Wrestling Volatility

Let's say that we during adventurous travels in the Hindu-Kush fall victim to a sinister maharaja. 

The whole affair has something to do with lovers, defamation and the beauty of punjabi men, that sort of thing.

To our horror, we learn that the punishment for debatable behavior is to be thrown out of a cliff. The maharaja then, according to ancient custom, gives us a choice: being thrown out of a ten meter (30 feet) cliff, or ten times from a one meter (three feet) cliff.

A big hit is, most would agree, much worse than many small hits. So either one has to make sure to chose the smaller hits, or else have a way to avoid the effects of the big drop.

The drop is of course our metaphor for volatility. Volatility, as our sinister maharaja, is the harbinger of ruin, and it's not symmetric. 

But volatility can also be the omen of good fortune. Let's say that one has prepared with a thick, bouncy mattress below the cliff (needs to be prepared in advance), or has learned how to fly a squirrel suit (takes some deliberation). In the last case, larger volatility might even be needed to get us somewhere. 

Volatility is also fractal. In the unlikely event that one survives the first drop, one might roll over the edge down below and find an even worse drop. One can lose 50% many times over when the markets go down. 

Volatility might seem to be calculable and controllable, but then shows up in new shapes unheard of; tulips, house markets, failing financial institutions, or the maharaja's crazy son, for instance.

Or perhaps the maharaja's (wooden) palace catches fire. An once-in-a-lifetime, high-volatility-event. And all the fire exits will be blocked by investors - or rather, ministers and courtesans, perhaps - that try to escape the burning palace, just as we ourselves might find that we need that fire exit. 

Some might laugh in the face of volatility. Some might want not to think of it. Some might earn from it, with that mattress and squirrel-suite.  

Whatever we might think of our tolerance, it's not naïve to expect that volatility might hurt more than our fragile human constitutions can take. 

The wise man prepares in advance. And while preparing our defenses, remember that it's better to protect against ruin rather than chase the higher return.

A high-volatility mountain range where it pays of the be both wise and prepared.

CC-4.0 Zeeshan-ul-hassan Usmanif

Let's look at three strategies to reach financial independence, from a Hindu-Kush perspective.

1. The very very heroic approach
2. The heroic approach, including mattress
3. The squirrel suit approach

1. The Very, Very Heroic Approach

A very, very heroic approach to financial freedom, akin to dare the maharaja's crazy son, Prince Singh, on a duel, is to start a company. To some extent or another, it's a gamble, heavily relying to our own capabilities and wit. No matter how good we fight there will be luck in the equation. 

We can fund the company with its own cash flows, or even more volatile: lend a bunch of money, buy something of value to others (rental properties, someone?) and sell the produce of the investment to others.

Then, lay awake at night at pray that the company doesn't burn to the ground, a competitor shows up and the market demands stays, or the Prince having a nasty trick up his sleeve.

Darius I, early ruler of the region.

It's as old as the the written word. Perhaps the written word even exists because of this strategy to wrestle volatility and get rich. And if you're lucky, one might get very wealthy with this approach - killing the prince, inheriting the whole of the Raj, et cetera.

But ruin can very well be complete, and severe.

2. The Very Heroic Approach

A less, yet still very heroic approach is to bet on all companies in the economy instead.  

The very heroic approach is to buy a broad stock market index fund, with the attitude that in the very long run the stock market will be going up.

Why is it heroic, and why do we say in the very long run? Well, because it can take 10-20 years to recover after a big drop for the stock market.

A few times in one's lifetime, one is likely to hit that big negative event. We know big volatility will come, because what is an unlikely event in one year suddenly becomes a likely event in ten years. Then, like our ten meter drop above, one better be of an unusually strong built, or have something prepared in advance to survive the drop. 

No, we hear you scream, you wrong, I've heard that the markets recover much quicker! But we're so sorry. Let's not mix up the duration of a crisis (often quite short) with the time for recovery of the stock market (can be several decades long). But yes, there is hope. Bear with us.

The way to survive this for many is to try to construct a mattress that will dampen the fall. 

The mattress can be a cash buffer one can live off during the worst year, or focus on the cash streams created by (hopefully) less volatile dividends. 

Another way is to have complete blind faith in the magic of back-testing and rely that the 4 percent rule* is not just a product of back-testing but more akin to a universal constant. 

So there are ways to try to get around the volatility of the stock market as a total. Open in new tabs for future reading!

• 20% Barbell - a better price for risk
• Dividends And The Sweet Scent of Mental Accounting

Yet, the attitude to risk still needs to be, well, heroic to say the least. In the accumulation phase, the goal of financial independence can suddenly be postponed five years or more into the future when the stock market misbehaves.

In the financial freedom phase, the size of the stash might be reduced for decades, and if one is unlucky, what felt like a safe margin for freedom might become a very small margin indeed. If something unforeseen hits - as it has a tendency to do in real life, we dare to say - that might even make the stash never recover again. 

3. Learning to fly on volatility

The alternative to the mattress might be to learn how to fly in times of big volatility, perhaps even understand how to earn from it. 

Instead of relying on one asset class, we have gone for four. The advantage with aiming for a set of very different asset classes is that they move much less in tandem, yet each and one of them takes part in the economic growth of humankind over time. 

Another appetizing property is that the portfolio profits from volatility in most cases. Each and one of the assets in the portfolio would be very dangerous to own by itself, but because they are put together, they create something that is much less dangerous, and will often  move counter to the stock market during a bad year.

So when volatility strikes, with big drops in any single asset-class, we can fly over the cliff with a surprisingly stable flight despite all the rough edges that are zooming past below us. 

And the types of portfolios we chose has an okay performance, getting us much more safely to financial independence by neutralizing the effect of a big drop. 

So with the right preparations, one can profit from the sinister maharaja's proposition, and both earn from the volatility that might kill others, and in the same time fly safely over rough terrain.

Read more about our thinking around our portfolio here:

• Time for Change: The Pathfinder Portfolio. 

Farewell!

//lucilius&antinous

* The 4% rule says that never, in the last 50 years, have a stock-heavy portfolio run out of money if one takes out a fixed sum each year and adjust it upwards with inflation. That yearly sum corresponds to 4% of the portfolio's worth the first year, and is often taken as a universal constant with the reliability of the Planck length, even though it's of course derived from historical data and thus assumes that nothing worse can happen than what happened during the last 50 years or so.

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

The Tragedy of Paul Allen

I don't know much about Paul Allen. Obviously, he has done much more for humanity than I or anyone reading this could ever hope to achieve.

A lonely man on a yacht

The only things I know are fragments, a few pictures in the media and a Wikipedia article.

Poor Allen will be a symbol here; a meme, something we might recognize. He is the picture of the lone billionaire who never married, sitting on his yacht.

Was he happy? I don't know. 

The Octopus, 2010.
By Issacc brock - Own work, CC BY-SA 3.0

Greatest Treasure

For Antinous and me, the greatest treasure is having one another. To be on the journey with our soulmate and married to our handsome best friend.

Sometimes we have the impression that heterosexuals might forget this, perhaps out of convention, more used to take a relationship for granted, or because the external and internal battling have been less confusing and conflicting. 

The picture is not that easy and stereotypical, of course. But whoever we are - let's not take our relationships for granted or as a convention, a comme il faut. 

The most fundamental capital we might have is our own, human capital. What we finally really own is our ability to create wealth.

This fundamental capital is infinitely boosted and magnified by having our best friend at our side.

And it's not only capital. It's two brains, two ambitions, two sets of friends and families and networks and passions and inspiration, and all that add up, and create something that exists between us, and is far greater than anyone of us can achieve, do, think or imagine by ourselves.

There's infinitely more wealth and adventure that materialize in the empty air when we are together. And adventure out of thin air is magic that not even Mr Allen's yacht seems to quite make up for.

Essential Reads: How to find freedom in an unfree world

A scary question; do we have the courage to be free? To defend it for ourselves? To act on our own freedom? Or do we just prefer to sit in our prison and complain about things conveniently remote?

One of Harry Brown's not-so-known books has the title "How I found freedom in an unfree world". The book is almost 50 years old now.

It might feel outdated in today's world, or, so we thought. Still, we got hold of it as an e-book and put it into our favorite speech-engine and listened to it as an audiobook, with the fire cracking in the fireplace and seeing spring slowly arrive at these northern latitudes outside the windows. 

The book is not quite as outdated as one might think. There's a very vibrant core idea in Mr Brown's thinking.

Pericles, Athens 429 BC, defender of freedom in the larger sense of the word. 

To build freedom for ourselves, the idea is to focus on what we actually can act on, and have the courage to do something if needed, or let it go otherwise.

So: let's not talk about the grass on the other lawn. Let's not get hung-up about who is the president of the US, what's happening in China, or if our local parliament is passing a law that we hate. Nothing if that is of much importance, unless we can truly do something real about it.

Life is and will always be a battleground. Let's not sit and be upset about that.

Let's focus on ourselves instead. Is any of that upsetting for us, in our immediate surrounding and interactions? And even if it is, how big is the impact? Or do we feel insulted, rather than our freedoms being really decreased?

Let's act on our immediate surroundings and how that creates freedom for ourselves instead. Those decisions are tougher but far more impactful than complaining about far-away, theoretical assaults on some kind of idealized freedom. Provoking thought? Perhaps, but then tell impact might happen on a small scale.

Stuck in a marriage, or don't like the laws around marriage? Divorce. Don't like the taxes? Find a way to optimize them. There's much that can be done. Or just earn more money. Don't like to be employed? Start one's own company. Don't like the school-system? Find alternatives.

Is this a lack of civil courage? Yes and no. I would say that it takes courage to grasp our personal freedom and realize that much more than one thinks is under our control. And if we want to fight in the public arena for real, we should do as Pericles and actually fight, and not merely complain.

Do or do not: there are no complaints.

Let's not complain about being unfree, or what is outside our control, so we loose sight of what can be done with our actual freedoms here and now. 

The conclusion would be: being unfree is usually much more in our heads than in our reality.

Hardcore Health

Something that comes back again and again in the financial freedom-sphere is health. Perhaps because there is a similarity between breaking free from misconceptions about finance and misconceptions around health.

Our conclusion is that we need to be as radical with health as with finance. Actually, health came first for us, and we discovered investing later. The same concept still applies - what is considered 'normal' has gone far away from what is in our own interest.

The 'normal' has inactivity as its goal, inventions that remove discomfort (e-scooters, really?) and convenience as its means. The 'normal' markets health as a commodity, with roughly the same mediocre results as listening to financial advice from the old banks.

When one has been indoctrinated to the normal for too long, the break seems hardcore. Just like with finances. 

The body below the head is not a dead appendix sewn on under the shoulders. It's something that requires attention!

And a really nice butt. Hermes, quick runner.

Marble Statue (~200 BC),  Metropolitan Museum of Art, NYC

Go Hardcore!

1) Sell the car. Just get rid of it, give it away if need be. Get to everywhere within 12 kilometers (7 miles) from where you live with muscle power. Kids? They can bike. We're not kidding.

2) Go up at 6:00 every morning and go for a 5-km run (2 miles). It's not so short that it doesn't matter, but long enough to make you really happy, and healthy. And the heart is a super-Godlike-fabulous muscle, that literally keeps you alive from second to second, so give it Respect! The secret to getting up at 6 (or 5:30)? Start with going up early! That's how one gets sleepy in the evening and gets into the habit.

3) Office? Stand up! At least 4 hours a day. And go for a lunch walk or run.

4)  Don't underestimate micro-training. Do pull-ups in that outdoor gym when running. Do 50 pushups, squats and sit-ups when you can.

5) Always have ready access to training. Have kettlebells at home. Running shoes by the door. Live close to a swimming pool. Get rid of the gym card, that's just a silly excuse, draining costs and worth nothing by itself. Get real, get out and get going instead.

6) Surprise the body. Go for the odd long run. Swim in lakes. Jump. Dance.

Don't fool yourself that hand-eye-control and kicking or throwing things is training. It's not. It's just eye-hand-control and throwing things. Benefit? Unclear. Grow up. 

Where to start?

Don't let the Ego be the Enemy. Run 1 km, walk 1 km, and progress slowly until you can run a complete 10+ km. Do push ups, squats and situps with body weight. Do yoga. Keep on until your body starts to respond.

We keep some metrics:

- Our BMI:s should always be in the 20-25 range. 

- We log training. In a year we should accumulate 10000 minutes. 

- We should run 80 mornings, and we have some stretch-goals to strive for: go for a long run at least every month and crawl +3km 3 times a year. 

Food? 

Some suggestions:

- Breakfast is a stupid invention of modernity, made up by the food industry to make us consume junk food (don't try to excuse yourself in thinking your breakfast is an exception) and pooring in useless, low-quality calories. Have a coffee in the morning, learn not to fear some hunger that keeps you sharp - and eat an early lunch with real food instead.

- Bread was invented by the Devil.

- Cole and broccoli were invented by the Gods. 

- Give up meats. It's as stupid to let a cow eat grass and then eat the cow as one might think. Did we mention hardcore?

- No alcohol. Not kidding. Why the heck would you?

- Popcorn is underrated.

- Use sweeteners if you like, or stevia. The criticism is machiavellian propaganda to the uninformed and mentally behind by the sugar and farmer industry. Sugar is the worst cancerogenous substance we habitually consume now, after alcohol. And you will be able to decrease sweeteners as you learn not to expect food to be so sweet.

- Think about how much energy you put in (nuts = much, cole=not much), and how much you use up by training, moving and being active during a day.  

- For GODS SAKE: the MOUTH should NOT be a path to great pleasures in life! We would recommend scenic runs, happy kids, good art, a meaningful vocation and a fun sex life instead. Stop whining and get serious.

Leaning in too much

As with finance, one can go too far, and let the ego-complex-nerd, the inner little person fueled by insecurities and control-needs take over. Then, just as with finance, one's compensatory behavior quickly becomes unhealthy. No, you don't have to run EVERY morning. No, don't run marathons, ultramarathons, iron-mans or any races for that matter. Who are you competing with? Why should you? 

And no, don't go and lift a mammoth three times in the gym to get biceps as big as your legs. 

There's healthy, and there's too much.

Even Seneca recommended just jumping around, to avoid the excessive eating that comes with excessive exercise. 

A Hardcore Break

There's no excuse. Just as we can realize that the 'normal' in finance is anything but healthy and requires a radical break; the same applies to an even more important asset - our body, heart and butt -  and the approach needs to be just as thorough, consistent and radical. 

Good luck and get going!

//antinous&lucilius

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