The Worst Way of Investing

Are we having fun watching our investments? Well, of course not. We shouldn't.

Today, I saw an add for some internet investment service.

One of all those thousands of ads that scroll past in a day.

I'm not sure if it was consciously designed to make me stop scrolling because of the stupidity of the message. If so, the ad creators succeeded, but on the other hand I don't remember the company behind. Only the ill-advised question stuck.

The ad asked: "Is this a Happy or a Sad day?" 

The masks of Melpomene and Thalia

Tim Green, CC BY 2.0

To replace the divine sensation of comedy and tragedy with quick thrills of if an investment went up or down, and to add to the stupidity, within only a day, is tantamount to spending a road trip in Tuscany with only eating on Kentucky Fried Chicken. 

If this is even close to one's view of investing, one can be sure that it's the absolutely worst kind.

Emotional neediness and one's life's savings should be kept far apart. The real struggle is in keeping emotions and investments separate. Not the opposite, deliberately joining them together.

It is easy to have a look if the portfolio went up or down within a day, because the internet brokers are designed that way, to make us want to log-in and do something, usually stupid, so they can gain on their fees.

If the most thrilling thing that happened over the day had anything to do with the stock market then:

a) the 'investment' strategy is guaranteed to be seriously flawed

b) one should rethink what one finds 'happy' or 'sad' in life.

If one is out of thrills, may I for instance suggest getting a squirrel suite?

   Other ways of getting one's dose of emotional thrills

Barry Holubeck, CC BY-SA 3.0 

I think it's every billionaire's right to die in a self-inflicted flight-accident, so if one has high hopes one better start practicing now. And it's probably beneficial to the development of the stash, as a dead investor is likely to be the best investor.

Or even better than getting superficial thrills from the stock market or a squirrel suit: grow up from toying around like an underdeveloped teenager.

Get a challenging, interesting vocation in life instead; one that actually matters to someone.  

//lucilius

Dividend Investing & The Sweet Scent of Mental Accounting

There are ways to wrestle with the volatility of the total stock market. One way is dividend investing. The idea is a very good one, and more perhaps in line with our thinking, because it's a strategy that doesn't ignore that we are mere humans, and doesn't suppose super-human tolerance with volatility, as a 100% stock-market approach seemingly does.

If one is starting from scratch so one has lots of future cash flow coming in from one's salary to use to damper the volatility of the markets, this might be one of the quicker path to financial independence. If one happens to hit a good 10 year stock market-run.

We still want to raise a very serious warning, though. 

It's not sure that the risk one is really taking on in the overall dividend portfolio has the best price. And one would need to be sure that one can stay very stoic, almost prone to self-hypnosis, during tumultuous times. Dividend investing still relies on a complete stock-only portfolio, with its grueling volatility. One important idea behind dividend investing is that one must rely on a very specific Yedi-mind trick to survive. 

We think that quite a few have gone into dividend or full-stock-exposure, without really reflecting on if they are able to do that mind-trick. 

But as long as one knows what one is in for, dividend investing has its charm. 

Let us explain.

How to Wrestle Volatility with Dividend Investing

The simplest way to achieve a dividend strategy is to buy broad index ETF that pays out the dividends as cash.

If one is brave, and sure that one will be able to spend much, much time keeping an eye on particular stocks, one can also cherry-pick stocks with a future potential for dividends and a good price per earnings-ratio, stocks that have a good proportion between the price one pays to own the stock and the dividends they pay out. 

A compromise might be to buy a broad value-ETF with dividends payed out in cash.

Stock cherry-picking comes with so many risks that we don't even want to start counting them, let's only mention the adage that the easiest person to fool is usually oneself.

Whatever way one choses, one intend to live off the dividends and stick with the same stocks, and strategy, for a long time - perhaps forever. Be it from the low-priced index fund or cherry-picking stocks that one hopes has a good future dividend (earnings) potential.

Hence one can concentrate not so much on the day-to-day or year-to-year valuation of the portfolio, but put one's mind at ease by concentrating on the dividends, which usually are much less volatile than the stock valuations.

Mental Accounting

So, as you, wise reader has already observed: by splitting one's focus on two different things, one can put one's mind at ease (supposedly) when the valuation of the portfolio itself gets cut in half and takes ten years to return.* 

Mentally, one imagines that the money from dividends are different from the money from portfolio appreciation. Hence, by mentally accounting for the dividends as separate from the appreciation, one gets a virtual stream of money that has acceptable volatility. The money one earns is, so to speak, split into two accounts. 

This is where the mental accounting comes in. 

One account doesn't move that much - the account with dividends; the mental account one dares to look at, and the other one, the portfolio valuation; there one shouldn't get upset if it swings. 

One needs to be able to look to the right (the dividends) and ignoring the left (the market valuation) to sleep well at night.

If one manages to pick good stocks, the dividend strategy might be one of the quickest ways to financial independence. It's s strategy that takes the price of what one is buying into the equation, and one that doesn't include totally wild speculation and pure fluke.

The Scent of Money

For us, as we saw it, it felt like too much of a mental trick to regard one part of the money as separate from the valuation of the portfolio. 

And we have never been sure that we would be able to uphold that illusion in a longer market crash, or sleep well at night in times of much volatility.

We also think that we wouldn't have the time or interest to pick individual stocks, and that would expose us to risks; for instance that we let our emotions decide, and an evident risk of too large a home bias.

Another problem we saw was getting a good price on the risk one is taking on. Downside protection has always had more allure to us than a higher average return, and the higher risk would then need to be compensated with a fair amount of higher expected return.

Perhaps it doesn't matter so much if one stops the mental accounting, even if one of the basic ideas with dividend investing then disappears.

When one goes to the grocery store, the cashier will not care if the money one pays with comes from dividends or stock appreciation. It's just money.

And as Vespasian said, money doesn't smell. 

Vespasian 17-79 AD, concerned with smell.

So if you venture out into dividend investing, be aware of the neutral, sweet scent of money, irregardless of if it comes from value appreciation or dividends.

//antinous&lucilius

Where to go now? If you want to read more on how to get a better price on risk, why not go here:

The 20% Barbell: A Better Price for Risk

* No, it's not a three years drawdown period of the total stock market. That's a misunderstanding from a misreading of an author that might have become slightly too popular in the financial independence-sphere.

Introvert-, Hippie- and Vagabond-Freedom

There are many types of financial freedom. The types of freedom are important, because our ideas about freedom put limits on our careers and implicitly sets a goal for our stash. 

What kind of life do we want to live? How sure do we want to be that we reach it? And what are we ready to sacrifice to get there?

Hole-in-my-Soul Freedom

No Entrance is Grande Enough
(Opéra Garnier Paris 1867, le grand escalier)

The most consuming kind of freedom is, as we all know, the never-is-enough-freedom; the kind of freedom that cannot be achieved even when one stands on one of the terraces of one's Penthouse, alone, at 70 years of age, silently looking out on the streets below. 

It's the Freedom of Imbalance, and an consuming one. The only capital on one's life's journey has been monetary. 

Where does the hole in the soul that needs to be filled with kitsch, in its many disguises, come from? Perhaps very poor beginnings, or at least a belief that one's beginnings were very poor, and then life turns into an everlasting revenge on that poor beginning.

The hole in the soul wants more, at the expense of all other sides of life.

Do you feel that enough is never enough? Well, at some point the money is better spent on a shrink than on more brilliant furnishings.

Joneses Freedom

Another kind of freedom is the one that is lived in relation with the closest social group that happened to be at hand: childhood friends, colleagues, neighbours and influences from media, social or otherwise. 

The common denominator is that the social group is not a conscious choice. They were just available, or imposed.

Freedom becomes what is reflected back from that unconsciously imposed social group: having that house, the two cars, better children, a better husband, more sanity, better work and better vacation. All in comparison to that group one happens to compare oneself with.

One becomes Ayn Rand's "Second Hander" who can only perceive oneself through the mirror of others. 

Introvert Freedom

A solution to the Hole-in-the-Soul and the Joneses is to go 180 degrees in the opposite direction. 

Cast all possible allure of the social mirror overboard. Let's not even be tempted to compare oneself with other people's social values, because, well, let's scrap social, shall we?

Especially easy if one is a stark introvert, who only needs the tiniest of external stimuli to be content. 

Hermit cave, Spain.

By Basotxerri - Own work, CC BY-SA 4.0

Financial freedom now becomes easy. There really isn't much need for money at all, so financial independence is almost automatically achieved. There are very few interactions with other people where money could even be needed.

Freedom, at last. 

As long as the hens survive the winter.

Hippie Freedom

Another kind of freedom is the one where one still participates in the arena of social life, but one is content with being a lot ... stranger than the Joneses.

Here one must put up with the scorn one will inevitable receive by not following the rules.

In many senses of the word, one is a hippie, a non-conformist, an epicurean; like the philosopher content with one's cheese.

Perhaps one can survive the social stigma by associating with something else, like the fire-moment, or some other kind of subculture, to build another, parallel but different pyramid of social recognition.

One is still connected with the world around, and one is not afraid to act in the arena, but in other ways, and not wanting to receive the usual kind of social recognition. 

And with that parallel value pyramid, one will probably start to value new things in life, more independently; be it the small things, the long runs, the good food and the peculiar hobby.

Vagabond Freedom

Whatever holes we might have in our souls; they are not about keeping up with the Joneses or building the Grandest Staircase of them all.

We suspect that our freedom is that of the vagabond, the wanderer, with a touch of the introvert. We've never been so much for a having a house or a home in any normal sense of the word.

We like the luxury of rootlessness, and enjoy the feeling of slight alienation that travels bring; being that citizen who is at home everywhere and nowhere.

Do we always want to flee the arena? No, probably not. Our appetite of vagabondism will probably change over the year and over time. So sometimes we will revert to a kind of epicurean hippie-freedom, and certainly also try to act with the world around us, and then be ready to leave for our next journey.

So that mean that we will probably not aim for the minimal stash when trying to seize up our portfolio. 

But even as one travels the world, one will discover, as the philosopher puts it, that one can really never truly escape oneself. Because one always has oneself in the saddle.

So where is the true limits of financial freedom?

As Seneca had it: What does it matter how much a man has laid up in his safe, or in his warehouse, how large are his flocks and how fat his dividends, if he covets his neighbour's property, and reckons, not his past gains, but his hopes of gains to come? Do you ask what is the proper limit to wealth? It is, first, to have what is necessary, and, second, to have what is enough. 

Farewell.

The 20% Barbell: A better price for risk

This is a hypothetical take, and an eye-opener perhaps; a starter to begin to ruminate on: the price of risk. 

Before venturing into the idea of a stock market barbell, we should say that this is an idea we have not chosen for ourselves. But we all love to get a good price, right? So it's still interesting to consider how one can think around getting a good price for risk.

A high price of risk 

One aspect with any portfolio is to look at the price of the risk in the portfolio. Is the price we pay for the risk, well, ... fair? And what could one even mean with that? 

As we all know, stock market downturns can be long, and severe, and as usual worse than all we've seen so far, and certainly deeper than data from the last 50 years shows. We think they can be more nerve-wrecking than more hardcore investors might give the appearance of.

And what do we get for that stock-market-risk? Well, the average return for the total stock market was 8.3% (excluding inflation) for the last 50 years in the US.

Even more interesting to consider is perhaps the safe withdrawal rate. For many of us, that's the penultimate goal we are after. The safe withdrawal rate for the US stock market, dividends and all, was 4.3% for the same last 50 years, which is the foundation for the famous 4%-rule.

What do we need to pay to get that return and withdrawal rate? 

Part of what needs to be paid for the average stock market return certainly relates to 10-11 year periods of nail-biting until the numbers get back into black.

For some, the story ends there. But perhaps, as often when haggling about a good price, that shouldn't be the end of the story. 

Not the end of the story

Creating a barbell

How can one get a better price for risk, without going into obscure financial wizardry?

One thing to do is to construct some kind of barbell. 

What is a financial barbell? It's about instead of going for the average, somehow balance extremes instead.

And example: one part of a portfolio can be something quite vanilla like a total stock market fund. Then we add something that is also quite risky, something perhaps as explosive as stocks, or even more explosive, but for radically different reasons - so to speak on the other side of the bar. 

This is not quite the same as regular 'diversification', but something more fundamental, another beast all together out on the other side of the barbell. 

One actually wants the barbell to be a dangerous thing, that is very sure to swing heavily in another direction as the market moves.

So it's not per se about reducing risk, but spreading it out to the opposite extremes, using it to one's advantage, and make sure it behaves differently from one's other assets.

There are very elegant ways of constructing a barbell, but let's be frank, they are not quite accessible to us more average investors. 

But just because some of the more elegant ways are only available to advanced investors, or the very wealthy, that doesn't mean that there is absolutely no way to get a better price for risk for the rest of us.

Gymnasium in Pompeii (79 AD). Place where barbells might have been in use. 

So let's construct our barbell.

We use the US stock market for illustration, but the same is true in most parts of the developed world.

First, we need a barbell that is heavy enough and volatile enough to actually matter at the other side of the stock market. Of course both size and volatility matters. In this example, we are satisfied with a 20% size of our portfolio for the other end of the barbell. 

But as said in the beginning, this is hypothetical. If you check the links below, you can see that what we actually did ourselves was not to have an asymmetrical barbell, but a very symmetrical approach, and we went for four different weights - two barbells - instead of two weights - one barbell, as the example here. 

Going less than 20% of the portfolio value in the barbell-asset? Then one must beware, so one is not falling for the siren's call of average return and upside potential, and the protection becomes so small that it's just illusionary.

By mixing in 20% of another asset class that is (also) volatile but under other risk conditions than the stock market, one reduces the volatility of the all stock market portfolio so much that, well, these strategies become quite powerful. 

We suggest considering gold as barbell. It's conservative, has been around in finance for a few thousand years, and is easily accessible in physically-backed ETF:s. Something else might work, as long as it's volatile enough, moves fundamentally differently from stocks, and can be supposed to still be accessible when the knifes are falling.

The barbell strategy of course also assumes that we keep that 80% 20% ratio over time, for instance with yearly re-balancing.

What happens then?

The 80/20 portfolio, surprisingly, just gives a tiny drop in the average return compared to the stock market index. It's as small as 0.4% difference for the US example, almost just a day of trading.

But, and here comes the much better price on risk, there's quite some things that we gain for those tiny 0.4% we pay with.

Suddenly, the safe withdrawal rate over the last 50 years increases to 5% (a very tangible increase, 7 k€ more to spend from a 1000 k€ portfolio, each and every year, adjusted for inflation, until death does us apart). 

Large volatility is dangerous for the safe withdrawal rate. Hence one gets a much better rate if one manages to keep the volatility lower, and especially mitigate the extremes. 

The time to recover from a downturn also shrinks much, and becomes a much more liveable five-six years, and the deepest loss is around 30% instead of a nerve-wracking 50%. 

Let's say that years to recover is what we "feel" that we pay for average return, and let's put the results  in a table:

	Getting	Paying	Price
	Average Return	Years to recover	Years to recover/ average return
100% Total Stock Market	8,3	10	1,2
20% Barbell	7,9	6	0,8

So what we want is the return, and what do we pay? A reasonable way to think about what we pay for the return, is the number of years until our portfolio is back on track. 

The usual definition of price is what we pay divided with what we get.

So, looking at the table, the price for the risk seems to be 50% better with our barbell.

This is an illustration of what one can feel in one's gut. There's something strange, perhaps even unfair, with the price one pays for the risk in the total stock market.

There's a better price to pay, with higher safety.

One might even dare to say that only a fool would go for a sub-optimal price on risk. 

A court fool.  But even the Romans had buffoons to entertain their dinners.

//antinous&lucilius

Where to go from here?

- We didn't go for only two assets in our barbell for our accumulation journey. We went for even higher security instead, with a double-barbell, with four assets.

- Read more about our thinking here: A well-kept secret and Our Crawling Road.

NB.

Oh, we hear protests of our presentation of risk. There are many ways to look at that. So just to be more complete, let's expand the table and add a more commonly accepted statistical measure of risk, even if we think that it's too narrow.

But if it makes a sceptical reader more intrigued, the better. 

The best yet is to think and investigate oneself.

	Getting		Paying		Price
	Average Return	Safe Withdrawal Rate	Longest Drawdown	Volatility	Drawdown/ Return	Volatility/ Return
100% Total Stock Market	8,3	4,3	10	17,3	1,2	4,0
20% Barbell	7,9	5,0	6	13,5	0,8	2,7