Don't predict

We want to avoid speculation. To avoid speculation, we need to avoid predicting. But how can we earn a good return and not predict?

It's really hard not to make a prediction. News, twitter and much commentary in general are predictions. Prediction creeps into our thinking whatever we seem to do, even if we actively try to avoid it. 

• "Let's hope this will be a good year"
• "Small cap, investment trusts or tech stock are overvalued. The P/E ratio seems high, don't you think?"
• "Inflation will destroy all returns in the next decade!"
• "Interest rates can't go down more"
• "I'm sure this stock is undervalued"

Why shouldn't we predict? Because there is no reliable crystal ball for the future. Predicting has a notorious bad track-record, obscured by winner bias.

The price on the market is the average prediction of all the market's participants. For us, the best model of the market is that it follows an entirely random process - it's perhaps not always true but it's the best approximation for how the market behaves for, we dare say, any small investor, like us.

The Oracle of Delphi, perhaps reading the financial news. 
Delphic Sibyl, fresco painted by Michelangelo, Sistine Chapel Ceiling (1508-1512) 

But what should one do if we don't want to predict?

First, we should refrain from predictive narratives that sound logical. Because that's what narratives do (sound logical) but it doesn't make those narratives into better predictions.

Examples:

• Reached the bottom? Perhaps we, or the 'experts', are sure that we're at the bottom of a stock market cycle - but in reality it's very hard to say when and how fast the recovery will come. And when prices are low, developments can be very quick. One can loose 50% or 90% of one's money in a day going in or out of the market when it moves around the bottom of a boom- and bust cycle. So it's better not to predict and stay the course with a strategy that was thought-through before the stock market cycle went downhill. 
  
  
• Reached the top? Perhaps we are sure that the stock market will stop going up, because any number of good-sounding reasons. Yet - when will that happen? Over time the market goes up, and that means that it beats its all time high again and again. And whatever theory one picks to predict the top, there are nuances that the theory will not encompass. The markets are a learning-machine, that already contains all known theories. For instance, a simple point: there's a denominator in the P/E-equation.
  
  
• Cash and gold. Perhaps we think that "only productive assets" will survive, and discover that market price appreciation for other assets also delivers real money, especially when those productive assets are at bargain prices. Who realizes that cash increased 500% in value between 2001-2003 instead of seeing the other (but same) picture - that the stock market went down 80%?
  
  
• Interests are low or high. Perhaps we think that "interests can't go down more" and discover that long term interest is powerfully controlled by the long-term expectations on inflation and interest rates by the markets. And as the central banks and politicians discover, markets are much more adaptable learning machines that are much more powerful then what a 'sovereign' state wants to admit or can fully control. 

We might hear what we want to hear when we think we should rely on a prediction. The easiest person to fool is ourselves, with our desire to hear what we want, and avoid to hear what we don't want to know. We're prisoners to our own delusions. 

Temet nosce as it was said in Delphi. Know thyself before you try to understand a prediction about the future; and the ancients knew with many a cautionary tale how a prediction tend to fool the listener.

We've tried as well. We've been rock sure that we're at the bottom of a stock cycle. And just as sure that gold can't go up. What we've learned is that we are usually 180 degrees wrong when we try to guess what is going to happen. 

Perhaps you are better than us; which shouldn't be too hard, but to really outperform the market one needs to be better than average, which doesn't mean better than any average Joe, but better than professional investors.

It's a tough game to play.

So what could one do?

A solution to not predicting

Well, build a strategy that doesn't predict. 

One popular way is just to buy the stock market on average, by buying an index fund.

We don't think this gives a good price on the risk one is taking on, but it's a strategy with less prediction. 

Another closely related strategy is to focus on dividends, not stock market prices.

Betting on many futures at once

Our way is to combine assets that performs well for most scenarios of an economic and credit expansion and contraction. 

The idea behind asset allocation is to buy into different likely scenarios and have assets that perform well in different futures and hence not bet on any future in particular.

What we started our journey with, was the hardcore solution of strategies like this and when it comes to erring on the safe side: the permanent portfolio, which has much better returns and performance than most newbie investors think.

Read more here: A-well kept secret: Our portfolio for accumulation.

Not even we are that hardcore as the permanent portfolio anymore. But it's worth knowing that it exists and how it behaves, and also ponder using it. We did so for many years.

The bottom line is: we still pay extreme attention to avoid trying to foresee the future.

Farewell.

//antinous&lucilius

Where to go next? Perhaps some thoughts of why it's not overly wise to rely on an expert. 

Time for rebalancing and avoiding the herd

We rebalance at 6 month intervals now, as we are still in the accumulation phase, so we never have too much cash laying aroundd.

And as it will take some days to move the money around we started today.

It's been a good 6 months. The portfolio is up 6 percent since the beginning of the year, so slightly above expectations, perhaps driven by some inflation also in SEK. Let's remember that any real return will need to have the inflation deducted at the end of the year.

Herd

Swedish small cap and investment companies are up 20+.  US stock market is not quite as impressive with + 13 percent from a SEK vantage point.

Gold is right plus minus zero in SEK.

Long term bonds are down much, around 20 down.

And as usual we bet on every future climate. Except that we don't bet. We behave more like robots.

So most of our money will go into long term bonds and gold. Feels strange to buy into a losing asset. But that's part of our strategy.

That is what it is to have a contrarian strategy and not follow the herd.

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

Life as a training arena for the stoic virtues

Antinous is the true stoic of us. If anyone would rate the four stoic virtues, Antinous would clearly come out on top.

Antinous wears a better social mask; he's friendly, agreeable, likeable.

If there's something that is going for Lucilius, then that would be that he's got his emotions on close range. Too close, according to himself.

We have come up with all sorts of explanations of the differences that are most of the time quite amusing. Probably genetics, and the role we played in our early teens seems to have colored these parts of our personalities.

A lot of things about personality are on a flip-side scale; on one hand, and on the other hand, and everything can be both good and bad, and there's no real value judgement to a personality trait, or so the common wisdom goes.

But here's something where the stoics, and the ancients before them, knew: that some scales are absolute. More is just better. And that insight is underlying the concept of the stoic virtues: fortitude, prudence, justice and temperance.

Fortitude

Fortitude, strength, the ability to endure the necessary hard times and do what must be done during challenges that life unavoidably entails.

"Are you samurai?"  is a question we ask each other sometimes, after having had a stab at the playstation game "The Ghost of Tsushima" where the phrase gets thrown around a lot.  

We say it like a; "wht the f*ck, how hard can it be?" and a "stop complaining, and get it done!"

Are you samurai?

To some extend it works. And it reminds of that some of the ghosts we face and that are stopping us from showing the strength needed in everyday life is more in our minds than real.

Prudence

Prudence, the ability to step back and think about the course of action and make cold-headed decisions. In latin, the word is prudentia, and this virtue is sometimes just translated as wisdom. 

So the ability to back off, let go of anger, giving up short term wants or silly cravings of recognition, and clearly see what path is best. 

Lucilius, as said above, especially can feel the sting of anger and get carried away by emotions. And it's dangerous. Suddenly he might have said something, let something slip, that gets a life of it's own.

Once upon a time, allegedly, there was a tribe in the arctics, that had the concept that they had a soul that always walked beside them, a kind of mirror-spirit of themselves, that they called the bigger man. 

They themselves were just the little man, consumed and dragged into the petty things of life.

But when something happens, we (and they) can always ask what the bigger man would do. 

Do we feel assaulted? Then we ought to ask ourselves: what would be the little man's response? And what would the bigger man do?

Justice.

Justice is about doing the right choice, of having an adequate sense of right and acting in accordance with the laws and what's right.

So not trying to cut a shorter path that isn't right, doing evil for short term games, and accept the just laws that govern human interactions and act in accordance with one's values.

Do the right thing.

Temperance.

Temperance is knowing what is enough, knowing how to control oneself, one's emotions and one's wants. 

There's more to temperance. As anyone striving to financial freedom knows, moderation is an absolute necessity to walk this path. Someone who cannot temper his appetites will always want more, and thus never becomes truly rich and never reach any kind of significant freedom.

Being In The Arena

The virtues are learned in the arena, with other people, while we are trying to achieve something difficult and of value.

The arena provides the training ground needed for freedom.

We suspect that it's much harder to chisel out the virtues if one is too deep into a propped-up otium. 

The world and its challenges, correctly taken on, train us in fortitude, temperance, prudence and justice.

Venus punishes Psyche with a task (more precisely to get water from a high rock guarded by dragons).

Ca 1692-1702, Luca Giordano

That's why, according to a more hardcore attitude, we should thank the gods for the misfortunes they throw in our way. 

If one should be able to truly enjoy freedom, we suspect that one better be trained, and keep on training, and embrace the training opportunities the arena throws in one's direction.

Farewell,

//antinous&lucilius

Truly not a slave: when the paycheck looses its attraction

What would your boss say if you came in and requested a 40% salary increase for the next year? And a 40% increase the year after that? Would she happily agree? Or would the cadres at your company think that you are more than insane?

A few years ago, we could expect a 40 k€ return from our investments for that year. The year after, this had increased to 60 k€, as it happened to be a good year.  The year after that, it was up at 80 k€.

That's a 100% increase in our income from investments per year over two years, or roughly an increase with 41% per year. All that just because we save and invest conservatively in our pathfinder portfolio. 

This is after-tax, in-our-pocket (or rather, investment account) money. So in many regards, much better than paycheck-money.

Now, compare that to how our salaries increased during the same period. These years were good to both of us, as we had changed job and had some salary progression. In the same time, that increase was hardly above 10% per year, so very, very far from the 40% increases in investment income.

This increase in investment income keeps rolling forward in a pace that is much, much quicker than any salary progression. 

It compounds quicker than one expects

Scientif38, CC-3.0

So, as all proponents of the FIRE-movement knows, there's a point where the investment income can cover for one's basic needs. 

Let's ask for a radical salary increase, shall we?

But there's also a point where the investment income is as big as the salary itself, and then - quite quickly - comes a point where the salary income just can't match the investment income at all under any realistic assumptions.

That's the point when a very substantial increase in salary - which for most people would mean a very drastic increase in responsibility or required skills - doesn't really do a significant change in total income nor wealth.

And then, suddenly, there's no salary that can realistically be paid, in any wage-based profession, that can be economically interesting to us anymore.

Truly not a slave 

This is the point where we loose financial connections the labour market, at least for all kinds of normal, labour-market-based monetary reasons.

We suspect that we have no inherent feeling that such a point in the financial journey exists. It should always be economically useful to work and earn one's living, right? Yet take any billionaire. There is no economic way of employing them with motivation of any normal paycheck.

There's a point like that for you and us as well. In Sweden, the take-home after-tax average salary after 5+ university studies is around 40 k€ (yes, we're in Europe, but the point still holds). That is a number we swooshed by several years ago with our investment income alone, and then continue to go beyond, with a very significant increase in our "investment salary increase" every year.

The progression, as we saw with the numbers, is such  that our bosses would be very surprised if we asked them to please keep up with our investment income increases with matching salary increases.

When most people hits a million euro, and keeps lifestyle inflation at bay, then it starts to get really hard to make significant improvements to one's economy by working for a monthly paycheck. The investment income becomes more than twice as large as what one earns via the paycheck. 

Suddenly, as sudden as how quickly a surprise avalanche builds up, it's no longer possible to employ us anymore, at least not for economic reasons. 

Then truly, we're not slaves any more.

At that point, only our own devotion can buy our time.

Farewell,

//antinous&lucilius

Volatility from a 5 year perspective: Welcome to the 1825 days year

Once upon a time, at the birth of our solar system, the time for the earth to spin around the sun became the 365 1/4 days we are used to.

It was a God given, a necessity, perhaps, and of course entirely out of human control.

Those 365 days has some impacts on our life, and certainly our evolution. For the two of us, the arctic summer and winter are a stark reminder of the solar year, on other places closer to the equator the climate will be more stable year round. 

The Arctic Sun

In the heated, air-conditioned, civilized life of today, the impact of earth's rotation on everyday life is smaller. The time it takes for earth to orbit the sun would seem even more arbitrary if one lived outside our frame of reference, let's say on one of the moons of Jupiter. 

From a more elevated perspective, an earth year is a seemingly randomly set constant.

Yet, we tend to give this period an out-of-proportion importance. We count our age in it, we celebrate the summer and winter solstice and equinoxes with rites and feasts. 

In finance the year has significance as well; as if the returns of our investments where a crop to be harvested every year. The year is the basis for what we understand with returns; if we see the number 7% it's assumed that it's the annual return that is meant. 

What is the impact of this metaphor on our thinking about investments? Investments that might not really care about the arctic sun, the moons of Jupiter or the passing of midsummer? 

What if we measured returns in another constant? 

Let's say that we just as arbitrarily instead measured a new unit that we set at 43 800 earth hours, or 1825 earth days, corresponding to 5 earth years. 

A unit, as if earth was spinning five years slower than we are used to. Or as if one only can be bothered to have a look at the planet every five year and wouldn't notice that it's actually spinning faster. Or as if we saw that grand red dot in the clouds of the gas giant Jupiter from our moon every five years, and measured the passing of time in red-dot-revolutions and not earth years.

What would we think of our investments then? How would volatility look with our new, more relaxed, slower 1825 days year's perspective? What decisions would we make?

Let's plot our pathfinder portfolio's return excluding inflation in a logarithmic diagram, with our normal earth years and our new, 1825-days-years. 

A thin red thread that always strives upwards

And voilà. An almost straight, red line that always marshes on upwards and never ever turns the other way. It's the same return, just with a lower resolution.

Our way of looking at things are bound by conventions that might be out of place. This hints on what volatility looks like for the Gods. 

And perhaps, it could for us too.

Farewell,

//antinous&lucilius

The built-in Identity Crisis of work-life: How Dante's Inferno got it right

A common way to enter the fire community seems to be to go through some kind of mid-life crisis.

Identity, crisis and burn-out

At the core of the fire community (and mid-life crisis, for that matter) seems to be not finance, but identity. 

What do we mean with that? Let's start by looking at identity. Here's an attempt at a two-fold definition. 

For an individual in relation to a group, identity will be any trait that most sets the individual apart from the  group.

For instance, in a small work place being gay will probably set you apart. Are you among gay friends, being the country boy might set you apart, et cetera.

Inversely, for the individual, identity will be the counteracting trait; anything that includes the person to a group and, importantly, also preferably puts that person higher up in the hierarchy, the status ladder, of that identity-creating group. 

During university and our early careers, we suspect they most high- and medium-achievers are so consumed with an identity based on a strive to find a profession, conforming into a role, that the profession becomes the trait that includes us in a group and sets us apart from other groups. 

Hence profession is a strong candidate to create our identity.

And with identity comes a lot more: the feeling of self-worth, feeling of respect in society and by friends and family and so on and so forth.

If it's not profession, other aspects are likely to compensate for identity: the kids, the house, the husband, friends.

These identities are naturally shallow, and early in life they need to be shallow to guide us into taking concrete, tangible (and by necessity, shallow) action. 

But kids grow up. Work changes and evolves and we become obsolete. The apartment or house as an identity creator? Let's not even go there. 

This early identity, as it's shallow - and society seems to need to keep our identities quite shallow - will eventually hit that trigger event that causes the identity to shatter, and a personal identity crisis will evolve. 

There comes a point when the identity and status in regards to one's chosen group is lost.

But with the identity goes one's feeling of self-worth, respect, belonging and recognition. We're probably hard-wired to react very strongly when that is lost, as this is something that was - and still is - potentially truly dangerous.

This loss of identity is so painful that it needs to be masked in other terms; often given an aura of scientism in the miss-normer of burn-out.

There might be some painful truth here. But in the midst of all ideas around burn-out, identity might often be an unfortunately lost concept.

The Evolutionary Advantage of Burn Out

If a sense of loss of identity wasn't involved, a burnout and the related feeling of stress might be easier to brush off. 

But the loss of identity makes it go deep.

A change in identity is intertwined with a feeling of gliding downward on the hierarchy ladder that our shallow identity is attached to.

Unfortunately for us humans, this seems to have a natural defense system that kicks in, to prevent us from doing dangerous attempts on the hierarchy ladder, as we have failed, or so our evolution tells us. 

There's an obvious evolutionary advantage to avoid further group exclusion. The one that survives, even further down in the group hierarchy, might still be lucky and propagate some more genes, compared to the one that challenges the status ladder and gets killed by the new matriarch, or whatever.

The name of that defense mechanism might very well be depression. Depression seems to be designed to keep us at bay, passively, and consider our options.

Let's sum up: the rules of life forces us to create a guiding identity, that through precisely it's concreteness is shallow and easily scattered, and then makes us fall down the status ladder into burnout and depression.

Is this even designed into the fabric if the human condition in society? This seems to be nothing new. 

Dante's Inferno, which, like the tradition of the alchemists, might have been a way to disguise philosophy and life advice in a religious language acceptable of the age, seems to be one large allegory on this theme, as a symbolic master piece about the midlife crisis and how it affects us and how to get throw it.

As we recall the protagonist's decent starts with:

Midway upon the journey of our life

I found myself within a forest dark,

For the straightforward pathway had been lost.

Dante et Virgile en enfer
William-Adolphe Bouguereau,1850

The midlife crisis is not just a theme in literature and art, it is also a core idea in individuation: to cast off the limited potential we have forced to constrain ourselves with to fit in society. Which is really nothing else than our constructed, shallow and fragile identity that we need to shake off through the nadir of our life. 

Our ambitions lead us exactly to the point where we do not want to be.

At some point in life, one will discover that what builds our identity isn't as stable and reliable as we hoped, and well, then our identities weren't as reliable and stable as we thought.

And that, not surprisingly as Dante saw, leads to a journey though hell that we must endure to reach heaven.

Conclusion

Here lies part of the beauty with the FIRE-movement. We need to build something more reliable to lean against than an all-too strong identification with things that will be taken away from us. 

Financial independence is a good and important step on that journey.

As long as we needed the paycheck, we are in a sense doomed to struggle with our identity and how it collides with the demands of our profession. 

This kind of identity struggle is not a good foundation to build a new, more free and robust identity upon.

At some point, though, one can become more free, perhaps supported by financial freedom, and start to reinvent the potential one has in life.

As long as that doesn't happen too late.

Farewell.

//antinous&lucilius