Category: Portfolio Management

Have Your Cake, Eat It Too, And End Up With Only Crumbs

Have Your Cake, Eat It Too, And End Up With Only Crumbs

Posted on by David Merkel
Photo Credit: brett jordan
Photo Credit: brett jordan

Beware when the geniuses show up in finance. “I can make your money work harder!” some may say, and the simple-minded say, “Make the money sweat, man! ?We have retirements to fund, and precious little time to do it!”

Those that have read me for a while will know that I am an advocate for simplicity, and against debt. ?Why? ?The two are related because some of us tend toward overconfidence. ?We often overestimate the good the complexity will bring, while underestimating the illiquidity that it will impose on finances. ?We overestimate the value of the goods or assets that we buy, particularly if funded by debt that has no obligation to make any payments in the short run, but a vague possibility of immediate repayment.

The topic of the evening is margin loans, and is prompted by Josh Brown’s article here. ?Margin loans are a means of borrowing against securities in a brokerage account. ?Margin debt can either be for the purpose of buying more securities, or “non-purpose lending,” where the proceeds of the loan are used to buy assets outside of brokerage accounts, or goods,?or?services. ?Josh’s article was about non-purpose lending; this article is applicable to all margin borrowing.

Margin loans seem less burdensome than other types of borrowing because:

  • Interest rates are sometimes low.
  • They are easy to get, if you have liquid securities.
  • They are a quick way of?getting cash.
  • There is almost never any scheduled principal repayment or maturity date for the loan.
  • Interest either quietly accrues, or is paid periodically.
  • You don’t have to liquidate securities to get the cash you think you need.
  • There is no taxable event, at least not immediately.
  • Better than second-lien or unsecured debt in most ways.

But, what does a margin loan say about the borrower?

  • He?needs money now
  • He?doesn’t want to liquidate assets
  • He wants lending terms that are easy in the short run
  • He doesn’t have a lot of liquidity at present.

So what’s the risk??If the ratio of the value of assets in the portfolio versus accrued loan value falls enough, the broker will ask the borrower to either:

  • Pay back some of the loan, or
  • Liquidate some of the assets in the portfolio.

And, if the borrower can’t do that, the broker will liquidate portfolio assets for them to restore the safety of the account for the broker who made the loan.

Now, it’s one thing when there isn’t much margin debt, because the margin debt won’t influence the likelihood or severity of a crisis. ?But when there is a lot of margin debt, that’s a problem. ?As I like to say, markets abhor free riders. ?When there is a lot of liquid/short-dated liabilities financing long-dated assets, it is an unstable situation, inviting, nay, daring the crisis to come. ?And come it will, like a?heat seeking missile.

Before the margin desks must act, some account holders will manage their own risk, bite the bullet, and sell into a falling market, exacerbating the action. ?But when the margin desks act, because asset values have fallen enough, they will mercilessly sell out positions, and force the prices of the assets that they sell lower, lower, lower.

A surfeit of margin debt can turn a low severity crisis into a high severity crisis, both individually and corporately, the same way too much debt applied to housing created the crisis in the housing markets.

I would again encourage you to read Josh’s excellent piece, which includes gems like:

Skeptics from the independent side of the wealth management industry would ask, rhetorically, whether or not most of these loans would be made with such frequency if the advisors themselves were not sharing in the fees. The answer is that, no, of course they wouldn’t.

He is correct that the incentives are perverse for the advisors who receive compensation for encouraging their clients to borrow and take huge risks in the process. ?It’s another reason not to take out those loans.

Remember, Wall Street wants easy profits from margin lending. ?They don’t care if they encourage you to take too much risk, just as they didn’t care if you borrowed too much to buy housing.

The Free Advice that Embraces Humility

Just say no to margin debt. ?Live smaller; enjoy the security of the unlevered life, and be ready for the day when the mass liquidation of margin accounts will offer up the bargains of a lifetime.

If you have margin loans out now, start planning to reduce them (before you have to). ?You’ve had a nice bull market, don’t spoil it by staying levered until the bear market comes to make you return your?assets to their rightful owners.

Wisdom is almost always on the side of humility, so simplify your life and finances while conditions favor doing so. ?If you must borrow, do it in a way where you won’t run much risk of losing control of your finances.

And after all that… enjoy your sleep, even amid crises.

Should Jim Cramer Sell TheStreet or Quit CNBC?

Should Jim Cramer Sell TheStreet or Quit CNBC?

Posted on by David Merkel
Photo Credit: Penn State
Photo Credit: Penn State

Like my friend Josh Brown does, I often don’t know where I will end when I start writing… I know I have something to say, given my own time writing for RealMoney.com, and now having publicly written on financial matters for over eleven years, with?thanks to Jim Cramer, who gave me my start.

Recently, a 9% holder of TheStreet sent a letter to Jim, asking him to either sell off TheStreet in an auction or leave CNBC and rebuild the value of TheStreet. ?The Stock rose roughly 7% on the news. ?Personally, I don’t think it should have budged. ?Here’s why:

1)?What is a perpetual money-loser worth? ?TheStreet hasn’t earned significant money since 2007.

2) What is TheStreet worth in an auction? ?The complainant says:

Despite these improvements TST trades at an enterprise value to 2015 estimated revenues of 1.3. This compares to BC Partners Limited?s acquisition of Mergermarket Group at three times revenue. Morningstar Inc. (?MORN? ? $65.97) trades at 3.4 times 2015 consensus revenue estimate. Allegedly, BoardEx competitor Relationship Science recently raised capital at a $300 million valuation compared with its purported $5 million revenue for 2013.

TheStreet is not comparable to these in my opinion. ?I’ll use Morningstar as my example: it is a comprehensive site offering a wide amount of data about investments, and relatively light on opinions. ?Where it speaks, it is authoritative, and it has a relatively sticky following, making their revenues more valuable than that of TheStreet. ?Let’s be real… would you buy TheStreet at the same enterprise value to sales ratio as Morningstar?

3) Selling investment opinions is a very competitive business, with low barriers to entry. ?If a party is any good at marketing it, and wants to sell a newsletter, there are a lot of people who will buy, as noted later by the complainant:

We estimate that 41,500 customers pay roughly $350 per annum ($14.5 million in totum) for your newsletters. This is nothing to scoff at but a fraction of the 400,000 to 500,000 subscribers enjoyed, by (we believe) The Motley Fool Stock Advisor and Stansberry & Associates Investment Research ? two wildly more profitable competitors which charge similar prices. (We estimate that each of these competitors yield $25 to $45 million of pre-tax earnings for their private owners.) Given the strength of your brand, it both amazes and frustrates that subscriptions to your products are so paltry. Were you to de-couple from CNBC (where you are understandably prohibited from promoting PLUS) I would hope, nay expect, that subscriptions of PLUS would treble.

I don’t like market newsletters generally, but I know there are a lot of people who would rather pay for opinions than money management services. ?I often get requests to start a newsletter, but I don’t respect the concept. ?My detailed ideas are for my clients; that’s the business that I am in.

Jim’s newsletter has been out for a long time. ?Of those that buy newsletters, most would be familiar with Cramer, and know that the newsletter?exists. ?Even if Cramer came back to TheStreet full-time, I doubt it would get that much more in subscriptions.

4) Also, auctioning off a Cramer-less TheStreet would likely flop. ?There would be few if any buyers for?a such a company that had lost its main writer.

5) Then there is the complainant’s appeal to Cramer as to his legacy:

You are 59. When you lie upon your deathbed, how will you reflect upon on your legacy? Once a $70 stock, TST is now $2.20. You have done well, but how has the common shareholder done?

I have a little insight here. ?A little less than twelve years ago, I was invited by my Merrill coverage to come to an institutional investor conference where Cramer would be the unscripted keynote speaker. ?It was a great talk, and?at the end of it, as Cramer left, I figured out where I likely needed to be if I wanted a word with him. ?Sure enough, he came my way, and I identified myself to him as the guy who had been writing to him on bonds for the past four years. ?He remembered me and greeted me warmly. ?I told him that I was going to work at a hedge fund. ?He?congratulated me, and said that it was where all the smart guys were going. ?And then he said something to the effect of:

I wish I were still running a hedge fund. ?I really loved that.

And at that point, the crowd caught up, and that was the end of my time with him. ?But when I got home that night, I sent him an e-mail telling him that life is too short, do what you love. ?Go back to the hedge fund and write more occasionally for the rest of us. ?His reply was brief as usual, and if my memory is any good it was something like:

Can’t do that. ?Gotta get the price of theStreet.com over the IPO price.

Even at the time, that made me blink. ?Make the stock rise by more than a factor of 10? ?That would be Herculean at minimum.

But, that gives you an insight into Cramer’s mind at one point. ?He’s already thought along those lines. ?He’s no dummy. ?He knows how difficult it would be — and he has pursued that effort for a number of years. ?My sense is that he has given up, or maybe something close to that. ?The price of TheStreet has been remarkably stable for the past five years, despite all efforts made…

6) But does Cramer have no legacy from TheStreet? ?I would argue he does. ?He enriched the investment writing world in two ways: he created a bunch of young savvy journalists that occupy many places in the broader investment journalism world, and he encouraged a lot of clever investors to write for him.

We are all better off as a result of both of these, even if the benefits never went to shareholders. ?It’s a tough business, and even the best enterprises have a hard time making money at it.

7) Perhaps the complainant needs to be reminded of one of Marty Whitman’s principles on value investing: “Something off the top.” ?Control of a company is a valuable thing, and one of the reasons is that a closely-held company does not merely pay the controlling owner dividends, they often receive something off the top. ?That is true of Cramer here, with a salary of $3.5 million/year. ?Why should he relinquish that? ?In his mind, he may think that he has tried to turn it around for years to no avail. ?If the company is not likely to ever get back to a significantly higher price, why should he knock himself out on a hopeless mission that he has already tried?

8?) So, with that, let the complainant contact his fellow shareholders and ask for help. ?I’m not sure they will agree with the prescription, though they might like to see some actions taken. ?Personally, I can’t get excited about it; I would be inclined to pass, and quietly sell my shares into the current strength generated by the complainant.

Full disclosure: no positions in any companies mentioned here, and as they used to say at TheStreet, I am?writing about a microcap stock, so they would typically not allow articles on it without a big warning, if at all. ?To make it plain: don’t buy any TST shares as a result of what I wrote here. ?Thanks.

Two Notes: Crude Oil & Bonds

Two Notes: Crude Oil & Bonds

Posted on by David Merkel
Photo Credit: S@Z
Photo Credit: S@Z

I’ve been busier than ever of late — not much time to blog. Thus, a few notes:

1) Often the rate of change in a price can tell you something, particularly if the good in question is widely traded/held by a wide number of parties with different interests. ?In this case, I am talking about crude oil prices, and the related set of prices that are cousins.

Overall demand for crude hasn’t shifted, and neither has supply. ?Yes, there has been some buildup of inventories, and some key global players refuse to cut production in response to lower prices. ?But the sharpness of the price move feels more like some large player(s) who were relying on a higher oil price finally hit their “stop loss” point, and their risk control desk is closing out the trade.

I could be wrong here, but paper barrels of oil trade more rapidly than physical shifts in net demand, and risk control and margin desks will force moves that are non-economic. ?Wait. ?Surviving is?economic, even at the cost of forgoing potential profits.

We’ll see how this shakes out over the next few months. ?There’s a lot of pain for pure play producers, and those that aid them. ?I particularly wonder at governments that rely on crude exports to support their budgets… they may not cut, but what will they do, if they don’t have reserves? ?Cuts will have to come from economic players initially. ?It make take a revolt to affect non-economic governmental entities.

All that said, sharp price moves tend to mean-revert, slow moves tend to persist, so be wary of too much bearishness here.

2) An article in yesterday’s Wall Street Journal was entitled?Bond Funds Load Up on Cash. ?This qualifies for the “Dog Bites Man” award, as it puts forth the conventional wisdom that interest rates must rise soon.

That drum has been banged so frequently that it is wearing out. ?We’re not seeing the pickup in lending necessary to convince us that the economy needs higher real interest rates so that more savings would be available to be lent out.

Also, some managers may be running a barbell, holding more cash and long debt, and not so many intermediate securities. ?This would be logical, because a barbelled portfolio does better in volatile markets — it’s ready for inflation and deflation, while giving up yield should times remain stable.

All for now. ?Maybe when my busy time is done, I’ll write about it.

It’s Their Money

It’s Their Money

Posted on by David Merkel

Photo Credit: Richard.Asia

Recently, I had a client leave me. I’m not sure why he did — I didn’t ask, because that’s his business. It *is* his money, after all, not mine. After deducting the accrued fee, I thanked him for his business, and wished him well.

I try to be low pressure in my work. I also try to discourage the idea that if someone uses my services, they will do better than the average, much less phenomenally. I remind potential clients of what happened to stocks in the Great Depression (down almost 90% during a period in 1929-1932). I ask potential clients to stick with me through a full cycle of the market, but I don’t require it because:

It’s their money.

One thing I do promise them is that my money is on the line in the exact same proportion as their money. Over 90% of my liquid wealth is invested in my stock portfolio. I don’t make any decisions for clients that I would not make for myself, mostly for ethical reasons. But I make sure of it, because I am still my largest client, and I am always on the same side of the table as my clients, aside from my one and only source of revenue, my fee.

It’s their money, but, when it is under my care, it gets the close treatment that my own money receives — no more and no less.

Many wealth/asset managers want as much of a client’s assets as possible. Me I get uncomfortable when more than 50% of their assets are riding on me, but if that’s what the client wants, I will do it if they ask, because:

It’s their money.

Jesus, inverting Hillel, said “Do unto others, as you would have them do unto you.” That guides my marketing, because I know that many people feel pestered by those who market to them, including those who once they have their foot in the door, now want the whole relationship. Thus I avoid as much pressure as possible in marketing, and leave it to the good judgment of my clients as to how much they want to entrust to my care, and for how long.

It’s their money.

I don’t pretend to have all of the answers, or even all of the questions. If one of my clients asks me an unrelated question, and I have the time and expertise to aid them as a friend (i.e., you can’t sue me), I will take some time to help. They may ask me about what other managers are doing for them, asset allocation, insurance policies, and other things also. I will give them friendly advice, without any other expectation.  I thank them that they are a client of mine — I try to end all of my client letters with that. In the end, I want them to be happy that they chose me to aid them, and to be happy when they leave as well.

That’s the way I would like to be treated as well — low pressure, transparency of services and fees, and alignment of interests with an ethical adviser who is a fiduciary.

Back to the beginning, aside from the client leaving me, the other reason I write this is all of the pitches I have been getting via e-mail, web, radio, etc., where I say to myself “How can they promise that?” “Doesn’t that break the ‘No Testimonials’ rule?” “Great to be selling advice and seminars — why not start an investment business and prove your theories?”

The investment business has more than its share of those who don’t deliver value, and I labor to be on the positive side of that ledger, as do many others. Choose those who will treat you as you deserve to be treated, and enjoy the benefits, because:

It’s your money.

The No-Lose Line

The No-Lose Line

Posted on by David Merkel

The No-Lose Line_14068_image001How long can you hold a Treasury Note or Bond, and not suffer a loss in total return terms, if yields rise from where they are today? ?Maybe the answer will surprise you, and maybe not — it depends on how fixed-income literate you are.

Okay, here’s the scenario: I start off with the current yield curve for 2-, 5-, 10-, and 30-year Treasuries (0.51%, 1.61%, 2.32% and 3.04%). ?I make the following assumptions:

  • Annual Coupon Payment at the end of the year (at the current bond equivalent yield)
  • The bonds are priced at par, so they are current coupon bonds.
  • They are new bonds with the full maturity to go.
  • Each year, the coupon payment is reinvested in bonds of the same type.
  • Each scenario is run until there is one year left to go. ?The rate in the last year is the total return earned in the scenario if the notes/bonds pay off.
  • I’m not considering inflation, so these will be real losses if inflation is positive on average.
  • Those that hold don’t need to earn any income, unlike insurers, banks, pension plans and endowments. ?We could do the same analysis for them, but the lines would look flatter, because they can’t afford to lose as much.

So, what higher yield rate on the bonds will make the total return zero as the years elapse? ?That’s what the above graph shows… so what can we learn from that?

For 5-,10- and 30-year Treasuries, a yield rate near 3.03% will hold the package to roughly a zero total return after 2?years. ?After 3?years, that same figure is around 3.74%.

As time elapses, scenarios above the lines would represent losses on a total return basis, and below the line would be gains. ?The path itself would matter a little, but?the latest position more. ?The graph can be used in another way also… if you have an idea of how high you think interest rates will go, you will have a have an idea of how long it would take to break even. ?Remember, if the Treasury is “money good,” you get it all back at the maturity of the note/bond.

Or, if you are holding bonds for a little while, if you think the stock market is too high, this can give you an idea on how long?to buy the bonds if you don’t want to take losses if you decide to reinvest in stocks. ?(Yes, I know… in a hard down market, you will likely be grateful that you held the Treasury notes/bonds. ?That is, unless the US Dollar is no longer viewed as a reliable international store of value… and then we will have bigger fish to fry.)

The main lesson: choose your maturity preference with care for slack balances that you don’t want to invest in risk assets… you get more yield as you go longer, but the longer bonds lose money more rapidly for a given rise in interest rates.

Final notes: the lines are a little cockamamie at the end — they aren’t wrong, but the economic scenario producing such a path of interest rates would imply very high inflation or capital scarcity — the latter would tank the stock market as well, at least in the short run, and the former might tank the dollar, or lead to a run in commodities.

Those scenarios are also unusual because they highlight how bond investors investing to a fixed term earn more reinvesting coupon payments in a rising interest rate environment. ?At least that is true nominally prior to taxes and inflation, but those are separate issues.

All for now. ?Thanks for reading.

Problems in Simulating Investment Returns

Problems in Simulating Investment Returns

Posted on by David Merkel
Photo Credit: Hans and Carolyn || Do you have the right building blocks for your model?
Photo Credit: Hans and Carolyn || Do you have the right building blocks for your model?

Simulating hypothetical future investment returns can be important for investors trying to make decisions regarding the riskiness of various investing strategies. ?The trouble is that it is difficult to do right, and I rarely see it done right. ?Here are some of the trouble spots:

1) You need to get the correlations right across assets. ?Equity returns need to move largely but not totally together, and the same for credit spreads and equity volatility.

2) You need to model bonds from a yield standpoint and turn the yield changes into price changes. ?That keeps the markets realistic, avoiding series of price changes which would imply that yields would go too high or below zero.?Yield curves also need ways of getting too steep or too inverted.

3) You need to add in some momentum and weak mean reversion for asset prices. ?Streaks happen more frequently than pure randomness. ?Also, over the long haul returns are somewhat predictable, which brings up:

4) Valuations. ?The mean reversion component of the models needs to reflect valuations, such that risky assets rarely get “stupid cheap” or stratospheric.

5) Crises need to be modeled, with differing correlations during crisis and non-crisis times.

6) Risky asset markets need to rise much more frequently than they fall, and the rises should be slower than the falls.

7) Foreign currencies, if modeled, have to be consistent with each other, and consistent with the interest rate modeling.

Anyway, those are some of the ideas that realistic simulation models need to follow, and sadly, few if any follow them all.

Back to RT Boom/Bust

Back to RT Boom/Bust

Posted on by David Merkel

On Thursday, November 23rd, I was recorded to be on RT Boom/Bust. The first half of it played that day, and the video of it is below:

We covered a lot of ground in a short amount of time. ?Here are the topics, with articles of mine that flesh out my thoughts in more detail (if any):

The second half of it played today on October 31st, and the video of it is below:

Here we talked about the following:

I really appreciated being on the show. ?Hope you enjoy the videos. ?Thinking fast is a challenge, and you can often see me trying to gather my thoughts.

My thanks to Erin, the producer Ed Harrison, and their segment producer, Bianca.

Full disclosure: long LUKOY, ESV, NAVI and SBS for clients and me

Book Review: Berkshire Beyond Buffett

Book Review: Berkshire Beyond Buffett

Posted on by David Merkel

Berkshire Beyond BuffettIt’s time to change what Warren Buffett supposedly said about his mentors:

“I’m 85% Ben Graham, and 15% Phil Fisher.”

For those who don’t know, Ben Graham is regarded to be the father of value investing, and Phil Fisher the father of growth investing. ?Trouble is, Warren Buffett changed in his career such that this is no longer accurate. ?Most of Buffett’s economic activity does not stem from buying and selling?portions of public companies, but by buying and managing whole companies. ?Buffett is the manager of a conglomerate that uses insurance reserves as a funding vehicle.

As a result, this would be more accurate about the modern Buffett:

Buffett is?70% Henry Singleton,?15% Ben Graham, and 15% Phil Fisher.

Henry Singleton was the CEO of Teledyne, a very successful conglomerate, and one of the few to do well over a long period of time. ?It is very difficult to manage a conglomerate, but Teledyne survived for around 40 years, and was very profitable. ?Buffett thought highly of Singleton as a allocator?of capital, though the conglomerate that Buffett created is very different than Teledyne.

Tonight, I am reviewing a book that describes Buffett as a manager of a special conglomerate called Berkshire Hathaway [BRK] — Berkshire Beyond Buffett. ?This Buffett book is different, because it deals with the guts of how Buffett created BRK the company, and not the typical and misleading Buffett as a value investor.

Before I go on, here are three articles that could prove useful for background:

The main point of Berkshire Beyond Buffett is that Buffett has created a company that operates without his detailed oversight. ?As a result, when Buffett dies, BRK should be able to continue on without him and do well. ?The author attributes that to the ethical values that Buffett has?selected for when acquiring companies. ?He manages to cram those values into an acronym BERKSHIRE.

I won’t spoil the acronym, but it boils down to a few key ideas:

  1. Do you have subsidiary managers who are competent, ethical, and love nothing better than running the business? ?Do they act as if they are the sole proprietors?of the business, and act only to maximize its long-term value consistent with its corporate culture? ?These are the ideal managers of BRK subsidiaries.
  2. Acquiring such companies often comes about because a founder or significant builder of the company is getting old, and there are family, succession, taxation, funding or other issues that being a part of BRK would solve, allowing the management team to focus on running the business.
  3. Do the businesses have sustainable competitive advantages in markets that are likely to be relevant several generations from now?

The beauty of a company coming under the Berkshire umbrella is that Buffett leaves the culture alone, and so long as the company is producing its profits well, he continues to leave them alone. ?Thus, the one selling a company to Buffett gets the benefit of knowing that the people and culture of the company will not change. ?In exchange, Buffett does not pay top dollar, but gets deals done faster than almost anyone else.

This is a very good book, and its greatest strength is that it talks about Berkshire Hathaway the company as built by Buffett to endure. ?If you want to understand?Buffett’s corporate strategy, it is described ably here.

Quibbles

Now, my three ideas above?*might* have been a better way to organize the book, rather than the hokey BERKSHIRE. ?Also, a lot more could have been done with the insurance enterprises of BRK, which are a critical aspect of how the company owns and finances many of the other subsidiaries.

But will BRK do so well without Buffett? ?Yes, his loyal son Howard will guard the culture. ?The Board is loyal to the ethos that Buffett has created. ?Ted Weschler and Todd Combs will continue to invest the public money. ?The all-star subsidiary managers will soldier on, at least in the short-run.

But will the new CEO be the person that “you don’t want to disappoint,” as some subsidiary managers think of Buffett? ?As a result, how will BRK deal with underperformers? ?What new structures will they set up? ?Tracy Britt Cool is smart, but will BRK need many like her, and how will they be organized?

Will he be a great capital allocator? ?Will he maintain the “hands off” policy toward the culture of subsidiaries, or will the day come when some centralization takes place to save money?

Will Buffett’s replacement be equally intuitive with respect to acquisition prices, and sustainable competitive advantage?

Buffett’s not perfect — he has had his share of errors with textiles, shoe companies, airlines, Energy Future, and a variety of other investments, but his record will be tough to match, even if replaced by a team of clever people. ?Say what you will, but teams are not as decisive as a single manager, and that may be a future liability of BRK.

Summary / Who Would Benefit from this Book

Most people will not benefit from this book if they are looking for a way to make more money in their life. ?There are no magic ways to apply the insights of the book for quick gains. ?Also, readers are unlikely to use Buffett’s “hands off” methods in building their own conglomerate. ?But readers will benefit because they will get to consider the building of the BRK enterprise from the basic principles involved. ?There will be?indirect benefits as they analyze other business situations, perhaps using BRK as a counterexample — a different way to acquire and run a large enterprise.

But as for getting any direct benefit from the book? There’s probably not much, but you will understand business better at the end. ?If you still want to buy it, you can buy it here:?Berkshire Beyond Buffett: The Enduring Value of Values.

Full disclosure:?I?received a?copy from the author?s PR flack.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

Full Disclosure: long BRK/B for clients and myself

Waiting to Buy

Waiting to Buy

Posted on by David Merkel
Photo Credit: Brett Davies || Waiting, but to what end?
Photo Credit: Brett Davies || Waiting, but to what end?

When I worked in the investment department of a number of life insurers, every now and then I would hear one of the portfolio managers say, “We know that the rating agencies are going to downgrade the bonds of XYZ Corp, but?we like the story. ?We’re just waiting until after the downgrade, and then we will buy, because they will be cheaper then.”

And, sometimes it would work. ?Other times, nothing would happen at the downgrade, and they would buy at the same price. ?But more interesting and frequent were the times when the bonds would rally after the downgrade, which would make the portfolio managers wince and say, “Guess everyone else was waiting to buy also.”

Now, there was a point in time where the corporate bond market was more strictly segmented, and getting downgraded, if was severe enough, would mean there was a class of holders that would become forced sellers, and thus it paid to wait for downgrades. ?But as with many market inefficiencies, a combination of specialists focusing on the inefficiency and greater flexibility on the part of former forced sellers made it disappear, or at least, make it unpredictable.

But so what? ?Bonds are dull, right? ?Well, no, but most think so. ?What about stocks? ?What if you want to buy a stock that you think is going to rise, but you are waiting for a pullback in order to buy?

In order to to get this one right, you have to get multiple things right:

  • The stock is a good buy long term, and not enough parties know it
  • The stock is short-term overbought by flexible money
  • Other longer-term buyers aren’t willing to buy it at the current level and down to the level where you would like to buy.
  • The correction doesn’t make quantitative managers panic, sell, and the price overshoots your level.

Maybe the last one isn’t so bad — no such thing as a bad trade, only an early trade, if the stock is good long term?

That’s one reason why I do two things:

  • I tend to buy the things I like now. ?I don’t wait. ?Timing is not a core skill of mine, or of most investors — if you are mostly right, go with it.
  • I pursue multiple ideas at the same time. ?If I have multiple ideas to put new money into, the probability is greater that I get a good deal on the one that I choose.

The same idea would?apply to waiting to sell. ?Maybe you think it is fully valued, but will have one more good quarterly earnings number, and somehow the rest of the world doesn’t know also.

Hint: do it now. ?If you are truly uncertain, do half. ?It’s tough enough to get one thing right. ?Getting short-term timing right verges on the impossible. ?Better to act on your strongest long-term sense of value than trying to get the short-run perfect. ?You will do best in the long run that way.

Risk Tolerance — The Ability to Deal with Loss

Risk Tolerance — The Ability to Deal with Loss

Posted on by David Merkel
Photo Credit: 401(K) 2012
Photo Credit: 401(K) 2012

No one knows their financial “risk tolerance” outside of the context of losing money. ?Part of the trouble is that risk and return are often described in the same breath as if they are inseparable, when they are more weakly related than most think, and certainly not linear.

Surveys, no matter how well-intentioned or -designed do not typically grasp the asymmetry of gain and loss. ?People feel losses much more acutely than gains, and are far more likely to change their behavior after losses. ?Can’t tell you how many times I have had people say to me, “I’m never buying stock again,” after 2000-2 and 2008-9.

Nothing can prepare you for the event of loss except prior losses. ?Those who have made it through losing money have coping strategies ranging from diversification to rebalancing to benign neglect, etc. ?The best look at it as a cost of doing business, and try to view it together with all other investment decisions made — there will always be losses, but were there gains as well, and more of them over the long haul?

Risk is best faced in prospect, and not retrospect: ask?yourself if?the current assets that you hold offer fair compensation for the risks that they have. ?Are they building value even if the market is not reflecting it yet?

I’m going to be starting a new irregular series at Aleph Blog, where I go through my past tax returns and pull out all of the blunders over the past 25 years. ?I hope it will be instructive to my readers in many ways, but perhaps the most important of those ways is that you have to get up and fight again if you have been knocked down. ?Don’t give up! ?If you leave the game, it is typically at the time prior to gains. ?Rather, ask whether what you are doing now is the right thing to do on a looking forward basis. ?The past is gone, and the only time to affect the future is now.

So look for the new series, and appreciate my packrat tendencies that I still have the records for these matters. ?Hopefully it will be fun, and particularly instructive for younger readers because I was young once too, and I started in this game as an amateur. ?I made a lot of mistakes, but I did not compound my mistakes by leaving the game.

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