Cathie Wood, her ARKK ETF, and your systems, processes, and behavior - how did you do?

Author's Note:  We do not use ARKK in our models

Given all the financial media piling on Cathie Wood's ARKK ETF, we thought it would be worthwhile to do  a retrospective on what the possibilities would be if we used ARKK in our models or if someone used ARKK in their portfolio.

When we ran our optimization, this was the result. ARKK had a run for 16 months that drove a lot of their returns.  However, the models soured on ARKK in April 2021. Note: Our model sensitivity is refreshed quarterly - the readings could have been, and likely were, different in 2021 where these results are most pronounced - this could result in better or worse results.

Results of our trend following model

The most amazing part of this isn't the returns as much as it is the start date of this risk on trade.  12/31/2019.  For some reason, everyone feels the need to compare their portfolio performance based on where the earth is relative to the sun.

In reality, you should be looking at your portfolio based on the date you made a decision to change it. ARKK delivered nearly 5x over the S&P500. In any event, this convenient timing created strong results over the S&P500.

Then reality came for a visit...

When you put the entire cycle together (and it isn't over yet).....ARKK still fails to be an outperformer.

Bottom line: We are not against the pursuit of finding a better investment for your money, but having a system and process that overrides your behavior to avoid huge downdrafts is the way to do this. Imagine if you didn't hear about ARKK or Cathie Wood until early 2021 after her blockbuster 2020 - you'd be in deep yogurt right now. It's not about a name or media hype, it's about your Net Worth and making the right decision at the right time - both buying AND selling. The best way to insulate yourself from risky behavior is installing systems and processes.

Market conditions change - the human condition doesn't

Markets change humans don’t, but you have a (not so) secret weapon

We are five months and counting into a market trending unfavorably.  It’s complicated to accept current market conditions when you look at our historically low unemployment rate.  The confusion compounds when you look at equally unfavorable bond performance.

We are in a battle between growing inflation pressure and slowing growth.  The smart thing to do is diversify, and then diversify the diversifiers.  Many will try to time the market and treat this as a “get in, get out” decision and only compound regrets.

The daily noise is loud with massive swings…up,then down, rinse and repeat.  The louder the noise, the harder to find the signals.  The world we live in doesn't change that dramatically from day-to-day.  Emotions do.  

Most people aren’t built for this treacherous, confusing  investing environment. And if you aren’t confused, then you don’t understand.  Side with those that admit it.  There are no experts, just cycles.

If you look at the 50 most volatile days in market history, 47 of them occurred when when the S&P500 was below the 200-day moving average.  While nobody knows how or when this will end, it is important to reflect on the fact that you can’t have the reward without embracing reasonable risks and losses along the way.

The purpose of a financial advisor is to help people be prepared for many unforeseen futures - not just in the markets, but other aspects of their lives.

So, after seven bad weeks, we have had a bit of a rebound.  Is it a head fake?  Head fake or not, what can be done to take advantage of the current, unfavorable conditions? 

If you are disciplined, you are likely doing fine by doing very little.  That said, there are some things that can make a difference, but not something you would see and feel immediately.  Progress happens too slowly to notice, while setbacks happen too quickly to ignore the temptation to act.  Here’s where to start.

Increase your savings rate and contribute more to the appropriate accounts. I can make the argument that many stocks and the market as a whole are still expensive, but they are less expensive that they were five months ago, and I don’t know when the market will rebound, so I’m willing to contribute to my accounts and take advantage of this Wall Street Sale, while other run for the door that were willing to pay when it cost them 15% more than today.  How does this help you?  Look at this chart from Ned Davis Research.  If you started buying close to the 2000 Peak, look what it did to your returns.

Manage your expectations. A well diversified portfolio over the course of the past 15 calendar years likely  has experienced two years of close to 0% returns, one decline of 6%, one 12% loss, and a 30% drop in their portfolio value.  However, over those 15 years, an 8% annualized return wasn’t unreasonable.

How many summers do you have left with your kids?  How many years of independent mobility do you have?

This market drama is a distraction.  It’s the price that long-term investors have to pay for the performance we have had since 2009. . You’ve got a front row seat and it has a price… if you’re willing to pay it.  Stock market history says it is in the long-term, but not everyone can and not everyone will be willing to pay.

We don’t live in 15 year increments.  Our attention cycle has a shorter half-life than milk.  We live in increments of today, and maybe tomorrow, and that means that is going to hurt and nothing hurts worse than pain.

If you can change your expectations and zoom out, what does this mean for you? Tell me your goals and timeframe as a starting point. If you don’t know what you’re trying to achieve by putting money at risk in the market, then how can you know how a particular market move might affect you?

So what’s going to happen next? I don’t know, but it’s likely less complicated than you think. With history as my guide,  human nature never changes.  We’ll see massive up days – where sellers melt away and stocks look like they’ve seen the worst. You’ll also see painful descents -  everything down and nowhere to hide.   These microbursts will go on for a while, until they don’t.   The damage will have been done, but a lot of potential opportunities get created as a result.

Who wins? The person who is disciplined, has a process, and does little.  Don’t be the human behavior that my models try to arbitrage - be on the side of capitalizing on detrimental human nature.

Buy with purpose and automate good behaviors.  With any market drop, Is this a 5 week pullback, a five month pullback, or a 5 quarter slog,  Begin by saying “I don’t know and that’s okay, because nobody else does”.  In doing so, realize you can’t go “all in” at once.  You have to ask humbly “what if I’m wrong”. You can automate and codify buying based on the calendar or  the price level.

Rebalancing is free and easy, but it only works, of course, if you have a target allocation in the first place.  The good news is you can do this any time.  Over time, rebalancing is the only way to buy low and sell high without guessing. Yes, stocks may go down further from here, but the beauty of long-term investing is that you don’t have to time it perfectly.  There is no prize for being first.

Take Tax Losses in some positions you own  may be below your original purchase price. If you sell these positions, you book a tax loss that can be used to offset capital gains either this year or in the future. You cannot buy the same security back within 31 days to avoid running afoul of the IRS wash sale rule. That doesn’t prevent you from reinvesting in something similar to maintain asset allocation disceipline. Sell a recent Amazon or Target purchase and buy a Large Cap index.  Sell a bond index purchase and replace it with a different type of bond.  Your tax losses are an asset. They will reduce your capital gains tax if you . harvest them.

Executing a Roth Conversion is best done when the market has dropped.  The tax owed on a ROTH conversion is calculated based on the value  of the conversion.  Why not convert more shares at a lower tax cost?  Ideally, the new ROTH will participate in the market’s recovery, resulting in a larger ROTH with less tax paid.  This isn’t about doing the conversion at an attempted timing of the market bottom.  It is about doing the conversion based on a lower lifetime tax impact at a level that you understand said impact.  This may be equally important for your parents to do if you don’t want a huge inherited IRA added to your annual tax bill.

There are other things you can do.  GRATs, Family Gifts to name a few.   But buy an income or  capital appreciating asset even if in the short term, it doesn’t work out.  The key is to remember - this too, will pass.

You know who could save you more in taxes than your financial advisor and accountant? Your Parents!

When I share stories with accountants, it’s interesting to me how financial planners struggle with client follow-through of tasks and accountants don’t.  Accountants have a few luxuries - government deadlines and immediate realized benefit from acting to name a few.  Financial Planners often have to balance functional jobs with emotionally charged life events that occur in times of life transition.  On top of that, planning often deals with no immediate benefit or urgency.  Often the functional jobs with low visibility add the most value heading towards the retirement glidepath.

Here is a story of a client where acting will save his estate several thousand dollars. I apologize for the amount of detail, but the tax math is important.

I have a client couple.  They are both 80, live in Florida, and have $2,000,000 in their IRAs and there are 4 siblings - three in Virginia, one in New York.   Kids are in mid-40’s.  All have incomes over $200,000, with two of them having incomes over $400,000.

The parents had a taxable income last year of $140,000.  

Some Key Tax Thresholds for context. 22% tax Bracket goes to appx $178,000; 24% Bracket goes to about $340,000 (Married Filing Jointly).  There is also a minefield of tax thresholds for Medicare and other things between 182,000 and 250,000.  More details later.  Here is what I am trying to anticipate and plan for.

Scenario 1:  Parents die tomorrow in a car accident

4 siblings get $500,000.  For illustrative  purposes, let’s say that the math pointed to taken out evenly - $50,000 a year for 10 years.  Let’s also assume no growth in the account over 10 years, so the tax estimates are likely understated.  Note:  Funds must be taken out within 10 years.

This $50,000 would be subject to the state income tax as well as the tax bracket that the kids were in.

NY Child:  6.85% + 35% = $20,925 in taxes per year x 10 years = $209,250

VA Child:  5.75% + 35% = $20,375 in taxes per year x 10 years = $203,750

VA Child:  5.75% + 32% = $18,875  = $188,750

VA Child:  5.75% + 24% = $14,875 = $148,750

$750,500 in Taxes on a $2,000,000 IRA.  This situation could actually be worse if your kids have a disability.  Their SSDI would result that for every $2 of inheritance, $1 of SSDI would become taxable (up to the SSDI limits).  Inheriting $40,000 a year, could result in $60,000 of taxable income.

Scenario 2:  One Parent lives to 90, One Parent lives to 95 (15 years) and they begin a series of micro Roth Conversions - $40,000 per year for 10 years.

This $40,000 per year would (1) avoid state income tax since they live in Florida, and (2) pay in a lower federal tax bracket by 2 to 13%.  So this move would save 7.75% to 19.85% annually and grow tax free.

Scenario 2:  $400,000 Roth Conversions pay $88,000 in taxes - 22%

Scenario 1:  $400,000 unconverted would pay $150,100 in taxes by the kids from the inherited IRA = 37.53%, a 70.5% increase over Scenario 2.

Scenario 3:  One client dies today.  Surviving spouse dies in 15 years.

In this example, beginning in year 2, the spouse will file as single and have lower thresholds for the respective brackets.

$140,000 Married Filing Jointly equals close to $70,000 Married Filing Jointly, but the IRA Distribution would be at $100,000.  When you add Social Security and other incidental income, the widow has a Taxable Income of $130,000.  IRA remains the same, less favorable tax brackets, lower standard deduction.

In short, the widow pays $27,246 on taxable income of $130,000.  While the couple paid $22,034 on $140,000 of taxable income.  $5246 a year in additional taxes and a Roth IRA conversion strategy for beneficiaries is likely not as viable, given her new income bracket.

Scenario 3:  $78,690 in additional taxes for surviving spouse.  Remaining IRA distributed to kids that could sabotage their retirement planning.  This could result in not qualifying for ACA Tax Credits ($12,000 per year until Medicare eligible) if you planned to retire early, IRMAA premiums, more of your social security taxable, and other tax adverse, income-triggered tripwires.

Not asking your parents to do a Roth Conversion is asking for a spontaneous, likely unfavorable, yet avoidable, tax reaction.  Even if you pay the taxes for your parents, you are still ahead.

Given this information, it may be worth it to trigger those minefields and still make out ahead.

Landmine 1:  IRMAA Surcharge up to MAGI (Modified Adjusted Gross Income) of $228,000 = $1929/year

Landmine 2:  IRMAA Surcharge for MAGI $228K to $284K = $4853/year

Landmine 3:  3.8% Net Investment Income Tax on MAGI Income over $250,000

Landmine 4:  24% Tax Bracket for taxable income over $178,000

In any event, the tax savings alone could be the equivalent of paying for college for a grandchild.  It wouldn’t be limited to gifting ceilings.  It could serve as an emergency fund for any medical catastrophes.  It can grow tax free.

Let’s also don’t forget how vulnerable this income could be to future legislation.  There is a clause in the Build Back Better Bill will hit some ultra high IRA’s harder = an 8% surtax.  You also want to be in a place where you can take advantage of any changes to itemized deductions which could change this whole equation if they change the limits on state tax deductions.

I share this because THIS is financial planning.  Saving a client and their spouse and children thousands, if not tens of thousands of dollars a year is something we can control.  How International Stocks do compared to the S&P500 isn’t.  Borrowing your parents tax bracket is creative and typically favorable to clients and their parents alike.  Seems that giving the government less is bi-partisan and transcends generations.

So rather than asking your financial team if you should do a Roth Conversion, ask them if your parents should.

Drop me a note if you found this article useful. Your situation may differ materially, so please discuss this strategy with your financial professional.

Best Money Practices: Part I, Savings Rate

The ingredients for a successful financial life are easy.  The chef and the recipe create a lot of non-value add, behavioral complexity which leads to a less than desirable meal.

The concept of investing for the long-term in a low-expense, tax-efficient, diversified portfolio so that compounding can take over is easy to understand.  However, humans are impatient creatures that compare and feel the need to tweak things that don’t need to be tweaked like a Major League Baseball manager running through his bullpen.

There is an expression in investing – “Don’t just do something, sit there.”  We suck at doing nothing.  We suck more when we do something.  The key is to find the right amount of “something” that balances the risk of loss and opportunity cost, when dealing with heightened uncertainty.

Markets don’t care about you.  Neither do traders, hedge funds, robo-advisers, or mutual funds.  They have no clue what your goals, time horizons, and risk tolerance are.

So what rules would I offer a public in need of a balance between structure and freedom that provides the emotional relief valve to investing?  I would start with savings.

“Save like a pessimist, invest like an optimist.” – Morgan Housel 

Savings Rules

Savings rate is the crown jewel of a successful financial life. True wealth originates with the absence of spending in the form of savings.  I really believe this starts with a mindset.  Spend what you don’t save, rather than save what you don’t spend.

·       The more you save, the more you have to compound.

·       The less you spend, the more you realize how little you really need

·       It is more fulfilling to attempt to save more rather than attempt to spend less

·       Savings goals, unlike many other elements of investing, are completely in your control

Savings goals are more forgiving than spending goals.  Once you miss your spending goal, you can’t really go back and “unspend” money.  However, with savings, if you have a short-term headwind that may make that savings goal less likely, you at least have the chance to save more later to offset the savings speed bump.

There are three levels of savings that everyone should automate and aspire to achieve.

·       Level 1:  Save enough in your 401k to achieve the maximum matching amount.

·       Level 2:  Save enough to fully fund all retirement and Health Savings Accounts.  Work with your advisor to determine where your next dollar of savings should go.

·       Level 3:  Save beyond retirement accounts so that you pay yourself as much as you pay in taxes.  I call this the Personal Freedom Index. 

If your Personal Freedom Index is greater than 1, then you are investing more in yourself than in the government.  Who wouldn’t want to do that?   By doing this through your working life, you should also avoid unsustainable lifestyle creep.  If for every $100 you make, $24 goes to taxes, and $24 goes to savings, that still provides a nice percentage devoted to paying off debt or spending on today.  If you don’t do this, your savings rate necessarily decreases and you will have a harder time making things work financially as you age.

Saving is the short-term intensity that takes out market volatility.  Investing is the long-term consistency that leads to the benefits of savings through compounding.  People underestimate the impact of these two forces because it happens too slowly for them to notice and seriously consider.

Whether it is savings, diet, or health, you pay for your good habits now, you pay for your bad habits later.  The cost of those bad habits compound.  The benefit of those good habits compound as well.

One disclaimer:  In any event, spend less than you earn doesn’t mean to skip out on purchases you can afford as a result of guilt, but recognize when you have approached mastery of savings, spending isn’t as fun.

If you are interested in calculating your Personal Freedom Index or other Financial Diagnostics, please reach out to me and let’s see if I can help. In the meantime, check out this table I created to give you an idea of how many months it takes, with a given contribution and return of 5% to reach various benchmarks. Here you can get a feel for the impact of compounding.

Understanding the Implicit Paradoxes in Investment Risk

We acknowledge that risk is personal and subjective by nature and thus the definition is as well.  Our species and our education system have a blind spot when it comes to risk and decision science mainly because it involves a math where we quantify uncertainty, rather than a fact like 2x2.

Risk is what’s left when you think you have thought of everything.  It’s magnified by the fact that nobody saw it coming - either the event itself, the timing, or the magnitude.  Risk management, when done right, is thankless - it isn’t sexy and really has limited utility to quantify that success.

Risk control is the best route to loss avoidance; conversely, risk avoidance, is likely to lead to return avoidance.   The paradox of risk comes to life in investment returns and just about anything - if you focus on what you lack, you will lose what you have and if you focus on what you have, you will gain what you lack.  So in that spirit, you have to choose your sacrifice - If you are not willing to sacrifice for what you want, what you want becomes the sacrifice.

Each investor has their own personal risk spectrum that must be explored to understand where that sacrifice can be minimized.

Here we offer some structure around the paradoxes to capture our interpretation of several on this topic to weave a unique perspective, with the hope of crystallizing your view on investment risk. 

• Take investment risks that consider the regret factor.  Make sure you won’t regret not taking the risk while simultaneously not regretting the risk when it doesn’t work out..

• Conversely, don’t take risk that prevents you from living the financial life you desire.  This cuts both ways - not just the risk associated with the  permanent loss of money, but also the opportunity cost of growth.

• The most dangerous risk may be expectations risk - when a gap exists between what you expect from market returns and what really happened, it can trigger behaviors that fuel greed or fear that can lead to compounding the risk you have already realized.

• Unnecessary risk, if experienced, can result in taking undesirable risks - any risk that you take that is greater than the risk you need to fulfill you desired life, is subject to experience risk that can be avoided without penalty.

• Investors have the right to change their timeframe and their benchmark to make their investments look as good or bad as they want.  Numbers have the right to say anything you want if you torture them enough.  When context is optional, you will only have cherry-picked facts, rather than a well rounded truth.

• Buying Bitcoin at $30,000 and selling at $40,000 is no less risky than buying Bitcoin at $60,000 and selling at $40,000.  It’s just that the outcome was different.

• As your wealth accumulates, you are faced with the strangest of risk paradoxes - having a low need for investment risk while simultaneously being able to absorb some of the worst losses ever experienced.  Likewise, if you liquid assets are just enough to scrape by, you may need more investment risk, while simultaneously being unable to absorb and experience risk events.

What do Forest Fires, Sewage Leaks, and Investment Portfolios have in common?

All will force you to pivot

My son recently completed an Advance Kayaking camp where he went through Class IV Rapids, over waterfalls, and had to demonstrate proficiency with some technical maneuvers like rolls.

During the camp there was a raw sewage leak in the James River - not ideal conditions for a kayaking camp unless Conjunctivitis is one of the certification prerequisites.

The camp made the decision to take the kids upstream so they could get their certification.  They spent a lot of time in a van, but they got the job done...they adapted.

While on vacation this year in Oregon, we were making our way from the high desert to the Oregon Coast.  The road we were going to take was closed earlier that morning because of a Forest Fires.

Luckily, we caught it early so we didn’t have to backtrack - but our plans to go to Crater Lake and some other sites were impacted.  We had to pivot and adapt. As a result, we got to see this…

My models rely heavily on Price and Momentum Trends. Some trends have ended, but that doesn’t necessarily mean news ones have started. Here are 3 examples.

This is the relationship between the Global Index and the Global Minimum Volatility Index. We are waiting to see which way the trend breaks - right now we are rudderless.

This is the relationship between Long-Term Bonds and Short-Term Bonds. Long-Term Bonds are currently in favor which goes against the media narrative. It makes you question everything - the model, the media, and the strength of our recovery.

Emerging Market Bonds, despite the recent political turmoil in China, remain favorable over the US Bond Index. However, it is sitting in a place waiting for a clear trend to develop as one doesn’t have a clear advantage over the other.

The bottom line is that life is about adapting and sometimes adapting is unexpected, on an inconvenient timeline, or not comfortable. However, adapting should be setting us up to grow and become less fragile and if you are lucky enough gain the benefit of some unexpected positive benefits. That’s true in life and in your investment portfolio.

Top Mistakes Investors Make - Mistake #1: Resulting

Image courtesy of Jack Butcher - Follow his work on Twitter @VisualizeValue

Investors often put the performance cart ahead of the decision process horse.  This is the path of least resistance since most advisors don’t offer clients a look under the hood.  Most investors don’t have the transparency, engagement, time, or curiosity, to learn about the decisions in their portfolios.  They do see the result, based on how their portfolio has done.

This result oversimplifies the decision made and masks the quality of the decisions, leading to the wrong questions and miscalculated judgements. This mindset can make you think that running a red light is a good idea.  Bad decisions can have good outcomes due to luck.  The converse is also true.

The ideal decision tool is one that creates the most gains, with the least risk exposure.  This result may not be as robust as one that just seeks the greatest gain.  It is also accompanied with the criteria that would be needed to change the decision that affects the portfolio.

Without context, results can be perceived as sub-optimal, even though it was the best decision in a world with several potential outcomes.  More importantly, it doesn’t allow you to have the deep, quality conversations with your advisor about what he is doing and why, and how that is considering your best interests and your unique circumstances.

There are several decisions in Financial Planning that go beyond your portfolio, that you have a lot more control over...finishing your estate plan and increasing your contributions are not a function of an Elon Musk tweet or a pandemic.

Some people need to have a narrative for every bump in the market which contributes to this outcome mindset, because we want to rationalize every market move so it feels less random.  The problem with that is that there are a lot of decisions that are contributing to one outcome you experienced, not all the possible outcomes that could have just as easily happened.  This is the element of luck. 

Developing the discipline to distill result quality from decision quality can help you determine what decisions to continue to pursue and which ones to re-evaluate.  This approach is less dependent on one’s ability to predict, and more about building a responsive, adaptive, and resilient approach to portfolio management around decision making.

How I Invest My Own Money

Transparency is the currency of trust.

How I Invest My Own Money  was recently released and I was compelled by the idea. What better way to strengthen that trust with clients than to show your own cards. One of the best questions you can ask when you are profiling financial advisors is how do they invest their own money. When you consider that 50% of fund managers don't invest in their own fund - that should raise red flags. I eat my own cooking.  I use the same approach for my portfolio as I do for my clients.

THE GOAL is the same regardless of who is investing. That said, we all have unique circumstances that give us unique definitions of wealth that deserve to be treated, uniquely. That goal is...

Can I do what I want, when I want, with my money?

This requires a thorough examination and diagnosis of your personal environment (age, kids, retirement wishes, savings) as well as your attitudes about money and risk.  Risk is both art and science.  It’s real and emotional at the same time.  It’s invisible until it’s not.  I have to understand my risk spectrum - my risk required, my risk desired, my risk tolerance, my risk composure, and my risk capacity.  An advisor should perform an MRI, a Meta Risk Investigation, so they can diagnose and prescribe, what is needed.

As Dr. Daniel Crosby says in The Behavioral Investor, “Humans are designed with dynamic risk preferences.”  My mission is to design a portfolio to support those preferences.

THE CONCEPT is that there are subsets in an asset class that at any time are more favorable than others.  I want to use analysis to determine the polarities between these subsets and know when to be in one subset or another.  I steer clear of targeting sectors (such as Energy, Financials, etc.) as you never know when political winds will shift and adversely affect decisions and lead to false reads in any modeling.  For the purposes of this article, I will call the subsets “Offense” and “Defense”.

MY STRATEGY is based on rules to identify evidence that there have been behavioral market shifts between subsets within an asset class.  I navigate these polarities to determine when to focus on gains and when to emphasize losing less, understanding that the rules aren’t perfect and the sensitivities are dynamic.

MY INTENT is based on an approach that lies at the intersection of process, behavior, and evidence.  I know at times this won’t work as expected and that sometimes, good decisions have bad outcomes (much like bad decisions can have good outcomes).  This is why I evaluate and fine tune my triggers quarterly to minimize future occurrences.

Process:  I have a transparent, rules-based process defined and I know ahead of time what will trigger a change.  I know what my next action is, just not when it will happen.  I perform retrospectives on trades for the duration of the holding period.  My performance timeframe has nothing to do with where the earth is relative to the sun.

Evidence:  The rules are based on creating a desire-able, but fully invested portfolio at all times.  The rules seek to own strong performers when the market is trending up and safe harbors when the market is trending down.  The evidence seeks to be right, not first, and find the more desirable subset at the time.  The rules are a function of the holdings representing the respective subset and the timing sensitivity.

Behavior:  This process and these rules are built around market behavior.  Therefore, I don’t want to sabotage the results with my own behavior.  Doing so would be the equivalent of trying to drive while wearing my glasses and my mom’s glasses.  Do I experience downdrafts?  Of course.  Knowing this consequence is likely to occur, I understand that maintaining a consistent allocation provides a cognitive back-up plan that minimizes regret in case the outcome is subject to more luck, government intervention, or skill.  This also gives me another form of diversification as I am managing a portion of my portfolio differently.  It serves as a better “what if I’m right” or “I knew I should have” line of defense that to be in or out of the market.  It makes my portfolio more anti-fragile.  As Nassib Taleb describes it:

...antifragile loves randomness and uncertainty, which also means— crucially—a love of errors, a certain class of errors. Antifragility has a singular property of allowing us to deal with the unknown, to do things without understanding them— and do them well...

...antifragility makes us understand fragility better. Just as we cannot improve health without reducing disease, or increase wealth without first decreasing losses, antifragility and fragility are degrees on a spectrum.

EXECUTION and Portfolio Construction begins by performing a Meta Risk Investigation (MRI) on our situation.  I start with finding my risk tolerance using Riskalyze (I can do this for you as well - if interested in learning your Risk Score, email me at jc at myfinancialstrategies dot com).  Riskalyze allows me to calibrate my appetite for uncertainty, given the associated risk/reward.  The higher the score ranging from 1 to 99, the higher my tolerance for a broader range of outcomes, both good and bad.  My risk score is a 60. The questions you get are kind of like a trip to the eye doctor.  You will get a series of questions with a binary choice between two outcomes - one being certain and one being a range, with each subsequent question getting a little more calibrated and precise, until we can see 20/20 on what your Risk Tolerance is.  This feeds into the rest of the risk spectrum.

Once I have the MRI results and my risk spectrum defined, I can determine how much of my portfolio should be in equities and how differently I should treat my taxable and retirement accounts.  I have three account categories that I treat differently due to tax implications, greater diversification, and risk posturing.

1. Taxable Brokerage - Taxed When Sold

2. Retirement - Buy and Hold (Strategic)

3. Retirement - Buy and Mold (Tactical)

My Taxable Account is 48% Stocks, 52% Tax Exempt Muni’s which provides a risk score of 45. I want to balance maximizing liquidity and minimizing taxable events.  I undershoot my risk score and I rebalance with my contributions or distributions using percentage cost averaging and tax sensitivity.

My Buy and Hold Retirement Account has a risk score of 62, whereas my Buy and Mold Retirement Account has a risk score range of 50 to 69.  Using both approaches, along with taxable account, provides me with a 3-D view on investing 

(1) Dynamic Risk Preference with a measured relief valve

(2) Diversified by Strategy and Asset Class

(3) Disciplined with rules around behavioral inflection points, process, and tax sensitivity 

Buy and Hold is placed as close to my risk score as possible (in this case, 62). It is important to re-emphasize that my risk score doesn’t mean I need that much risk. I may be able to do everything I want in life with less risk. It may be more risk than I can afford to take, but it is a good place to start in defining that full risk spectrum. This is where the value of an advisor comes in to facilitate this conversation.

Morgan Housel offered the following in The Psychology of Money about taking more risk that what you need

To make money they didn’t have and didn’t need, they risked what they did have and did need. And that’s foolish. It is just plain foolish. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.

For some people, this is enough. For me, I want additional diversification with a complementary strategy that provides a dynamic risk adjustment.   Enter the Buy and Mold Retirement Account  which recognizes the importance of staying invested, the value of a rules-based process, and understanding that I am an emotional human, not a rational spreadsheet.

Buy and Mold is the result of a cocktail of ideas from Lawrence Hamtil, Corey Hoffstein, Meb Faber, and Daniel Crosby.

The key is to:

(a) stay invested, 

(b) realize we are emotional creatures, and 

(c) maintain process discipline.  

I do this by following relative market trends between two subsets within the same asset class within the constraints of asset allocation and risk sensitivity.  Let me use an example.

Lawrence Hamtil uses a “barbell” strategy of using factors together, like a balance between a Momentum Index and a Low Volatility Index.  The results are attractive.  Essentially, he is owning my Offense and Defense simultaneously.

In contrast, I use a “seesaw” approach.  The seesaw approach owns either the Offense or Defense subset, depending on the relative trend between the two. I will look at the two holdings on a relative basis weekly and make any adjustments to the sensitivity quarterly. I do this across nine asset classifications, as I detail below.

How does relative trend work?  For one of my nine subsets, I use the ETF symbol MTUM for offense, and I use USMV for defense.  

In the graphic below, when the red line is above the black line, I own offense. When the red line is below the black line, I own defense. Given that I have to wait for enough data points, this calculation actually begins on 9/9/2013. Over nearly seven and a half years, this generated 21 trade signals between subsets of the broader index. What would those 21 trades “buy”?  The backtest is the result of switching between Offense and Defense when the red and black line cross.

On a smaller scale, here is how one fortunate cycle worked out.

Between 2014 and 2016, the line is much flatter so the results aren’t as robust in that timeframe,  but that is part of the process where skill could not be distilled from luck….welcome to investing. The goal is to make good decisions that result in good outcomes. Having good outcomes from bad decisions may feel good in the short term, but could create a false sense of security going forward with an eventual, emotional 1-2 punch of greed and regret.

NOTE: This one sliver of a portfolio is offered for illustrative purposes only. This is not investment advice and past performance may not translate to future results. My goal in sharing my process is to build trust, awareness, and understanding.  When you look under the hood, everybody wins.

This may not be aligned with you philosophically or emotionally. This is one reason that your conversations with your financial advisor are a vital part of the investment process. If that is the case, don’t try this.  

I repeat this across the following asset classifications. For each Asset Classification, the first index is Offense; the latter is Defense.

Asset Classification:  Offense vs. Defense

U.S. Equity:  Momentum vs. Minimum Volatility

U.S. Equity:  Large Cap vs Small Cap or Equal Weight

Global:  Index vs. Minimum Volatility

International:  Momentum vs. Minimum Volatility

Emerging Markets:  Momentum vs. Minimum Volatility

Fixed Income (Duration):  Long-Term vs. Short-Term

Fixed Income (Issuer): Corporate vs. Government

Fixed Income (Quality):  Junk Bond vs. Investment Grade

Fixed Income (Nationality):  Emerging Markets vs. USA

How does this change my risk? 

By switching between Offense and Defense, my risk score will fluctuate, even though my asset allocation does not. Here is the individual holding risk scores for the Offense and Defense that I just illustrated.

Offense, MTUM 

Defense, USMV: 10 points lower risk, but still full invested.

The same concept works for bonds

Offense, ANGL - Junk Bonds

Defense, QLTA - Investment Grade Bonds, 18 points lower, but still invested.

When I look at the trend with each Offense and Defense subset, this is where I found my personal peace in investing.  I have an anchor with my risk tolerance and the slack in my rope gives me some grounded, but rules-based behavioral freedom when the winds or the currents shift. It also is reassuring to know I am diversified by strategy as well as asset class.

I hope you have learned something from sharing these details.  If you have, feel free to share your learnings with others and  I welcome the chance to discuss them further with you.

Is your savings rate a slow oxygen leak in your portfolio?

A seemingly uneventful flight from Orlando, Florida, to Houston, Texas on October 25, 1999, captured the nation for a few uncertain hours when the unthinkable happened.

U.S. Open golf champion Payne Stewart boarded a Lear Jet along with the flight crew.  Stewart was a three-time major champion who was known for his fashion of ivy caps and knickerbockers, combined with his NFL sponsor where he wore the colors and logos of their teams.  Payne won the title one year after giving up a four stroke lead in the 1998 U.S. Open.  Payne won the title against a gracious Phil Mickelson.  For Payne, it was redemption from his 1998 result.  For Phil, it was a missed opportunity to gain that elusive first major, but he couldn’t have been happier for Payne and his family.  The U.S. Open is held on Father’s Day weekend each year, so the event is as much about the winner’s family as it is the winner himself.

As the twin jet climbed up to cruising altitude, something didn’t happen.  The cabin didn’t pressurize. The crew lost consciousness and didn’t respond to Air Traffic Control. The Air Force scrambled jets as the plane continued off course to the northwest.  

When I was in the Naval Aviation Training, they told us that a slow pressurization change was actually more deadly that a rapid change.  A rapid change was easier to notice and mitigate, but a slow change just resulted in slowly having less oxygen until you become lethargic, then unconscious, and die.  The entire crew died of hypoxia before the plane crashed in South Dakota. 

That slow change resulted in Payne Stewart’s death.

Slow leaks happen everywhere with our day-to-day life behavior, including investing.

Annie Duke’s recent brilliance, How to Decide, revealed some statistics about those that belong to a gym that I have always been curious about.  82% of gym members go to the gym once a week or less.  77% of that 82%, don’t go at all.  80% of gym members that join in January, quit within five months.

At the gym and in investing, our cultural affirmation makes complacency acceptable – it’s not.

Social media and instant gratification are the slow, hypoxic behavioral link to not becoming fit or not achieving wealth.  When we attempt to keep up with the Joneses, we show that when we aren’t willing to sacrifice for what we want, what we want becomes the sacrifice.    

The slow leak in our plan starts with our savings rate.  Let’s say you make $138,000 a year and you contribute 14% to your 401k.  Then you get promoted and a raise, and make $150,000.  With the restrictions on the 401(k) maximum, you now can only contribute 13%.  On top of that, you now have additional cash flow later in the year thanks to the Social Security cap.

So if you don’t save this additional windfall (not to mention some of your actual raise) – you are introducing $2238 of lifestyle creep at the same time that you are saving at a lower rate.  Repeat this for 10 years at a 5% return rate, that isn’t just $28,150 in savings opportunity cost, it is also $22,380 in lifestyle creep…$50,530.

This number is likely somewhat understated if you continue to get raises.  That 401k percentage will continue to go down.

It’s one thing to spend your raise. It’s quite another to combine that with decreasing your savings rate.  It is unintended compounding that likely has contributed to the middle class squeeze. Adding to your savings reduces uncertainty and is not subject to counterfactuals. Many say you should try to save half of your raise.  That is a good place to start the discussion.

People with money are like labrador retrievers with food - you may not be hungry, but you still want to consume now because it is emotionally pleasing.

Accomplishment predicts self-esteem and intrinsic reward more than shallow participation trophies. The investing process is slow, continuous, invisible, and intangible.  This slow pressurization as we look to get the desired cruising altitude of life doesn’t get noticed.  Conversely, we recognize when the oxygen masks of investment pain come down immediately.

My job as an advisor is to attempt to connect with my clients in a way that will influence better behavior.  I want to make these good behaviors more noticeable and pleasing. I want them to notice the pressurization and oxygen levels.

Here are four concepts I am currently experimenting with in an attempt to provide a metric that is sensitive enough to measure progress .

Life Time Savings: Lifetime Income – this will provide you a good view of how compounding is working.  Technically, it is impossible to save more than you make, but if you are saving and investing well, then you can get this number over 1.

Freedom Ratio:  Annual Savings/Annual Taxes - are you depending more on the government than yourself in the future?

Wealth:Spend Ratio – Ideally, you want this number to stay over 30 for your retirement.  Before retirement, we should monitor how this number is trending.  If you intend to retire before 65, this number should be higher (if you retire at 60, this number should be 35).

Savings Rate:  Tracking this over time relative to income is a good way to see how our behavior is keeping up with our income changes.

These metrics can be socially rationalized with 401k matches and home equity.  Those adjustments to make you feel better may let you better monitor the oxygen in the cabin, but may also result in you settling for a lower, less efficient cruising altitude to get to your destination.  Higher altitudes will allow you to capture the tailwind of compounding and let you get to your destination faster and with less fuel.

James Clear in Atomic Habits discusses how our good habits cost us now and we get the dividends later, while our bad habits are satisfying now, but cost us later.  He discusses how we chase pleasure and that our emotions drive our behavior.  Probably most importantly, he says that we can only be rational and logical after we have been emotional.  Self-control is difficult because it is not satisfying.

The metrics I shared earlier are my way to make those habits using James’ four characteristics to good habits:  Obvious, Attractive, Easy, and Satisfying.

Bad or complacent saving habits are slow depressurization that lead to financial hypoxia.  Good habits ensure you have enough oxygen for the entire journey.

Is Shame part of your Asset Allocation?

I talk with clients about Money as a function of their Behavior, their Expenses, their Risk, and their Taxes over time.  Danessa Knaupp in Naked at Work:  A Leader’s Guide to Fearless Authenticity eloquently simplified this with what she learned from tennis instructor Tim Gallwey.

Performance = Potential - Interference

Interference can be internal or external, real or imagined.  ~ Danessa Knaupp

This holds true for your wealth and your investments.  External interference can be taxes or a pandemic.  The stories I get from my clients surrounding this pandemic aren’t about money.

Postponed weddings                                                        Cancelled vacations

Impact to their small businesses                                   Virtual graduations 

Rescinded job offers                                                         Constrained Healthcare Access

These are painful experiences, but the pandemic has allowed us to experience unique and unexpected adversity.  However, they have also afforded us to be human and authentic...to let our guard down collectively to connect. 

These stories are shareable because there is no blame and there is no shame.  

Internal interference is often described in the financial world as fear, envy, or greed.  The interference I want to focus on today overlaps with the behavioral aspect of money.  Danessa confronts what many of us won’t publicly or even reflect on to ourselves...shame.

Past performance is not indicative of future results is something that holds true for real assets.  However, shame is a certain cost.  It is an emotional tax on your investments.

We pay the cost of shame in installments over time. - Danessa Knaupp

The reason your neighborhood Facebook page or Next Door membership has lots of people looking for plumbers, electricians, and tree removal is because there is no shame involved.  Issues happen in all of our houses.  It’s transactional.

However, you rarely see someone looking for a financial planner because money invokes a feeling of shame, either because you need a financial planner because you are struggling OR you had a failed relationship with another planner.  Even when this isn’t so, you are letting everyone know you have a money issue.  It’s a perceived admission of defeat.  It’s personal.

The reason we hold on to a stock that has lost 80% of its value is because it is an admission of defeat.  It’s a type of shame.

My business integrates investment management and financial planning by being evidence-based, process-centric, and behaviorally sensitive.  Thanks to Danessa, my epiphany on the role shame plays in attracting new clients and overcoming behavioral challenges with existing ones is simple.  The perspective that I can offer may not be to offer something new, but more importantly, to remove what’s in the way.

Shame focuses on the precedent of past performance, like in the Great Financial Crisis.

Shame paralyzes because of the fear/admission of failure and rejection, and the potential of future shame.

Shame has a cost, both past and future.  Avoiding shame creates an illusion of control.

Rejection—and the fear of rejection—is the biggest impediment we face to choosing ourselves. - James Altucher

I have seen the stock market misbehave...a lot.  I have seen the links between market performance, economic data, and political affiliation result in laughable forecasts vs. actuals.

One concept we discuss in investing is “regret minimization”.  To do this effectively, it means to understand what amount of stock market exposure is required vs. desired.  That gap can produce regret, but with proper awareness, it can prevent shame.

Maybe the financial planning needs to confront shame as boldly as Danessa.  Shame minimization would likely lead to better active decisions.  Daniel Crosby in The Behavioral Investor offers this:

Conservatism status quo boils down to regret aversion - one would rather lose with inaction than have the possibility of winning.  A rules-based system is the best way to avoid the paralysis between these two paths.

Danessa introduces the concept of getting lost on a venture and you come to a map that says “You are Here”.  It doesn’t say “You were here” or “You should have gone that way”.  It affords you the opportunity to do a course correction and back on track.  Often your memories are stories that simploy need to be re-assessed and re-framed.

James Altucher builds on this point with this:

Most people obsess on regrets in their past or anxieties in their future. I call this “time traveling.” The past and future don’t exist. They are memories and speculation, neither of which you have any control over. You don’t need to time travel anymore. You can live right now.

Advisors should look at new opportunities and circumstances as a chance to say “You are Here”, and let me be the Mountain Guide who can get us where we need to go and not let them bring shame in their backpack. 

Stocks in an investment portfolio shouldn’t be bought with the currency of shame.  Shame is an imaginary debt that can slow growth in yourself and possibly in your investment portfolio.  Stock market behavior combined with emotional investors with memories of uncomfortable losses can lead to “shame inflation”.  A portfolio should be built about choosing your authentic self rather than having the markets choose you.

Good news!  You can create a new story and portfolio for yourself.  Building a portfolio with assets  that work closely with others, while accepting vulnerability and risk is authentic investing.  You can choose if investment risk is a rational temporary setback or if shame is a permanent part of your asset allocation.   

Footnotes:

(1) Tim Gallwey was a point of focus on Michael Lewis’ podcast “Against the Rules” - Season 2, Episode 3

(2) Danessa had a recent discussion about her book on the Suburban Folk Podcast, Episode 37

Frustrations in Interpreting an Implicit Crisis - Part II

In Part I, I discussed why this is hard.  Today, I want to address this from the perspective of elements of your wealth where the difficulties are becoming evident.  Wealth to me is having the freedom to enjoy your money, experiences, relationships, and time the way you want to.

Time keeps on ticking, but who called timeout?

The Coronavirus has made life feel like a Ferris Wheel.  It takes forever to get off because you can only get off at the bottom and you wait for everyone else to get off and you sit there...and wait.

There is a lot of neuroscience for why there is so much anxiety.  The reason time is dragging has as much to do with (a) we are experiencing something new - think of kids, and (b) we are grieving the loss of our definition of normal.

Relationships are interesting given the stay-at-home orders than many are living.  Domestic violence is up here.  Divorce is up in China.  We are all a little too close to the ones we should want to be closest too.  However, I have had some other interesting observations.  

Who are the children? Who are the adults?

Parents are doing their best to still work from home and teach from home simultaneously.  The spectrum of approaches range from laissez-faire to gung-ho.

The consequences are part of this implicit crisis.  Our kids thrive on structure, freedom, cadence, and chemistry. We depended on teachers for this academic framework.  Without it, I see kids having to live like adults, while simultaneously I see adults acting like kids.

There are unattractive components of adulting such as taking care of yourself (the gym, your diet, work, cleaning, taxes).  Parenting is just another element to adulting and with all activities “outsourced” to parents - every teacher, every Tae Kwon Do instructor, every church youth group, is essentially giving parents “homework” on top of their normal responsibilities.  We used to be Uber to get our kids to their activities.  Now we are planning, preparing, executing, and evaluating our kids...non-stop.  Simultaneously, we are co-mingling our personal and professional lives with no natural breaks on our calendars.

It can seem as hopeless as Jimmy Carter getting re-elected.  It’s easier to defer responsibility, and many do.  The unfortunate part is that people are passing this on to their kids.  The kids then have no role models for how to “adult” - thus extending adolescence not just on the front end, but the back end as well.  Virtues are dismissed.

When you have an overwhelming life rather than a simple, essential life - your task list becomes another source of anxiety and everyone is adding to your list.

Responsibility should be more rewarding than freedom.  Freedom is superficially glamorous, but ultimately unfulfilling. It’s like a trip to Sweet Frog.  You can feast on a buffet of overpriced yogurt and sugary toppings, but it’s a bunch of empty calories that you don’t really need.

Our unprecedented, yet fragile, prosperity has a consequence: the generation coming of age is stuck in a hazy, extended adolescence, never allowed simply to be children, and yet also rarely nudged to be fully adult.  When I was 16, I was mowing yards and working at Disney.  I rarely see kids performing tasks or working these days.  Now these generations are facing a crisis and looking to each other to lead...not good.

We rationalize and embrace degeneracy and avoid growing up. Our “adulting” culture worships happiness over fulfillment - kids age fast and adults mature slowly.   

Good adulting offers the ultimate wealth to others -  structure to succeed, the freedom to pursue a vocation, the wealth to nurture your community, and the wisdom to raise the next generation.

A life well-lived demands we lean in to responsibility. We should drop the freedom from mindset and welcome the freedom to learn, the freedom to work, and the freedom to tackle meaningful challenges. Otherwise, coming-of-age Americans will float without direction, drifting like a rudderless sailboat.   It’s limiting challenges rather than challenging limits.

In the end, until we can restore a true childhood, we will feed a culture of adultish children and childish adults.

Navigating Facts, Truths, and Outcomes regarding our health, our government, the media, and our economy

As I continue to read about the backdrop to the simultaneous and polarizing dilemmas between the economy and the pandemic, I have come to the conclusion than the science is scarier than the math, but the government is scarier than the science.  

Equally as conflicting is that if the Coronavirus is as dangerous as they said, then we can’t lift the lockdown until we have achieved herd immunity. But we can’t achieve herd immunity until we lift the lockdown.

I tried to model where this conflict is coming from.  My first model was to see all the different perspectives that reside in our current world view.  I posted this picture.  Quick!  Which number represents your views one month ago, two weeks ago, and today?

The second model was to try to understand where the gaps were in those different perspectives.

These models heightened my awareness and understanding of different views and appreciate where those degrees of difference exist.  As George Carlin once said talking about state license plates.  “Some people are like New Hampshire - Live Free or Die.  Others are like Idaho - Famous Potatoes.  I would like to think I’m somewhere in between.”

 Money

Try this exercise.  Look at your credit card spend from 3/15 to 4/15 for 2019, then repeat that for 2020.  Our family spending is down 31%.  Multiply your reduction in spending by 128 Million Households, and you’ll get the idea of the impact on the economy and thus experiences.

Summary

Covid-19 has impacted our wealth.  It has impacted our money, our experiences, our relationships, and our time.

The impact to our lives has been something unthinkable six months ago.

The math on cases, deaths, and growth rates has been scary.  The science on asymptomatic carriers and how contagious it has been has been scarier.  The only thing that has “trumped” that has been the reaction of our government.  We are clearly not all rowing together.

This impact on our wealth and our ability to live the way we envision wealth is beyond frustrating. Wealth is typically about trade-offs like time and money. During this transition to a new normal, all elements of wealth feel weakened. Now we must hope that the we can recognize when the light at the end of the tunnel isn’t just another freight train, but an actual path for our wealth to grow again

The Frustrations in Interpreting an Implicit Crisis - Part I

Your routines have been abruptly halted. Your systems have been transformed, and your behaviors and the behaviors of others have a unique, unprecedented, and invisible dependency.  The actions and inactions of our government and our neighbors have made you question what is right and what role our government plays in this situation. The flow of information and misinformation doesn’t make this any easier.  This directly influences the four components of your unique definition of wealth: Money, Experiences, Relationships, and Time.

We are all sorting through the chaos and trying to give some deliberate thought to how to re-establish routines in an environment where our personal and professional domains have been co-mingled.  I need time to organize my kids so I can give them the structure, freedom, cadence, and chemistry needed to succeed. I need time to figure out my day now that I no longer go to the gym at 330 am (i miss my pool). I need time to figure out when I will read, work out, work, be a dad, be a husband, and hopefully not all at the same time.  This is our current reality.

The fact that a book has been written called The Ostrich Paradox:  Why We Underprepare for Disasters, probably tells us that this was inevitable.

Why is this Hard?

Daniel Kanheman has written in the past about situations that cloud our judgement.  The key attributes include: 

A Complex Problem

Incomplete and Changing Information

Changing and Competing Decisions

High Stress and High Stakes

Must Interact With Others To Make Decisions

If that one doesn’t connect, maybe this will.  Daniel Crosby feels there are four items that prevent us from making good decisions:

See benefits now and costs later

Decision is made infrequently

Feedback is not immediate

Language is unclear

Finally Michael Mauboussin says that the a recipe for stress includes the following:

Lack of control/predictability

Loss of outlets to let off steam

Perceive things are getting worse - contributes to a crisis of confidence

All three psychological artists are painting a different picture of the same environment that we are all experiencing today.

While we need to find ways to simplify, structure, and add routines to our lives.  We must also look for clear and collective direction.

Social Distancing is not a Behavior - it is a Characteristic

I find the implicit nature of defining “Social Distancing” creating more problems than it is solving.  If I were to ask 10 people what the definition of Social Distancing is, I would get 10 different answers - none of them wrong as we have tried to oversimplify direction and all we have done is added to the complexity.  Then we have those that are totally neglecting the concept all together or at least that is the way it is presented - think of all the crowded beach and Disney World pictures you have seen.

Dr. Price is a Pulmonary Doctor in New York City.  He has tried to convey what others are failing at. This is what we need to do to protect our family.

Doctors are torn.  Their labor of love seems unappreciated as they feel the rest of the country isn’t taking this seriously.  They also feel obligated to educate an audience willing to listen. It isn’t the oversimplification of “social distancing”.  Here is what Dr. Price asks us to do.

1. Sanitize your hands after all transactions - the elevator button, the mailbox, the credit card swipe

2. Don’t touch your face - if wearing a mask creates awareness to prevent it, do that.

3. Don’t spend time indoors with those outside your immediate family for more than 15 minutes and only if absolutely necessary.  Don’t invite others in your house.

4. Reduce your social circles - we need to avoid co-mingling.  We are only as strong as the weakest link.  It’s not about if you trust Jimmy. It’s about whether you trust Jimmy’s neighbor’s mom who smokes two packs a day because you think you are “only spending time with Jimmy” but Jimmy is spending time with others and Jimmy is making your social circles - both social and professional, larger and more vulnerable.  Conversely, are you making Jimmy’s neighbor’s mom vulnerable from your required professional socialization due to the high amount of asymptomatic carriers? This concept has been called edge carriers.

Those that are doing all they can to isolate are necessarily frustrated and feel their efforts are being marginalized by those that aren’t, but this is what happens when we use an implicit definition.  It doesn’t matter if it is “Be Good” to your kids or “Be Compliant” to a Financial Services Company. You have to show the behavior and attributes, not state the characteristic you are aiming for. If you cancelled your daughter’s birthday party three weeks ago, but see the family across the street with 15 people in their house last weekend, your efforts have been cannibalized.

Our Government, Our Economy, and Our People

I think we are all torn on what our government’s role is here.  I am struggling with three concepts:

1.  Ben Franklin - “Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety.”

2. James Franklin - “If you are not willing to sacrifice for what you want, what you want becomes the sacrifice”

3. John F Kennedy - “Ask Not What Your Country Can Do for you, ask what you can do for your country.”

We are struggling to understand government’s implicit role with this on top of the implicit concept of social distancing.

Ben Franklin’s quote is the most absolute, but “essential” is the key word.  The beach isn’t essential, neither is the NCAA Tournament, or a trip to Disney.  What has others concerned is a word that is missing in Franklin’s quote. That word is temporary.  You could argue that opening Pandora’s box is a dangerous precedent.

Balancing the medical, government, economic, and civil rights side of this is not easy.  The best thing for me is to consider that by giving up my liberties voluntarily now, I am affording others the liberty of a longer life.  I am affording myself the right to get those liberties back sooner. I am helping small businesses open sooner. I am not providing the government a weapon to control our lives any more than they already do.

I feel by doing this, I am asking what I can do for my country.  I am showing that I am willing to sacrifice for what I want so that what I want doesn’t become the sacrifice.  I am giving up non-essential liberty temporarily on my own accord to prevent the government from making that choice for a longer timeframe for me.  Unfortunately this is subject to all Americans and all of mankind rowing together as Pope Francis recently offered us in his words.

“We were caught off guard by an unexpected, turbulent storm. We have realized that we are on the same boat, all of us fragile and disoriented, but at the same time important and needed, all of us called to row together, each of us in need of comforting the other”

The absolute lack of leadership is showing.  Leadership is not calling for us to row together.

Economically, The New York Federal Reserve published a paper that stated that the sooner that preventative measures are indoctrinated, the better it is for the economy.  Their summary states:

   "We find that cities that intervened earlier and more aggressively do not perform worse and, if anything, grow faster after the pandemic is over. Our findings thus indicate that NPIs not only lower mortality, they also mitigate the adverse economic consequences of a pandemic."

This drive me to inaction so I can get the economy rolling again.  We can argue about how different the world is today than in 1918, but I am willing to give it the benefit of the doubt as the authors did.

Our Collective Mindset

The problem with our mindset I have found is that many feel they are “stuck at home” rather than “safe at home”.  Some don’t consider either and they aren’t concerned at all.

"All of humanity's problems stem from man's inability to sit quietly in a room alone" - Blaise Pascal 

Another issue is that we “Default to Truth” as Malcolm Gladwell calls it in Talking to Strangers.  Default to truth is when we have an operation assumption that the people we are dealing with are being honest.  In this case, it is the federal government. Gladwell also discusses the illusion of transparency - where people believe they can make sense of people through their behavior and demeanor.  This is compounded by not understanding the importance of the context of which someone is operating. This applies to our government and our neighbors. I may have a 30 year old neighbor who isn’t worried about getting sick and continues with his daily life without self-chosen change.  That is his context and it is likely correct. My mindset may be the same, but it also considers others and it considers the economic impact and the impact on our liberties. Neither is wrong, and thus the implicit frustration we are all feeling, but it prevents us from rowing together.

Doubts are not the enemies of belief, they are its companion.  

Default to truth becomes an issue when we have to choose between two alternatives - one of which is likely in our minds and one which is impossible to imagine.  We start by believing and we stop believing only when our doubts and misgivings rise to the point where we can no longer explain them away.

We have seen these mindsets before with judging others - it’s how Chamberlain viewed Hitler.  It was how Penn State judged Sandusky. With few exceptions, we can’t understand how so many missed this.  It’s frustrating but you have to do your part and try to help others see things differently, but define the line so that you don’t get frustrated.     

From Scott Adams:

If your view of the world is that people use reason for their important decisions, you are setting yourself up for a life of frustration and confusion.  You’ll find yourself continually debating people and never winning except in your own mind. Few things are as destructiving and limiting as a worldview that people are mostly rational.

This Extraordinary Time requires Extraordinary (In)Action but that isn’t how Americans think

Ted Anthony offered his analysis in this AP News piece.

Americans prize concrete ideas  - that’s why they give Buckeye football players stickers on their helmets; fighting the minute and invisible coronavirus is too small and abstract for our brains.  This is compounded by our obsession with outcomes (stickers for voters, kindergartners, and Buckeye football players). On the contrary, this is about establishing and adjusting systems, processes, and behaviors.

We are conditioned to fight and not stand down.  Now, the best way to fight is to stand down. “We think if we fight hard enough and use sheer willpower and outmuscle it, then we’ll conquer it. But that can cause us to ignore wise advice from experts,” Van Tongeren says. “If we think of this as an enemy we might have to outsmart instead of outmuscle, then we start to think differently.”

Those are important questions for Americans: How to recognize that outsmarting might work when outmuscling can’t? And how to rebrand the act of, well, not doing things as an expression of resolute commitment to a cause?

The paradigm of 2020 is that to stay at home and not go out, that’s action, but we can’t think that way based on how we have been groomed.  Imagining that: an American inaction narrative where staying home is an act of bravery, and when it is multiplied by millions of households, it can literally vanquish the “enemy” at our doorstep.

SUMMARY

We have been groomed for different battles intellectually and psychologically.  Now we must adapt.

We all have decisions to make:  as individuals, as family units, as a society, and as government leaders.  To date, the evidence and the impact of our actions and inactions has just left us frustrated on all fronts.

Understanding the psychological limitations of the framework we have been given, provides us with the insight to understand others contextually, and to begin the process of rowing together.

It helps us understand how this benefits the greater good economically and to reinstall the freedom and liberties we all crave in the long run.  This freedom is the “True North” in everyone’s definition of wealth.

Your Life and Your Investment Portfolio Just Changed - Now what?

The middle of March seems to be eventful for some reason.  We’ve had Julius Caesar assassinated, tsunamis hit Japan, an assault by a virus, March Madness, and market misbehavior.  The middle of March also has some personal headlines for me.

The last time we went through this, we just had our first child and I just changed jobs. This time, we now have a child starting (but apparently not finishing) Middle School and my wife just changed jobs.

2008 - My son Nathan was born on March 10th.  You may remember it as the day that Elliott Spitzer, the Governor of New York, got caught in an escort scandal or the day that oil reached $108 a barrel and how much you were paying for gas.  This was also the week that Bear Stearns had their financial issues brought to light.

2009 - The stock market finally bottomed from the Great Financial Crisis on March 9th.  It would go down an additional 45% from when my son was born.

2010 - My daughter Shannon was born on March 9th.  The market has rebounded 74% since the bottom the previous year, but still 5% lower from when Nathan was born.

What makes this interesting is drives my curiosity on how the markets did around that two year time period and how they have done since.  Most importantly, I would like you to consider the optics of these different timeframes around Nathan (03/10/08) and Shannon’s (03/09/10) birthdays and how you felt about it at the time.

Here is the year before the GFC bottom (when Nathan was born to the GFC bottom).  ITOT is the S&P1500 Total Market Index and AGG is the Aggregate Bond Index.

Here is the year from the bottom to when Shannon was born.  The market was up over 70%.

Here is what it looks like when you put the two together:

Now let’s change the optics from from GFC low to today.  The peak-to-trough drop, including dividends for the S&P1500 was 55.2%.  Probably more importantly, the value of the market, when you account for dividends took 4.5 years to return to its October 2007 highs.  18 months down, three years up. What kind of growth rate does that compute to be today if we are already at the bottom? It’s about 12.6%.

What if we continue down to the drop we saw in 2007-09?  To recover in three years, it comes to 30.6%

We can’t count on that.  We have to count on ourselves.  Things are different. Specifically, the bond market is not acting normal compared to previous market drops.

Last time:

This time bonds are offering as much:

What can we do today?

The best thing you can do for your future returns is treat this like an opportunity, not a threat.  This can take the form of changing your future contributions or a Roth Conversion. The key is to have a plan to get back into the game without emotional influence.

Past performance is not indicative of future results, but it may help you contextualize your feelings and actions and how that worked out.  Not accounting for dividends, that would take the S&P would have to drop from its February 19, 2020 high of 3389 to 1518 (we are at 2422 as I type this so imagine going down another 31% from these levels.  We are “only” down 35% right now.

You know how you reacted, you know what the outcome was.  Use that knowledge to create a plan for this time. Life is going to change. Some of those things you have control over. Others you don’t. Learn from yourself and your previous responses and create better outcomes going forward.

6 Shared Paradoxes in Parenting and Investing

Investing and Parenting are full-time jobs for me.  Both create unnecessary drama. Presidential tweets and starting middle school just add to that.  Both require understanding the left brain and the right brain of yourself and of others. Both overvalue the present and undervalue the future.  This creates a lot of paradoxes.

Here are some of the common paradoxes that I have noticed recently.  I would love to hear your stories and what you have seen in this space or in the overlap between your parenting and professional lives.  Enjoy!

Parenting and Investing is hard because it requires a lot of reasoning and logic while working with something or someone that is unreasonable and has no logic.

Given the development of brains take about 25 years, we can often see when our kids are not being logical.  It is our job as parents to understand that and also apply reason and logic that can translate to them.

The markets are quite similar.  Emerging Markets today are reacting to a virus that someone obtained - they are down 2% and the other markets around the world are equally as illogical about an event.  We must use reason and logic with this illogical situation from viruses in China to bills passed in Congress.

Parenting and investing is hard because it requires an infinite mindset toward freedom and at the same time a mindset that requires installing structure and discipline.

Investing at its best is based on rules and evidence installed into a process - the process isn’t about “beating the market”, doing well today, or giving you something to brag about to your brother-in-law.  It is also about dealing with small, but frequent setbacks, that make the market stronger over time. In the long run, this process can be rewarded if implemented correctly.

Same goes with parenting.  Our kids have bad days - they lose games and robotic competitions and get a poor grade at school.  These are all part of the learning process toward raising an adult. Giving them the freedom to fail, while providing the structure to succeed is a delicate balance, but it makes their portfolio of social skills stronger in the long run.  You are constantly trying not to fail while recognizing that failure is good and presents opportunities for your kids and your portfolio.

Parenting and Investing are hard because it requires sticking with extreme process vigilance and guidance, but you will be at your worst when you are trying to be too controlling of the outcome

We all have had an instance where we have been the helicopter and bulldozer parent - it usually involves a transition where we feel that life isn’t fair or is implicit to our kids at no fault of their own.  When we step in, it can be a teaching moment or a control moment.

Investing requires you have a plan and stick with it religiously.  If you focus on the outcome instead of the process and try to control that outcome, your portfolio will suffer with inferior returns.

Parenting and Investing  is hard because you have no idea what your kids or the market are doing, but you have to know exactly what you are doing.

I’m going to keep this simple.  Parenting is doing the impossible for the ungrateful.   On top of that, parenting is hard because you have to always do what you say you’re going to do.  Investing can be simple, but it isn’t easy. It is next to impossible to read the markets and the markets really don’t care about you - so they are as ungrateful as your kids.  

Parenting and investing is about a spectrum of options but our decisions often feel binary.

Our answers to our kids are often “yes” or “no”.  Our investments are “buy” and “sell” or “all in” or “go to cash”.  With our portfolios, we can have an allocation toward stocks, but the decision to buy and sell often faces a lot of internal emotional strife.  Punishing our kids or telling them they can or can’t do something feels the same way.

Parenting and investing decisions present tough choices in unfavorable situations because you care, but your kids and your investments often don’t.

You aren’t raising a child, you are raising an adult.  You are going to face adversity, often created by that human you brought into the world.  Things are going to be made a lot harder than they need to. Why? Because you were lucky enough to pass on to them your personality and attitude.  You will butt heads and while it may not show, you care a lot more than they do.

Your investments are the same way.  You bought those shares of that biotech that didn’t get their drug approved by the FDA, now go make the undesirable decision to sell and admit defeat.  When you do this, you are moving on. Nobody cares - the company has thousands of investors. You are simply an account number to them. But this company was going to cure cancer...yeah, sure it was.  It’s down 80%, take the loss and go invest for the long term, not the lottery ticket.

Kids - same thing.  Don’t win today as a parent and let him have ice cream after hitting his sister.  Let him pay the price and both of you will gain perspective and learn from the incident.  That has a greater payoff down the road.

Parenting and Investing - fun, but scary;  needed, but hard being “always on”; you care, they don’t;  lots of options to process, but binary decision outcome. Every minute can’t be as fun as when Nathan and Shannon were ziplining in Costa Rica that you see in the picture. Both require a lot of work and process vigilance, but it can be very rewarding.

The Difference between a Money Master and a Money Disaster

Who is ready to be a Money Master and Pursue True Wealth?  Is the alternative more attractive.

Money Masters count on themselves to invest more that they can control. 

Money Disasters count on high returns they can’t control.

Money Masters are playing an infinite game. 

Money Disasters play a finite game.

Money Masters spend what they don’t save. 

Money Disasters save what they don’t spend.

Money Masters seek information with signals. 

Money Disasters seek affirmation in noise.

Money Masters exercise emotional discipline with rational decisions. 

Money Disasters rationalize emotional decisions.

Money Masters rise above the day-to-day. 

Money Disasters are distracted by the day-to-day.

Money Masters invest to strive. 

Money Disasters invest to arrive or  survive.

Money Masters seek evidence-based processes

Money Disasters seek event-based forecasts.

Money Masters confront and respect investment risk as a spectrum

Money Disasters treat risk as binary.

Questions to ask a potential advisor

Let’s face it. Unique investors want to be treated uniquely.  They have unique needs and unique triggers on what matters to them.  “What questions should I be asking an advisor?.” 

I was recently asked this on the Suburban Folk Podcast.  I get asked this question a lot - I get asked these questions a lot and decided to create a list so that people would have a healthy list to choose from depending on what matters to them.  Here goes...

BUSINESS TRANSACTION QUESTIONS

1/ Are you a fiduciary?

2/ What is your investment philosophy?

3/ What asset allocation will you use?

4/ What investment benchmarks do you use?

5/ Who is your custodian?

6/ What tax hit do I face if I invest with you?

REAL QUESTIONS FOR A REAL ADVISOR

1) Who are you?

2) What is your actual value proposition?

3) How is your offering different than everyone else's?

4) What are you trying to build?

5) How do you add value to me?

6) What are your credentials?

7) Do you have client references for people like me?

8) Tell me about your personality

TACTICAL QUESTIONS TO ASK

1. Will I own funds that cost > 0.6%? If so, why?

2. Will I pay trading commissions? If so, why?

3. What do we earn on our cash? If not over 1%, why not?

4. Does our broker lend out our shares and earn revenue? Do we share in that revenue? If not, why not?

5. Do we own stock mutual funds in taxable accounts that are expected to pay capital gains? If so, why don’t we own tax efficient ETFs?

6. Will you show me how you allocate your own money with holdings? If not, why not?

7. For the fee I pay you, what do you consider your major value add is and will be in the future?

8. Do we have a home country bias in our portfolio (meaning you have less than 25% in foreign investments). If so, why?

9.  How did you do last year?

In 2020, You Can Master Your Money

This year, I want to assist clients with a TRANSFORMATIONAL INVESTING AND FINANCIAL PLANNING EXPERIENCE to answer the one question they all want answered, even though they all ask it differently.

CAN I DO WHAT I WANT, WHEN I WANT, WITH MY MONEY?

 The S&P500 was up 31.5% in 2019. 

Josh Brown offers this...

Let’s take a hypothetical portfolio of 60% S&P 500 and 40% Barclays Aggregate Bond Index, on a total return basis. Assuming a single rebalance at the mid-point of the year, you’re up 20.1% for 2019.

Let’s say you had international exposure – this hypothetical portfolio consists of 30% S&P 500, 20% MSCI EAFE (foreign developed market stocks), 10% Emerging Markets stocks and then 40% in the Barclays Aggregate Bond Index. With this more globally diversified mix, you did 16.5%, assuming that same single rebalance at the end of June. Now of course, these are indexes, so if you’d expressed these allocation selections using the representative ETFs, you’d have had whatever trading costs were involved plus minor basis point fees (now trending toward zero in both cases).

2019 offered a lot of drama and overthinking of investing.   The Trade War? Inverted Yield Curve? A presidential tweet?   Impeachment? Take your pick. 2020 will likely offer more of the same.  Investing is necessarily uncertain and unpredictable and you can’t have the upside without the downside.  This from Ben Carlson…

$10k invested in the S&P 500 in Jan 2000 would be worth $29,181 by the end of Aug 2019.  $10k invested in the S&P 500 in Jan 2010 would be worth $32,100 by the end of Aug 2019

And this from Michael Batnick...

There have been 47 double-digit sell-offs in the S&P 500 since 1928. 31 of them occurred outside of a recession so 66% of the time stocks fell for a reason that's wasn't related to an economic slowdown

This illustrates the un-necessary drama in the investing world.  Investing is about saving for the future when you can’t/don’t want to work, have major expenses like homes, health care, and cars, and to keep up with inflation - not for drama and not for winning a game.  Investing isn’t a game because who’s game is it and who’s rules are they?

More from Josh Brown…

There are those who tell you they can mitigate, or even eliminate, these risks, but even if they can, there is a price to be paid – sometimes a price higher than what the risks you were trying to avoid in the first place would have extracted from you! “More people have lost money waiting for corrections and anticipating corrections than in the actual corrections.” – Peter Lynch

The S&P 500 gained almost 30% on a total return basis for 2019. Those who embraced the uncertainty got paid. Those who fled uncertainty can now claim, with utter certainty, that they fell far behind their fellow investors once again. Their sole consolation – at least the macro newsletters were really interesting this year.

Let me offer you a secret weapon to market uncertainty.  Double Digit returns and negative returns are far more likely than single digit returns - that is how you should posture yourself, at least mentally.  You are empowered to master the situation and I am here to help you. If the market goes up more, I want you to participate. If the market goes down, I want to immunize any portfolio to strengthen it in the future and buy in at a lower price.  In short, it becomes antifragile AND an emotionally therapeutic process to contribute more to my portfolio on a regular basis. 

Rather than wager on the market, I choose to bet on myself and greater certainty of doing well in the long run.  Don’t count on unpredictable returns - count on yourself and your ability to save more. It is a more constructive path and it is better for your mental state of wealth.

Here is my ask...commit to raising your contributions with me.

It is easier and more inspiring to chase increased savings goals than decreased spending goals because let’s face it - life happens and if you miss a spending target, you tend to quit chasing it.  Conversely, if for some reason you have to put increased savings on hold and suspend automatic contributions, you still have time to get back on track. 

How I Can Help You

I have already talked about how investing more immunizes your portfolio and allows you to control what you can control and bet on yourself.  Let me demonstrate two things you probably already know about investing, but may not have the tangible evidence.

1/ How investing accelerates your goal achievement.  This table shows the number of months it takes for your portfolio to grow at various contribution rates, given a constant contribution amount and return rate.  500K to 1MM is just over 10 years when you contribute $1000 a month. This number goes down by 2 years if you increase your contributions to $2000 and over three years when you go to $3000 a month.  This is a great reason to do more than just “max the match” of your 401k.

With a 5% Rate of return and contributing $1000/month, it would take you nearly six years to get from $500,000 to $750,000. At $3000/month, it would take 4.5 years.

2/ How investing enhances your results.  Not only does investing expedite your portfolio growth and shave years off your working career.  It also can enhance your returns in certain markets. Look at the difference in the growth and rate of return on a $100,000 portfolio where someone does and doesn’t contribute $500 per month.

Originally provided by Ned Davis Research in 2017

Being a money master is a little bit of work, but it is fun to track and the results, much like the gym or dieting become more evident the longer you go.  In my next post, I will discuss the alternative of being a money master.

My 4th grade daughter lost a basketball game 56-8 this weekend. What 8 things I (re)learned that apply to investing.

My daughter started playing basketball again after taking a couple years off. Her soccer team put together a basketball team this year. Most have played before but they haven’t played all together. This past weekend they lost 56-8 (don’t ask, I haven’t figured it out yet). I had several observations that I also see in the investing world…and frankly, writing about the experience was therapeutic.

1/ Ego is the enemy.  When you beat a bunch of 4th grade girls by 48 and you are keeping your AAU players on the court, you are clearly doing this for you ego.   I know what this says about you and I wonder what message you are sending to your team.

2/ You never make yourself look good making someone else look bad.  Shannon’s team is made up of nine 4th graders and one 3rd grader. Basketball is their cross-train sport from soccer.  The girls have played together for nine seasons in soccer. They got so good, that they moved to the boys league. Staying in the girls league wouldn’t have made them better and it wouldn’t have felt good to destroy these other teams.  The basketball team that Shannon played against Saturday had 3 AAU players and four fifth graders. What did beating them by 48 achieve? The context of the team make-up is also important for Shannon’s team to understand - the context matters. Context is what changes facts into truths.  

3/ Win the next possession, keep working, keep fighting - I keep the book for the team and I have known these girls for a long time.  This picture really captures their spirit, and notice one of their coaches letting them work through this challenge sitting in the background.  With their great coaches and great attitude, they ignored the scoreboard and tried their best on each end of the floor each possession. I guarantee you the next game they play is going to seem a lot slower and a lot easier.

My daughter Shannon discussing the game and what the other team was doing

4/ Basketball is a finite game with infinite life lessons - better to win the latter.  A fourth grade pre-season basketball tournament score is as close to irrelevant as you can get (except to the girls playing during the actual game).  However, using those games to teach about life outside the line is of great importance.

5/ Coaches matter - I have been fortunate enough to coach basketball teams with my kids on it and without.  I think the only thing I really did different was sit my son quicker because he was trying to get away with something.  My daughter was a great listener. I loved working with the teams where my kids weren’t playing. I always treated basketball as a dynamic puzzle.  I tried to give my teams the structure to succeed, the freedom to fail, the cadence to stay engaged, and the chemistry so the sum of the parts is greater than the whole.  I stopped coaching because of the egos of other coaches. It was no longer about teaching and learning, it was about winning and losing. It wasn’t about process, it was about outcomes.  It was about “me”, it wasn’t about us. The gratitude for the time and sacrifice of the collective group atrophied and it wasn’t worth it to me anymore (but I still go through everything in my head when Shannon plays). 

I am very, very lucky to have the coaches I do for my daughter in soccer and basketball.  What Shannon doesn’t have in aptitude, she overcomes with attitude. Always giving her all - always with a smile on her face.  Her teammates genuinely enjoy each other. Are there things I would do differently? Yes, but just because I think I am right doesn’t mean the other coaches are wrong - and I hung up my whistle.  I always have the right to work with Shannon individually and I do. All of this I attribute to the culture that her coaches have created - in victory and defeat. Developing character, having fun, and making friends is important, but having a coach that exemplifies that culture is a gift they will appreciate and cherish decades from now.

6/ Preparation and Execution Matters.  If you want to get the results when everyone is watching you have to be willing to work when nobody is.  Practicing on your own and trying to be better than you were yesterday is something we try to teach our kids on the playing field and in the classroom.  Shannon dribbles to and from the bus stop each day it isn’t raining. You have to want it work like that.

7/ You are never as good as you think you are when you win, and you are never as bad as you think you are when you lose.  Often when you win, you can get complacent, think you are great, and stop working so hard. Conversely, when you lose, you can feel like giving up.  These girls enjoy their sports and each other so much that I haven’t seen this, but I definitely saw some deflation a couple of times on Saturday.  They have had so much success playing soccer (against boys) that this was new and character building for them. It shows me why losing is important - learning to lose and learning to respond both externally as well as how you internalize it. My daughter had a million questions after the game and a lot of thoughts. My favorite was, “I want to play them in soccer.”

8/ One team limited their challenges, the other team got to challenge their limits.  If I am winning by 30+ points with 8 minutes left in the game, I would hope that my entire 2nd string would be in the game.  That didn’t happen Saturday. Their coach lost the opportunity to develop his weaker links and give them a chance to learn from their mistakes. At that point in the game, there is nothing that you can prove or work on. Meanwhile, my daughter’s team is 0-0 today….just like the other team.

How does this translate to investing?

1/ Ego - I see how people treat their investments as a means to try to win - beat the market, brag to their neighbor, show off to their brother-in-law.  Why? What does this do? Likewise, this happens at companies and it is reason #483 of why I don’t buy individual stocks. CEO’s tend to try to “win” for their shareholders rather than focus on the employees and customers.  Simon Sinek discusses this in his new book “The Infinite Game” and how it affected companies like Kodak, Sears, and Apple differently.

2/ Making yourself look good by making others look bad - It is quite easy to pick a timeframe of your liking and a performance benchmark of your liking and make your advisor look really bad.  Conversely, your advisor can likely pick the timeframe he likes and the benchmark he likes and make himself look good. This solves nothing. What matters is that you are progressing to be better postured to achieve your life goals that you were last time you did a review with your advisor.

3/ Win the next possession, keep working, keep fighting - life and investing is going to throw you curve balls - market crashes, job loss, family health. You must keep working through your community to get solutions and get through the tough times.

4/ Play the infinite game, not the finite game - Basketball is a finite game - you know the rules, the players, the desired outcome.  Investing is an infinite game where you are simply trying to move forward. You don’t win if you have the best investments today. You don’t win if you are the richest person in the graveyard.  Those are not the rules and not everyone is playing by the same set of rules. What matters is you and your ability to achieve those goals.

5/ Coaches Matter - While I am clearly biased, sometimes you need a coach who sees what you can’t or to share what they have learned to make your life easier.  Financial advisors should help with the monetary and non-monetary side of managing your wealth

6/ Preparation and Execution Matters - In basketball, you need to know how to scheme against the other team and you have to score.  Your portfolio needs to have a game plan that you have prepared and then you have to act on that plan. Remember, it is just a plan, and it is likely subject to change, but going through the exercise will make everything else about wealth easier to absorb and achieve.

7/ Never as good as you think when you win, never as good as you think when you lose.  If you “beat the market” today, you are not invincible. In fact, you probably should be asking what risk are you unnecessarily exposing yourself to for that “victory”.  Much like a starting point guard can get hurt, a portfolio may not require silly risks when your goals are not in jeopardy. Playing that point guard could put the title in jeopardy, especially when this game is already won.  Conversely, if your portfolio doesn’t have a great day, understanding the context of why will either make it easier to accept OR make you re-evaluate what you are doing. Hopefully one “loss” doesn’t lead to drastic, unnecessary action.

8/ Challenge Your Limits - Investing is a place where risk and volatility are scary to many people.  Find ways to fight those fears successfully. Set savings goals rather than spending goals and understand how that impacts your future and your ability to absorb market misbehavior.

While I am disappointed that my daughter lost by such a margin of victory.  I think she learned a lot in the process. I am going to guess that her team and coaches will perform better in the infinite game of life...which is what really matters.

My wife thinks I'm nuts for weighing myself everyday - here's why it helps my investing

Almost every day, I get up before 4am and I go swim somewhere between 2.5 and 3.25 miles - with a monthly goal of swimming 25 days a month and 67.5 miles a month. When I get done, I weigh myself - with the hope of being under 161 pounds and also being at my current weight as consistently as I can.

What is the habit? Getting up at 4? Swimming? Weighing myself? What is the Goal?

You can see the results here.

…and here is my weight on the scale…

My wife thinks I’m crazy, but I would argue that by looking at my numbers daily and seeing what they are telling me, it allows me to be a better investor for my clients.

My process is wake up, swim, weigh, record. This behavior, when coupled with the results, help give me my identity. It makes me more aware of what to eat and that I have the luxury of “cheating” every once in a while, because I have good habits.

I have added to this process a “target” of not eating or drinking alcohol after 600pm. The cost of this system or habit is a little bit of sleep and sore muscles. The benefit is that I can pretty much eat my wife’s amazing cooking without guilt. The process and the measures reinforce my dedication to it because I can see how much it benefits me.

We see this in other places. Delta has a different boarding time than American and Southwest. This longer turnaround time costs them flights and revenue, but it prevents re-work and losses associated with rebooking. It allows them to make up for weather or passengers that have no clue how to board or get off an airplane. Delta overbooks flights by a smaller margin of error to avoid the friction - costs, customer emotions, and a bad reputation. This is their process - they are sacrificing a little bit of “performance”, but they have lower failure costs and fewer failures.

Process vs. Performance

My son loves to pitch. He has great process and habits on the mound and if he doesn’t throw a good pitch or he misses the strike zone 3 times in a row, all I have to say is “Process Check Nathan”. It has gotten to a point that I see where his hands are before he starts his wind up and where his foot lands, and I don’t even have to wait for the umpire to know if it is a ball or strike.

First thing he asks me when the inning is over? Dad, what’s my pitch count? Where are we in the order? How many pitches did I lose? He doesn’t ask about strikeouts or other stats. He knows if his pitch count is low, he has a good process and the results are likely following (with help from his defense).

My weight is feedback on my process. My son’s pitch count is feedback on his process. Likewise, investment performance is one feedback mechanism on my process. My clients shouldn’t want anything different. Otherwise, we are measuring luck.

I look at my client portfolios every day based on the process that I use. I want to know when shifts may be occurring and how I need to respond. Some may say I am crazy, but I don’t look at it through an emotional lens - I look at it through a process lens.

My large cap Offense-Defense holdings are MTUM and USMV, respectively. The triggers and the holdings have “behaved” exactly the way I expect them to. However, there were three days in September that got my attention and then I see a lot of research discussing the valuation and construction of these funds. Do I need to adjust? If my process, my controls, and my action triggers are working as expected, probably not, but I should always be questioning if they do need to be adjusted and if they do, how can I justify the adjustment.

This chart is the process. When the read line is above the black line, i own MTUM. When it is below, I own USMV.

The bar graph below is the outcome. “Backtest” shows what happens when I switch from my action triggers in my process above over if I just stayed in either of the two choices (shown next to back test). I follow this process for all holdings in my accounts. This just allows you to understand the process. These results over this timeframe look good. They don’t always work out this well.

When a batter has figured out my son’s process on the mound, or an umpire has a strange strike zone, he has to adjust - change the pitches he used, shift the infield. Whatever it takes.

Investment monitoring and weighing myself isn’t about the outcome, it is about how my process did. Layovers aren’t about turning airplanes as fast as possible, it’s about the delivery of the highest probabilistic number of passengers. Pitch Count is about command, not the score. The next time you do some form of measurement as a habit, think of it as feedback on your process and not just an outcome.

Investing Processes are about command of your financial plan with your portfolio. It’s about if you have good discipline and hygiene in your financial practices. It’s not about capturing every basis point, it’s about not having to “rebook” your plan or required risk because you were trying to turn around the proverbial airplane in the name of greed or worry more about your strikeouts than your pitch count. When your advisor discusses automating contributions to your account, he is attempting to improve your process and your command over your financial plan.

Swimming, pitching, flying, investing - when your measures focus on the process, you look to improve the process. When your measures focus on the outcomes, you introduce emotions that are unhealthy to your identity, behaviors, and habits. As long as I measure my swimming and investing through an unemotional process lens, it should serve me and my clients well.

Structure and Freedom

What do you need in your job, your kids need in life, and your investments need?

They need the Structure to Succeed. They need the Freedom of choice. They need Cadence and Flow. They need Chemistry so the parts are greater than the whole.

Think of a time when your kids were at their best playing sports. Your child likely did his best when he had a coach that provided him with the perfect balance of the structure to succeed and the freedom to fail.

A coach that sets up an out of bounds play in basketball that only has one passing option has too much structure and not enough freedom. A coach that sets one up with three passing options, has struck that balance.

When my kids are at the beach, they have the structure of activities that a beach allows, and I give them the freedom to experience the beach in those ways - building sand castles, fishing/crabbing, boogey boarding, looking for shells, swimming, and countless others. Skiing is similar - they have the structure of a blue or green trail to select and they have the freedom to get down the way they want - fast, slow, through the trees - you get the idea.

I bet if you take that to your own work, the exact same thing happens with your best work - your boss knew how to balance these attributes. You know what needs to be done and you have the freedom to accomplish it the way you want. This likely created flow or cadence - intense focus, authority to choose and creative license in the activity, not too hard or too boring, immediate feedback. This is often framed in a team environment and likely feels best when everyone is making everyone else better.

Now let’s take that to your investments. Your adviser should be providing you with a structure to succeed - anything he is recommending should be achievable and specific. At the same time, there should be some freedom so that you are motivated/empowered to control your destiny. That freedom is necessary because "life happens" and you need those degrees of freedom so that the plan doesn’t have to fail but is capable of pivoting. Job change, sick parent, kids in day care or private school - just to name a few.

Market behavior can be a lot like the behavior of your kids. Most of the time, they behave well. However, there will be times where they do misbehave. All parents and all investors have different thresholds for this misbehavior and how they respond. Market misbehavior is typically accompanied with four behaviors: do nothing, buy more, go to cash, or adjust your portfolio. Recognize that these answers may be different for individual stocks than for the overall market as the concentration risk and the factors involved may influence the answer (hopefully your advisor is coaching you on this - that is a different matter for a different time).

Do nothing: Most market “tantrums” are temporary. You and your portfolio may just need a hug and to learn from the experience.

Buy more: If this is done within the structure of an investing plan, you likely will do this several times in your 401k or other automated contributions. This is the cadence that leads to better plan adherence. If it’s done under the emotional premise of fear or greed, then we should probably think twice.

Go to cash: This is the least healthy situation. It is emotional and binary in a system of complexity. It doesn’t involve a plan - it involves an emotional trigger, a hunch, a gut feel.

Adjust your portfolio: Adjusting your portfolio because of market behavior as a catalyst shouldn’t be done on the fly. Building action triggers that have no emotion is the best way to do this. Typically this involves rebalancing, making a slight adjustment to your allocation, or changing the holdings within an asset class. These can be healthy, they can be over-engineered, they can be ill-advised. In any event, proceed with caution and know what you will do before the drama gets underway. This is about intent and execution matching each other. If you proceed without intent, then this will likely not go they way you like and make you more emotional the next time around.

The bottom line is that whatever you do in this space should have the same critical ingredients your kids have on their sports team.

Structure: Having a Plan as well as a well designed Portfolio to support that plan.

Freedom: A Plan where you understand the impact of changing your spending, your savings, or your portfolio allocation - but having the freedom to choose these options is a great way to make sure you stick with the plan.

Cadence: Regular updates, regular contributions - “flow” that is automated to reduce the impact of misbehavior by you or the markets.

Chemistry: The parts are greater than the whole. They temper the misbehavior.

Structure, Freedom, Cadence, and Chemistry - The next time you are experience frustration with a team you coach, how your kids are responding, the work you do, or how your financial plan and investments are working - look at these four ingredients and figure out what isn’t working and take control.