Tag: investing

The best uncorrelated asset

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One framework for investing is the bathtub model. Individuals (but also managers of OPM like pension funds, endowments, etc.) aim to fill the tub as much as possible. An individual’s main stream is their salary. Maybe some salary first goes to an investment, and then pours in the tub. A rental property, a second job, a military retirement are inputs too. 

But the tub doesn’t just fill up, it drains too. Losses in the market are like leaks in the tub, hopefully we can mop these up and dump them back in. The big four unexpected costs: health, house, job, spouse are major leaks. Retirement is the intentional draining of the reserves.

More water and more pressure is good. Fewer and less severe leaks are good. One way to add on net are uncorrelated assets. What flows faster as something leaks more? Real estate and gold are classic examples. Bitcoin too – kidding! ‘All weather’ and ‘cockroach’ are portfolios which blend assets for uncorrelated returns. The goal is to prevent major mop ups or total losses. 

But the best and only uncorrelated asset is mindset. 

A common mindset during drawdowns for investors who dollar cost average is that stocks are on sale. This attitude goes beyond investing. When something bad happens it’s a chance to get stronger. Another is, you’ll have a great trip or some really good stories. 

The world is complex. There’s a lot going on, sure. But also ‘a butterfly flaps its wings in Kansas and causes a Tsunami in Guam’ complex. How does someone plan for just what’s happened since 2016?! How do investors (but also managers of OPM like pension funds, endowments, etc.) find that someone? Not only is our mindset the best and only uncorrelated assets, it’s ours to control. We can want less or more. We can view the obstacle as the way. We can match expectations to reality.

Made up start up: The Financial Game

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Edit: this was drafted in late 2019.

I loved the movie The Game. The premise was that for his birthday, Michael Douglas’s character was ‘attacked’ in a real life adventure. It was part thrill, part horror. I can’t even remember how much of it was real.

‘What is real’ is a common premise in my favorite movies.

https://www.youtube.com/watch?v=SOlmyv1WTBY

Part-of-the-reason I like it is because it holds a truth. Without skin-in-the-game we really don’t know what we would do. There are our stated and revealed preferences. There are our human biases. There are the ways something is presented.

It’s a real quagmire and something Sallie Krawcheck noted when she spoke on The Long View podcast:

“Ya’ll probably know this as well or better than I do, but when you ask someone what their risk tolerance is, nobody knows it until they go through an ’07 or ’08. They just don’t. Let’s call a spade a spade. But we answer it. Men will answer it and women will go, I need to figure out what it is.”

Sallie Krawcheck

According to Daniel Kahneman, we’re answering an easier question. Instead of what is my risk tolerance we probably answer something like how do I feel today or which column of returns looks good? We do the same thing when choosing college.

Here’s the pitch: Taking a cue from David Fincher and Krawcheck, we’ll create a company that coaches financial advisors on how to stage Doomsday Days with their clients. Like for Douglas, the clients won’t know when it will happen (and we’ll hide this feature in a bunch of legalese).

The plan would be to make up financial statements that mimicked actual downturns; 1953, 1981, 2008, etc. Clients would come in for their regular meetings, be presented with a fictionalized loss for twenty minutes, and then have a debrief session. It’s the financial equivalent of a false positve lung cancer diagnosis.

During the debrief the advisor could talk about real feelings of loss, of risk, and pain. Then, together, work out a new plan.

As advisors are already busy, the business would sell them a script. They could choose a level of pain, and we would provide the portfolio forms (printed on very formal looking paper) as well as suggestions on handling the psychology of it. As an upset we could offer “Confederate Coordination” as we called the wife and explained the plan to her. Yes, it would have to be, the wife.