Here’s the second half of my most recent interview with Erin Ade at RT Boom/Bust. [First half located here.] We discussed:

  • Stock buybacks, particularly the buyback that GM is doing
  • Valuations of the stock market and bonds
  • Effect of the strong dollar on corporate earnings in the US
  • Effect of lower crude oil prices on capital spending
  • Investing in Europe, good or bad?

Seven minutes roar by when you are on video, and though taped, there is only one shot, so you have to get it right.  On the whole, I felt the questions were good, and I was able to give reasonable answers.  One nice thing about Erin, she doesn’t interrupt you, and she allows for a few rabbit trails.

Photo Credit: Fortune Live Media

Photo Credit: Fortune Live Media

As I mentioned yesterday, there wasn’t anything that amazing and new in the annual letter of Berkshire Hathaway.  Lots of people found things to comment on, and there is always something true to be reminded of by Buffett, but there was little that was new.  Tonight, I want to focus on a few new things, most of which was buried in the insurance section of the annual report.

Before I get to that, I do want to point out that Buffett historically has favored businesses that don’t require a lot of capital investment.  That way the earnings are free to be reinvested as he see fit.  He also appreciates having moats, because of the added pricing power it avails his businesses.  Most of his older moats depend on intellectual property, few competitors, established brand, etc.  Burlington Northern definitely has little direct competition, but it does face national regulation, and dissatisfaction of clients if services can’t be provided in a timely and safe manner.

Thus the newer challenge of BRK: having to fund significant capital projects that don’t add a new subsidiary, may increase capacity a little, but are really just the price you have to pay to stay in the game.  From page 4 of the Annual Letter (page 6 of the Annual Report PDF):

Our bad news from 2014 comes from our group of five as well and is unrelated to earnings. During the year, BNSF disappointed many of its customers. These shippers depend on us, and service failures can badly hurt their businesses.

BNSF is, by far, Berkshire’s most important non-insurance subsidiary and, to improve its performance, we will spend $6 billion on plant and equipment in 2015. That sum is nearly 50% more than any other railroad has spent in a single year and is a truly extraordinary amount, whether compared to revenues, earnings or depreciation charges.

There’s more said about it on pages 94-95 of the annual report, but it is reflective of BRK becoming a more asset-heavy company that requires significant maintenance capital investment.  Not that Buffett is short of cash by any means, but less will be available for the “elephant gun.”

Insurance Notes

Now for more arcane stuff.  There are lots of people who write about Buffett and BRK, but I think I am one of the few that goes after the insurance issues.  I asked Alice Schroeder (no slouch on insurance) once if she thought there was a book to be written on Buffett the insurance CEO.  Her comment to me was “Maybe one good long-form article, but not a book.”  She’s probably right, though I think I have at least 10,000 words on the topic so far.

Here are two articles of mine for background on some of the issues involved here:

Here’s the main upshot: reserving is probably getting less conservative at BRK.  Incurred losses recorded during the year from prior accident years is rising.  Over the last three years it would be -$2.1B, -$1.8B, and now for 2014 -$1.4B.  (See page 69 of the annual report.)  Over the last three years, the amount of reserves from prior years deemed to be in excess of what was needed has fallen, even as gross reserves have risen.  In 2012, the amount of prior year reserves released as a proportion of gross reserves was greater than 3%.  In 2014, it was less than 2%.

In addition to that, in general, the reserves that were released were mostly shorter-tailed reserves, while longer-tailed reserves like asbestos were strengthened.  In general, when longer-tailed lines of business are strengthened in one year, there is a tendency for them to be strengthened in future years.  It is very difficult to get ahead of the curve.  Buffett and BRK could surprise me here, but delays in informing about shifts in claim exposure are a part of longer-tailed lines of insurance, and difficult to estimate.  As I have said before, reserving for these lines of business is a “dark art.”

From page 91 of the annual report:

In 2014, we increased estimated ultimate liabilities for contracts written in prior years by approximately $825 million, substantially all of which was recorded in the fourth quarter. In the fourth quarter of 2014, we increased ultimate liability estimates on remaining asbestos claims and re-estimated the timing of future payments of such liabilities as a result of actuarial analysis. The increase in ultimate liabilities, net of related deferred charge adjustments, produced incremental pre-tax underwriting losses in the fourth quarter of approximately $500 million.

This was the only significant area of reserve strengthening for BRK.  Other lines released prior year reserves, though many released less than last year.

There were a few comments on insurance profitability.  In addition to asbestos, workers’ compensation lost money.  Property-catastrophe made a lot of money because there were no significant catastrophes in 2014, but rates are presently inadequate there, and BRK is likely to write less of it in 2015.

My concern for BRK is that they are slowly running out of profitable places to write insurance, which reduces BRK’s profitability, and reduces the float that can be used to finance other businesses.

Maybe BRK can find other squishy liabilities to use to create float cheaply.  They certainly have a lot of deferred tax liabilities (page 71).  Maybe Buffett could find a clever way to fund pensions or structured settlements inexpensively.  Time to have Ajit Jain put on his thinking cap, and think outside the box.

Or maybe not.  Buffett is not quite to the end of his “low cost of informal borrowing” gambit yet, but he is getting close.  Maybe it is time to borrow at the holding company while long-term rates are low.  Oh wait, he already does that for the finance subsidiary.

Final Notes

From an earnings growth standpoint, there was nothing that amazing about the earnings in 2014.  A few new subsidiaries like NV Energy added earnings, but existing subsidiaries’ earnings were flattish.  Comprehensive income was considerably lower because of the lesser degree of unrealized appreciation on portfolio holdings.

On net, it was a subpar year for Berkshire Hathaway.  The annual letter provided a lot of flash and dazzle, but 2014 was not a lot to write home about, and limits to the BRK business model with respect to float are becoming more visible.

Full disclosure: long BRK/B for myself and clients, for now

Photo Credit: Chuck Coker

Photo Credit: Chuck Coker || Another Dynamic Duo and their secret Batcave

This piece has kind of a long personal introduction to illustrate my point.  If you don’t want to be bored with my personal history, just skip down to the next division marker after this one.


There will always be a soft spot in my heart for people who toil in lower level areas of insurance companies, doing their work faithfully in the unsexy areas of the business.  I’ve been there, and I worked with many competent people who will forever be obscure.

One day at Provident Mutual’s Pension Division [PMPD], my friend Roy came to me and said, “You know what the big secret is of the Pension Division?”  I shook my head to say no.  He said, ” The big secret is — there is no secret,” and then he smiled and nodded his head.  I nodded my head too.

The thing was, we were ultra-profitable, growing fast, and our financials and strategies were simple.  Other areas of the company were less profitable, growing more slowly, and had accrual items that were rather complex and subject to differing interpretations.  But since the 30 of us (out of a company of 800) were located in a corner of the building, away from everyone else, we felt misunderstood.

So one day, I was invited by an industry group of actuaries leading pension lines of business to give a presentation to the group.  I decided to present on the business model of the PMPD, and give away most of our secrets.  After preparing the presentation, I went home and told my wife that I would be away in Portland, Oregon for two days, when she informed me we had an important schedule conflict.

I was stuck.  I tried to cancel, but the leader of the group was so angry at me for trying to cancel late, when I hung up the phone, I just put my head on my desk in sorrow.

Then it hit me.  What if I videotaped my presentation and sent that in my place?  I called the leader of the group back, and he loooved the idea.  I was off and running.

One afternoon of taping and $600 later, I had the taped presentation.  It detailed marketing, sales, product design, risk control, computer systems design, and more.  If you wanted to duplicate what we did, you would have had a road map.

But the presentation ended with a hook of sorts, where I explained why I was so free with what we were doing.  We were the smallest player in the sub-industry, though the fastest growing, and with one of the highest profit margins.  I said, “The reason I can share all of this with you is that if you wanted to copy us, you would have to change an incredible amount of what you do, and kill off areas where you have invested a lot already.  I know you can’t do that.  But maybe you can imitate a few of our ideas and improve your current business model.”

So my colleague took the tape to the meeting, and when he returned, he handed me a baseball cap that had the word “Portland” on it.  He said, “You did it, Dave.  You won the best presentation of the conference award.  Everyone sent their thanks.”

Sadly, that was one of the last things I did in the Pension Division, as corporate management chose me to clean up another division of the company.  That is another story, but one I got few thanks for.

Today I call that hat “the $600 hat,” and I wear it to my kids baseball and softball games as I keep score.


The secret of Berkshire Hathaway is the same as my story above.  There is no secret. Buffett’s methods have been written about by legions; his methods are well known.  The same applies to Charlie Munger.  That’s why in my opinion, there were no significant surprises in their 50th anniversary annual letter. (There were some small surprises in the annual report, but they’re kinda obscure, and I’ll write about those tomorrow.)  All of the significant building blocks have been written about by too many people to name.

Originally, this evening, I was going to write about the annual report, but then I bumped across this piece of Jim Cramer’s on Buffett.  Let me quote the most significant part:

…Cramer couldn’t help but wonder if things in the business world could be different if we approached other CEOs the way that Buffett is approached.

Perhaps, if the good CEOs were allowed to stay on longer like Buffett has or if people treated them as if they were their companies the way that Buffett is treated in relation to Berkshire, things could be different?

“Clearly something’s gone awry in the business world if we can praise this one man for everything he does, and yet every other chief executive feels shackled into being nothing like him,” Cramer said.

Cramer is very close to the following insight: the reason why more companies don’t imitate Berkshire Hathaway is that they would have to destroy too much of their existing corporations to make it worth their while.  As such, the “secrets” of Berkshire Hathaway can be hidden in plain view of all, because the only way to create something like it would be to start from scratch.  Yes, you can imitate pieces of it, but it’s not the same thing.

Creating a very profitable diversified industrial conglomerate financed by insurance liabilities is a very unique strategy, and one that few would have the capability of replicating.  It required intelligent investing, conservative underwriting, shrewd analysis of management teams so that they would act independently and ethically, and more.

Indeed, an amazing plan in hindsight.  Kudos to Buffett and Munger for their clever business sense.  It will be difficult for anyone to pursue the same strategy as well as they did.

But in my next piece, I will explain why one element of the strategy may be weakening.  Until then.

Full disclosure: long BRK/B for myself and clients

Photo Credit: Roscoe Ellis

Photo Credit: Roscoe Ellis

I was reading an occasional blast email from my friend Tom Brakke, when he mentioned a free publication from Redington, a UK asset management firm that employs actuaries, among others. I was very impressed with what I read in the 32-page publication, and highly recommend it to those who select investment managers or create asset allocations, subject to some caveats that I will list later in this article.

In the UK, actuaries are trained to a higher degree to deal with investments than they are in the US. The Society of Actuaries could learn a lot from the Institute of Actuaries in that regard. As a former Fellow in the Society of Actuaries, I was in the vanguard of those trying to apply actuarial principles to risk management, both when I managed risks for insurance companies, worked for non-insurance organizations, and manage money for upper middle class individuals and small institutions. Redington’s thoughts are very much like mine in most ways. As I see it, the best things about their investment reasoning are:

  • Risk management must be both quantitative and qualitative.
  • Risk is measured relative to client needs and thus the risk of an investment is different for clients with different needs.  Universal measures of risk like Sharpe ratios, beta and standard deviation of asset returns are generally inferior measures of risk.  (DM: But they allow the academics to publish!  That’s why they exist!  Please fire consultants that use them.)
  • Risk control methods must be implemented by clients, and not countermanded if they want the risk control to work.
  • Shorting requires greater certainty than going long (DM: or going levered long).
  • Margin of safety is paramount in investing.
  • Risk control is more important when things are going well.
  • It is better to think of alternatives in terms of the specific risks that they pose, and likely future compensation, rather than look at track records.
  • Illiquidity should be taken on with caution, and with more than enough compensation for the loss of flexibility in future asset allocation decisions and cash flow needs.
  • Don’t merely avoid risk, but take risks where there is more than fair compensation for the risks undertaken.
  • And more… read the 32-page publication from Redington if you are interested.  You will have to register for emails if you do so, but they seem to be a classy firm that would honor a future unsubscribe request.  Me?  I’m looking forward to the next missive.

Now, here are a few places where I differ with them:


  • Aside from pacifying clients with lower volatility, selling puts and setting stop-losses will probably lower returns for investors with long liabilities to fund, who can bear the added volatility.  Better to try to educate the client that they are likely leaving money on the table.  (An aside: selling short-duration at-the-money puts makes money on average, and the opposite for buying them.  Investors with long funding needs could dedicate 1% of their assets to that when the payment to do so is high — it’s another way of profiting from offering insurance in of for a crisis.)
  • Risk parity strategies are overrated (my arguments against it here: one, two).
  • I think that reducing allocations to risky assets when volatility gets high is the wrong way to do it.  Once volatility is high, most of the time the disaster has already happened.  If risky asset valuations show that the market is offering you significant deals, take the deals, even if volatility is high.  If volatility is high and valuations indicate that your opportunities are average to poor at best, yeah, get out if you can.  But focus on valuations relative to the risk of significant loss.
  • In general, many of their asset class articles give you a good taste of the issues at hand, but I would have preferred more depth at the cost of a longer publication.

But aside from those caveats, the publication is highly recommended.  Enjoy!

At Abnormal Returns, over the weekend, Tadas Viskanta featured a free article from Credit Suisse called the Credit Suisse Global Investment Returns Yearbook 2015.  It featured articles on whether the returns on industries as a whole mean-revert or have momentum, whether there is a valuation effect on industry returns, “social responsibility” in investing, and the existence of equity discount rate for the market as a whole.

There are no surprises in the articles — it is all “dog bites man.”  They find that:

  • Industry returns exhibit momentum
  • There is a valuation component in industry returns
  • Socially responsible investing doesn’t necessarily produce or miss excess returns
  • There is an overall equity discount rate, which is levered about 20-25 times, i.e., a 1% increase in the rate lowers valuations by 20-25%.

The first two are well-known for individual stocks, so it isn’t surprising that it happens at the industry level.  The third one has been written about ad nauseam, with many conflicting opinions, so that there is little effect is no big surprise.  The last one resembles research I saw in the mid-90s, where the effect of changes in real interest rates has about that impact on stocks.  Again, nothing new — which is as it should be.

But now some more on industry returns.  They found that industry return momentum was significant.  Industries that did well one year were likely to do well in the next year.  The second finding was that industries with cheap valuations also tended to do well, but it was a smaller effect.

So, using one-year price returns as my momentum variable and book-to-market as a valuation variable (both suggested in the article), I divided industries for companies trading in the US into quintiles (also suggested in the article) for momentum and valuation.  (Each quintile has roughly 20% of the total market cap.)  Here is the result:



Low valuations are at the right, high at the left.  Low momentum at the top, high momentum at the bottom.  Ideally by this method, you would look for industries in the southeast corner.

To me, Agriculture, Information Technology, Security, Waste, Some Retail, and Some Transportation look interesting.  One in the far southeast that is not so interesting for me is P&C Insurance.  Yes, it has done well, and compared to other industries, it is cheap.  But industry surplus has grown significantly, leading to more competition, and sagging premium rates.  Probably not a great time to make new commitments there.

Anyway, the above table should print out nicely on two sheets of letter-sized paper.  Not that it would be a substitute for your own due diligence, but perhaps it could start a few ideas going.  All for now.

Photo Credit: NoHoDamon

Photo Credit: NoHoDamon

Brian Lund recently put up a post called 5 Reasons You Deserve to Lose Every Penny in the Stock Market.  Though I don’t endorse everything in his article, I think it is worth a read.  I’m going to tackle the same question from a broader perspective, and write a different article.  As we often say, “It takes two to make a market,” so feel free to compare our views.

I have one dozen reasons, many of which are related.  I do them separately, because I think it reveals more than grouping them into fewer categories.  Here we go:

1) Arrive at the wrong time

When does the average person show up to invest?  Is it when assets are cheap or expensive?

The average person shows up when there has been a lot of news about how well an asset class has been doing.  It could be stocks, housing, or any well-known asset.  Typically the media trumpets the wisdom of those that previously invested, and suggests that there is more money to be made.

It can get as ridiculous as articles that suggest that everyone could be rich if they just bought the favored asset.  Think for a moment.  If holding the favored asset conferred wealth, why should anyone sell it to you?  Homebuilders would hang onto their inventories. Companies would not go public — they would hang onto their own stock and not sell it to you.

I am reminded of some of my cousins who decided to plow money into dot-com stocks in late 1999.  Did they get to the party early?  No, late.  Very late.  And so it is with most people who think there is easy money to be made in markets — they get to the party after stock prices have been bid up.  They put in the top.

2) Leave at the wrong time

This is the flip side of point 1.  If I had a dollar for every time someone said to me in 1987, 2002 or 2009 “I am never touching stocks ever again,” I could buy a very nice dinner for my wife and me.  Average people sell in disappointment thinking that they are protecting the value of their assets.  In reality, they lock in a large loss.

There’s a saying that the right trade is the one that hurts the most.  Giving into greed or fear is emotionally satisfying.  Resisting trends and losing some money in the short run is more difficult to do, even if the trade ultimately ends up being profitable.  Maintaining exposure to stocks at all times means you ride a roller coaster, but it also means that you earn the long-term returns that accrue to stocks, which market timers rarely do.

You can read some of my older pieces on how investors earn less on average than buy-and-hold investors do.  Here’s one on how investors in the S&P 500 ETF [SPY], trail buy-and-hold returns by 7%/year.  Ouch!  That comes from buying and selling at the wrong times.  ETFs may lower expenses, but they also make it easy for people to trade at the wrong times.

3) Chase the hot sector/industry

The lure of easy money brings out the worst in people.  Whether it is tech stocks in 1987, dot-coms in 1999, or housing-related assets in 2007, there will always be people who think that the current industry fad will be a one-way ticket to riches.  There is psychological satisfaction to be had by buying what is popular.  Everyone wants to be one of the “cool kids.”  It’s a pity that that is not a good way to make money.  That brings up point 4:

4) Ignore Valuations

The returns you get are a product of the difference in the entry and exit valuations, and the change in the value of the factor used to measure valuation, whether that is earnings, cash flow from operations, EBITDA, free cash flow, sales, book, etc.  Buying cheap aids overall returns if you have the correct estimate of future value.

This is more than a stock market idea — it applies to private equity, and the purchase of capital assets in a business.  The cheaper you can source an asset, the better the ultimate return.

Ignoring valuations is most common with hot sectors or industries, and with growth stocks.  The more you pay for the future, the harder it is to earn a strong return as the stock hopefully grows into the valuation.

5) Not think like a businessman, or treat it like a business

Investing should involve asking questions about whether the economic decisions are being made largely right by those that manage the company or debts in question.  This is not knowledge that everyone has immediately, but it develops with experience.  Thus you start by analyzing business situations that you do understand, while expanding your knowledge of new areas near your existing knowledge.

There is always more to learn, and a good investor is typically a lifelong learner.  You’d be surprised how concepts in one industry or market get mirrored in other industries, but with different names.  One from my experience: Asset managers, actuaries and bankers often do the same things, or close to the same things, but the terminology differs.  Or, there are different ways of enhancing credit quality in different industries.  Understanding different perspectives enriches your understanding of business.  The end goal is to be able to think like an intelligent business manager who understands investing, so that you can say along with Buffett:

I am a better investor because I am a businessman, and a better businessman because I am an investor.

(Note: this often gets misquoted because Forbes got mixed up at some point, where they think it is: I am a better investor because I am a businessman, and a better businessman because I am no investor.)  Good investment knowledge feeds on itself.  Little of it is difficult, but learn and learn until you can ask competent questions about investing.

After all, you are investing money.  Should that be easy and require no learning?  If so, any fool could do it, but my experience is that those who don’t learn in advance of investing tend to get fleeced.

6) Not diversify enough

The main objective here is that you need to only invest what you can afford to lose.  The main reason for this is that you have to be calm and rational in all the decisions you make.  If you need the money for another purpose aside from investing, you won’t be capable of making those decisions well if in a bear market you find yourself forced to sell in order to protect what you have.

But this applies to risky assets as well.  Diversification is inverse to knowledge.  The more you genuinely know about an investment, the larger your positions can be.  That said I make mistakes, as other people do.  How much of a loss can you take on an individual investment before you feel crippled, and lose confidence in your abilities.

In the 25+ years I have been investing, I have taken significant losses about ten times.  I felt really stupid after each one.  But if you take my ten best investments over that same period, they pay for all of the losses I have ever had, leaving the smaller gains as my total gains.  As a result, my losses never inhibited me from continuing in investing; they were just a part of the price of getting the gains.

Temporary Conclusion

I have six more to go, and since this article is already too long, they will have to go in part 2.  For now, remember the main points are to structure your investing affairs so that you can think rationally and analyze business opportunities without panic or greed interfering.

Photo Credit: Thibaut Chéron Photographies

Photo Credit: Thibaut Chéron Photographies

I wish I could tell you that it was easy for me to stop making macroeconomic forecasts, once I set out to become a value investor.  It’s difficult to get rid of convictions, especially if they are simple ones, such as which way will interest rates go?

In the early-to-mid ’90s, many were convinced that interest rates had no way to go but up.  A few mortgage REITs designed themselves around that idea.  Fortunately, I arrived at the party late, after their investments that implicitly required interest rates to rise soon, fell dramatically in price.  I bought a basket of them for less than book value, excluding the value of taxes that could be sheltered in a reverse merger.

For some time, the stocks continued to fall, though not rapidly.  I became familiar with what it was like to go through coercive rights offerings from cash-hungry companies in trouble.  Bankruptcy was not impossible… and I burned a lot of mental bandwidth on these.  The rights offerings weren’t really good things in themselves, but they led me to buy in at a good time.  Fortunately I had slack capital to deploy.  That may have taught me the wrong lesson on averaging down, as we will see later.  As it was, I ended up making money on these, though less than the market, and with a lot of Sturm und Drang.

That leads me to my main topic of the era: Caldor.  Caldor was a discount retailer that was active in the Northeast, but nationally was a poor third to Walmart and KMart.  It came up with the bright idea of expanding the number of stores it had in the mid-90s without raising capital.  It even turned down an opportunity to float junk bonds.  I remember noting that the leverage seemed high.

What I didn’t recognize that the cost of avoiding issuing equity or longer-term debt was greater reliance on short-term debt from factors — short-term lenders that had a priority claim on inventory.  It would eventually prove to be a fatal error, and one that an asset-liability manager should have known well — never finance a long term asset with short-term debt.  It seems like a cost savings, but it raises the likelihood of insolvency significantly.

Still, it seemed very cheap, and one of my favorite value investors, Michael Price, owned a little less than 10% of the common stock.  So I bought some, and averaged down three times before the bankruptcy, and one time afterwards, until I learned Michael Price was selling his stake, and when he did so, he did it without any thought of what it would do to the stock price.

Now for two counterfactuals: Caldor could have perhaps merged with Bradlee’s, closed their worst stores, refinanced their debt, issued equity, and tried to be a northeast regional retail player.  It didn’t do that.

The investor relations guy could have given a more understanding answer when he was asked whether Caldor was having any difficulties with credit lines from their factors.  Instead, he was rude and dismissive to the questioning analyst.  What was the result?  The factors blinked and pulled their lines, and Caldor went into bankruptcy.

What were my lessons from this episode?

  • Don’t average down more than once, and only do so limitedly, without a significant analysis.  This is where my portfolio rule seven came from.
  • Don’t engage in hero worship, and have initial distrust for single large investors until they prove to be fair to all outside passive minority investors.
  • Avoid overly indebted companies.  Avoid asset liability mismatches.  Portfolio rule three would have helped me here.
  • Analyze whether management has a decent strategy, particularly when they are up against stronger competition.  The broader understanding of portfolio rule six would have steered me clear.
  • Impose a diversification limit.  Even though I concentrate positions and industries in my investing, I still have limits.  That’s another part of rule seven, which limits me from getting too certain.

The result was my largest loss, and I would not lose more on any single investment again until 2008 — I’ll get to that one later.  It was my largest loss as a fraction of my net worth ever — after taxes, it was about 4%.  As a fraction of my liquid net worth at the time, more like 10%.  Ouch.

So, what did I do to memorialize this?  Big losses should always be memorialized.  I taught my (then small) kids to say “Caldor” to me when I talked too much about investing.  They thought it was kind of fun, and I would thank them for it, while grimacing.

But that helped.  Remember, value investing is first about safety, and second about cheapness.  Cheapness rarely makes something safe enough on its own, so analyze balance sheets, strategy, use of cash flow, etc.  This is not to say that I did not make any more errors, but this one reduced the size and frequency.

That said, there will be more “fun” chapters to share in this series, because we always learn more from errors than successes.

Here is the second part of my interview on RT Boom/Bust. It was recorded while the FOMC was releasing its statement, so I had no idea at that time as to what the announcement had been.

The interview covers my view of Apple (not one of my strong points), Fed Policy, and what should value investors do in this low interest rate environment. Note that not all of my opinions are strong ones, and that in my opinion is a good thing. Often the best opinions are not controversial.

If you are interested in these topics, or listening to me, then please enjoy the above video. My segment is about seven minutes long.

Photo Credit: PSParrot

Photo Credit: PSParrot

Happy New Year to all of my readers. May 2015 be an enriching year for you in all ways, not just money.

This is a series on learning about investing, using my past mistakes as grist for the mill.  I have had my share of mistakes, as you will see.  The real question is whether you learn from your mistakes, and I can say that I mostly learn from them, but never perfectly.

In the early 90s, I fell in with some newsletter writers that were fairly pessimistic.  As such, I did not do the one thing that from my past experience that I found I was good at: picking stocks.  Long before I had money to invest, I thought it was a lot of fun to curl up with Value Line and look for promising companies.  Usually, I did it well.

But I didn’t do that in that era.  Instead, I populated my portfolio with international stock and bond funds, commodity trading funds, etc., and almost nothing that was based in the USA.  I played around with closed-end funds trying to see if I could eke alpha out of the discounts to NAV.  (Answer: No.)  I also tried shorting badly run companies to make a profit.  (I succeeded minimally, but that was the era, not skill.)

I’ve been using my tax returns from that era to prompt my memory of what I did, and the kindest thing I can say is that I didn’t have a consistent strategy, and so my results were poor-to-moderate.  I made money, just not much money.  I even manged to buy the Japanese equity market on the day that it peaked, and after many months got out with a less-than-deserved 3% loss in dollar terms because of offsetting currency movements.

One thing I did benefit from was learning about a wide number of investing techniques and instruments, which benefited me professionally, because it taught me about the broader context of investing.  That said, it cost time, and some of what I learned was marginal.

But not having a good overall strategy largely means you are wasting your time in investing.  You may succeed for a while with what some call luck, but luck by its nature is not consistent.

Thus, I would encourage all of my readers to adopt an approach that fits their:

  • Knowledge
  • Personality
  • Available time

You have to do something that you truly understand, even if it is hiring an advisor, wealth manager, etc.  You must be able to understand the outer edges of what they do, or how will you evaluate whether they are serving you well or not?  Honesty, integrity, and reputation can go a long way here, but it really helps to know the basics.

Picking fund managers is challenging enough.  How much of their good performance was due to:

  • their style being in favor
  • new cash flows in pushing up the prices of the assets that they like to buy
  • a few good ideas that won’t be repeated
  • a clever aide that is about to leave to set up his/her own shop
  • temporary alignment with the macroeconomic environment
  • or skill?

Personality is another matter — some people don’t learn patience, which cuts off a number of strategies that require time to work out.  Few things also work right off the bat, so even a good strategy might get discarded by someone expecting immediate results.

Time is another factor which I will take up at a later point in this series.  The best investment methods out there are no good for you unless you can make them fit into the rest of your life which often contains the far more important things of family, recreation, faith, learning, etc.  It’s no good to be a wealthy old miser who never learned to appreciate life or the goodness of God’s providence in life.

And so to that end, I say choose wisely.  My eventual choice was value investing, which isn’t that hard to learn, but requires patience, but can scale to the time that you have.  For those that work in a business, it has the side-benefit that it is the most businesslike of all investment methods, and can make you more valuable to the firm that you work for, because you can learn to marry business sense with your technical expertise, potentially leading to greater profit.

For me, I can say that it broadened my abilities to think qualitatively, complementing my skills as a mathematician.  The firms I worked for definitely benefited.  Maybe it can do the same for you.

Till next time, where I tell you how value investing is *not* supposed to be done. ;)

PS — one more note: it is *very* difficult to make money off of macro insights in equities.  Maybe there are some guys that can do that well, but I am not one of them.  Limiting the effect of my insights there has been an aid to doing better in investing, because it forces me to be modest in an area where I know my likely success is less probable.