Thursday, March 5, 2009

A Manifesto of Personal Finance

We have short memories. I have had many, many conversations about personal finance recently. I had the same conversations seven years ago. We are a generation in charge of our own retirements[1], and we don’t really seem qualified.

I have several thoughts on this that have served us pretty well. So I thought I’d post my guiding principles of personal finance…a manifesto if you will.

1. You Can Not Time The Market

My first principal of personal finance is to embrace incompetence. The vast majority of experts cannot time the market. And I am not an expert. Day trading and moving large chunks of your retirement between stocks and bonds is not only a recipe for insanity, but a sure way to lose money. The result of embracing incompetence[2] is designing an approach to market uncertainties that is designed for all contingencies.

So I suggest forging a strategy that you can live with in bull and bear markets and sticking with it. Keep your stocks when they are crashing and hold on to your bonds when stocks are running amok. Very few people can time the market…I am not one of them…you are probably not one of them either…so make a sound strategy based on financial goals and risk tolerance and stick with it. We hold about 60% quality stock[3] mutual funds and select them based on a value approach.[4] The rest is government and industrial bonds, REITs,[5] and some emerging markets stuff. It ‘underperforms’ during bubbles but weathers crashes pretty well. Most importantly, it frees me from daily decisions. In my opinion, the quality of amateur financial decisions is inversely related to their frequency.[6]

2. Avoid Greed and Fear

At two points, in the last ten years, I have been widely advised that it was simply moronic for someone my age to be in anything but stocks. Recently someone close to me just pulled a large chunk of money out of stocks. Another contemplated a large investment in gold. These are each errors in my opinion, and they are based on the two biggest enemies of sound personal finance: fear and greed, the Scylla and Charybdis of negotiating the markets. Assets in our economy seldom seem to be in equilibrium, they tend to be in one of two states, under priced due to fear or over priced due to greed. The key to ‘beating the market’ is not timing it correctly, but making sound, objective decisions when the voices are calling you to fear or greed. Because the most profitable decisions you can make are generally counter-consensus. Making a disciplined plan and sticking to it can circumvent our emotional apparatus and help us make better decisions.

3. Buy Whatever No One Else Wants

So how do the first two principles turn into action? Well, regardless of market direction, I do not move more than 10% of our money between our stock and bond holdings based on my guess of future events. That is not my primary ‘knob.’ I am more interested in where my new money is going. I’m a sucker for a good sale.

My guiding financial principal is that most people are led into poor financial choices by either fear or greed. Therefore, I try to do the opposite of whatever the current trend is. I buy what no one wants at the time. A year ago, we stopped buying stocks and put our money in bonds and the plummeting housing market. Now, with the stock market 50% off, all our new money is going into stocks. It is all cyclical. I expect another three to five cycles before I need the money. I buy whatever assets are on the down side of the cycle. It doesn’t bother me that the market will likely loose another 10 to 15% (Or another 50% in some kind of dooms day scenario). I’ll buy then too. Probability is on the side of an eventual recovery.[7]

I am not driving myself crazy checking my dropping balance every day…I only check the balance quarterly to make sure I am on target with my overall strategy.[8] Rather than loosing sleep over how our holdings are doing, I am ecstatic to be buying whatever I am buying at a great price, confident that it has way more room to appreciate. And even the stuff that is loosing value…I knew it was over valued…I re-balanced…I kept a strategy that I could live with in bull and bear markets…and I know I got most of that stuff on sale anyway during the last correction, so most of the value it is loosing is value I didn’t pay for.

4. Ownership: The Path to Social Change

I am an environmentalist. I feel pretty strongly about the human mandate to care for the things God made. When it comes to environmental groups there are two main kinds: the litigious approach and that of the Nature Conservancy (NHC). I don’t mean to drop a pejorative on the Sierra Club et al. I think it is fantastic that there are privately funded organizations that exist solely to keep industry and government accountable to the rule of law. It is a great example of why I dislike our way of governance least[9] among the options. But they are not my favorite.

My favorite environmental organization is the NHC. Our office does a lot of work with them as they have sought a cooperative relationship with the Corps, rather than an antagonistic one.[10] But the thing that is most impressive about their approach is what I would call environmentalism through capitalism. If they see endangered habitat or a river reach prime for restoration or a unique natural resource, they don’t picket or sue or whine…they buy it.

This is also my favorite approach to the ills of capitalism. In our model of publicly traded companies, it would actually be immoral for company leadership to act outside of the best interest of the share holders. And most collections of share holders are interested in one thing…share price. I have said it before, but I get tired of people with 401k’s full of stocks complain about the evils ‘big business.’ THEY are big business.

The only way to change company behavior (other than government regulation, which I cautiously support in a number of forms) is to change share holder expectation. What if the share holders largely wanted the company to take a smaller profit to reduce emissions, or pay a higher wage to factory workers in India, or offer health care to its workers? The company would be beholden to these values, since it is supposed to act in the interests of the owners…the share holders.

So much of our money are in what I am going to call ‘advocacy instruments.’ These financial products are generally called ‘screened funds’ or the nearly comically self congratulatory ‘socially conscious[11] funds.’ We originally got into these from what I will call a ‘contamination’ angle. This is the ‘screen’ idea. We wanted a company to keep us from moral contamination by keeping our portfolio free of Philip Morris and the big polluters. But my take on their value has changed with my take on Christian ethics.[12] Now I see their value is consolidating ownership behind some sane, extra-monetary objectives. If Calvert or Domani tells a company that some costly environmental policy or health benefits or a living wage is ‘worth it’ they are not just taking a moral position, they are making an ownership request. They are affecting the mandate. So we hold much of our money in these kinds of ‘advocacy’ instruments.

So there it is, my manifesto of personal finance. Bottom line, if you are 20+ years from retirement, and can avoid the siren fear, it is a very good time to be investing. But it will be imperative to remember the lessons of the last year has held when the siren of greed comes calling.

This post was prepared while listening to: ‘The Lonesome Crowded West’ by Modest Mouse.

[1] Though, as you might guess, I don’t really believe in retirement. One of the reasons I am wrapping up a PhD I don’t need and already have my sights on the next degree, is that I want to work in some capacity until the day I drop dead and answer for my life. But there are a couple famous parables about wise investment, so it is something I have given some thought to.
[2] Which is easier to swallow since ‘competence’ is so rare in economic projection.
[3] Presumably this number will drop as we get older and our risk tolerance drops.
[4] The value approach revolves around the idea that you want to evaluate the price of stocks based on how they compare to actual earnings. It is contrasted to the 'growth' approach that seeks to put money where things are 'hot'.
[5] A REIT is a way to invest in real estate incrementally, without buying a whole building. We started buying these in US and European markets
[6] And research backs this up.
[7] Even if the market never returns to its peak, fear discounted assets purchased today will VERY likely appreciate substantially…they have more room to. If someone thought buying stocks was a good idea a year ago…than it is twice as good today.
[8] For example, since stocks have dropped, my stock holdings are less than 60% so we move some money over from bonds. This is called rebalancing and is a good anti-bubble discipline to keep you from chasing bubbles.
[9] Sorry for the double negative, but dislike least, in this case, certainly means something other than like.
[10] And the approach has worked…they have found that in many places, reservoirs could be re-regulated for biological objectives without sacrificing ANY human objectives.
[11] The funny part is that the question of ‘who’s conscience’ turns out to be a big one. You can get into a fundamentalist fund that advocates against abortion and same-sex benefits or an Islamic fund that is usury free, or a Mennonite fund that military free or, what is suppose would be best called a ‘secular liberal’ fund that screens for promotion of women, environmental record, and labor practices…Oh, and the Mennonites and Catholics do those things too.
[12] Which, pretty much, was the result of reading Bonheoffer.


Kel said...

I would recommend the documentary "The Corporation". The problem I have with big business is that the mindset has changed in the corporate world, and people who make the decisions don't seem to be concerned with the effect their decisions make on the larger world. Some places are better than others, but the point that the makers of the documentary make is that if a corporation is a person (which is how it is seen by law) then it is one with a antisocial personality disorder, because they act with no regard for those around them to a disturbing degree. That's part of why I am pro-union.

I think your perspective on investment as a whole is a good one. Bubble chasing never seemed like a good idea.

maybe more thoughts when I'm more awake.

stanford said...

Yeah, a buddy of mine watched that film and pitched the premise to me. Here’s the thing, though. If a corporation is a person, his/her psychology is influenced by one important detail…S/he is a slave. S/he is OWNED. This ‘person’ is supposed to (by law) have one driving purpose, to perform the wishes of her/his owners. So while most boards of directors are inbred and are not even making decisions in their share holder’s interests, a publicly traded company, even working the way it is supposed to work, will pillage the environment and oppress workers to turn bigger profits to its owners…which is US. They are not supposed to think about their larger effect IF their owners’ primary interest is prophet. If corporations are deprave (and I think they are) it is simply because they reflect our collective will. The general white collar, 401k holding public tries to off load responsibility by vesting the corporations with guilt, but they are (or at least should be) simply reflections of OUR values.

So the traditional ways of combating the maniacal corporate interest in making us money are either legislation or organizing labor (unions), as you mentioned. I support both of these things, but I am arguing that we think about the problem backwards. In addition to organizing labor, we should organize ownership and exert our will (that the corporations we own take some thought for the world around them). The corporation is only anti-social psychopath because that is what we ask of it…I would like us to think of what the world would be like if we had the ownership power to ask something else of them. By consolidating ownership in ‘advocacy instruments’ we amplify the voice for environmental and labor sanity.

Kel said...

The idea of organized ownership (that a group of stock owners would get together and talk about what they wanted for the company direction) is interesting. I'm not sure how it would work with the way corporations are structured now (I could be wrong, but I think primarily the stock holder responsibility is to vote for a board of directors who then go on to make the decisions. It would be interesting to see how those elections would change, and also to see if individuals could organize enough to compete with larger firms that do most of the buying and selling). I think the problem is that somewhere (and I think that the rise of the LBO could be a part of this) corporations and their board of directors started to become more "psychopathic" when they seemingly abandoned concepts that were part of the "social contract". Things like "A rising tide lifts all boats" and "take care of the people who take care of you". Granted, there are still companies that do that, who pay living wages and have genuine concern for their workforce. Kinkos (where I used to work) used to be one of those places, but once we started to make the move from privately held to publicly, there were a lot of changes big and small that seemed to send the message that you were but a cog in a wheel. It would be interesting to see how many of the "Top 100 companies to work for" are privately held vs public. It seems like publicly traded stock allows for people to see companies, and the people who work for them as commodities, which makes them less likely to support measures that ensure worker happiness and health. As for what to do with the situation we are in now...I feel like stronger unions and more regulation around worker standards (pay, health care, ect) is the most realistic way to address it, although your idea of ownership unions is intriguing.

I also reccomend going to This American Life to listen to their three shows about the economy (although not so much about this issue as explaining why we are in the situation we are in).