14 November 2008

Reflections on Savings and Investment

This week we return to a more financial-oriented letter. Now that the US election is out of the way, it seems like the bad news has started rolling again. The bad news can seem relentless at times and, following my trip around the world, appears to be happening in the US, Europe as well as Asia.

With the mood (near universally) negative, I've been trying to figure out my long term strategy for savings and investment. As I mentioned a few weeks back, I'm currently projecting a cash flow deficit for 2009. I suspect that I'm not alone in being in that position! Frankly, being able to absorb an unexpected set back is why I've been conservative over the last twenty years. I have been reminding myself that the world isn't ending but human psychology can be tough to counter.

I have also been reminded myself of a few other aspects of investing (at least in my, rather unsophisticated, world).

Ability to forecast -- I have ZERO confidence in my ability to make accurate short-, or medium-, term forecasts and I don't trust my memory about historical forecasting. When it comes to past predictions, I suspect that I tend to forget my errors and remember my successes. Incidentally, this is a large part of the value that an investor/athlete can get from reviewing written logs of past decisions/training.

Timing -- Something about my nature makes me so conservative that I miss a lot of opportunities (not necessarily a bad thing). A friend once made the comment to me that if he'd listened to me then he never would have started his business -- perhaps an exaggeration, but a fair point that I have spent a lot of my life pointing out potential pitfalls to people. Interestingly, the triathlon equivalent of this is that an athlete never really knows when they are going to be in top condition -- so, if you're trying to make a living, then when conditions are right, you need to be willing to go for it. In other words, it's pretty tough to predict opportunity 1, 2 or 4 years out.

So what I have been researching is:
  • What assets do I want to buy, and hold, for the long term.
  • Separate from their current price, what is a reasonable assessment of their long term value.
Once I figure out #1 and #2, I plan on buying every time price gets below value. It sounds simple but is surprisingly difficult -- right now I am struggling to find an asset where I have 25-year confidence on existence, let alone value.

As the above chart shows, I don't think that there is a large rush. You can find the article about the chart HERE. When one is in cash, reading about capitulation is strangely entertaining, another aspect of human nature.


Global Property Outlook
I had some questions about my views on global property, not just the US. Unfortunately, my research over the last three months doesn't point to any good news. This spring, prices were holding in the prime sector throughout the world. As we near the end of the year, my estimate is that prime properties (UK/HK) have fallen 20-25% in local current terms (in FIVE months). Market participants are not prepared to admit that publicly at this stage but if you actually want to realize cash then market clearing prices are 20-35% off the peak.

The vultures ARE the market. Owner occupiers have, largely, stopped buying.

So my entry pricing advice for non-US buyers would be similar to what I laid out to US readers. Make sure that you have a margin of safety in your entry price and remember that there is very little opportunity cost to renting, versus buying (these days there is an implied option value in waiting).

Take your time and remember that returns from property investment are always overstated because people fail to accurately reflect their holding costs.

That said, a leveraged property investment (where a high quality yield covers a fixed interest expense) can be a good inflation hedge. Still, like most, my recent property investments are impairing my appetite for further exposure. My aversion is why I continue to investigate opportunities.


The Cost of Time
How does an investor, parent or employer, quantify the true cost of a poor decision?

While a bad investment costs you money. The most costly losses stem from the aspect that never hits your bank account.

What do I mean?

The #1 cost of a poor decision is the time lost sorting out the situation.

Specifically, not having the time to focus on the highest return areas of your portfolio, or life. We make a far greater return from backing our stars, and investing in our strengths, than getting bogged down with losers and weaknesses. High performers have an innate ability to combine passion with inherent ability.

I have recommended this Drucker article before but it is even more important in the current climate -- when we share a tendency to obsess on negative news, sunk costs and weak investment positions.

In challenging times:
  1. consider each dollar (and minute of your time) to be a new investment;
  2. move to limit liabilities and cut-off drains on finite resources (time, energy, capital);
  3. ensure full disclosure to, and honest communication with, all parties; and
  4. make time to identify your highest yielding opportunities.
The four points above are REALLY hard to implement consistently. Why?
  • We tend to overvalue existing positions
  • We tend to overestimate the impact that we can have on a situation
  • We are VERY likely to be part of the problem, rather than the solution
  • Problems rarely turn themselves around in a global recession, with massive liquidity headwinds
So I have started an internal review considering my personal return on how I am using my time and how I have budgeted to use my cash flow over the next year. Looking even further out, I want to figure out my desired life/portfolio 15-25 years out.

Monica loves it when we talk 2033 strategic goals, our lead photo this week shows her coping with more pressing concerns...

To wrap up, I will share the best question I have been asked over the last two weeks...
How much is enough and how will you know?

Back next week,

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At 10:45 AM, Blogger Matt said...

"So my entry pricing advice for non-US buyers would be similar to what I laid out to US readers. Make sure that you have a margin of safety in your entry price and remember that there is very little opportunity cost to renting, versus buying (these days there is an implied option value in waiting)."

Gordo, What does "very little opportunity cost to renting, versus buying" mean exactly?

I'm renting now, saving hard. Does that mean I'm playing "smart"?

Thank you!

At 10:13 PM, Blogger Bruce said...

From reading your article, which together with the Drucker article I need more time to carefully digest, while I can to some extent identify with you, I feel I can perhaps better identify with the vultures you refer to, although I am only a small one at that. The work I do keeps me very busy at present, but I am informed by those I work for that I will probably be even busier during the recession. Provided one can be generating a cash surplus these days, then surely there are many bargains out there, from the seemingly insignificant things one picks up in the local recycling junk yard to bigger things that are beyond my reach. Of course the overall size of the pie may be shrinking temporarily, but it should grow again and get even bigger eventually, so we need to adapt ourselves to the changing conditions and navigate our way through these troubled waters. I totally agreed with your point "we tend to overvalue existing positions". This is particularly true in the stock market. Sometimes we hang on to the past too much or let sentiment cloud our rational decision making. While of course the past and sentiment are very important to us, we have to put a price on them to make sure they don't rob us of a better future.

At 8:24 AM, Blogger Gordo Byrn said...


Many of us share a "fear of missing out" if we don't invest "right now". In a rising market these emotions are what causes manias and bubbles.

In a stable, or falling, market the buyer can save money by waiting. Especially when the cost to rent is lower than the cost to buy.

As well, we can only live in one place at a time and switching costs (brokers fees, transaction expenses) are high for real estate, As a result, you want to be careful before you buy.



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