Enlightened Money: Part 3 - Finding Your Way

The last of a three-part series that lays out the path to enlightened money.

Economic conditions for the "common working" person are adverse and not looking to improve anytime soon.
The only person who really cares what happens to that "common working" person can be found in the mirror
Now what?

First off, the idea of "beating the Street" is dangerous to retail investors. What does it mean? How do you measure it? One of the accepted benchmarks is to measure your performance against an index like the S&P 500 on a yearly basis. But this is arbitrary; unless you pull your money out at the end of the year, this benchmark isn't overly helpful if you're in it for the long haul. That said, it's good to gauge whether the time and effort you're putting into building your portfolio is worthwhile or if you'd be better off with a passive approach. Just don't let these benchmarks cloud the overall goal and morph your investing into short-term trades.

I do not believe that "beating the Street" will be easy. Warren Buffett has said on many occasions that you don't have to be terribly smart or a genius with numbers. In his opinion, the most important qualifications needed to invest successfully are patience, emotional stability and a keen sense of who you are. Who am I to argue with Warren Buffett?

Every person needs to find his own unique approach to investing but it strikes me that as individual investors, the terrain presents common challenges (and opportunities) that we will have to address in order to succeed. Another aside:

I bought an excellent book on chess called "The Amateur's Mind." I wanted to play better but didn't want to waste my life away memorizing opening moves, variations etc. So I found a book that outlined general themes and strategies to help achieve victory. One of the core concepts was that a player should do the following:

examine the board,
determine the strengths/weaknesses of both positions,
craft a strategy to emphasize your strengths and attack the opponent's weaknesses
ensure that EVERY MOVE advances that strategy.

For example, if after the opening sequence, you find yourself with two bishops and a knight to the opponent's stereo knights and single bishop, then you should strive to open up the position (ie clear the middle of the board) to give your bishops clear lines of sight for attack and at the same time, work to deprive his knights of key support points. Don't stray from this strategy. Don't take a pawn simply because you can. Don't claim the other bishop just because it's there. If taking this piece clogs the board, you've minimized your army's potential and made her opposing knights more effective. In chess, there are myriad examples of this simple principle.

With that in mind, let's analyze the position of the mainstream/Wall Street investing establishment as it relates to DIY retail investors.

Wall Street - Let's be plain: Wall Street is the "inside." As much as we'd like to think that "insider trading" is policed, the whole system is set up for insiders. Take the sell-side research scandal during the dot-com bubble as Wall St firms pumped tech stocks and dumped them onto retail investors. Try getting the listed price on a hot IPO. Enron, anyone? How about getting the best interest rates for your money or when you borrow? This list could go forever.
Our advantage - Freedom from the fast lane. The money handlers of Wall Street are under tremendous pressure to deliver results yesterday, much less now. As a result, the vast majority of money managers can't afford to wait for long-term payoffs for all the reasons we talked about. Many of them handle so much money, they can't invest in small companies because the payoff isn't enough to "move the needle." A million dollars here or there doesn't mean much when you manage billions. Mutual funds are regulated to an extent that they may be forced to invest in companies that weren't necessarily their first, second or twentieth choice. If a mutual fund manager KNOWS that a certain company is going to be a winner, she is only allowed to invest a certain percentage of the fund's capital in that stock. The only thing that can stop you and I from cashing in on a solid prospect is the courage of our conviction or lack thereof.

Wall Street's advantage: The big-money players have teams of analysts, industry specialists, economists, weather forecasters, etc. to give them the dirt on everything from macroeconomic trends to weather patterns six months down the line. These are people whose only job is to eat, sleep, breathe their little corner of the financial world. They even have specialists for each of the global markets. That's a lot of data you and I don't have access to.
Our advantge: the paradox of data. In Barry Schwartz's "The Paradox of Choice", Schwartz argues that while people cherish having choices, too many possibilities can overwhelm us and lead to indecision, buyer's remorse and ultimately, unhappiness. He posits that anything beyond a few core choices is white noise in a world filled with useless noise as it is. In investing, it's important to have enough information to make good decisions. But perhaps it's just as important to limit data overload. This reduces the likelihood of overthinking, outguessing yourself, information paralysis and plain-old wasting time. Interestingly enough, Wall Street's access to mounds of data may not be as great as it might seem. In today's Internet era, a retail investor can find comprehensive data on companies, industries, economies, countries, analyst reports, anything that might impact investments. SEC filings are available almost instantly and annual reports are accessible through websites before they can be printed. Anything else short of inside information is diminishing returns, requiring more time and energy to digest while adding little insight not available from the above listed sources. The history of bubbles and manias shows us that data is only half of good investing; the other half is judgment. Two parties can look at the same data and come up with two different conclusions. Good data can not make up for good judgment.

Wall Street sets the tone - In politics, there is this concept of framing the debate; you always want your opponent to discuss issues using your language, your words and with them, your implied assumptions. Once you've set people's perspectives and expectations, the argument is already won. Well, in the financial world, Wall Street frames the picture. If stocks are up big, Wall Street's gonna tell you that you're leaving easy money on the table. If stocks take a nose dive, your money's going down the toilet unless you pull out now. Either way, Wall Street doesn't care -- they make money off churn (turnover). As long as people are buying or selling, Wall Street makes money. But sitting still and doing nothing benefits no one -- except you. But it's hard to sit still when everyone, ie the media, the "experts", friends/families, tell you that you need to be doing something. Wall Street has an inherent bullish bias and they infect the rest of the markets through the media with this outlook.
Our advantage: the real world - we live in it. Wall Street lives in a bubble. Warren Buffett made the decision to work out of Omaha because New York City would warp his perspective. Peter Lynch, the famous mutual fund manager, espoused "buying what you know" -- if you love shopping at a store and it's always busy, perhaps it'd be a good investment. If you work in an industry, then you know more than other investors and may make better decisions. Well, let's broaden this concept to everyday life. Because Wall Street lives in a world of perpetual hype, they can't help but buy into it. The latest, greatest web technology might sound good in an investor presentation but most people don't need it and don't want to learn how to use it. The experts might say that housing is bottoming and they place bets accordingly. But I KNOW that I can't come close to affording a house and I make slightly more than the average income. I see the legions of homes for sale and the prices asked and it's pretty obvious housing won't bottom until people like me can afford them again. So I'm not making any pro-housing bets no matter what Wall Street says. Warren Buffett's number one rule is DON'T LOSE MONEY. If you use what you know and have confidence in your judgment, you won't lose money. That's more than half the battle.

Wall St's advantage: Yes, the biggest piles of money in the world get government welfare if they get into trouble. This welfare is usually not called welfare (that would be too honest) but rather "systemic risk" or "too big to fail." By whatever name, knowing that the Federal Reserve will bail them out allows the biggest Wall St players to take tremendous, almost idiotic risks with other people's money without the fear of complete ruin that you and I would face if we bet everything we owned plus everything we could borrow on risky plays. In the '90s, Citigroup was on the verge of bankruptcy so the Fed basically screwed regular Joe and Jane Saver to pay Citigroup to borrow money. If I'm going broke, who's going to pay me to borrow money?
Well.....what a bunch of crooks!

Those appear to be formidable advantages that we as individual investors have to overcome. But here's how I see it: the way the game is laid out, we're not on the same field. We're not even playing the same game. See, Wall Street is playing checkers but we're playing chess.

Ok, maybe that only makes sense in my head. Wall Street's game is the short game -- short-term, in-quick-out-quicker, wham-bam-thank-you-ma'am. Take mutual funds - most funds are just as focused, if not more, on marketing as they are in generating big returns. Taken to an extreme, big returns can be harmful to job security -- if returns are too high, there's nowhere to go but down and once that happens, people pull their money out to find the next hot fund. Better to intensify marketing efforts to draw money into the fund, aim for average returns and not give people a reason take their money out. They might not be overjoyed with their returns but most people are fairly inert -- they'll stay where they are unless given strong impetus to move. The investment banks, the brokerages, the whole industry is geared toward this mindset.

So what's my game? Obviously, the long game -- I'm in this for the long-term. I make moves, not because of what might happen next, but what I KNOW (as much as one can know these things) will happen 5 or 10 moves down the line. Like the poker player who doesn't mind losing a hand or two to set up the big pot later in the night, I try to focus on solid, underlying fundamentals -- the price movements in the short-term don't matter because at the end of the night, our investment will deliver value.

In future articles, I'll expand on some of these concepts that have led me to believe that people can invest their own money just as well as some anonymous mutual fund manager. Investing is simple -- buy great companies at low prices. But it's not easy. If you're not willing to put in the time, effort, preparation, research and conviction among other things, then perhaps it's not a good idea to manage your own money. While I think anyone can do it, it's definitely not for everyone.

The Enlightened American

Enlightened Money: Part 3 - Finding Your Way