31 October 2008

Family Finances & Bear Market Psychology

Investment strategy is the topic for this week. I am not going to tell you what I think you should do. Rather, I am going to share ideas about how I approach my family's investment strategy and outline some observations from the last few weeks. An interesting article where the author does offer some "to do's".


Two quick announcements.

Fit Pregnancy -- many thanks to everyone that wrote in. It's been an adjustment -- more for Monica than me. The "fun" part of being Dad is watching my wife morph into an FHM model. The challenging bit is that our daughter seems to be in a pattern of melting down around dinner time. Our photo this week shows me heading out on a walk to chill her out.

Real World Marathoning -- this week finance, next week running. If you have questions about marathon training then insert a comment this week and I will try to address next week.


Wall Street Compensation
For those of you that wonder what sort of money the folks at the top of Wall Street make -- you'll enjoy the video inside this LINK. If, like me, you pay taxes in America, then you're now paying to keep these guys in business. If you want more detail then this Bloomberg article gives specifics -- wonder how an auto worker feels about this use of taxpayer money?

There's got to be a better way. Watching from the outside, revolutions happen when the elites stray too far from the needs of the people. I sense there's going to be tremendous backlash as the economy absorbs the impact of the Great Unwinding. People will be upset and looking for the federal government to take action -- and -- we are likely to have a Congress in the mood to do just that. It is not going to be pretty.

I suspect that every rich person in America is pulling forward income and capital gains. Tax revenues are going off a cliff in 2009/2010. No matter who wins the election, we're all going to be paying a lot more in taxes. Take it from a Canadian... no free lunch!


The Great Unwinding
My main concern these days is wondering if the last 20 years were all driven by leverage. Have I lived my entire investment career with a massive tailwind of ever increasing liquidity? Have I fooled myself by seeing knowledge/experience where reality was a global ponzi scheme?

When I look through my best deals -- leverage, and ownership, plays a central role. In fact, even when the gains were "value" driven -- the fact that I was working at a Private Equity fund was a direct result of a huge increase in global liquidity.

If it was 'just leverage' then we are nowhere near the end of the Great Unwinding -- the snap back from two decades of easy money is going to be severe. Our governments are seeking to replace the capital that has been lost in the system. Perhaps the hole is too big? How does the Fed go lower than 1%?

How much further can we lever up consumers, companies, countries? I don't think very much.


The Psychology of Portfolio Tracking
How often do you track returns?

It makes a big psychological difference in times of stress (such as October 2008). Here is a data set of portfolio returns:
  • 10 yr = 17.5%;
  • 5 yr = 6.2%;
  • 3 yr = 0.0%;
  • 1 yr = -65.0%.
All of these numbers come from the same portfolio, my own. I would have saved myself a ton of energy if I'd been asleep for the last three years! I worked hard for that zero percent return, wonder if I worked smart?

Still, I'm the lucky one - I know people that will be totally wiped out in 2009.

When I compare the family's balance sheet to various equity benchmarks, I can see why folks that have been playing the market have been a bit blue. 1/3/5 year returns are negative (depending on the hour you check!) and 10 year returns are pretty flat. A decade of getting nothing. No wonder Michael Moore calls the stock market "a rich man's game".

Here is where human psychology comes into play. Three years ago, I was concerned over the risk profile of my portfolio, so I sold nearly all of my high risk exposure down. I rolled a fraction of my high risk exposure into a new venture -- which promptly shot up to a paper value of 15x cost, then tanked.

When I talk with people concerned over the current value of their 401Ks... we ask each other... did we really "have" our peak portfolio values? Were you really going to sell a few months ago when it topped out? If not then why does it hurt so bad?!

For me, the 'return' was never there. I wasn't able to take that value off the table, or hedge it, or lock-in any of the gain -- believe me, I tried. Even sold assets at a massive discounts to shift out of risky exposure.

Even when I calmly think it through, I experience a real (and irrational) sense of loss from the movement off the peak. I'm up at midnight trying to write it out of my head so I can get back to sleep...

We are all feeling shell shocked right now. At some stage, we are going to have to pull the trigger and make some investments. Just not sure in what, or when!


Timing and Asset Classes
Friends, and columnists, are starting to tell me how cheap valuations appear. Speaking from experience, when companies look really cheap, then you had better start checking if the earnings are really there. With the Federal Funds rate at 1%, people wanting to sell you companies priced at 15% yields on current earnings... that should tell you something about the earnings.

When to buy? I see savvy friends (and people like Buffett) buying in the current market (looks awesome on a two week basis). However, I know that being wrong will hurt more than being right. that's the emotional side.

The analytic side runs like this -- where I like to invest (other than core capital) is projects where I am able to increase my return through an employment, or consulting, relationship with the company. Generally, I look for a 20% return achieved through a mixture of current income and long term capital gain.

If you've ben prudent then you can take (a measure of) solace from the fact that we are all in the same boat and you've likely been hit less than others. I've also rationalised to myself that a major economic downturn is a good time to have kids -- perhaps the ultimate in being countercyclical.

When people tell me that I risk missing the boat, I just don't see it. Even if I timed the market perfectly over the last ten years, I would have been better in cash.

That combines with my sense that the Great Unwinding as a lot further to run and a concern over the deflationary effect due to simultaneous global asset bubble implosion.

Besides being right wouldn't change my life that much and being wrong would blow my daughter's college fund.


A Good Bet
If I was a young couple, or family, then I continue to believe that there will be good investment opportunities this winter in the housing market. I strongly suspect that we will see a very soft property market in early February. Figure out what makes sense now. As we approach the bottom, you will have a psychological headwind against investing.

In figuring out what type of property might make sense -- review the buy:rent equation. That should be starting to get attractive in many markets. In some places you can pick up houses for less than construction value (and possibly get the foreclosed lender to give you a mortgage).

Here is what I'd look for -- you aren't likely to be able to get everything but it will give you ideas on how to evaluate your potential purchase:
  • 50% reduction from peak pricing in 2006/2007
  • 10% under replacement value
  • mortgage payments no more than 80% of your current rental cost
  • if buying a foreclosed property then negotiate a price reduction that is a multiple of any defects you uncover with your survey
Unexpected unemployment is a possibility for many of us -- consider your income security. It probably makes sense to consider a smaller property than you may have aspired to a few years ago.


Looking Forward
All-in-all, remember that there is still a lot of good out there. It is so easy to get caught up in the negative noise being pumped out by the media. I have friends that don't own shares that are tracking the Dow hourly.

Turn it off... it's not doing you any good!

While far from a blessing, a difficult economic environment certainly makes life more simple. The core items that make Monica, and me, happy are low cost.

As for my own portfolio, I'm not really sure what to do and I can't afford to be wrong. So I'm going to take the Asian solution... wait.

Back next week,

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At 9:26 AM, Blogger Douglas K said...

"As for my own portfolio, I'm not really sure what to do and I can't afford to be wrong."

thank you, now I don't feel so bad about my own haverings.. We have a large chunk of savings languishing in cash (money market). Now my failure to invest it more intelligently, looks like masterful indecision. It's intended for a house upgrade but perhaps it will be needed for living. For the moment I've adopted a defensive crouch, though the 401k investments are still going.

Mr. Bogle and Mr. Buffett think it's time to buy. If I could get a guaranteed 10% like Mr. Buffet, I'd be buying too..

For the baby meltdown, we found white noise would often help - washing machine, or one of the white-noise devices sold to help sleep.

At 2:55 PM, OpenID matthewhirschey said...

Next week post question, Re: Marathoning
When training for an IM-marathon, I suppose you might say to become efficient at MAF, and when it comes time to race, don't slow down. But for an open marathon, how does your strategy change? Still need to train primarily on top end aerobic, or do you work more your glycogen burning mechanisms? When race day comes, it seems you could be a little more aggressive in your race strategy. After all, you don't have a 112 mile warm-up; right?

At 5:15 PM, Blogger Mike said...

Inflation? Deflation? Both?

Knowing which way the wind is blowing would really help me get off the block. My gut tells me inflation(the statist's remedies of liquidity flooding worry me more than the mackinations of the marketplace). Its the easiest out for our government.

In the meantime, I choose to be on the side of our hisitorical experience...I'm buying in ala' Buffet(albeit not benefitting from his sweethart deals as Doug mentioned).

I thank God every day that the things that bring me joy (training, fitness,family,friends and maximizing the experiential)are low cost items.

Mike B
Congrats on your new child

At 10:59 PM, Blogger Chris said...

Hello Gordo,
Re: Real World Marathoning

My original goal for '08/'09 was to complete a HIM & IM, however increased hours at work have seen me shift my focus towards the marathon. I was interested to hear your views on training methodology for this event. Personally I am going to experiment with a "complex" plan like de Castella. What are your thoughts on complex training vs a Lydiard or periodised approach. I am to train mainly aerobic, incoporating a long run, a strength endurance session, sub-threshold session and hill session each week, obviously progressivly overloading these training variables throughout the plan. Basically I wish to create a massive aerobic that has been trained to work for long periods of time between 60-85% of MHR that can be carried over to HIM and IM racing.


At 12:05 PM, Blogger Stephen said...

Hi Gordo,
Can you please clarify what you mean by "10% under replacement value".

At 9:03 PM, Blogger Gordo Byrn said...

Let's say construction costs in your town are $220 per square foot -- if you can get a property at a value of $200 per square foot then you are, essentially, getting the land for free. This is an extreme case -- you'd need a scared, or foreclosed, vendor for that. In the most overbuilt markets, we will see prices like that during times of heavy foreclosure.

Another way to look at is take a very conservative view on land value -- in the example above... you'd add a conservative land value to your building valuation.


Had a friend comment that nobody forced people to take mortgages out... I agree completely. However, we know that certain markets, and people, do a poor job of self-regulation. Therefore, when defaults eventually come back to the taxpayer, it is reasonable for "the people" to demand regulation to protect responsible citizens from paying off the debts, and bonuses, of irresponsible citizens.


Finally, there are valid points on both sides of the argument. What I think the financial industry is missing is the mood of non-financial citizens. Fear, anger and a sense of injustice -- that is a recipe for people "storming the gates". My point about the source of revolutions.

Going back to the clip from the US Congress, if global citizens decide that the financial industry isn't "fair" then the lucky few on the inside will have their game spoiled.


At 9:46 PM, Blogger thejacka1 said...

Re marathon training. Is it better to (a) run 7 times per week; (b) run 5 times, cycle once, swim 2-3 times; (c) run 3 times, cycle 1-2, swim 3 times, weights/yoga 1-2 times, nordic ski machine once?

At 6:12 AM, Blogger Steve said...

Read Bill Gross over at Pimco.

When it comes to investing or thinking about investing sometimes less is more. Less CNBC, Barrons etc... more Peter Lynch type of stuff,,, "that's a million dollar house????" stuff.

Regarding "If I could get a guaranteed 10% like Mr. Buffet, I'd be buying too..". You can, buy BRK.B or BRK.A if you have some spare change.

Finally, running. After weight-loss or body composition I believe that power improvement would provide the biggest ROI. (95% of all runners) Gordo, what running protocol would you advise to build power or strength. I assume this would include squats & dead lifts in combination with daily runs.

At 2:52 PM, Blogger Jason said...

I'm interested knowing your thoughts as to how someone with a history or Achilles and calf injuries should handle training for a marathon.

Is it a pipe dream that i should forget???

Can you use other pieces of equipment such as an elliptical trainer to replace some sessions.

Trail running v road running to reduce impact or is it a case of nothing beats specificity.

At 5:20 AM, Blogger Alex said...

Hi Gordo, congratulations on your child, that is a great photo that you have there :-)

Regarding your post, I think that a lot of what has happened could have had less impact if all of the parties involved had taken some time to slow down a bit and think of what they were doing.

For example, I was reading the other day what a Credit Default Swap is and what the history is behind it. It is amazing that one of the most important reasons (if not the most important) to create such an instrument, was for the banks to be able to release capital that they kept as a guarantee for loans that they had already made. This and also the fact that in 2004 the 5(back then) biggest investment banks were excluded from a basic rule that defined how leveraged they could be, make it really difficult for me to accept that plain and simple greed isn't the issue here.

The same applies on the other side of the fence. When I came here in the UK 4 years ago, I was amazed at the way people were buying houses. How is it possible for an individual to go and borrow money for something that costs £300,000 with a salary that does not exceed £40-50,000(and this is not the worst case scenario)? I would be very very nervous if I knew that if something went against me in such a situation I would basically be against the wall. Yet not only this happened but people were also bragging that they would make a ton of money out of basically thin air. Now that a black swan has happened everyone is jumping around blaming everyone else but themselves.

At 11:03 AM, Blogger Brett Skyllingstad said...

Marathoning Question:

First off, love the blog read it every week. I even shared it with my sister who is expecting her third child and just did her first Triathlon this past summer. Great writing.

So as I am sure with many other triathletes as winter approaches many turn to an early spring marathon as a way to keep fitness and keep themselves entertained. I am doing this myself and have just began my ramp up for a marathon on 2/15/09. I will follow a normal schedule for traning never increasing by more than 10% a week and backing off every 3 or 4 weeks.

This past season of triathlons I completed 3 Half Iron Distance races. Next season I will be racing my first ironman at IM Wisconsin. My training will be with a coach and begin in Jan or Feb. of 2009. My current training till the Feb. Marathon will be running 3 days per week, Strength Training at least 2 times if not 3 times per week. and yoga once per week. How much swimming and biking should I interject into this winter to not loose all the base while I am training for my marathon?

At 12:07 PM, Blogger chip said...


Another excellent post!! I believe fatherhood has enhanced your clarity :)

And ANOTHER cute baby pic--outstanding!!

One comment you made that was transformational in how I viewed my stock portfolio was to think of it terms of how many years of living expense it equates to. Now THAT'S a mindset that will get you over to cash pretty quickly.

You're exactly right--greed being the powerful force that it is, along with hubris, if someone had told me on Jan 2, the day the market opened, that I could stop right there and take 0% return for the year but no losses, I would have taken a pass. By Jan 4 after 3 straight says of heavy selling I would have still said the same, yet the paradigm shift had already occurred.....

One thing you never see in standard financial writing is comparing money saved for "x" time period vs those tables showing money invested the market for 30 yrs. Folks would be surprised to see how well you can do with dedicated saving even at near-passbook savings interest rates....and easier to deal with than 50% hits to equity.

That being said, govt needs to incentivize savings if they really want people to save--not happening yet.

thanks again for the post!!

At 7:05 AM, Blogger Peter Oom said...

hi there. have found your blog and enduracecorner a couple of weeks ago. Great stuff

I did the IM on sub 10 (of which the marathion in 3:30) and marathon (only) in sub3.

How do I get faster, or rather: how can I run the marathon in sub 3 on the Ironman?

Another question I have:
Since a year ago, I have had problems with my knee, the "runners knee" aka "jumpers knee". It wont go away, but I can live with it and perform, given that I use a Knee strap, which takes away some of teh stress. But I believe I could do harder intervals and harder training if I can get rid of the problem fully. Any suggestions? I have tried new shoes and stretching the ITB (outer muscle of the leg)+ glueteus maximus.

Thanks for a great blog.
Peter from Sweden.

At 1:55 AM, Blogger Bruce said...

Congratulations on your baby girl Gordo. It's great to hear you are doing so well. I missed you last time you breezed through Vancouver. Hope to catch up with you next time.
Bruce Voyce


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