Cash - The Strangest Asset Class

As we write this, inflation sores, markets tank, even hedges against inflation such as gold stay back.

We see our savings slashed as measured in euros and dollars, 

Day-to-day prices fall and fall.

Yet. There is one asset that behaves strangely. 

If another asset is down 50%, that means that cash is up 200% compared to that asset. 

 Le Radeau de La Méduse, sailing through strange waters
(Théodore Géricault, 1819)

And suddenly, cash - a perfect hedge when markets plummet - step out of the shadows with a quite impressive value explosion. 

Even when inflation rages through the economy.

These are months for cash.

How do you measure your wealth?

Farewell

//antinous&lucilius

Why stock index investing is probably wrong for you

Stock index investing is a common recommendation on the journey to financial freedom.

And sure, it looks like there could seemingly be advantages to stock index investing. 

Are we sure which chimpanzee is picking the stocks here?

In stock index investing, there is no smartassing around with what stocks should be in the index. 

Hence, a stock index is less risky than certain other high-risk-behaviors, such as running around in a cage of chimpanzees armed with guns, sky diving in a squirrel suit, picking stocks, etc.

An index has the advantage that we don't need to bring our small and far too proud and easily tricked brains into how to pick out individual stocks. No guns, no squirrel-suits, no fragile ego complex in the equation.

Just a mathematical, simple rule, behind the index.

That's good, in the exceedingly likely event that we do something stupid when we try to 'think'.

Another important advantage: it's easy to start investing in a stock index. 

Investing in an index can very easily be set up to be automatic. 

Yet, does that automatically make the index the right choice for you?

Obviously, index investing is - over the very, very long time - probably better than not investing (but that's not entirely true, as we will see below, and that's a helluva important nuance). 

"It's better to start early" as they say.  "Good for you that you are still young if something happens", is what they actually mean.

Why stock index investing is not good for you

So one way or the other, we're talking about our life's savings.

Even if it takes a few hours more of effort, we think that given all the tens of thousands of hours one has potentially spent earning one's life savings, one might be able to stomach a few more hours to understand some more nuances than just blindly following the stock index investing-recommendation.

Let's say that we're not complete investing newbies and have understood that we need to invest, and that it's better to avoid the squirrel suit-bunch and chimpanzees with guns, yet we're still ready to spend some hours to think a little deeper, after all. 

So is there something hiding immediately beyond stock index investing? Is the recomendation, well, really good?

Let's start with what "good" could mean.  

Good could mean 'good' as in efficient; as in there is no other obvious alternative that, with reasonable ease, provides a better price for the risk one is taking on. 

Unfortunately, it doesn't seem that stock index investing is efficient; however we measure risk, as long as we stay within some minimal boundaries of what 'rational' can mean; there are simple yet better variants. 

Here's a trivial example: balancing in just 20% of a very different asset class (we propose gold) makes the resulting two-asset portfolios much, much less volatile. 

And that has a tremendous impact. Less volatility means a higher probability to reach the destination in a comfortable time even in a bleak scenario. Less volatility means a higher safe withdrawal rate when living off one's investments, which directly translates into higher material standard. 

Less volatility means sleeping better at night.

Why wouldn't one go with that?

Well, you're right. Why wouldn't one. 

A rule such as the 80/20-split is so simple that one can easily stay rule-based, applying yearly rebalancing back to the asset split. Such a rule is so straightforward that only someone with severe cognitive deficits would say that the the portfolio suggested above is not, to the minimally interested investor, just as trivial as investing in an index. 

There are other alternatives; investigate and find a composition that suits you, instead of assuming the one-size-fits-all-recommendation of pure stock index investing.

A quick summary from previous articles here on the blog:

• Stock index investing can have up towards the double time needed to recover back to +/-0 (often more than 10 years) than a simple modification with another asset class. 
• A stock index is a very dangerous place to be. 10+ years of severe underperformance is common. Life is long enough for most of us, and everything that can happen should be assumed to happen during our investment lives.
• Even worse: catastrophic setbacks of 20+-25 years have happened in recorded history. What, then, promises that such setbacks, or worse, might not happen again in our lifetimes? 
• Because of the risk of decade-long setbacks, one is much more likely to try to time the market with stock index investing even if one is 'supposed' not to. This will destroy the average return that was the motivation in the first place.
• One doesn't get fair compensation of a better average return for the wild swings of a stock index compared to easy adjustments to a much safer portfolio. 

Let's leave the serious reservation concerning the lack of efficiency with that. Because that's not the most important objection.

Most importantly: where are we in the assumption?

We're concerned if one doesn't feel that one shouldn't even consider one's own risk tolerance when investing one's life savings. 

Serious downside protection is very cheap, like house insurance. 

One-size-fits-all is a non-sequitur; a deceptive misuse of logic. The conclusion (that it's right for us) don't follow on the premise (that stock index investing is easy and hopefully gives some kind of average return after a few decades).  

Yes, a stock index buys a certain basket of stocks. But that doesn't mean that the risk implied in that basket is acceptable for us. 

We have our own plans, goals, appetites, emotions, journeys and ambitions.

Why should a certain portfolio by default match an acceptable investing profile for us? Why assume that we are not ready to 'pay' with less chance of the most rosy best scenarios, to be able to stay out of seeing or investments devaluated for decades until they reach the same level again, if we're even there to see it?

Not to mention a higher withdrawal rate, that just plain simply translates into a higher material standard when living off one's investments. 

The 'one-size-fit-all' assumption of the stock market, and stock market index investing, is, we think, a dangerous one.

For us, for instance, it has been more important to arrive at financial freedom within a reasonable time, also in a hypothetical bleak scenario, rather than arrive a tiny little bit quicker on average. 

The assumption that all our hopes and dreams fit automatically in the strategy of stock index investing is a hole in the deceptive conclusion of stock index investing as a universal recipe for everyone. 

Examples of misalignment 

- Importance to reach the goal: There are better ways when it's more important to reach the goal within a reasonable time, than to reach the goal quickly.

-High and stable withdrawal: There are better ways when it's more important to be able to withdraw a high, sweet amount to live of. Risk efficient returns it's the cherry on financial freedom, and stock index investing doesn't have it as we saw above. 

- Fear might derail the plans: In the beginning of one's investment career, contrary to common wisdom, one might be so discouraged by a long setback that it's worth to trade a slightly lower expected return and have serious and robust protection of the downside. The same fear might get hold of experienced investors as well, when they realize how long a downturn might turn out to be.

A side-note on cost averaging

It's at this point that proponents of blind stock index investing might throw in the argument of cost-averaging. Of course we don't mean that you should invest everything you own tomorrow, they say. The risk of regret would be to high, they try to comfort the nervous investor. 

Cost-averaging, we're afraid to say, is a fallacy. Let's see what we mean. 

The problem lies in the answer to this question: If one feels that one can't go all in with a large sum due to fear of regretting the timing, well, why should one be comfortable with the risk profile in a year? Or in two years? 

There's a never-ending recursion behind the argument. 

Two years down the line when one is entirely in the stock index; should one sit awake every night and wonder if we should "cost average" in (or out) of the investment? 

No. The obvious conclusion is that the risk profile of the investment is wrong for that investor from the outset.

A tragic recommendation

The most tragic (almost criminal) aspect with recommending stock index investing as a cure for everything, is perhaps to recommend it for complete newcomers, perhaps especially those with some savings already. 

Many are the examples of a newcomer that are emotionally attached to their savings ("I worked a lifetime!") or perhaps sudden wealth ("I inherited my mother!").

These newcomers are then scared and overwhelmed when the market eventually drops (as it always does), and sells at a low point, misses the bounce upwards and might be set back for decades, if they even ever gets back in ("I destroyed my life savings", "I lost not only my mother, but also the sum of money she left me").

Think about your risk profile first, if someone recommends that you should cost-average into an investment. If you can't stomach to own a certain portfolio today, why should you be able to stomach that in a year from now? 

Once more, volatility is more dangerous than one might think from the armchair, until one starts to face real prospects of financial ruin, however minute they are.  

So why would you assume that stock index investing is right for you? 

Farewell

//antinous&lucilius

Hope is not a good strategy

When we started to think about investing, one of our reservations - and a reason that we avoided investing - was that we felt that there was, well, far too much hope involved.

And hope felt like speculation.

Who would like to put one's hard-earned money up for something as fickle as that?

Hope is not a strategy

Yet, if one can make a decent return again and again, consistently, even if one doesn't end up on top every year, as time accumulates, one will have a very good return over one's investment lifetime.

John William Waterhouse, Pandora, 1896.
According to Hesiod, Elpis - the Goddess of Hope - was hiding as the last item in the box.

When thinking through a strategy, as we felt intuitively when we were young, the best path is to try to figure out a way to remove hope. 

If we can look at the strategy without hope for any particular scenario over another, then we're on to something.

Removing hope

For a small-guys investor, there are some ways of removing hope.

• Long-run. One strategy is to go for the long run (read: Welcome to the 1825 day-year)
  
  - If you don't need the money for 20+ years: invest in the stock market (but we have some reservations)
  - If you don't need the money for 5-10 years, invest in some kind of asset allocation

• Creating a well-devised money machine (read about our pathfinder portfolio, or the permanent portfolio), put the money there, and trust the mechanics that a certain withdrawal rate (3% or 4%) should work in the future as well. 

The stomach and the trade-off

The trade-off here is: will one stomach the lower returns when other assets are booming? When the less prudent investors chase hope and gets the fickle rewards as fortune sails in their waters?

Betting on both

The mistake in our youth was to think that there was no other strategy than hope.

But there is, call it the Kelly-criterion, the safer bet, or winning the war - not the battle.

Bleed a little, and win a little, all the time.

Yes, a strategy contains an element that bets on a good outcome.

But it also bets on protection, so even a bad outcome becomes good.

Don't chase the risky bet.

Or as Howard Marks has it: Take care of the downside, and the upside will take care of itself. 

Farewell.

//antinous&lucilius

More reads:

- Amor fati. The art (and Stoic habit) of loving whatever fate has in store for us. 

- Don't predict. The ego-defending little-sister of Hope is the Fortune Teller. 

- How long is the long run? Read: The speed and the destination

- What is asset allocation? Some thoughts here: How we dared to start investing

When the knifes are falling

It has been a rough spring for our open societies, not to mention the people in Ukraine where we have friends and acquaintances that have caused many a white night for us. 

A stress-free portfolio

Despite all that, we have not been particularly anxious about our portfolio. Sure, it has fallen somewhat, but not with more than we can brush it off. We also remember all the simulations and back-tests for the "bouncing back factor" of our portfolio, which is one of the reasons we've chosen it. 

Over a three-year period the portfolio has been back where it began in all cases, during the last 52 years. 

So it's more bombs falling than the portfolio falling that keep us up at night. 

In short: we felt prepared when the financial world started to seemingly fall apart during this spring.

,
In Ciceros original telling of the story, there were boys (twinks?) at Democeles' party. Just saying. But a debauched same-sex orgy (with additional food and wine to satiate all appetites) was a little too much in 1812 when Richard Westhall imagined the impeding fall of the sword and gory end of the party, so the twinks became ladies instead. 

The markets price everything in

In the last few weeks, we've read doomsday forecasts for all asset classes we own. 

Allegedly, Putin would be sitting like an old dragon on a ton of gold, and what happens with that pile, one way or the other, might completely perturbate the price of the shiny metal. We'll soon see kitchenware in pure gold instead of steal at Ikea, according to the most negative predictions.

Inflation eats bond yields, and it's going rampant and then central banks and governments will not able to control inflation, or so it goes, so treasury bonds and toilet paper are soon to be equivalent investments. Actually, toilet paper might be an investment with a better outcome if the wars in Europe get severe enough. 

And the world economy will never be the same, with supply chain disruptions, a scared populace that refuses to consume and shrinks demand, and shortages of all kinds. 

Perhaps. Perhaps not.

Don't forecast. And with enough time, everything happens. 

What these fortune tellers seem to forget is, in our opinion, a very fundamental thing. 

All assets above correspond to financial contracts, traded on open markets in anonymous transactions, by intelligent agents - mostly institutions - with access to much information, and much more than the alluring stories presented above. 

Which means that all ideas about what will happen in the future is already priced into the current asset prices. There's no "natural laws" or "safe bets" that haven't already been baked into a (very refined) average assessment of the situation - an assessment that we normally call the current price.

For instance, bond prices already anticipate what the future payment stream (coupons) will be worth today, in today's money, inflation and all, with expected real returns, in the net present value in relation to existing bonds, buy backs, expectations of future quantitative measures, money printing and issues of new treasuries. It's all there, in the price, already.

So what one is saying when trying to see anything as "doomed", is that one is more intelligent than the market, or perhaps that one has figured out a bias that no-one else is exploiting. But beware. Markets are learning machines, and they are smart. 

As good stoics, we prefer to lean back instead of trying to outsmart people that, truth be told, probably are much more intelligent than us. 

We rely on the method, and we have pre-meditated that the sword may fall.

Come year's end, we will follow our strategy, and as usual pour our hard-earned money into the worst performing asset of the year (whichever that might be). That is probably then the lowest priced bet possible between long term treasuries, gold and stocks, and hence, also the bet with most upside if the market expectations are surprised.

So yes, we bet, but according to a pre-meditated and simple plan.

And the markets are always surprised, but not in ways that the stories above indicate - but genuinely surprised and one, at least not we, will not be able to predict why, when or how. 

For instance, in our own risk assessments for our future FIRE-life, we hadn't even really written out war explicitly (it was implicitly there, but more like "Sweden becomes impossible to live in"). 

Once more: with enough time, everything that can happen will happen, and now war is raging in Europe, despite (at least) us not foreseeing it. 

The best is to be aware that the knives might be falling at any time, and take precautions in advance and not hope that one will be able to do a last millisecond rescue when the unforseen actually happens. 

Be prepared in advance, prepare for all eventualities, consider a strategy that works for the human you are and not the hero you wish to be, so you are able to stick to the plan when the party ends.  

Farewell,

//antinous&lucilius. 

More reading:

Ergodicity - everything that can happen, will eventually happen.

Amor fati - love what destiny has in store for you.

Our portfolio - the pathfinder, bringing us to our goal. 

Amor fati

Mark Spitznagel of Universa, the guy that did a 2000% return on the start of the pandemic, has an interesting thought experiment, that he attributes to Fredrich Nietzsche. 

It's about a curse (and a lion).

The curse is that we will freeze in a time-loop, being 5 years long (yes, there are a Hollywood clichés on this theme).

And the loop is there forever and contrary to the Hollywood clichés, there's no hope of escape. And we wouldn't know what would happen during those 5 years that would repeat forever.

What would be a wise strategy going into the time-loop, before we know the results?

In Nietsche's writing the answer to that question is represented by a lion, what else. And the lion turns "thou shalt" spend an eternity into "thus I willed it and thus I willed it for eternity".

Because, well, a lion doesn't much care what happens. 

Would we be able to say, whatever fate has in store for us; "thus I willed it"?

Medici lion, reasonably calm about the future.

sammydavisdog CC BY 2.0 

We do plan to live longer than 5 years. But we are also interested in what will happen during the next 5 years. It's a liberating thought-experiment to try to look oneself in the mirror and think about one's own strategy for the next half-decade. 

Is it a strategy that gives the confidence of a lion?

Are we so calm and confident with our strategy so we are able to, like Nietzsche's lion, say "Thus I willed it and this I willed it for eternity", whatever happens?

Or is something meeker looking back at us from the mirror?

Farewell,

//antinous&lucilius

Where to go now?

Try: Ergodicity: Anything that can hit us will, eventually, hit us

Ergodicity: Anything that can hit us will, eventually, hit us.

Ergodicity is an interesting property. 

The idea of ergodicity is that in a stochastic process, a point will eventually visit all parts of the system it moves in.

Another way of phrasing it is that given enough time, everything that can happen will happen, with a probability approaching one.

We're by no means mathematicians, and even less experts in probability theory. 

Yet, what we've understood (or misunderstood) about ergodicity might be interesting for how one looks at the world, and how one looks on investments and an investment strategy in particular.

Let's start with examples.

Two Sides of A Pet Example

And where better to start than with a gun. 

Mikhail Yuryevich Lermontov aged 33, four years before he was shot through the heart during a duel. He was, allegedly, the inventor of the morbid game of Russian Roulette.

Russian roulette is a favorite game of all amateur game theoreticians. 

1 gun, 6 chambers, 1 bullet in one of the chambers. We spin the barrel, and then the game begins.

So, in which of the following game settings of Russian roulette would we like to participate?

Game A: Ensemble probability

6 persons walk into a bar (in Novosibirsk). The first one puts the Russian roulette-gun to his head, and pulls the trigger. If he survives, he hands the gun to the next person, and so on.  

What is the a priori expected return from participating in this game?

Game B: Time probability 

Now a much more, for the individual, deadly version of the game. One person walks into a bar to play Russian roulette. In this version of the game, she puts the gun to her head, probably has an good glas of vodka, and pulls the trigger 6 times.

What is her expected return from participating in Game B?

Let's conclude that whatever the return is for game B, it's not good. 

What does this mean for us?

In life, one might easily believe that one is playing Game A. When a yearly expected return is calculated, it gives the illusion of Game A. 

It's as if we participated in one year only, and, like our six Russian Roulette-players above, we cross our fingers when we pull the trigger and hope that it's a good year.

We hear ourselves say things like 'Let's hope that the portfolio goes up this year'.

In Game A, hope is part of the equation. We can hope that we are on a good run. We can hope that we will pull out of the game before that fatal bullet. 

When we look at expected return, like in Game A - it's ensemble probability we see; an ensemble of years as if they happened at the same time, not as if they where happening one after another. 

Of course, years doesn't work the way Game A does. 

It's not ensemble probability that is a good model for designing a strategy. 

Like our unfortunate player in Game B, we must survive time probability. 

Which means acknowledging that bad events will hit us as well, due to ergodicity. What is unlikely to happen in a year might very well be very likely during a lifetime or over the timespan of our strategy, or for the unfortunate lady playing solitary Russian roulette.  

In investing, we are playing the long game, year after year. So the mechanisms of our strategy and the behavior of the game table we're at, are very important indeed. 

During a life time, a really bad year WILL hit us. Really bad events WILL happen. Then our strategy better be wiser than the one fool hoping about the average outcome of Game A above. 

Our strategy to increase and protect our wealth must be built in such a way that we don't end with a gory mess.

There's no use in having a strategy on the assumption "as long as nothing bad happens", or even worse, a strategy that leads to ruin if a bad event or year hits us. 

Then we might permanently be out of the game, and our strategy doesn't matter much anymore.

Real life examples

What does ergodicity mean for us, practically?

To sum up: if we are to stay in the game, ergodicity means that in the long run, our strategy need to be able to survive anything that can possibly happen.

Application 1. Return.

The diagram above shows the same run for the Pathfinder portfolio.Why does it look so spread out if it's the same run? We've just varied the start date with three year intervals and repeated the same series of returns on the same starting point. 

Look at the diagram again. The green, the red and the blue line all come from the same run of years. The green line sure looks lucky. But even a "lucky strike" as the green line, also has a "bad run" as can be seen around 2031 in this simulation, and what looks like hopeless laggards will overtake the initial good run. Remember that this is the same series, the variation comes from the starting year only.

The same strategy gets hit with every event; with everything that happened, and luck and misfortune even out. 

So this would be as example of a strategy that can do well both if we're lucky or unlucky with a run of years.

A side-note: Ergodicity also puts some lights on the thinking around the FIRE-number itself; the amount of money invested needed, to reliably cover one's expenses. If one hits the fire number early, one should probably be cautious. On the other hand, if one never seems to hit the fire number, one might be on a lower trajectory, with more upside potential. More about that in another article, perhaps.

Application 2. Risks.

When contemplating exiting the work life, we've set up a list of risks, consisting of things that might derail our future freedom. Socialism (this is Europe, after all), large unexpected costs, family members faring bad, our relationship taking a bad turn, and of course death. With risks, it's tempting to assign impact and likelihood and care about the high probability, high impact ones.

But ergodicity introduces something that normal risk-thinking doesn't quite comprehend. The longer a game is played, the more likely all events become. 

In the long run, we need a strategy for everything. Nothing can really be avoided.  

So we must be prepared that we will have to perform all the mitigations for all risks. We will at some point have to pay that unexpected cost. 

There will be a run of socialism with high taxes and a wealth tax during the roughly 50 years we will live from our portfolio. There will be family problems and relationship problems, illness and tragedy. And finally, one of us will die and leave the other one behind. 

Conclusion

If we at any time think it's meaningful for us to "hope" for a certain outcome, then we have probably fooled ourselves into believing that we are playing Game A.

Our strategy needs to be adopted to reality, and the long run. Amor fati; love what fate has in store for us. Or as Mark Spitznagel of Universa fame has it. He makes a parallell to Nietschze for a good investment strategy - being able to exclaim "Thus I willed it" for whatever fate throws at us. 

In real life, hope is not a good strategy.

Farewell,

//antinous&lucilius

Thinking too much or too little

We think that there's a dichotomy between thinking too much and too little in the financial freedom-sphere. One could call it oversimplification versus overthinking. 

Clearly overthinking.

(Ny Carlsberg Glyptotek, Copenhagen, 2019)

Here's an Einstein-ism: one should, generally, simplify as much as one can, but not further. 

In other words: it's better to aim for the sweet spot instead of finding oneself in the extremes.

Oversimplification

There's a popular advice in investment that goes something like this. Keep investments simple - really, really simple. Just put your money in one broad index fund and leave it there and don't think more about it. 

Then keep the savings rate high, and if it's really high (50-80%) one will hit financial independence soon enough.

It's admirable, and it's absolutely true that investments are easier than one might think, and if one does the above and sticks to it, one is probably well off in 10-20 years.

But is the advice good? 

The answer perhaps lies in that word 'probably'. There are several layers behind what the word 'probably' hides.  

We would like to point out three things with the seemingly simple advice above. 

Oversimplification 1. Difficulty of keeping calm.

The above assumes, and this is a BIG assumption, that the investor really can stay calm during a credit crunch and stock market setback. Many, many new investors can't do that. 

And many seasoned investors neither, even if they think so. 

When one jumps in and out of the market, driven by fear, one might very well destroy a large part of one life's savings. Then one might have a really hard time to get back, or perhaps get so scared that one never gets back to investing. 

Oversimplification 2. The risk is higher than the oversimplifier thinks. 

Risks don't just disappears because one doesn't want to think about them. 

One aspect of this is the effects of start date sensitivity. A new investor is likely to jump in after seeing others earn from the stock market. The stock market is, after our new investor has been standing by the sidelines, more likely to be close to the top of a bubble/burst-cycle.  The sudden fall might come as a big surprise, and there might be a long, long time until a beginner is back where she started, with the emotional toll that follows.

The adage is that there's just so many decades in a life and one probably only get one shot at early financial independence.

Another challenge is that the highest mountain we've seen is probably not the highest mountain there is. What does that mean? It means that during the last 100 years there have been several crises that set an investor back with 10+ years, and the worst with 25+ years. But that's the last 100. Going back to the 1870, it's even worse in many countries. 

A lifetime can prove to be long, so one should probably think a little about the possibilities for the future, and bear in mind that the highest mountain we've seen, well, as said, is probably not the highest there is.

This is a game where our freedom is at stake, and chances to play the right game are few. Probably we will only get one shot at truly early retirement. 

We only get one roll of the barrel for our gamble, so it might be wise to consider the odds. Or, in other words, we only get one shot at the target, so one should mind the precision of the weapon. How many empty chambers in that revolver do we need to be ok with, to play russian roulette? When the counterpart is unreliable and not quite revealing the whole truth to us? 9 to 10? Or 99 to 100? Or 999 to 1000?

Oversimplification 3. One doesn't get a fair compensation for risk. 

The risk, however we measure that, is related to what we pay to get something in return; in investing that's some kind of expected return - average return for the oversimplifying investor, baseline-return at 15% of the worsts cases for the more thoughtful investor perhaps. 

But what do we pay? However we measure, the quota between risk and reward is not particularly good for the oversimplifying investor. 

This is not just an academic problem. Let's not just consider the average case. Is it ok to have a bad case that prolongs the time to financial independence 8 years into the future? Or 15 years? Or 20 years? Where is one's ruin, one's breaking point?

For a total stock market investment, beginning some time into one's career, the bad case might not be acceptable, corresponding to that ill-fated chamber in the revolver.

And furthermore, and more importantly when getting closer to independence, volatility is BAD for the safe withdrawal rate. Really bad. 

Just some very easy tweaks with the investment strategy can significantly improve the safe withdrawal rate (e.g. 4%-rule). This can turn into additional budget to spend in the freedom phase, or extra safety margin, or an earlier retirement.

This is why we think one should think twice before giving the above overly simplified advice to oneself or anyone else. 

It might be worthwhile to stop and think, at least a little more then a few hours or reading one single author or blog post, before putting one's life's savings are the table.

Overthinking 

The first effect of overthinking is, of course, paralysis by analysis. Instead of thinking for too long, one should select a reasonably conservative approach, go for it, and learn as one goes. We have never really learned something from the armchair beyond the initial reflections.

It's by trying, repeating and refining that we make a sufficient emotional investment to really think hard, observe and learn.

So sitting still and overthinking will not help much more beyond some thorough initial investigations. Then it's time to act.

Ego & overconfidence

But when one acts, one shouldn't trust that logical-ego-complex-voice in one's brain, with its alluring whispers that everything is square, well-behaved and understood.

The consciousness is a late and secondary addition to the brain, as Joseph Campbell observed, and is never to be fully trusted. Our consciousness thinks it's in the driver's seat but, as it seems, the consciousness is better at making up a story why it's in control than truly run the show.

We don't understand what we don't understand. And if one is too prone to the ludic-fallacy - the fallacy that we mistake the world for being a casino with understandable risks; then it's about at that point that we get run over by a train that showed up from a totally unexpected direction.

Hence, for instance, for us we never pick single stocks and call that investments. Actually we never pick single stocks. 

Don't think soo much that you fool yourself that you can outsmart the market. Then we are overthinking. 

It's always much easier to fool oneself than the market.

What do you live for?

Even worse in the overthinker's corner is when one gets really interested by investments. The inner nerd takes over, and uses the stock market or other speculations to cover for another need: a feeling of emptiness, a hope of recognition, a want to feel alive, a complex of inferiority or superiority.

Needless to say, such games are not a good foundation for decisions regarding one's life's savings.

For a retail investor, like us, the stock market shouldn't be the meaning-creating part of life, or an emotional thrill.

There are much better things to spend one's time with.

Conclusion:

It's our life savings we are talking about. Think of all the long years it took to come where we are now.

It's worth to spend some time, perhaps even weeks, to dig into the subject and do research.

A checklist for those weeks of study could be:

• Do we know at at least three different portfolio strategies, and at least one that uses other assets than stocks and bonds? (so, at least, one knows what one is saying no to when selecting one's own strategy)
• What are the longest drawdown periods during the last 50 years for those portfolios? 
• How would the longest drawdown feel if that happened to us? If it was 20 percent worse?
• What is the difference between some kind of baseline return and average return, and why is that important?
• How long was the longest time and baseline time to financial independence for the portfolios of our choice, for our circumstances, during the last 50 years? 
• How would the longest time to financial independence feel for us?
• What is the safe and perpetual withdrawal rate and how does that compare for the portfolios?
• What can be meant with start date sensitivity, and in what way can the time-stability of portfolio returns be important both for starting with investments, and also after one has been in an investment for 5 or 10 years?

When those questions are at least partly understood, then there is probably not that much more to gain from spending years trying to understand an art that still at its core is both random and beyond the grasp of the ego--narration-complex-fellow in our monkey brains. If one tries, one needs to be prepared, as said, that one is more likely to fool oneself and not the market.

In the choice between overthinking and oversimplification; don't let the pendulum swing too much in either direction.

Farewell,

//antinous&lucilius

Where to go now?

Read more about our articles about portfolios here.

Or read more about volatility here.

Always also bet on a loosing strategy

Fundamental to our way of investing is to apply several strategies - in the shape of asset allocation - at the same time.

It feels good to see a strategy be on the winning side. 20-40 percent up in a year as stocks are now, when a credit crunch seems like a forgotten phenomena domesticated by seemingly sage monetary policy. It's all sweet for the ego. We can look ourselves in the mirror - and look on the black numbers on our accounts - and pat ourselves on the shoulders and admire how smart we are.

That's the easy part.

The hard thing in our case is that we are much more paranoid. And being paranoid seems to often involve to  also always bet on a loosing strategy.

There's at least one strategy that we have in our portfolio that needs to be on the correspondingly very much losing side.

Not just a little on the losing side, but on the lunatic kind of loosing side that no-one writes anything positive about, except predictions of ruin and how imbecile one has to be too have even a penny in that corner, not to mention one's mental prospects if one actively pours money in that direction.

At the time of writing, that might be dollar-denominated long term (25y+) treasury bonds. Only a fool would buy, the saying goes.

He had it going, but in the end even his horse abandoned Marcus Antonius

CC-3.0 Pierre Selim

Not only that, we need to buy into the losing strategy, and see that money disappear in a market that has lost faith in whatever asset it is.

The losses are offset by the winning asset, in most cases (but not always). 

In order to get protection, one can't only win. One always also need to accumulate losses.

Because when the pendulum swings, everything catches fire and everyone is running to the doors, there will be no time to buy into that contrarian asset. 

The only sane thing to do is to already stand with a substantial part of one's wealth in the corner that most investors thought was wrong.

The final conclusion would perhaps be: additionally to winning, make sure that you're also always loosing money.

Farewell.

/antinous&lucilius

Were to go from here?

Try: A well kept secret: our portfolio for accumulation

Why the Expert We Follow Will Go Bust Tomorrow

There are no experts that will make us rich. Here are some thoughts why the strategy one copies is surprisingly likely to go bust tomorrow.

The Problem with the Expert

How can we fool ourselves by following an expert?

It feels good to let someone else do the thinking. And we could sure enjoy some high returns while we follow an investment-wiz, instead of the painstaking 5-8-10 years' slow road of frugal living until we achieve financial independence, right?

Let's say that we have been following some portfolio-wizard for a long time; a stock-picker or investor in some more or less exotic assets.

And by the Gods: is she good! Our guru outperforms the market with 20-30% year after year. Not so much that it's obvious that its a fluke; no - just so good that she Amounts to Being A Very Gifted Investor. 

And, in this hypothetical world, we can't help but to dream away. 

If we keep up with a 20-30% growth year after year we would already be deep into financial independence, sipping sublime pink champagne from a golden bathtub in a glade with the Gods since many years.

Poolparty for the Gods
Diana and Actaeon, Titian 1556-1559 

So we start to get more interested by the guiding light of this sage, and we read ourselves into the details of her thinking.

And indeed, she has a theory. Her ideas are based on bright and piercing observation. It just makes sense. How could such clarity, perhaps tinted with refreshing cynesism, be false? She might even be like us. How wonderful.

After several years of observation - we are overly cautious and conservative, after all - we decide to copy her portfolio.

We've done our homework. And we have the facts to prove it, or so we think, with increasing significance with the evidence accumulated of each successful year. It's a strategy that have been going strong for so long. What could possible go wrong?

The month after we buy into her portfolio composition, the losses are up to 90%. Her webpage and blog disappears, and she is nowhere to be found. And, before we understand what is going on, and because losses are fractal and can happen over and over again, we lose another 90%. 

Our life's savings are now obliterated.

The Expert We Copy Will Loose Everything Tomorrow

When we first read about the expert fallacy in Harry Brown's book about financial safety, a chapter entitled "Don’t expect anyone to make you rich", it seemed contra-intuitive, almost mystical. It smelled like a believe in foresight, a believe in faith; something to be taken as serious as a fortune teller armed with a crystal ball or a quack selling a cure against upset bowels, ill temper and social media addiction. 

How could one possibly know what will fail tomorrow? 

Now the funny part: It's not just the Gods machinating against us for their pleasure. There is math and logic behind this. The example above with the wunderkind investor wasn't as simple as us being unlucky. Just like a magic trick, where reality and our own dreams are the magician; a magician that turns one's expectations inside-out, a trick made by our own brains by wanting to cling to a good narrative.

But there is another, truer perspective. The failure of the expert is much more probable than it might seem at first glance.

The answer lies in the realm of our good ol' friend probability theory, and how she can sneak up on us in unexpected, opaque and subtle ways.

Winner Bias, once again

Apart from the opacity with an investor itself (do we know all about her investments? What are here motivations ? How oblivious to Fortune changing course is she?) But in a larger picture, this fallacy is about winner bias in one of its many disguises and reincarnations.

Many of the 'experts' we see, are just those that happen to still not have blown up. 

We might have been watching a few gurus, and semi-unconsciously lost interest as this or that 'expert' blew up with his or her portfolio. By forgetting about evidence - not to mention all evidence that never reach us - we masquerade the likelihood for ourselves if our a single expert is succesful or not. 

We see only Her, the one that survived, and it's Her that we fall in love with.

In reality, it was never much special with the portfolio of the wunderkind. It just happened to have survived a little longer than the others that went out of the game. And we happened to fashion a narrative around it, a constructed explanation why we liked the portfolio, or the person, or the made-up 'theory', or all of it.

But there was nothing special with any of it. We just got lost with the direction time moves. What one has seen is not what will be in the future.

When we act in the now, we loose this advantage of hindsight, and like a Heisenberg equation around an electron, the probability wave collapses to the observation - or rather, to our action. The strategy that we had been able to cherry pick in a cloud of possibilities, that strategy now become concrete, real. And we no longer has a possibility to cherry-pick. 

And this mountain of self-delusion is build on a truly, non-linear, high price for the risk of the strategy's over-achievement. Hence the dramatic downfall.

There is always someone standing on the battleground of life, and she might seem clever, but all things considered - it might be a question about luck, and it will be very ill-advised to copy her behavior.

Shouldn't We Never Listen to Advice?

What can we do against this? Can we never trust anyone?

Well, we think that it's just hard - we're so sorry to say. And as said over and over again, the easiest person to fool is usually ourselves.

Here are some rules of thumb we try to use:

1. We don't pick individual stocks. We just don't. 
2. We ask ourselves if an idea we have is actually just about chasing higher returns instead of balancing and protecting the downside. 
3. We think that it's very hard to reach above 10% annual growth consistently. And when one does, the risks behind the return are not linear. Then we believe that the hidden risks are much more dire, and can very quickly get us close to ruin and a loss of all our savings. 
4. We try to catch ourselves when we are retrofitting an explanation to past performance. In science, that would be very bad. In investing, it might be even worse.
5. We try to imagine if there might be dead, silent evidence that we are missing.
6. We try to look at similar strategies; did they leave blown-up investors in its wake? 
7. We ask ourselves; would this be good advice if history unfolded differently? Paradigms shift, what would happen if there was a new paradigm tomorrow? 
8. We don't believe in going all in in a single strategy. 
9. We don't tie our savings to a single asset class, and barbell the risks.
10. We try to construct a simple rule or algorithm, linked to the bouquet of strategies we use, and try to figure out if there's true return under different paradigms behind our idea, independent on past performance or a certain future playing out. But even then we don't trust our idea.
11. We test our thinking over a long run of past data. We really do remember the downturn in 1871 here, no kidding.
12. We try our thinking in many different countries, as a proxy for different paradigms and scenarios.
13. And we test even more scenarios that even never really happened, by doing Monte Carlo simulations; by using tools on the net and just building them ourselves.

We will not be the smartest ones out there. In all likelihood, no individual retail investor ever will, even if they might seem to be able to pick stocks or a fancy strategy for a while, even a long while. All that will change as soon as we invest.

So rather than chasing the higher return and dreaming about the divine pool party, we think it's better to waterproof our strategy before trying to join the Gods.

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