Humanity, Our Collective, and Investor Opportunities
We are saturated with information, enough information to make some of us sick, or behave in a self-destructive manner. We could call it an ‘infodemic’. False and contradictory statements are routinely being made with pointed conviction and the full power of the internet. Difficult to defend assertions are made to appear credible with the anecdotal use of viral memes and short video clips polarizing people with divergent opinions.
The difference between fact and fiction is being blurred by an over-abundance of information.
Speaking out against popular group think is risky – a looming cancel culture is forbidding open discussion. With reality shaped by our own perception, truth appears to be elusive and where there is doubt, there is fence sitting. When we stand for nothing, we may fall for anything, including fake news and other propoganda.
Let’s wade into these uncertain informational waters and take a fresh new perspective on your wealth and well being.
Daze of Summer
Attention spans are distracted by every squirrel in sight. An Instagram collage, a meme of the 5 things you need to know, or even a three-minute YouTube sound byte would gloss over important ideas that need to see the light of a bright summer day. I’m writing this as one friend to another, sharing top-of-mind thoughts and reflection on money and humanity. I hope you will excuse me if I’m overstating the obvious; the message is worth repeating.
In this message, we are going to see ourselves in a different light, shift our gaze to others, and consider the opportunities and how we can capitalize! Are you ready? Let’s begin!
Exploring our Humanity
Here at the end of summer, we are in a traditional period of transition. This is a time of reflection for some and may be accompanied by a fleeting sense of loss for others. We may also be anticipating a hopeful and pending sense of renewal as we wind down the third quarter and move toward the beginning of another year.
Investors around the world are taking inventory, checking account balances, and asking tough questions. What happened this year? Where am I going, what am I going to do?
The normal dialogue is coached within the framework of financial speak, starting with plans, risk, and long-term objectives, and weaving through macro viewpoints of markets, with forecasts for inflation, interest rates, employment, investment performance, and most everyone wants to discuss real estate values. We’re going to dispense with all the financial group speak for the time being. We are going to take a more human approach to understand what is going on.
The Dance with Entropy
Entropy is simply a measure of disorder and affects all aspects of our daily lives. In fact, you can think of it as nature's tax. Left unchecked disorder increases over time. Energy disperses, and systems dissolve into chaos. The more disordered something is, the more entropic we consider it.
We’re going deep when we consider that since the moment of our inception we have been engaged in a dance with entropy. Each day of our lives, there are about 330 billion cells replaced in our bodies, equivalent to about 1% of our body mass. Every 80 to 100 days, some 30 trillion cells are replenished – the equivalent of a new you. Some people are uncomfortable with the fact that behind the scenes, we are constantly engaged with maintaining our physical sense of self while our shape is shifting to become something new. We are not our bodies, or our minds for that matter. It takes a lot of energy to feed them both.
The pervasive lack of order and gradual decline of our physical condition has been with us since the beginning of time. We seek out and value stability over uncertainty, whether we know anything about entropy or not. Insecurities about our physical condition are far older than Napoleon. There is nothing new about how thriving and surviving is playing out today. We are doing our best to overcome unpleasant feelings of any kind, including the fear of loss and coping with loss aversion.
To be clear, we are not only talking about our physical condition. Physical pain and emotional pain are both felt in the amygdala, and they are indistinguishable from one another when the fight or flight response is triggered. In this day and age, we have new ways and means to soften the impacts of entropy, and to distract us from having to face and accept the inevitable cycles of gains and losses that challenge us on a daily basis.
We don’t want our savings to deteriorate as we are doing our dance with entropy.
Financial plans are an example of how we manage the uncertainty of financial markets and an uncertain future. The plans don’t make uncertainty go away. They are a blueprint for how to deal with a flair up of uncertainty. We don’t want our savings to deteriorate as we are doing our dance with entropy; we need to be protected against inflation and the loss of purchasing power, and the permanent loss of capital through poor capital allocation decisions.
Some of the “fixes” we may use to avoid entropy are Band-Aid solutions, treating symptoms rather than the underlying cause. Financial markets are cyclical, they surge, retreat, and regenerate – it’s been that way since markets began. Reacting with a flight to safety, by seeking a guaranteed solution after a market decline, is only temporary relief for some of the short-term pain of uncertainty. Corralling the horses after they have bolted may also result in a permanent loss of capital, and guarantee the remaining capital will lose purchasing power by not keeping up with inflation. Better to have a plan for how we’re going to deal with adversity before the challenge sets in.
The richness of life is enhanced by enduring the stress that accompanies many of the challenges we are facing. A popular saying is, “If it doesn’t kill you, it makes you stronger”. The various stresses we face often exploit weakness and vulnerabilities, and like a bone or muscle that becomes calcified or built up from repeated injury, our ability to become resilient to financial shocks is enhanced by developing healthy coping mechanisms. Our behavior evolves as a result of our experience, if we have been paying attention.
Financial plans are part of the mechanism that allows us to keep our perspective when others around us have lost their own. Plans allow the winds of panic and uncertainty in markets to serve us with opportunity rather than blow us around like a tattered sail.
Temperament is an inside job, not everyone can or should do it. Anyone with a time horizon of less than three years should not be in equities. Anyone who does not have the temperament to withstand a temporary, (three years or less), 30% loss of investment capital, should not be in equities either.
Our low points in life set the stage for recoveries. The inevitable high points that follow are accompanied by feelings of joy and elation that are larger than those that came before them. There are striking similarities with investing.
Attachments
Feelings of joy and happiness are positively correlated to surges of dopamine in the reward pathways of our brains. Beneficial things essential to life, such as eating, drinking, and intimacy stimulate dopamine production. The release of dopamine is also one of the major neural centers involved in addiction, including nicotine, cocaine, methamphetamine addiction, as well as gambling and pathological risk-taking behaviors. Biologically, we are predisposed to experience pleasure and happiness. Money in our society is clearly essential to life, so it’s no small wonder it generates such strong feelings within us.
When we are happy about someone or something, we are also inclined to form an attachment. Much like a dopamine addiction, we want to see that those good feelings continue. We form expectations around those pleasurable things and when things don’t go according to our expectations, we react, in a knee jerk fashion, driven by emotion. In the absence of acceptance, our expectations bring about far more pain than is necessary.
“The key to a happy life is to continually lower your expectations.”
Charlie Munger
Surprises around money are not usually good things. Attachment and the expectations that come with it, generate involuntary reactions from the sub-conscious mind. The flight to safety mentioned earlier is only one example. We are loss averse, meaning we are pre-disposed to avoid the feeling of loss. The involuntary reflexive reaction of the mind is to go hyper-active with thoughts and conjure up all kinds of stories and narratives that are suited to our world view. The stories are mostly negative.
Our “truth” becomes what we want to believe, supported by all the self confirming evidence we can harvest from a growing over-abundance of data. We use biased reasoning and confirming evidence, motivated by our personal beliefs.
The book by Peter Bevelin, “Seeking Wisdom, from Darwin to Munger”, outlines 39 reasons for mistakes that can be explained by our psychological make up. “Many of the reasons are rooted in psychological tendencies and bias that often influence us subconsciously. The more emotional, confused, uncertain, insecure, excited, distracted, tired, or stressed we are, the easier we make mistakes. Geniuses aren’t excluded.”
Privileged Beliefs
The automatic nature of thought is often driven by our early experience with life. If we grew up in poverty, we are cultured in a scarcity mindset. If we experience the anxiety of abuse, we are inclined toward trust issues. If we grow up in an environment surrounded with love, good friends, the comforts of life, we are more likely to experience security and an abundance mindset.
Our collective learnings are taught by our families, others we have encountered, the education system or religion we were affiliated with, and the culture we are part of. We are influenced by news and social media. Most of these experiences are not consciously chosen by us.
As adults we can choose our friends and relationships, the post secondary schools we want to go to, what companies we want to work for, or who our role models are. We take control of our destiny by making our own decisions. We shape our own trajectory with the thoughts we choose to keep, and the best loved ideas that we choose to let go of.
Our freedom to choose is a belief many feel entitled to and that it is a belief that cannot be violated in a free and democratic society. A privileged belief is one where the attitude and belief is formed out of a privileged existence. Many people around the world, not just in North American societies, are living a privileged existence and the result is that many of the more privileged beliefs are held by a minority of affluent people. The top 2% of individuals in Canada have a net worth of around $2.5 million, the top 10% have a net worth of $840,000, and the top 50% have a net worth of $482,000. Compared on a global level, if you have a net worth of about $127,000, you have more than 90% of the people on the planet.
Whether it is a sense of guilt or unfairness, shame or loss of dignity, or some other virtue, we are perfectly capable of making decisions that signal our privileged beliefs and that can cause us to behave in ways that are counter productive. Let’s pause on that note and wrap up these short observations about our humanity.
People with their emotions and beliefs are complicated, and we need a sound framework for decision making that allows us to remain rational during times of uncertainty.
An important part of my role as a financial advisor is to manage expectations. We are shining a light on automatically generated thought, which is arising from people and experiences we did not choose, and from circumstances out of our control. Our best remedy to quiet the mind is to observe it, without judgement, and watch as the negative feelings give way to deliberate and conscious rational behavior. We need to be willing to destroy our most loved ideas when something better comes along.
Our survival and ability to thrive depends on critical, second level, thinking.
The Collective Good
Diversity and Diversification
With an open mind, it’s amazing how much garbage others will try to put in there.
Diversity is generally good and healthy where it concerns our ability to adapt. Necessity is said to be the mother of invention and we don’t all share the same necessities. For someone who is blind, there is a necessity to find different solutions than those needed by someone who is with sight. The blind person, enabled by education, technology, and employment opportunities, may develop solutions that are portable and useful to all people including those who have the benefit of sight.
A same small percentage of the most exceptionally gifted people, who live in the most heavily populated areas of the world, have the ability to find ideas and solutions that will benefit people from all walks of life, by making our lives safer and easier.
A pregnant idea is one that gives birth to other ideas, and those ideas lead to other ideas, compounding our advancements. We need everyone’s involvement, with a diversity of thought and opportunity, from all over the world.
Diversity of thought is subject to the same rules of Darwin based evolution. Bad thoughts that are not fit to survive will be selected against by better thoughts.
Everything new is not necessarily better. On the contrary, some of the best ideas have survived a very long time for a reason. We need to know the difference between new and best, how to determine a good idea from a bad idea.
Let’s stay focused on diversification for a moment.
Diversity is a good thing where it concerns the organic nature of life in the physical world. Diversification where it concerns money and finance is often touted as, “indispensable truth,” where it concerns portfolio allocation. You may be familiar with the phrase, don’t put all your eggs in one basket. The concept sounds as wholesome as a home baked apple pie.
Diversification hides mistakes by providing a hedge against ignorance, and on the flip side, it is dilutive to the benefit of focusing on the best of the best.
Warren Buffett, the most successful investor in modern history, has referred to diversification as de-worsification. One of Buffett’s suggestions to investors is to choose only a select few investments and watch that basket closely.
Out of all the 53 publicly traded stocks owned by Berkshire Hathaway, 5 of them represent about 75% of the holdings. Buffett’s wealth, much like most other billionaires, is tied to the share value of only one business, in his case, Berkshire Hathaway. Think about that. How does that compare with what you’re doing to accumulate wealth?
Berkshire is also the majority owner of about 60 other businesses and holds over $100 billion in cash and equivalents, along with treasury bills. Buffett’s nickname is the Oracle of Omaha.
For most others who are not Oracles and don’t own shares of Berkshire, the world’s most expensive stock, Buffett suggests they invest in an index, a basket of stocks representing a broad cross section of America’s largest businesses. Those who do not want to put the effort into selecting and watching a small basket of carefully chosen businesses and who instead, would prefer to set it and forget it, they ought to invest passively with a broadly diversified portfolio.
Buffett’s advice may seem hypocritical. Those who know Buffett have come to see him as a man of great integrity. I’ve held him up as a role model to my children and we’ve made the pilgrimage to Omaha together many times to listen and learn among clients and friends.
Buffett’s Berkshire does not look anything like the index, and it is not operated like an index. Why does he do one thing, and suggest others do something different? What he does is simple, but not easy. Many are also not able to quiet the involuntary reaction of a hyper-active mind with calm and rational thought.
Most are not willing to put in the effort that it takes to be an investor, to do the homework on understanding value. Instead, many are lured by the attraction of easy money from picking the next winner as though they are at a racetrack betting on ponies. They often lack a suitable framework for decision making, or the framework they are using is corroded with an over abundance of data that is not assembled correctly. Many rely on social proof to make decisions. There are lots of reasons smart people fail to be good investors.
Buffett has not been static with his way of thinking; he changes his mind when better ideas come along. Most of us want the certainty of a fixed recipe – if this, then that. An algorithm coupled with AI to solve for every possible outcome to make us rich would be nice, yeah, that’s the perfect ticket! Quit thinking altogether and just get rich.
As an example, investing in technology and airlines are contrary to Buffett’s previously held opinions and evolving investment decisions that seem to reverse those opinions are a signal that thought needs to be exercised on every decision that we make. We can’t be lazy about our thinking. Diversity of thought is critical, along with a sound framework for decision making.
Diversification is what fools do to hide their mistakes, or to avoid making decisions altogether. We need to make our own decisions on how we want to experience diversity.
Capital is Agnostic
Regardless of your personal beliefs, money will flow to where it obtains the most value. This is especially true during times of uncertainty. Value is a neighborhood, not an address, meaning it is subject to interpretation. In the short term, investment markets are like a beauty contest with money flowing to the best stories, the most attractive candidates. In the long term, markets are more like a weighing machine, the final arbiters of value.
The flow of capital does not care about active versus passive styles, value versus growth, foreign versus domestic, or even stocks versus bonds. Preservation of capital and its purchasing power are the primary drivers of investment. Long term investment capital doesn’t care about the stories we tell ourselves about a few rich people controlling everyone else, how the system is rigged to benefit the few at the expense of the many, or other popular nonsense.
The agnostic nature of capital gives rise to the weighing machine which necessitates that capital flows toward safety and the preservation of purchasing power, period.
Get Off the Couch!
Why Waste a Good Recession?
We don’t officially know when there is a recession until after the fact – it’s one of those weird things that are revealed by looking backwards. The boom and bust of cycles are accompanied by opportunities, just as every demand shortage of supply is followed by a generated surplus selling into it. Recognizing the opportunity of every downturn as it arises brings about equal or greater benefits.
In a down market, prices for the things we like to own are discounted. Buying the same thing at a discount that was bought at the beginning of the year, will return the amount of the discount once it returns to its previous value. Price discounts are temporary. The less time the prices take to rebound, the more the return for an equal amount of price appreciation. If you can afford to wait for the rebound, you can also get paid to wait with the dividends that our businesses are paying and compound the gain beyond the price recovery.
If you are fully invested and there is no cash to invest, our managers are searching out investment opportunities where we can trade up by arbitraging a business we own for a more secure and valuable business.
If we are considering a major purchase or a vacation, look for deals to be had when disposable income is becoming scarce and inventories are piling up and seats are open.
When the lights have come on, the punch bowl is turned over, and the party has cleared out, there are lots of deals to be had among the discarded and downtrodden.
Current Opportunities
In the current environment, there are places to go for capital preservation and long-term inflation protection. Interest rates have been rising to beat down the rapid price inflation of an economy that is operating at pre-covid levels. We are using lots of energy, and employment is running at near full capacity. Geo-political tensions are affecting energy prices.
At the outset of this message, I vowed to avoid financial commentary, so let’s keep it brief.
The spread between investment grade bonds and high yielding bonds has narrowed and that is presenting opportunities in the high yield space. In an inflationary environment, commodities have performed well historically. Canada is fertile ground for commodities and there is room to pick through that basket of opportunities.
We have some equity fund managers who have positive returns year to date. We have a bond fund that is still generating 5% returns. The rough patches never last, tough people do. We have what it takes, this time is no different!
Click here to schedule a meeting