Increased Wealth Without Increased Income

Agenda:

1.    How to spend money to maximize happiness

2.    Defensive Investor Strategy Performance (down 1.3% in last 12 months)

3.    “All Seasons” Strategy Performance (down 3.9% in last 12 months

I usually write about strategies one can use to maximize their long-term wealth, however, what good is wealth if it doesn't bring you happiness?

Thinking about your long-term plan of how to make more money is a total waste of time, if you aren't going to spend that money in a way that will maximize happiness for you and your family.

Let's explore this together... 

Sometimes it's easy to fall into the trap of thinking that life would be easier (or you would be happier) if you made more money:  if you could just get a 10% raise? Or if you didn't have to pay a mortgage? In my experience, this approach is problematic. A year later, even if things work out as planned (and you got that 10% raise or magically pay off your house), you are unlikely to be happier. Why?

If you read the mass media, you have likely seen that: 

Thus, we appear to be stuck in the "money doesn't buy happiness" problem. I'd argue that "money doesn't buy happiness" is incorrect, that "money typically doesn't buy happiness" is more appropriate. With some effort, you can use solid scientific evidence to spend money in ways that can concretely increase happiness - effectively increasing your "wealth" without increasing your income.

I'd like to encourage you to focus on spending money differently rather than making more money. To be fair, I don't claim to be great at this, but I hope to get better. I discovered the following recommendations from the book "Happy Money: The Science of Happier Spending"- it's a good book and you should read it, but even if you don't, I encourage you to spend more mental energy thinking about if you are spending your money wisely - in a way that maximizes happiness - than on finding ways to make more money.

Per the authors:

Every large bookstore has a shelf filled with books designed to help you get more money. By focusing on how to spend the money you have rather than how to accumulate more of it, our perspective departs from the obsession with chasing increased wealth in the pursuit of happiness. New research shows that greater wealth often fails to provide as much happiness as many people expect. In a national sample of Americans, individuals thought that their satisfaction with life would double if they made $55,000 rather than $25,000: twice as much money, twice as much happy. But the data revealed that people who earned $55,000 were only 9 percent more satisfied than those making $25,000.

According to the book, there are five basic principles that can help increase your happiness.

1. Buy Experiences - this is simple, you are more likely to experience happiness from experiences (a road trip, a concert, sky driving, bike ride with friends, etc.) than from material possessions... again, per the authors:

Shifting from buying stuff to buying experiences, and from spending on yourself to spending on others, can have a dramatic impact on happiness.

2. Make it a Treat - when the special becomes the routine, it fails to produce the same level of enjoyment. This is the classic overconsumption problem: it happens to me with caffeine, cinnamon rolls, and burritos. Simply, when things are a special treat you enjoy them more (this reminds me of a theory economists call the law of diminishing marginal utility), but don’t over-indulge in them or they will become less special.

3. Buy Time - when possible, you should "buy" time. The book argues that paying for something like housecleaning is one of the best ways to use money to increase your happiness. If it takes you four hours to clean your house, paying someone else to clean it helps you get four hours back (having four more hours in your day can make you happier). I like to think this also applies to jobs; which job is likely to make you happier: Job A where you work 40 hrs/week and get paid X, Job B where you 60 hrs/week and get paid X + 15% or Job where you work 80 hrs/week and get paid X + 50%. If you can pay the bills with Job A, it may be the ideal choice to maximize your happiness. 

4. Pay Now, Consume Later - if you can disassociate the "pain" of paying for the experience/treat from the act of enjoying it, you can enjoy it more. If you pay for something like a vacation far enough in advance it can almost feel "free" when you enjoy it. Unfortunately, most of society does the opposite; they enjoy something now and pay for it later using a credit card.

5. Invest in Others - volunteer, give time and money to people less fortunate than you. These activities and actions are proven to make you happier. 

When possible, you should even try to combine these principles. The book closes with a slightly extreme example (but it really illustrates many of the key points):

As we saw in the last chapter, a Starbucks gift card provided the most happiness when people used it to buy coffee for someone else, while accompanying them to Starbucks—which allowed them not only to invest in others (chapter 5), but also to buy an experience (chapter 1), and change the way they spent their time that day (chapter 3). And in your daily life, you could knock off the other two principles by paying up front for the Starbucks card at the beginning of the week (chapter 4) and putting just enough money on the card to buy a basic coffee Monday through Thursday, but a Frappuccino on Friday—making that delicious dose of creamy caffeine a treat (chapter 2).

I hope enjoyed the slight detour from my typical subject matter – enjoy the raise.

My Benjamin Graham inspired fund has underperformed the S&P 500 recently. 

In the last 12 months, it is down 1.3% (through July 7, 2017). 

Defensive Investor Notes: My personal favorite investment strategy uses Benjamin Graham’s (Warren Buffett’s mentor and professor at Columbia Business School) guidance to identify companies with a strong cash position, low debt, and stable dividends paid over many years that are trading at bargain prices. Similar techniques have yielded annual returns of approximately 18% since 2001.

Returns since creation shown below:

          Date                                Defensive Investor Performance           S&P 500 Performance

07/22/15 - 12/31/15        +1.0%                                                    -1.9%

12/31/15 - 12/30/16        +22.0%                                                  +12.0%

12/30/16 - 07/07/17       -5.6%                                                      +8.6%

My more conservative "All Seasons" inspired fund is down 3.9% in the last 12 months (through July, 7 2017).

Notes on the All Seasons Strategy: I use this strategy for cash management (and to minimize draw-downs). It is intended to reduce volatility without significantly reducing upside. From 1973 - 2012 the max draw-down of this approach was only 14.4% (http://mebfaber.com/2013/07/31/asset-allocation-strategies-2/), yet the compound annual return was a very solid 9.5%. One additional note- this strategy is 70% bonds, which have been in a bull market for 30+ years (this overlaps with the back-testing period). In my opinion, it is unlikely to perform as well in the next 30 years as it has in the last 30 years.

Returns since creation shown below:

Date                                All Seasons Performance

09/11/15 - 12/31/15       -1.3%

01/01/16 - 12/31/16       +2.7%

01/01/17 - 06/01/17       +2.7%

 

Inversion Thinking

Agenda:

1.    Inversion Thinking

2.    Defensive Investor Strategy Performance (up 41.8% in last 12 months)

3.    All Seasons Strategy Performance (up 2.5% in last 12 months)

Many good value investors have written about Charlie Munger's use of an approach called inversion thinking. I'd like to briefly discuss inversion thinking in this quarter's newsletter, as well as why I believe that inversion thinking makes a strong case for quantitative investing. Tren Griffin, a Munger biographer, describes this problem-solving approach much more eloquently than I can:

Charlie Munger has adopted an approach to solving problems that is the reverse of the approach that many people use in life. Inversion and thinking backwards are two descriptions of this method. As an illustrative example, one great way to be happy is to avoid things that make you miserable. 

Munger even jokes that he wants to know where he will die so he can just not go there. -25iq

I'll attempt to leverage Munger's philosophy to explain how to make wise investments. If you want to make money investing (grow long-term wealth), and you use inversion thinking, start by asking how you would destroy long-term wealth. The next time you decide you would like to destroy your wealth, I would recommend the following:

·       Pay high fees and/or commissions

·       Buy expensive or speculative assets

·       Trade frequently

·       Use leverage

·       Make emotional decisions about buying or selling assets

If you have read my previous newsletters these suggestions won't come as a surprise (I often recommend the opposite). At this time, I’d like to focus on making emotional decisions. Before we can improve our decision making, we first must understand that we are prone to making poor investing discussions. One typical decision-making deficiency is illustrated in the Greenblatt study. The study identified a group of stocks that outperform the market over time and gave investors two options:

1.    To choose when they buy and sell stocks on the list (self-managed)

2.    To have a formula determine when to buy and sell stocks on the list (this quantitative approach was described in the study as "professionally managed")

The self-managed account allows clients to choose which stocks to buy and sell from a list of approved Magic Formula stocks. Investors were given guidelines for when to trade the stocks, but were ultimately able to decide when to make those trades. Investors selecting the professionally managed accounts had their trades automated. The firm bought and sold Magic Formula stocks at fixed, preset intervals. During the two year period in Greenblatt's study, both types of account were able to select only from the approved list of Magic Formula stocks.

If investors in the study made rational decisions about the appropriate times to buy and sell stock, I would expect them to outperform the market significantly (because they were given a basket of stocks that outperformed the market).

…What happened? The self-managed accounts, where clients could choose their own stocks from the preapproved list and then exercise discretion about the timing of the trades, slightly underperformed the market. An aggregation of all self-managed accounts for the two-year period showed a cumulative return of 59.4 percent after all expenses, against the 62.7 outperformance of the S&P 500 over the same period. The aggregated professionally managed accounts returned 84.1 percent after all expenses over the same two years, beating the self-managed accounts by almost 25 percent (and the S&P by well over 20 percent) (emphasis mine). For a two-year periods a huge difference. It's especially so since both the self-managed accounts and the professionally managed accounts chose investments from list of stocks and followed the same basic plan. People who self-managed their accounts took a winning system and used their judgment to eliminate all the outperformance and then some (emphasis mine). Greenblatt has a few suggestions about what caused the underperformance, and they are related behavioral biases. - From "Quantitative Value" by Wesley Gary and Tobias Carlisle

The investor's "best judgment" was the difference between outperforming and underperforming the S&P 500. Most investors show similar underperformance in "self-managed" accounts because of emotional decision making when buying and selling stock (causing them to buy high / sell low). We can leverage inversion thinking to solve this problem: if self-management and emotional decision-making are the problem, using a systematic approach is an ideal solution. Depending on your investing approach, implementation of a systematic or quantitative approach might vary:

1.    For an index investor – it probably means buying at predefined intervals (every two-weeks, monthly, etc.)

2.    For a disciplined value investor – it likely means buying when a stock is significantly below fair value and selling when the stock reaches fair value

3.    For a less disciplined value investor – it likely means buying stocks that are significantly below fair value and selling after a defined period of time (one year, three years, etc.)

Is your "best judgment" the cause behind your investment’s underperformance? It's worth some thought. If so, consider adding a quantitative element to your investing approach. 

If you are interested in additional reading on the subject check out the following links: on Munger; on Quantitative Investing.

My Benjamin Graham inspired fund has outperformed the S&P 500.

In the last 12 months, it is up 43.2% (through December 21, 2016). 

Defensive Investor Notes: My personal favorite investment strategy uses Benjamin Graham’s (Warren Buffett’s mentor and professor at Columbia Business School) guidance to identify companies with a strong cash position, low debt, and stable dividends paid over many years that are trading at bargain prices. Similar techniques have yielded annual returns of approximately 18% since 2001.

My more conservative "All Seasons" inspired fund is up 2.5% in the last 12 months (through December, 21 2016).

Notes on the All Seasons Strategy: I use this strategy for cash management (and to minimize draw-downs). It is intended to reduce volatility without significantly reducing upside. From 1973 - 2012 the max draw-down of this approach was only 14.4% (http://mebfaber.com/2013/07/31/asset-allocation-strategies-2/), yet the compound annual return was a very solid 9.5%. One additional note- this strategy is 70% bonds, which have been in a bull market for 30+ years (this overlaps with the back-testing period). In my opinion, it is unlikely to perform as well in the next 30 years as it has in the last 30 years.