Complicate Your Investments. Here’s How.

You can make investing complicated and not very successful . You can do it with an ignore list and a focus list.

Ignore

  • Volatility
  • Liquidity
  • Income taxes
  • Transaction costs
  • Time
  • Leverage effects

Focus On

  • Rate of return
  • Relative rate of return
  • Publicity regarding your investment

I will guarantee bad results if you do all of these.

Instead, think about buying businesses not stock. Good businesses may not always reflect their value in the stock price, but over time, they tend to move toward higher value and better dividends.

I noticed recently that Bill Gates’ investment management firm holds a large stake in John Deere. Interesting. The company is a dominant one in its field (pun intended,) and has been so for more than 140 years. It pays a comfortable dividend and it does not seem to be under attack from other well financed and innovative competitors. Nice deal. No drama.

Drama is the hard thing to avoid. For some people the drama is the part of the investment they seek. I suppose most tax shelters and initial public offerings would be difficult without this aspect. If you invest for excitement and social status you are in trouble. You will have given up other values to get these. There is nothing free in the investment world. If you get more of one thing, you gave up something else to get it.

Private equity is the most difficult. Everyone wants in on the ground floor of a successful business. It is not that easy.

Even professionally managed venture capital firms, exposed to well understood and rational projects, analyzed by people with years of experience and superior skills, lose their money more often than they make money. 4 times as often! The expectation of success with your idea for a better dog harness or an ipad app or a Tanzanian theme restaurant are in the 1 in 100 range if I am being generous. More likely in the 1 in infinity range.

There was an interesting piece in USAToday which dealt with why athletes go broke. They point out three reasons.

  1. They invest in private equity deals,
  2. They buy real estate,
  3. They spend too much.

You knew about the third one.

Better to invest in boring businesses with a track record, competent managers, and a transparent, liquid market. It will not be as exciting to talk about at the bar at the golf club but it will generate more net worth.

If you change the ignore list to focus and the focus list to ignore, you will be okay. You can buy a nice trip or a new car (with cash) to impress the folks at the club.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. don.s@protectorsgroup.com

Insurance Poor??

Somebody is always insurance poor.

It could be your future self or estate who is insurance poor because the claim received for your death or disability is too small.   Alternatively, it could be your present self who has to come up with the premium each month.

People tend to get his wrong because they don’t analyze the problem very well.  The present self uses hyperbolic discounting to estimate the value of the future benefit.  The current premium seems to be worth more, so the present self feels hard done by if they pay.

There are many excuses that help justify the behaviour.

My favourite, “Every morning I get up and say, ‘Good thing I didn’t buy insurance yesterday, because I didn’t need it,’  I have been right way more often than I have been wrong”  The future self is going to lose big while the present self wins small.

I would be willing to wager that the Harvard Business School does not teach their MBA students that win small / lose big is a good strategy.

Some people don’t like life insurance because, “It is like betting against the home team.”

True in a way, but again the present self is putting their feelings in opposition to the needs of the future self.  The reality is that the present self could afford the loss of the premiums and the future self cannot afford the absence of the claim.  Clearly one or the other is going to lose.  Support the one with the bigger loss.

You can be insurance poor but only if you have covered risks that don’t exist, have failed to cover risks that do exist, have mismatched the product and the problem, or if you have covered things that are certain to happen.

In the last case, you are paying the claim plus the insurer’s overhead.  Think $0 deductible dental plans.  The claim is certain, the premium will be more than the claim because the insurer has overhead to recover and a profit to make.  For a single person, a deductible results in a premium reduction that is greater than the amount of a small deductible.

Talk to a professional, they can help you sort out the real issues.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. don.s@protectorsgroup.com

Kill Them While They’re Small

Math professors love to hand out problem sets.  Many a weekend was consumed resolving these.  One of my friends pointed out that problems are only problems if you don’t know how to solve them.  If you know how to solve them, they are merely questions.  The distinction is true outside the walls of a university too.

We get confused some times. We fix things that are not broken and apply difficult methods to easy questions.  For example, as Harvey MacKay has pointed out, “If you can solve a problem by writing a cheque, you do not have a problem, you have an expense.”  Too bad they are not all that easy.

Problems without known answers, come in two forms.  Big enough that you must deal with them and small enough that you can ignore them.  The trick is to know the difference.  Right?

Probably wrong!  It is the “ignore” part.  A problem you can ignore forever is not a problem to begin with.  I routinely ignore the traffic problems in New Delhi even though it ranks 5th in the world for traffic congestion.  So far no adverse consequences.

Small problems that you ignore, but cannot ignore forever, accumulate.  Eventually you have a large bag full of them and the bag takes on a life of its own.  Jordan Peterson at University of Toronto contends that stress results from the the accumulation of small undone tasks.  A bag of small problems is itself a big problem.

You cure the big bag of small problems issue by using two criteria:

  1. Can I ignore this forever?   if yes, ignore it forever.    if no,
  2. If it were a hundred times bigger how would I deal with it?

The 100-times bigger problem must be solved.  Understanding how you would relate to it at that size, will give you insight into how to remove the little problem.   For example, warranty claims when you could redesign a part to cure the problem.  Then  you must act on it and empower systems or people to keep it at bay.

As you do this, you will find that it takes less time than the ignoring method.  Remember that the ignoring method keeps issues coming at you while the solving method is done once, done forever.  (Well almost that good)

Once in a while, certainly not every time, facing down the little problem, gives you insight into what could have become a big problem in the future.  Even more rarely it gives you the insight into an opportunity.  The rare occurrence of these will pay you for all the effort elsewhere.

Killing big problems while they are small is a competitive advantage.  Use it.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. don.s@protectorsgroup.com

There Is Only One Workable Government Incentive

The American Presidential election has provided us with repetitive rhetoric about how the government will create jobs and renew prosperity.  Surely, no one takes these folks seriously.  It is hubris and the result is the same as it would be in a Greek tragedy.

No government has ever created a productive job.  No government incentive has ever led to much either.  If Thomas Edison had relied on governments for success, we would be reading by candlelight.

I have a client who claims that he would not consider government grants (not loans, outright grants) for a new project unless the grant exceeded $1,000,000.  Not worth the paper work and the “advice.”  Government money is like lunch, there is no such thing as free.

Another client is now in the midst of a freedom of information act request regarding his business expansion.  I think if he had thought that possibility existed, he would not have applied for the grant.  In his words, “I could have saved more than the grant by shopping better.”

So where are we?  If the government cannot create jobs, who can?

Some would argue that businesses do so.  Probably true, certainly more true than the government does it.  However, to be complete, the marketplace creates jobs.  Businesses will not do so unless the marketplace demands it, by requiring product and services and by supplying labour and other resources at competitive prices.

The only thing that can go seriously wrong is that the marketplace distorts.  Minimum wages, payroll taxes, difficulty in reducing labour force, unions, land use regulations, product safety, tort lawsuits and a thousand more restrict the ability of enterprises to get the most from their opportunities.  I would like to blame the government for all the distortion but that would be unfair.  The only produce most of it and create a culture that permits the rest.

Most of it is well meaning, but regulation and limitations on performance have passed the point of innocuous.  The result is slower than required job growth, reduced expectations and higher than required liquidity.

If a business moves some excess money into new products, services and facilities, jobs will follow.  They will not do that until they can see two things:

  • Level of intrusion is less than it is now
  • The future of the marketplace is reasonably predictable.

Tax rates matter too.  Business tax rates should be zero.  AS LONG AS THE EARNINGS ARE REINVESTED IN PRODUCTIVE ASSETS.  Tax the money that goes for dividends, marketable securities, and excessive cash.  Productive investment should happen without a cash drag to the government.

In the end, there is only one workable incentive that a government can give businesses.  They can reduce the level of disincentives.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  don.s@protectorsgroup.com

US Federal Debt Is Lower Now Than It Was In 1970

Several months ago a restaurant opened here and offered hamburgers made from a recipe that was popular in our first drive-in.  (back in the early ’60’s)  At the counter, I mentioned to the cashier that $5.49 seemed a lot because the last time I bought a “Royal Burger” it was 40 cents.  Her reply.  “So was a gallon of gas.”

You have to love smart, young people.

We can learn from that exchange.  Information, e.g. prices, is useless until you know what it means.  Usually the meaning is found by finding connections to other things – context.  In this case, in terms of gasoline, hamburger prices are unchanged.

Something to think about.

Is the current US federal debt level good, bad or indifferent?

It is somewhat north of $16.2 trillion.  In 1970, the debt was $370 billion.

But upon examination of context, we find that in 1970 the price of gold was $37 per ounce so it took 10 billion ounces of gold to pay off the debt.  On November 2, gold is around $1,677.  It takes only 9.66 billion ounces to pay the debt now.  Emphasis on ONLY.

So what happened?

Anyone who held the debt lost purchasing power in terms of gold.   Who won?  The issuer of the debt.  The money they borrowed was more valuable than the money they repaid.  Given that a large share of the debt was and still is held by foreigners, it is possible that the most valuable US export has been inflation.  Can you reasonably believe that the saga will continue forever?

Within the US, the prices of the things money buys have risen but not as much as the price of gold. Cheaper consumer goods from Chine and elsewhere, and cheaper resources from countries who lack the price leverage to demand more, cushioned the blow.  Not to mention the gain on the debt that accrued to Americans.

Some examples.

In 1970 a barrel of  oil cost $3.18, now it is about $85.  Half price.  1/11 of an ounce 40 years ago, versus 1/20 of an ounce now.

In 1970 a new teacher made about 125 ounces of gold annually.  Today about 25.  Partly because of the cheaper cost of living and partly because of the supply side effect.

Some things to think about

  • You cannot tell what is happening when the measuring device (the dollar) is changing in size.  It is like a fisherman’s ruler.  The readings are not useful
  • If you tend to focus on the numbers, you can easily draw the wrong inferences.  How expensive should a thing be, is a difficult question.
  • It is hard to know where to direct your attention when you cannot understand what you see.  Prices have always been an indicator of supply/demand.  If price goes up then there is more demand.  You cannot use that rule today.
  • You cannot predict the future value of your money with any expectation of being right.  It is like trying to predict the temperature next July 15th when the size of the degree is changing at an unknown rate.
  • Letting politicians influence the money value is insane.  There is always a short term win for them from depreciating the currency.
  • Inflation is merely a tax on people who own money or money denominated securities or pension plans.

Some say that things are not worth the money; the truth is that the money is not worth the money.

You will need to think about your strategic financial plans in a different way.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  don.s@protectorsgroup.com

Has Investing Changed?

On 10 October 2008, 11.5 billion S&P 500 shares changed hands.

For context, from January 1951 to December 1969, there were fewer than 25 billion shares that moved.

In the decade of the 2000’s four times more shares traded than in the entire history of the index to that point.  Prior to 2000 stock prices and volume were correlated.  .82 R-Squared in the 90’s.  In the 2000’s not so much.  R-Squared of .01.

We have learned that knowing things is nice, but knowing what they mean is better.

Knowing that volume and price are no longer correlated could mean that the old ideas about how markets work and how one should design a portfolio, may be defective.  If that is true, then passive investing may not be a good tactic.

Have you heard of “Project Express?”

It is a $300 million Trans-Atlantic fiber-optic cable that will exchange data between London and New York 5.2 milliseconds faster than existing cables.  A few electronic trading firms will have exclusive access to it.  The 5 millisecond speed difference gives them a huge advantage over their competitors in electronically traded stocks.  Enough to pay off the $300 million investment at least.

That makes me wonder two things.

  1. Is an index that is created by trades where a 5 millisecond difference matters, the same as an index built on the activities of people who were buying and selling, as investors, over a period of years?
  2. And if it is not the same, does Modern Portfolio Theory and its derivatives really make sense?

All of the indicators like alpha, beta and the Sharpe ratio might be misleading.  Does anyone know what volatility and risk mean in the electronic trading world?  Not likely.  Most of those trades are not speculative.  They lock in a price anomaly and keep the difference.

I don’t know the answers to the questions.

I do know that if you are basing your investment decisions on what you read in last week’s Forbes or yesterday’s Financial Post, and then executing trades through an on-line brokerage, you are not playing the same game as the people who are trading the bulk of the stock.  According to Tabb Group LLC, a market research firm, 55% of current trading volume comes from firms using high frequency trading tactics.  You, on the other hand, are a cave-dweller who is more than 5 milliseconds behind.

Over the years, I have decided that it is not smart to play games when you don’t know the rules, who is on the opposing team, and how they keep score.  So, it could be that a common sense approach to investing will make more sense.  Pay less attention to statistical material and more to the underlying businesses you are acquiring.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  don.s@protectorsgroup.com

The Soft Side of Estate Plans

There are several types of assets people deal with when they build their “estate plan.”  It is a mistake to deal with all of them in the same way.

In the beginning, you can simplify the process by separating the assets into two types – ones that are fungible and ones that are not.  Fungible means that they are replaceable with an identical example.  $100,000 is money.  Money is fungible.  A bank account, a GIC and a marketable bond are all the same thing.

Fungible assets are easy to deal with.  Add them up and divide.  Nobody really cares where money comes from.

Non-fungible assets are more difficult.  They are not replaceable, and they frequently have an emotional component.  We see it with the family cottage.  A cottage worth $750,000 after taxes does not “mean” the same thing as $750,000 in bonds.  There are problems when all of the children want it.  There are approaches to that.  The approaches work better if they done early rather than after you are gone.

Parents need to spend time working on this part of their estate.  Non-replaceable assets fall into two types.  Monuments like the family business or family farm, and heirlooms like the cottage, the art, the piano, the jewelry.  Who gets grandpa’s family photo album or the family bible?

Your purpose is to enhance the family as a whole.  To provide intergenerational emotional content to what you and your forebears have built.  To preserve important memories.

There are multimillion-dollar estates that have led to bitterness because no one worked through the emotional assets.  Most of these were inconsequential in the financial sense.  Try to deal with a monument or heirloom so that the eventual owner will be the one who will derive the most satisfaction from possessing it.

Trust your children to help find the solution on these things.

You need to do so because you probably do not know how they think about the heirlooms and monuments.  You definitely do not know how they relate to their siblings about them.  Chat with each.  Invite them to meet with their siblings.  Later host a family meeting to clarify preferences and wishes for you and to present you with the disagreements that have arisen.

You should make the final decisions.  Please do so.  It does not work as well when you abdicate that responsibility.  Even the ones that do not agree with your decision, will go along more readily if they think you did your best to make things work out for everyone.

Being fair does not necessarily mean equality of money.  Being fair means the result is equitable.  It is “equal enough” and heirs have the things they value the most.

Guaranteeing the preservation of family history is an important part of your responsibility.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  don.s@protectorsgroup.com

The Law of Non-Reciprocal Meaning

When people do a deal, each expects to get what they want from the arrangement.  Sometimes that leads to unnecessary and fruitless conflict.  In the end, neither gets what they want.  In lawyer talk, it is a good deal because they are equally unhappy.

Sometimes there is a way to get what everyone wants.  Maybe more.  Instead of looking at what the deal is, look at what the deal means.  You will find that it means different things to each party and the deal is how they will get those things.  When you start from meaning, new alternatives become apparent.

What follows is a highly simplified example and is not intended to be advice of any kind.  It is intended to be the basis for discussions with knowledgeable advisers aware of your specific resources and desires.

Parent

Father (age 62) wants to sell the family business to one of three children.  It is worth $4,000,000 ($600,000 in taxes due.)  He owns other assets worth another $2,000,000 after taxes have been paid on them.  The other two children are not involved in the business.  He wants all three to be treated equally.  Each will get $1,800,000 from his estate.

He wants to invest the after tax proceeds from the sale and spend about $9,000 per month from the income.  He will need to earn about 6% to achieve that

Father’s meaning – An estate for the children of $1,800,000 each, and $9,000 per month to spend.

Child

Wants to buy and $4,000,000 is a fair price.

Child’s meaning.  Own the business with no debt after 20 years, Pay about $28,000 per month for 20 years at 6%.  (Assumed to a bank, but parent might do it too with slight variations.)

Here’s where it gets interesting.

Over 20 years, the child will pay $6.7 million of which $2.7 is tax deductible interest and the rest is capital.  To pay that much you need $10,100,000 of corporate pretax income and you get what exactly?

  • An estate of $5.4 million.  $1.8 million for each child.
  • Looking from the buying child’s viewing point, it means $3.6 million to the siblings.  Of that $2,000,000 is made up of other assets, so only $800,000 each will necessarily come from the business sale.

Question.  Does it make sense to use $10,100,000 of pretax income to pay someone $9,000 a month of spending money when they are alive, pay two siblings each $800,000 (they split the other $2 million) when the parent dies and get an  inheritance of $1,800,000 cash?  That is $500,000 per year that cannot be used in the business.

Revising the question to address meaning.  If we assume there is no commercial risk to the business, how much pretax income would it cost to supply $9,000 per month after taxes, guarantee two payments on death of $800,000 each, and pay $600,000 of income taxes.

Using a freeze instead of a sale.  $9,000 per month paid as a dividend  requires about $205,000 per year of corporate pretax income.  The $2.2 million due at death is satisfied  with guaranteed life insurance for about $90,000 of corporate pretax income.  Total about $300,000.  A lot less than $500,000.

From the buying child’s place, either way, the result is that the business is paid for, taxes due are remitted and each sibling gets $1.8 million.  Only the cost to acquire the result is different. It is 40% lower, but you give up the $1.8 million cash inheritance.  If you want that, bump the insurance to $4,000,000 and pay an additional $75,000 or so of earnings toward the premium.  That would still leave it around 25% less costly.

There are two points of interest.

  1. Addressing the meaning of the transaction exposes alternatives.
  2. Use pretax income to compare the cost of the alternatives because that is where all the money will come from.

Freezing a corporation is a well known and straightforward tactic.  The insurance assumes a 62 year old male nonsmoker in standard health.

As with all transactions, there are many other details and alternatives and some may be important.  Like some cash up front, like an Individual Pension Plan and a lower rate on the dividend, or some other salary/dividend mix format for  father.  Most can be worked out as long as the parties are addressing the meaning of the deal.

Meaning matters.  Do not get stuck on the form of the deal or a particular number.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  don.s@protectorsgroup.com

 

Are You Hunter or Farmer?

 

Are you a hunter or a farmer?  Not actually, but in how you organize your career.

The essential difference is that farmers are about process and hunters are about events.

Hunters look for a situation that matches their talents and BANG!   Done!  Now go find another situation that works.

Farmers create and nourish the things that nourish them.  They build structures that carry out their goals.  They manage the process with the idea that the outcome will be reasonably predictable.

The hunter does not know, clearly, what will happen on a given day.  The hunter seeks contacts, people, problems or opportunities.  Every day they wake up unemployed.  Some days are dry some are spectacularly good.  They are on offense all the time.  Bad things will happen unless they find the situations they need.

Farmers do not seek a special situation.  They have already built it.  They are looking for more of the same.  They watch for the things that will derail the carefully constructed process.  Farmers are on defense all the time.  Bad things will happen unless they are vigilant.  Long plans.  Preventive actions.  Skill building.  Maintenance.

It has to do with how they seek fulfillment.  Fishermen and trappers fit the model too, but in a different way.  They are hunters since they are event driven.  But they are more passive.  They bring the game to them rather than seeking it out.  A little hunter and a little farmer.

The hunter farmer difference is the difference between starting a new business and buying a McDonald’s franchise.  Both could be successful but the operational details are different.  Neither is wrong, but they are fundamentally unalike.

Hunters cannot run businesses once they have built them.  It is boring.  To a hunter, it is like constructing a clock and then watching it run.  Not fun.  No high.   Instead, they tinker with things that work, ignore efficiencies that are obvious but do not involve the hunt, or fail to notice people encroaching on their turf.  Think RIM.

Problems arise when either tries to do the job of the other.  The builder-type (hunter) cannot communicate with the runner-type (farmer) because they share nothing.  Their time frames are wrong, hunters favor immediacy as in the long run is lunch, their methods conflict, only one of them trusts others enough to delegate well, their risk tolerances are unalike.  Hunters want to achieve results by themselves and to get credit by themselves.  Runners want to achieve results through the efforts of others and share credit.

They can work together as long as they do not try to do the same things.  It works if they can separate the tasks.

Notice Steve Bulmer doing the day-to-day at Microsoft while Bill Gates did the hunting.  Steve Jobs was the visionary, but Tim Cook tilled the fields.  Notice how Mark Zuckerberg found a runner early on.  Sheryl Sandburg knows how to do the things that inventive geniuses do not or will not.  There are more.  Meg Whitman formerly at EBay comes to mind.  Edwin Land was the genius at Polaroid but never rose above vice-president, research in the corporate hierarchy, even though he was the dominant owner of shares.

So what?

Financial advisers tend to be hunters.  That is how they earn their pay in the early days and they have never climbed away from that method.  Mostly because it works.  The farmer mentality does not work in the early going because there is nothing to run.  Not enough income.  Farmers mostly do not survive.

As they mature though, hunter-based businesses could benefit from some farming methods and thinking.  Existing client service would improve immediately.  (tilling the fields.)  So would dull things like filing, training, compliance, marketing, and staffing.  (preventing bad things)

Clients would be harvested instead of hunted.  Hunting could still go on but it would tend to be for bigger game.  With a steady predictable income happening on the farm, the hunter can become more specialized.  You may have noticed that lions do not hunt rabbits.  However, they might if they were hungry or concerned about becoming hungry or did not know any other way to eat.

Most advisers start by hunting rabbits and they never move on very far.  They need to find a farmer to help them.

A very few have done that.  They now have a large prosperous farm with a game preserve on the corner.  They leave farming to others and go to the preserve when they feel the need to hunt.  They do not hunt rabbits.  Ever.

If they come home without a catch, the farm will have provided dinner.

Now something to think about for a bit.  Is farming a marketable advantage?  If you were a client would you rather deal with a farmer or a hunter?

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  don.s@protectorsgroup.com

Are You Listening to Signal Or Static??

When I was in high school, I listened to baseball on the radio.  Joe Chrysdale and Hal Kelly on AM 580  CKEY told the story of the Toronto Maple Leafs baseball team.  Sparky Anderson played there in the early ‘60’s.  Who could forget Rocky Nelson?  He was a very good hitter but the story was that he kept his glove in oil lest it get rusty.  Clang!

If there was no Leaf game, you could catch Harry Caray with the Cardinals on KMOX.  You could hear Gibson versus Koufax or Drysdale or Marichal, and follow Stan Musial at the end of his brilliant career.  You had to pay attention though, because listening to KMOX required that you ignore the static.

Sort of like the stock market.

AM radio stations send a strong clear signal and the vagaries of the atmosphere and the receiver’s location interfere with it.  That is what static is.

In the stock market there is a clear underlying value driver (the signal) obscured by short term variability (static)

The signal for a given security is a combination of things.  The national and global economy, the business and its management, population growth, demographics, competitors, technology, brand.  The static is political comment, pundits, new and unproven connections, newspaper and TV stories, short term dominated thinking.

If you track values of the S&P 500 since the early 1920’s, you will find the signal is almost exactly 10%.  The values tend to run in a trough between 9.8% and 10.2%.  It is moderately clear.  Values do not stay far away for very long.  Year over year variations are seldom more than 3 times the size of the signal.  Most years lie between minus 20% and plus 40%

For 250 trading days a year, 10% annually is roughly .04% daily.  When you look at daily returns, the signal cannot be seen at all.  Static dominates.  There are days when the change has been more than 100 times the expected .04%.  There is one day when it was more than 500 times.  Yet, at the end of several years, the static all cancels and the underlying signal remains.

What does that mean?

  1. Most of the intense investors are trading on noise not signal.  Day trading does not use investment rules for success even though it sometimes looks like they do.  Day traders are trading the static.
  2. You will usually be upset with the stock market if you follow it too closely.  How so?  I should have less risk if I pay attention.

True if you are a robot.  Not so much for humans.

According to Nobel Prize winner Daniel Kahneman, people are about twice as upset over a given loss as they are happy for an equal sized gain.  To give yourself a chance you should look at intervals where you are about twice as likely to see a gain as a win.  If you look at the market every day, the odds are about equal that you will see a loss or a gain.  Emotionally though, that is plus one and minus two.  Emotion leads to weaker decisions.

I am sorry to say that I am not as fluent with math as I once was, and my awareness of the Central Limit Theorem is vague at best, but I think if you look about once every 42 months you should expect to see positive results twice as often as negative results.  This will not, and probably should not, change your behavior, but at least you can console yourself that the market is working as it should, just not today or this month, or however often you look.

When you buy shares, you buy part of a business.  Thinking business instead of stock will help you see the day-to-day variances in context.  When instead, you think share price, it is easy to fall into the volatility trap.

Warren Buffet buys businesses not stocks.  The difference from you is that he buys the whole or most of the business rather than a minute fraction of it.  He has said that he would not care if they close the stock exchange for 10 years after he buys.  He is seeking management, market position, products, techniques and people, and time does not change that.

You might want to do the same.

 

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  don.s@protectorsgroup.com