Weekend Reading

Vanguard Research recently published a paper on how to assess the value of financial advice. They mention that the global demand for high-quality, cost-effective financial advice is growing. In many countries, increasing reliance on defined contribution systems means more households will be retiring with substantial savings and will need affordable and effective help in managing them. More broadly, the financial services industry faces rising demand to improve client outcomes and value for money. How should investors measure the value of financial advisory services provided?

Vanguard suggests a three-dimensional approach. Investors should evaluate the adviser’s services in three areas.

Portfolio value. The first dimension concerns the portfolio designed for the investor. Value comes from building a well-diversified portfolio that generates better after-tax risk-adjusted returns net of all fees, suitably matched to the client’s risk tolerance. Portfolio value can be quantified in many ways, including different measures of portfolio risk-adjusted return, diversification and allocation metrics (such as active/passive share), the impact of taxes, and portfolio fees.

Financial value. The second dimension assesses an investor’s ability to achieve the desired goal. A portfolio does not stand on its own. It is in service to one or more financial goals, such as retirement, growth of wealth, bequests, education funding, and liquidity reserves. One way to evaluate success is to estimate the probability of achieving a financial goal or wealth target at the end of a specified period. Ultimately, an advisor should seek to improve an investor’s chance of achieving his or her desired future spending goal. To do this, the advisor must consider a myriad of planning-related metrics that extend beyond portfolio outcomes. These include financial behaviours such as optimal savings and spending; the assumption of debt; budgeting; insurance and risk management; various elements of tax-efficient retirement planning; and legacy, bequest, and estate planning.

Emotional value. The third dimension is an emotional one: financial well-being or peace of mind. The value of advice cannot be assessed by purely quantitative measures. It also has a subjective or qualitative aspect based on the client’s emotional relationship with the advisor. Underlying elements include trust in advisor, the investor’s own sense of confidence, the investor’s perception of success or accomplishment in financial affairs, and the nature of behavioural coaching such as hand-holding in periods of market volatility.

I believe that most of the times investors are overly focused on returns and cost of service (portfolio value) and overlook the other two (financial and emotional value) until it is too late.  

John Huber writes about the risk of outsourcing thinking in an update on his blog. There is a famous sociological experiment from the 1950s where 75% of the participants denied completely obvious facts that were right in front of their eyes simply because they were told that the rest of their peers chose a different (incorrect) answer. There are many reasons why many financial frauds occur, but Huber thinks one of the main reasons the frauds became so big and lasted so long is that investors primarily relied on the opinions of others. The fact that so many other smart people had already given the company their stamp of approval led to massive outsourcing of original thought. No real due diligence was performed by this investor group. If they had, they would have likely discovered numerous warning signs.

Huber gives one example each of independent thinking and outsourced thinking. During the last financial crisis in September 2008, Ken Lewis (CEO of Bank of America) hired two different banks to provide him with a fairness opinion so that he could buy Merrill Lynch. Lewis badly wanted to buy Merrill. The banks he hired to value Merrill knew this. And those two banks dutifully performed their job, giving Lewis the value he needed to justify the acquisition. So, on the Sunday of the epic “Lehman weekend”, Bank of America decided to pay $50 billion for a company whose equity would have most likely been worthless just two or three days later.

Earlier in the summer, Warren Buffett got a call from Dick Fuld (CEO of Lehman Brothers) late on a Friday evening. Fuld wanted Buffett to invest fresh capital into Lehman. This was before the crisis was in full force, but Lehman was starting to haemorrhage cash and was clearly struggling to survive. Buffett told Fuld he would think about it over the weekend. That same night, Buffett pulled out Lehman’s annual report required by the U.S. Securities and Exchange Commission (SEC) that gives a comprehensive summary of a company’s financial performance and began reading it, making notes in the margin. After a couple of hours, he put the filing down and called Fuld back and told him he wasn’t interested. There was simply too much about Lehman’s books that he didn’t understand and couldn’t figure out, and so he found it too risky and quickly decided to pass. He came to this conclusion on his own after reading a document that was publicly available.

Buffett didn’t make calls to Berkshire CEO’s in the finance industry, he sent no analysts to talk to bankers on Wall Street, and he certainly didn’t read any third party research. He simply pulled up a filing that any one of us could have accessed, and decided to see if the company was worth investing in. One guy outsourced his thinking, and one guy did the thinking for himself.

Huber’s observation is that independent thought is extremely rare, which makes it very valuable. On the other hand, outsourced thinking appears to be pervasive in the investment community, and because of how we’re wired, this dynamic is unlikely to change. Regardless of how convincing the facts are, we are just more comfortable if we can mould our opinion around the opinion of others. Understanding this reality and being aware of our own human tendencies is probably a necessary condition for investment success in the long run.

Vishal Khandelwal in his recent blog post reminds investors to ask themselves this question. He quotes Rework by Jason Fried. You don’t make a great museum by putting all the art in the world into a single room. That’s a warehouse. What makes a museum great is the stuff that’s not on the walls. Someone says no … There is an editing process. There’s a lot more stuff off the walls than on the walls. The best is a sub-sub-subset of all the possibilities. “It’s the stuff you leave out that matters,” writes Jason in Rework.

When you apply this crucial lesson to building your stock portfolio, it means that you are likely to succeed as an investor not just by the stocks you own, but more importantly by the ones you don’t. But often, we end up building warehouses of our portfolios, not curated museums. A stock is followed by another, then another, two more, three more, and on, and on, and on. Some people even maintain multiple portfolios, and each looks like a zoo of mismanaged, rowdy animals.

People buy stocks for all kind of reasons – they like them, their neighbours like them, their friends are making money on them, someone on Twitter is shouting about them, their prices have risen sharply in past few months, someone recommended them on TV, someone wrote about them on online forums, someone is boasting about them on WhatsApp groups, etc.

Investing follows life, and this is also what a lot of investors end up doing. They create crowded warehouses of portfolios in the initial years of their investment careers, realize most of their choices were mistakes, and then they start subtracting vigorously.

Lest you lose out on the positive compounding timeframe, you will do yourself a world of good by respecting and practising this lesson – of saying no to most things, of not adding a lot of unwanted stocks to your portfolios – early.

Khandelwal concludes by asking investors to be a curator of stocks, not a warehouse manager.

Dated: 27th July 2019

I came across this article written by Jeremy where he talks about that we have four currencies, four things we can use, invest, manage, and exchange. They are our Time, our Money, our Energy, and our Ability. The classical understanding of stewardship also is similar in defining stewardship as the management of our time, talent, and treasures. The balances of these currencies fluctuate with life’s seasons for each of us.

What’s interesting about these currencies is that they don’t exist in a vacuum. They’re interrelated. Each one requires varying degrees of effort to manage, and each one can negatively or positively impact another.

Jeremy’s point is that as humans in general, and investors specifically, we’ve got a whole lot more to manage than just our Money. And it is an ongoing management plan – things change, sometimes really quickly.

If you find yourself getting stuck, it’s super helpful to step back and look at the currencies of your life and see which, if any, are running low. And then think about ways you can try and bring it back up, even if it means dipping into another currency’s present excess.

The easiest currency to focus on is Money. Money is, arguably, the most renewable of the four. It’s also the most flexible – it can be used to buy more time, gain more energy, and build more Abilities. And that increase in Time, Energy, and Ability can then be used to acquire more Money if we’d like them to.

Jeremy thinks a reason why we talk and focus so much on money is that it’s the most concrete, and it’s the easiest one to measure. And it’s a good starting point, but don’t stop there.

If we want to live a life that manifests our true values – our true goals and intentions – we need to pay attention to all the currencies and manage them wisely.

Source: https://calibratingcapital.com/

Dated: 14th July 2019

Morgan Housel reminds us that Investing skills are important, but they have to be paired with personal finance skills to be sustainable.

Housel is surprised how many good investors he knows with terrible personal finance habits. Maybe he shouldn’t – they are completely different skills. The ability to uncover an undervalued investment is not associated with your propensity to avoid lifestyle bloat. The irony is that people who will move mountains to gain a few basis points of return bleed ten times that amount on personal spending that all science says adds little to their net life happiness.

But investing and personal finance rely on each other because few industries are as cyclical as investing and as Charlie Munger says, “The first rule of compounding is to never interrupt it unnecessarily.” Compounding works only to the extent that your lifestyle doesn’t force you to sell investments at inopportune times to fund your lifestyle. Someone earning average but uninterrupted returns may be better off than someone outperforming by 50 basis points a year yet forced to liquidate a portion during every bear market to pay off lenders.

Investment returns have a lot of potentials to make you rich and achieve your goals. But whether a strategy will work, and how long it will work for, and whether markets will cooperate, is always a question. Personal savings and frugality – finance’s conservation and efficiency – are parts of the money equation that are largely in your control and have a 100% chance at being as effective in the future as they are today. So which should you pay more attention to?

This is not about living like a monk, hampered by frugality. It holds true at every level of wealth and spending. Housel concludes that the idea that reducing your needs has the same impact as increasing your income – but the former is more certain and in your control than the latter, so it has a higher expected value – is as true for someone spending Rs15,000 a year as it is someone spending Rs15 lakhs per year.

With indices touching new highs every day, many investors start thinking that they should be 100% invested in equity markets. No one wants to hold cash as there is high opportunity cost. Instead of holding cash in the portfolio, investors want to own a stock, any stock. This is perhaps the best time to remind ourselves of the value of cash. Let us remind ourselves of how successful investors look at it.

“I think it’s [cash] actually an aggressive strategic asset because it’s one of the few things that rises in value as the market plunges. Its value is inversely proportional to how challenging the environment is” Ken Shubin Stein

“Holding cash is uncomfortable, but not as uncomfortable as doing something stupid” Warren Buffett

“I have found it wise, in fact, to periodically turn into cash most of my holdings and virtually retire from the market. No general keeps his troops fighting all the time, nor does he go into battle without some of his forces held back in reserve” Bernard Baruch

“Naysayers argue that holding a large amount of cas

stimate (Source: marketscreener website)