Common Sense Investing Rick Van Ness

Common Sense Investing: Sharing an excellent set of simple videos (less than 60 minutes) by Rick Van Ness. All that an average individual investor needs to know and follow.

This is what the site http://www.financinglife.org/ says about these videos:

“These short videos teach basic financial concepts to make it more likely that you’ll achieve common life goals such as owning a home, providing for yourself or your family, taking fun vacations, and retiring in comfort–all free from financial stress.”

“These videos are inspired by the friendly and unselfish help given to individuals at Bogleheads.org, now the largest not-for-profit investment site on the Internet.”

Running to Stay at the Same Place: Tum Kisliye Bhaagta Hai Bhai?

“Aisa to Aadmi Life mein Doich time bhaagta hai. Olympic ka race ho, yaa Police ka case ho. Tum kisliye bhaagta hai bhai?” asked Amitabh Bachchan in ‘Amar Akbar Anthony’.

I felt like asking this to a friend of mine who I met a few days back.

Despite the fact that he worked in the financial services industry (or perhaps because of it maybe?), he was dreadful of investing his money anywhere. No stocks or mutual funds for him, no property too because he was afraid of loans. All that he ever bought was fixed deposits and government bonds, and sometimes, some gold.

He said ‘I have been running a lot, I seem to have a good life and my income seems to have multiplied many times too, but one thing has not changed. When I started I could not afford a house in Mumbai, and even today, I cannot afford a house in Mumbai.’

Prices of houses in Mumbai is another matter. But like Anthony, I felt like asking him ‘Tum kisliye bhaagta hai bhai?’

In the book ‘Through the Looking Glass’, which is a sequel to Alice in Wonderland, there is a scene where the Red Queen drags Alice and both of them run fast over a chess board. After a while, Alice realizes that they are at the same spot, and starts wondering where she is going; and asks the Red Queen for an answer.

“Well, in our country,” said Alice, still panting a little, “you’d generally get to somewhere else — if you run very fast for a long time, as we’ve been doing.”

“A slow sort of country!” said the Queen. “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

Inflation is the reason why we keep running fast but still stay at the same place.

It is an invisible tax, a not-felt-directly kind of penalty. No matter how many times your earnings grew, or how many times an investment multiplied, the real returns on an investment are represented only by the gains in purchasing power it provides. And inflation is all out after you, your earnings and your investments to make sure that doesn’t happen. And like cancer, you don’t realize it is eating you.

Read Warren Buffett’s classic article written in 1977 on how inflation swindles even equity investors here – like so many of his timeless writings, it is as relevant in today’s times as it was 35 years back.

In his letters to his shareholders, he has often warned typical individual investors of the effects of inflation and how it slowly erodes capital, and is an invisible tax. As per Buffett, the only solution to inflation is to invest, at a reasonable price, in businesses that earn return of equity consistently and have pricing power to beat inflation over long periods of time.

High rates of inflation create a tax on capital that makes much corporate investment unwise – at least if measured by the criterion of a positive real investment return to owners. This “hurdle rate” the return on equity that must be achieved by a corporation in order to produce any real return for its individual owners – has increased dramatically in recent years. The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil.

Here is a nice and insightful collection of Buffett’s writings on inflation: Collection of Buffett’s writings on Inflation

So the real issue in investments in not whether bonds are safe or equity is volatile or property is illiquid or gold is a hedge. The real issue is whether the rate of return of your investments is faster than the down escalator of inflation over the long-term?

Other-wise, like my friend, we are all running to stay at the same place.

Somewhat like this woman on the escalator. Funny, but then, may be not – if you are trying to beat the down escalator of inflation.

[youtube=http://www.youtube.com/watch?v=PNC1YyTXujk]

Guru Speak: A glimpse into John Maynard Keynes’ profoundness

sepia tone if possA predominant economist from the early 20th century credited with shaping modern economic theory, now called ‘Keynesian theory’, John Maynard Keynes was a British economist and thinker who wrote a number of influential books and essays such as ‘The Economic Consequences of the Peace’, ‘The End of Laissez-faire’ and ‘The General Theory of Employment, Interest and Money’. His writings, though centered around economics, gradually covered issues around human behavior, his profession and philosophy, and often had far-reaching, profound impact.

Here is a selection of a few lines from his famous writings:

1. When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.

2. By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

3. The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us that when the storm is past, the ocean will be flat again.

4. Most men love money and security more, and creation and construction less, as they get older.

5. Education is the inculcation of the incomprehensible, into the indifferent, by the incompetent.

6. If you owe your bank a hundred pounds, you have a problem. But if you owe it a million, the bank has.

7. The power to become habituated to his surroundings is a marked characteristic of mankind.

8. For my part I think that capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight, but that, in itself, it is in many ways extremely objectionable.

9. Capitalism is the astonishing belief that the nastiest motives of the nastiest men somehow or other work for the best results in the best of all possible worlds.

10. I do not know which makes a man more conservative — to know nothing but the present, or nothing but the past.

11. The difficulty lies, not so much in developing the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.

12. Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole.

13. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.

14. It is generally agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges.

15. For the importance of money essentially flows from its being a link between the present and the future.

16. People are apt to be unduly interested in discovering what average opinion believes the average opinion to be; and this weakness finds its nemesis in the stock market.

17. Markets can remain irrational longer than you can remain solvent.

18. If farming were to be organized like the stock market, a farmer would sell his farm in the morning when it was raining, only to buy it back in the afternoon when the sun came out.

19. Most, probably all, of our decisions to do something positive, the full consequences of which will be drawn out over many days or years to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as much the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

20. It is better to be roughly right than precisely wrong.

Entry Load and Bubbly Soda: Losing the Forest for the Trees

Three years back, SEBI decided to ban entry loads on equity mutual funds to stop their gross mis-selling. What this move also ended up doing was it stopped its selling.

While it is true that no one has any monetary incentive to sell mutual funds anymore, the widespread perception that the problems in the mutual fund industry are attributable to this ban is stretching the argument too far. What is being portrayed is that all that is required is to bring back the entry load and, lo and behold, all problems would go away.

Mutual funds + Entry Load = Industry Problems solved. Hence, absence of Entry load is the reason for industry problems.

Well, that is a bit like the example that our market research professor used to give: what we referred to as the Soda research by a mistaken researcher who forgot the ‘control sample’.

whiskysodavodsodIt goes like this. A researcher undertook a few experiments to determine the causes of intoxication and as part of those, he came up with the following observations:

Whisky + Bubbly Soda = Intoxication

Vodka + Bubbly Soda = Intoxication

So he reached the conclusion that Bubbly Soda is the reason for intoxication!

The ban on entry loads might explain why no one is selling them, but just re-introducing it as a fix for the industry’s problems is losing the forest for the trees.

The truth is that the real problem is the education of the investor and a complete lack of a long-term orientation towards equity investing via mutual funds in individual investors. Fixing that does not have any magic button like increasing, decreasing or removing entry load.

All that entry load explains is why a businessman sells or does not sell mutual funds. It does not explain why no one is buying them or why they are buying the wrong things with the wrong orientation. You can keep tinkering with entry load all your life, but uneducated investors will continue selling at the bottom and buying at the peak, and with mis-selling they would do it for the wrong things.

The real reason for intoxication in the equity markets in not the entry load. It is a clear investing framework, and sticking to it over the long-term through multiple cycles. If you miss the alcohol of long-term orientation and educated behavior, whether you buy or sell something with or without entry load, it will not matter. You will still not get any high. Like the researcher, you can keep having that soda all your life hoping to get a high, but all it will lead to is stomach upsets.

Book Synopsis: The Black Swan by Nassim Nicholas Taleb

The_Black_SwanI recently finished reading ‘The Black Swan: The Impact of the Highly Improbable’ by Nassim Nicholas Taleb, the Lebanese essayist, writer, philosopher.

I had read his ‘Fooled by Randomness’ a few years back, and the essential message of this book is, more or less, similar. The basic premise of both the books is this: The past is always only clear in hindsight, and it is not a good predictor of the future. The additional elaboration in this book (and a lot of it!) is that not only is the past random, but the future is not predictable based on the past simply because, most of the times, the future happens due to a ‘Black Swan’ event that nobody can predict in advance, but ends up shaping the future.

While this is the core concept, the book is relentless in providing multiple examples through history, culture and markets to prove the point. While the book is not in the same category as some of the legendary ‘Guru Books’, it is still reasonably decent reading with some good takeaways once you get this basic point of the futility of predicting the future. It tends to get a bit self obsessed at times, and keeps on rambling in a sense – often forcing the reader to, kind of, turn to the next page after getting the point. One of the disappointments of the book is that eventually it ends without any clear thoughts on how to handle ‘black swan’ events, except saying that ‘get it into your mindset and prepare for it’.

Now, whether one agrees or not with the basic proposition based on which this book is written, it contains a number of nice quotes that make you stop and wonder whether it is humor or wisdom or both. So if one can have the patience to finish the book, it does contain a number of such snippets which provide for entertaining reading.

Excerpts

Here are a few of those excerpts from ‘The Black Swan’ that are worth remembering:

1. ‘Black swans’ are highly consequential but unlikely events that are easily explainable – but only in retrospect. Black swans have shaped the history of technology, science, business and culture. As the world gets more connected, black swans are becoming more consequential.

2. When you develop your opinions on the basis of weak evidence, you will have difficulty interpreting subsequent information that contradicts these opinions, even if this new information is obviously more accurate.

3. If you hear a “prominent” economist using the word ‘equilibrium,’ or ‘normal distribution,’ do not argue with him; just ignore him, or try to put a rat down his shirt.

4. In developing treatment theories, doctors most commonly get mixed up between absence of evidence and evidence of absence. So do statisticians.

5. The inability to predict outliers implies the inability to predict the course of history.

6. If the past, by bringing surprises, did not resemble the past previous to it (what I call the past’s past), then why should our future resemble our current past?

7. Things always become obvious after the fact.

8. Missing a train is only painful if you run after it! Likewise, not matching the idea of success others expect from you is only painful if that’s what you are seeking.

9. Cumulative errors depend largely on the big surprises, the big opportunities. Not only do economic, financial, and political predictors miss them, but they are quite ashamed to say anything outlandish to their clients — and yet events, it turns out, are almost always outlandish.

10. The same past data can confirm a theory and its exact opposite! If you survive until tomorrow, it could mean that either a) you are more likely to be immortal or b) that you are closer to death.

And finally, the book ends with this.

“I am sometimes taken aback by how people can have a miserable day or get angry because they feel cheated by a bad meal, cold coffee, a social rebuff, or a rude reception… We are quick to forget that just being alive is an extraordinary piece of good luck, a remote event, a chance occurrence of monstrous proportions.”

“Imagine a speck of dust next to a planet a billion times the size of the earth. The speck of dust represents the odds in favor of your being born; the huge planet would be the odds against it. Don’t be like the ingrate who got a castle as a present and worried about the mildew in the bathroom… remember that you are a Black Swan.”

Of Quotes and Learnings, From Investors and Hindi Movies: Jigneshbhai and Swami

“The problem with famous people and their quotes is that I don’t understand which one to apply when.” Swami remarked, as he walked in for our coffee meeting with a disappointed, confused face. He had a book of quotes with him.

“Is India a leaky boat?” he asked suddenly. Surprised, I looked up to my broker friend for a reply, as I did not understand the question.

But Swami continued. “I read in this book that Warren Buffett once said that if you perennially find yourself in a leaky boat constantly fixing patches, it is better if you devote energy to changing the boat rather than fixing the patches. So I was wondering with all our problems currently, is India a leaky boat?”

Jigneshbhai, my broker friend, maintained a studied silence.

On getting no response, Swami peeped into his book and read out. “He also said that when a management with a good reputation joins a bad business, it is the reputation of the business that stays. So is India a bad business?”

Again, Jigneshbhai maintained a studied silence, perhaps not quite sure what to say.

Meanwhile, Swami was in his own world of quotes and learnings.

He continued. “But he also says that we only attempt to be greedy when others are fearful, and fearful when others are greedy. So is it time for me to be greedy or fearful?”

Swami’s questions were relentless. Jigneshbhai’s silence was unending. Swami continued.

“And there is also a quote where he says that it is better to buy a wonderful company at a fair price, rather than a fair company at a wonderful price. So in the current situation, which one is India and its companies? I am getting confused.”

laugh2He was just not stopping and Jigneshbhai was just not speaking. His studious silence was not making things easy for Swami.

Just then, I noticed that the wealthy man in the palatial bungalow who lived next to me was also sitting in the coffee shop. He must have heard our conversation – actually Swami’s monologue – for a while. We had known from earlier interactions that he speaks little, and whenever he does it is cryptic.

He had probably finished his coffee, and while leaving, he walked up to Swami and smiled.

“अब इन्हें दवा की नहीं दुआ की ज़रूरत है. So wait for the miracle.”

As he walked away, I could see that the wealthy man and Jigneshbhai were looking at each other and sharing a smile.

The Dilbert One Page Summary: All that one really needs to know

dilbertA couple of days back I was reading “Dilbert and The Way of the Weasels”. While this is a funny book, a small section has some amazing insight quietly embedded. In that book, the author claims, perhaps jokingly, that everything that a person really needs to know about personal finance and investing can be summarized in one page. Which actually, I thought, is quite true.

Exactly the kind of problem that I had been facing for a while, when a friend of mine asked me why I don’t write about specific stocks or do more frequent analysis. And all I could tell him is I felt it was not important, and also that I honestly did not have anything to write.

There is only so much you need to know about finance and investing, as an ordinary investor. If a reader reads the earliest few posts written in this blog about investing, and garnishes it with some of the book synopsis or guru speak posts, that’s all that any one needs to know. And that’s also an overkill in my view, and perhaps, even unnecessary. The truth is everything that one needs to really know does not take much writing. The tougher part is in following the simple things with discipline and without emotion.

As an individual investor, if you are interested in a really brief and simple summary, Dilbert’s summary is all that is necessary, honestly. Simple, but by no means, easy to follow.

Dilbert One Page Summary

So here are the 10 things mentioned in the ‘Dilbert One Page Summary’, adjusted a bit with my own inputs. The things that one really needs to know, and would work for most individuals in ordinary conditions:

1. Pay your credit card bill in full, and stop using credit cards. Use only debit cards – money that you already have.

2.  Get term life insurance as early as you can in your life, and keep adding cover every 5 yrs as your income increases. Don’t buy any other insurance, except health insurance every year.

3. Contribute to your employer’s PPF/ Retirement scheme by making mandatory as well as voluntary contributions if you can.

4. Buy a house, if you want to live in your house, and if you can afford it assuming you don’t take more than 60% of house value in loans, which should also be less than double your annual post tax income.

5. Put 6-9 months of your expenses in a liquid fund or cash equivalent that you can liquidate in a day or two.

6. Save at least 25% of your post tax income.

7. From your savings, put 65% in a stock index fund, 25% in a bond fund (or fixed deposits based on tax slab), and 10% in a gold fund. Make increments every couple of years. Do not touch it till retirement.

8. In case you are adventurous, replace the stock index fund with (or add) 3 actively managed diversified equity funds which are rated 4 or 5 currently on Morningstar (or Value research online or similar). Once you choose them, stick to them for at least 5 years, else replace them with the index fund.

9. If any of the above is confusing (specially step 7 and 8), hire a fee-only based financial planner (not someone who takes a fee based on percentage of assets or transaction size) for a two hour advice session and follow whatever he tells you.

10. Ignore everything else that any one tells you.

Anything else is likely to be a waste of time (and money perhaps) more often than not. Even if it does give you some incremental returns for some time, the costs and lack of sustainability are unlikely to make it worth it.

At the crux of it, honestly, that is all there is to it.

Two Books: The Lazy Person’s Guide and The Coffeehouse Investor

I had the opportunity to read two books over the past two weeks.

the-lazy-persons-guide-to-investingThe First One was ‘The Lazy Person’s Guide to Investing’ by Dr Paul Ferrell, a former investment banker with Morgan Stanley and a columnist later, with some really useful and simple advice for the individual investor.

Here are some excerpts:

“Investing really is very simple stuff. You can do it yourself.”

“Lazy portfolios are keep-it-simple, no-hassle, low-stress, time-saving, low-maintenance portfolios–so you can get on with the business of everyday life.”

“Believing that investing requires some kind of special or weird thinking that you don’t have will blind you to your own natural instincts.”

“The only solution is to be in the market all the time and stop jumping in and out.”

“The more I know, the more I know I just don’t know, and neither does anyone else.”

“Taxes, Time, and Psychology favor the laziest portfolios.”

“The market is totally random, irrational, and unpredictable. And it loves humbling the mighty. Try to beat it and you’ll lose money.”

“Perhaps the single most important lesson you’ll need on the road to becoming a millionaire is frugality.”

“A penny saved is a dollar earned, thanks to compounding.”

“Buy the whole market with index funds, and never sell.”

“Experience has taught me that the relentless noise from breaking news sources, like CNN and CNBC, easily distracts most investors from what really works in the long run.”

“The ideal hybrid fund acts like a whole portfolio, diversifying between stocks and bonds for you.”

“Keep it simple, very simple. Lazy investing works.”

thecoffeehouseinvestorAnd the other book was ‘The Coffeehouse Investor’ by Bill Schultheis, a former broker with Solomon Smith Barney.

Here are some excerpts from it:

“The first step in being a responsible investor is to calculate an approximate savings goal.”

“We have the misconception that dealing with something so far away means sorting through thousands of mutual funds, hundreds of advisors and dozens of financial magazines.”

“The three fundamental principles of investing: Asset allocation; approximating the stock market average; saving–and these three principles are in our control.”

“As long as Wall Street has a vested interest in lots of transactions and busy portfolios, investors will continue to latch on to the hype and hysteria of Wall Street, perpetuating the misconception that by carefully reviewing market trends, diligently studying mutual fund tables, religiously researching global economies and closely watching interest rates, anyone and everyone can own a successful portfolio.”

“Let go of the mistaken belief that the secret to a successful portfolio is to accurately forecast bull and bear markets.”

“I know of no other industry in which so many self-proclaimed experts try so hard to convince us that they are wildly successful at that which they so miserably fail.”

“The most important factor when diversifying is to adhere to your asset allocation strategy, because when you stick to your strategy and rebalance your asset at year-end, buy and sell decisions are no longer arbitrary.”

“Maybe if mutual fund companies sent a bill each month, more investors would take the time to see whether they were getting their money’s worth.”

“Somewhere along the line Wall Street has forgotten that we can retire and be happy on a little less than millions and millions of dollars.”

“Strike a balance.–It is not worth making our life miserable today so you can retire in style tomorrow.”

“When we simplify investing, we take another step toward discovering our contagious spirit and our unique energy in such a way that we impact our world, making this a better place for everyone. I suspect that’s what most of us would say life’s all about.”

Some wonderful, honest and wise words indeed!

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