scenarios that have the same total return, it won't make a difference if you have the good years late or early. However, what if you are adding $5,000 a year to your IRA and the market has its best years at the beginning when you are have the least amount of money invested and the worst years at the end when you have the most? You can't do much about it, but this isn't ideal.

Or, think about another scenario: what if you follow the above plan for 28 years and you have a need to withdraw money in years 29 and 30 AND in those years the market suffers a downturn? Suddenly, your base of capital is greatly depleted and even if the market rallies, you won't be able to take full advantage. Your account has been beat up by both your subtractions and the market.

Read the full article, but the best ways to combat this are to 1) be aware of it so you can set reasonable expectations and 2) have cash in reserve so you don't become a forced seller. If you have cash on hand for emergencies, you won't be compelled to sell devalued positions to put food on the table and keep the lights on. Then, your account will be in a better position to bounce back when (and if) the market rallies.

Fees, Wealth and Value

When it comes to fees, people often think that higher rates mean better value/performance, and that's simply not true. It's to the point where charging low adviser fees borders on a competitive disadvantage as people assume the adviser must not be worth it. The amount you pay in fees has no positive bearing on your performance, and is likely a negative, as fees eat into returns. And fees can take lots of forms, you can pay them to an adviser, to a fund or to both, if you use an adviser who also uses funds, as most do. 

[For the record, most advisers charge fees @ 1.00% of assets under management. As for funds, you can get simple index funds for as low as .05%.. There are some good funds that charge more, but there are also funds that are essentially index funds but charge well over 1% in fees.]

There also seems to be a perception among some that you have to be wealthy to get access to good financial advice. This is sort of true. If you have a small amount of money, it won't be cost effective for most advisers to work with you (and you might not want to pay out any of that money to an adviser anyway), so you get shut out of "the game". But, that doesn't mean the advice gets super-fancy as you creep towards the 6 or 7 digits. It's just that the options increase (most people would shove a $5k account into one fund, but probably wouldn't do that for a $500k account). 

But, any small thing that an adviser does to "juice" returns on a modest account is going to pale in comparison to you saving more money, so don't waste too much time trying to maximize return on an account that's barely worth enough to buy a very used KIA. If you have only a few thousand bucks, the best advice is to save more, save consistently and invest in one or two simple low fee funds. Then, if you want your hand held by an adviser as your account gets bigger and there are other corners of your finances to consider (greater insurance needs, financial planning, small business retirement plan options, etc.), hire one. Or maybe by that point you feel confident enough to do it continue doing it yourself.

And once you turn that into more money, you admittedly have a few more options. But the principles will remain the same: watch your fees, be consistent, stick to your plan. By and large, the world of sophisticated financial advice doesn't suddenly open up to you because you have some wealth. You get a few more tools in the toolbox, but you can also potentially stab yourself with them. The rich are subject to many of the same constraints as the rest of us. Being wealthy means one thing: you have money. It doesn't necessarily mean you are smart and may not even mean you are good with money. It it definitely doesn't make you immune from bad returns or being swindled.

As to those options available to wealthy investors, as I said,  a few things do open up. First, if you meet certain income/net worth standards, you  become an "accredited investor". That means that the government then assumes you are knowledgeable enough to handle some riskier investments in securities not regulated by financial authorities, such as hedge funds. The problem is that, while we can make some broad assumptions about returns in the "vanilla" stock market, the returns of these hedge funds and other pseudo-private investments are all over the map. So, as is the case in many areas, the government's assumptions are often wrong.

And hedge fund returns have been downright ugly as of late. Of course, periods of under-performance are a certainty with any investment, but the problems with hedge funds could be structural as long as they continue their high fees. Historically, these funds have charges 2% of the assets under management and 20% of the profits, but the smart funds are bringing fees down. 

And, of course, people with a higher net worth can also invest in real estate without needing excessive leverage, which can work out very well. But again, those returns vary by location, experience and luck. And, remember, I'm not a real estate adviser, so I won't go out on any limbs here. This is often more about how you are at the business of real estate than how you are as an investor. And business and investing are not the same thing, though the line can get blurry.

So, it's not so much that only rich people can afford good advice, it's more that poor people generally can't afford advice and/or don't need it yet. If price equaled value when it came to investing, we'd see hedge funds as a class have consistently superior performance. Also, we'd see the high fee, actively managed mutual funds with similar success. But, most don't beat the indices, and you generally have to pay for this middling performance. There are ways to attempt to improve on the index returns, but often they can be implemented with tactically using inexpensive index funds or using mechanical, algorithm-based funds that still charge much less than 1%.

Most successful investing is simple, and the simplest investing is essentially index investing, give or take. Are there things you can possibly due to improve upon that and/or mitigate the ups and downs? I certainly believe so, but they won't be as essential as the amount you save, your consistency of implementation and of course, how much you pay in fees.

More Thoughts on "The Quants"

As mentioned in one of last week's posts, I was reading a book called The Quantswhich is basically about how a bunch of nerds climbed to the top of Wall Street and then proceeded to get shot in the foot, both by themselves and other people. I will spare the reader a proper book review (there is only so many ways to say "very readable" and "I liked it") and instead throw out some takeaways and reactions.

Most of us understand that bad stuff can happen in the markets, as we've lived through it. However, it seems we tend to comfort ourselves by saying that those times are in the past and that they were the result of greedy gunslingers. I think one of the big things that was reinforced to me by this book was that this stuff still happens when people "get their math right". Sure, these guys took some risks and a lot of them were greedy, but many of them did this in the context of dotting their "i's" and crossing their "t's". Things like the crisis of 2007-2008 were only modeled to happen once in a few thousand years, and probably not even that  frequently. Clearly, the impossible happens a lot more often in world of finance than we would like to acknowledge. And recent college football endings like Auburn's "Kick Six" or the 2015 Michigan State win over Michigan prove the impossible seems to happen often more than expected in other domains, as well.

Nassim Taleb talks of a conference in Las Vegas he attended in which the concept of risk management in casinos was discussed. The owners were focused on cheaters and the actual games, but he felt that this was the exact wrong approach. Casinos are a sterile (figuratively, not literally) and closed environment in which the returns often matched probabilistic expectations, mostly because there are set rules and casinos have gotten pretty good at catching cheaters. These days, it's what happens outside the games that kills you. His theory was played out in the ensuing years when the casinos had to deal with issues like IRS troubles brought about by negligent employees, the kidnapping of a casino owner's daughter (which caused him to raid the casino coffers for ransom money) and the Siegfried and Roy tiger attack (which cost that casino about $100 million). The math took care of the slot machines and blackjack, they needn't worry about that.

That's what the markets are like, in that real life keeps getting in the way of models. We aren't completely helpless, though. Some things that might aid us.

1) We can avoid esoteric derivatives. Standardized instruments such as options and futures can cut deep enough as it is, but the collateralized debt obligations that brought about the crisis where a whole new breed. Luckily, they were out of the reach of average investors, but unluckily, their decline still effected the average investor. As for the fancy quant hedge funds who got burned? For many of them, their mistake was not that they directly invested in these CDOs, its's that they underestimated the impact that their implosion would have on more regular stocks and access to credit (a necessity in the hedge fund world).

2) Diversify outside of stocks and bonds. Cash, home equity, a small business, permanent cash value life insurance (if it is a good policy and you have a realistic idea of possible returns) are no guarantees of protection against bad things. However, if there ever comes a time when ALL of these types of assets get hammered, having almost all of your wealth in stocks instead would have likely been close to as bad, if not worse. If you can stand a risky strategy such as having all of your net worth in equities or highly leveraged real estate, those options offer the hope of the best returns, but also the biggest chance of ruin. 

3) Avoid leverage. This is closely related to the first point. As a book such as The Quants indicates, it's impossible to completely escape leverage in our economy (this could come back to bite us, but that's a bigger argument for smarter people-and they probably won't get it right, anyway). No need tempt the devil by borrowing to invest in things like stocks, options or futures. Obviously, a mortgage is borrowing, also. But, you can live in a house, you can't live in 100 shares of Google, so it's not a complete apples-to-apples comparison. But, even in real estate, not all mortgages are created equal. The quality of the property, the ratio of debt (are you putting 3% down or 20%?), your experience in real estate and the use of the property (investment vs. residence) can all factor into whether or not to use debt.

Having the math right is great, but remember, our models are an attempt to reflect the real world, not a means for controlling it. Markets will do what they are told, but their master is all of us, and not a formula. Quantitative research and analysis is fantastic and can be a great tool, but it is always imperfect and only as good as the assumptions used to create it.

Roth Versus Traditional

Much ink has been spilled over the Roth IRA versus traditional IRA debate. To a degree, I think this is a tempest in a teapot because I don't know how many investors agonize over the decision. The very act of saving/investing is more important than the tax structure. That is assuming, of course, that the way you are saving offers some type of tax benefit. Things like 401(k)s and both forms of IRAs have tax advantages, as do real estate and and to a different degree, cash value life insurance. From a tax perspective, these things all offer advantages over just stashing your money away in a vanilla taxable account. Now, the taxable account generally offers more control and easier access to funds than these other things, so it is up to the investor to assess how and when to use taxable savings/investments.

But, back to the point at hand: Roth vs. traditional. We can torture the data enough to tell us either one is better. A lot of it depends on what your tax rate is now and what it will be in the future. As you can see from this Nerd Wallet study, Roths generally do better than traditional IRAs. This is even true in the most apt comparison: the one that takes tax savings from the Traditional and invests it. In that scenario, it is close, but the general tendency still benefits the Roth. Now if you go to the chart (the first one on the above link), you will see the Traditional tends to do better at the bottom left (low future tax rate and high current tax rate).

To play devil's advocate, here is an article at Financial Samurai which tears the Roth a new one. He raises a lot of good points, but I think the gist comes down to this: taxpayers are unlikely to have higher tax rates in retirement, so it is better to defer taxes until later.  Probably true, but remember this: personal finance is often more personal than finance (also, projections generally stink). Some people like getting their taxes out of the way. If it is worth it from a behavioral/psychological standpoint, that has value. The important thing is that you are saving and getting some tax benefit from it. We can game plan all day, but we won't know the optimal solution until it's history.

Nerds Flying Too Close to the Sun

I'm reading a book called The Quants by Scott Patterson. Basically it's about the run up from the 1960s to 2008 when Wall Streets old guard of jockish, gut-feeling-based, egotistical traders was usurped by nerdy, algorithm-based egotistical traders. In both cases, overconfidence ultimately did them in. The jocks underestimated the nerds and got taken to the cleaners and the nerds underestimated risk and achieved a possibly worse result.

I think there is absolutely a ton to be said for algorithmic, rules-based investing. It really permeates our investing lives, whether we know it or not. As Cullen Roche points out, the S&P 500 index is really just a rules-based investing system. That is good, but the problem is that the system is only as good as the people who buy and sell it. So, a person who is constantly in and out of and S&P 500 index fund is really overriding the rules based on their own judgment. It's like have an awesome constitution that is only selectively followed by the judiciary, not that any of us would know anything about that.

The point here is that these "quants" felt they could completely subdue risk with math, which is  fool's errand. Investing is full of surprises, the only surprise would be if we didn't continue to get surprised. Simple works better and the most basic methods have tended to be the most enduring, but even these rarely offer a smooth and risk-free path to success. Want to buy and hold? Awesome, just be ready for a possible 50%+ decline in your portfolio. This number sounds hairy,  but can be offset partially by regularly (and mindlessly) adding to you portfolio.

The reasons that a mortgage can work so well for our net worth isn't because real estate is such a bulletproof asset (it's not), it's because a mortgage requires regular payments and is cumbersome to get in and out of. It has consistency and rules. These are more important the the actual return on our investment, which is important, but tends to take care of itself when  consistency is present and rules are obeyed. These things tend to tame risk better than fragile and complex algorithms.

And, while personal finance loves consistency and rules, it tends to punish hubris, as many of the math experts discovered.

As a final plug, remember that all assets are not created equal. The mortgage crisis hit mainly because of the over-reliance on derivatives, which are notional investing instruments that "derive" there value from an underlying asset (examples include futures and options). There is certainly a place for these in the modern economy, but they can lead to outsized bets equal to many times the net worth of the investor. When these go bad, it's like being upside down on a home, but with potentially many more dollars at play. And also, there's the fact that, as depressed as home values can be, it makes for much better shelter than an options contract. Our economy is modernizing, but we can't let our obsession with  new technology and complex financial instruments and  cloud the fact that the building blocks of economies are tangible things and services. 

 

 

 

Why This Bull Market Stinks

Actually, if it's making you money (and some of that money remains after the inevitable correction), it doesn't stink. But, perception is reality, sort of, and the current eight year run up of the stock market hasn't been fully embraced with the folly and euphoria that we normally see. Generally, at this point in a bull market, the ideas that the good times will last forever and that we have reached a new era in investing/the economy start to take hold.

As an aside, take note of that. Because everyone has been waiting for the other shoe to drop, it's taking longer for the other shoe to drop. Don't be surprised if the bull market chugs along longer until we REALLY leave sanity behind or our economic situation  becomes so stark and dismal that even our guarded optimism proves too optimistic.
 

Josh Brown of The Reformed Broker lays out a good case as to why the this bull market is so disdained. Technology and algorithms are taking over and automation is a threat to the careers of many in the industry. So, the professionals fearing for their jobs is poisoning Main Street's feelings about the markets. Do I have strong feelings about where the market is headed? Well, it will come down sometime. When or how much is impossible to know. However, I do have strong feelings about trying to predict the markets. Don't. It's ok to have misgivings about the market, just don't let it be due to Wall Streets career worries and don't let concern paralyze you.

As another aside, Brown mentions the overarching trend towards quantitative, rules-based investing. While this is an improvement upon "gut-based" investing, let the buyer beware. Simply having an algorithm is no assurance of success. It must be robust, simple and able to survive markets that are constantly adapting. Some of these programs will likely deliver superior results, some will be serviceable and some will blow up. Control what you can control, kick the tires on your methodology, play it safe and follow your plan.

Fiduciaries and Fragility

In case you haven't noticed, the much talked about (in some circles) Dept. of Labor Fiduciary Rule has gone into effect. What does it do? Well, basically, it's going to elevate most people in the financial services industry to the level of fiduciaries. Being a fiduciary means acting in the best interests of the client. Many people (including this author) already operate under this standard, as opposed to the lower "suitability" standard used by many brokers and people in the insurance industry (who aren't also investment adviser reps-which would make them subject to the fiduciary standard).

There's little things people in the financial services industry like more than looking down on other people in the financial services industry, so I won't throw dirt on anyone's grave. There are some excellent and knowledgeable people in all corners of this business, and being a "fiduciary" is all well and good, but at the end of the day, it just gives a bad actor one more rule to break in pursuit of your money.

This probably isn't a bad thing, but I don't know how much help it will be. At the end of the day, it will result in more documentation and work for the adviser, but likely little advantage for the consumer. I'm not a Randian free market fetishist and  wouldn't pretend to think that no regulation is needed in the investment industry, but we are way past that point. From our overly-complex tax code to dizzying investment adviser laws to our arcane farm subsidies, our top-down economy is looking extremely fragile as it is poised to choke on itself.

This isn't me predicting "The Big One". After the 2007 crash, I was sure the next big market move was farther downward, and that simply wasn't the case. But, I would implore everyone to have their heads on a swivel, though, and realize the limits of laws and regulations while having an investment plan that doesn't lean on predictions and can survive both a good and bad economy. The odds are that laws such as the DOL will be ineffective at best, and at worst, will sap your adviser's time with more admin work. As usual, the client must remain informed, because your finances can't be completely outsourced any more than diet and exercise can.

Lastly, here's a good summary of what the DOL Fiduciary Rule.

The Calm Before the...?

Anyway you slice it, volatility is low these days. Per this article (with pretty charts) from Pension Partners, by a lot of different measures, the stock market is overwhelming stable and consistently higher than its historical averages. Do this mean that stocks have become less risky?

Well, actually, be grateful that stocks are risky. After all, risk drives the returns. If stocks start to look like bonds, be ready for bond-like returns. However, it's doubtful that stocks are less risky, but, as a whole, we will likely start to believe they are, settle in for nice, consistent positive returns and then we will get steamrolled by a market dive. The article quotes the one and only Nassim Taleb: "Don't confuse lack of volatility with stability, ever."

History's least favorite bull market is now over 8 years old. No one thought it would last this long, and while the party can't last forever, I'm not going to be the one foolishly attempting to predict when it will end, nor will I extrapolate these returns indefinitely into the future. Don't cash out and run for the mattress just yet, many have lost out on great returns by predicting doom and gloom. Just have a plan that can survive the bad times...and the good times, as well. No two market cycles are the same, but that doesn't mean the rules have altogether changed. The markets go up, then they go down. We just don't know when or by how much. So, expect the unexpected.

Managing the Excesses

Knowing that crazy things happen in the market and living through them with your portfolio intact are two very different things.

One of my favorite bloggers, Ben Carlson, points out that everything is obvious in retrospect. He really nails it here. There's a certain snide aspect to our writing about past market overreactions, positive or negative.  Ex post facto, we seem to take it on face value that "obviously, the market will come back" or "clearly the high valuations were unsustainable", but few of us actually put our money where our mouth is in real time.

Correspondingly, seeing a mathematical model of the returns over a time period isn't the same as experiencing the ups and downs in real time. As Michael Batnick points out, it's the difference between seeing a map and making the actual trip.

Every time the market experiences a wild swing, we weigh the possibility that this is just another example of the normal ebb and flow vs the possibility that something has fundamentally changed. The vast majority of the time, it's the former, but the latter theory is seductive, and that's why we fall for it.