Thursday, November 14, 2019

Poor Charlie’s Almanack

Most people have heard of the great investor Warren Buffett, but fewer have heard of his long-time business partner Charlie Munger. Charlie’s approach to understanding the world is laid out in Poor Charlie’s Almanack, a long, but interesting, book edited by Peter D. Kaufman.

This book covers such a wide array of topics that it resists summary. To this reader, Munger’s biggest ideas are 1) that we should understand the biggest and most useful ideas from a broad range of fields, and 2) that we should understand the many ways that our psychology gets in the way of drawing sensible conclusions.

Whether we agree or disagree with Munger’s ideas, I found a great many worth thinking about. I’ll list a few here as an enticement to reading the book.

Munger is known for challenging and often abandoning his best-loved ideas: “a thing not worth doing is not worth doing well.” It may not be a good idea to change your mind too often, but we have to be open to the possibility that our ideas are wrong or no longer useful.

“Our investment style has been given a name—focus investing—which implies ten holdings, not one hundred or four hundred.” Other investors should be wary of following this path; few others have the stock-picking skill of Buffett and Munger.

“Black-Scholes [option-pricing model] works for short-term options, ... but the minute you get into longer periods of time, it’s crazy to get into Black-Scholes.”

“The efficient market theory is obviously roughly right—meaning that markets are quite efficient and it’s quite hard for anybody to beat the market by significant margins.” However, Munger is very critical of the strong form of Efficient Market Theory. He laughs at those who claim that Berkshire-Hathaway’s investment record is just luck.

“Anytime somebody offers you a tax shelter from here on in life, my advice would be don’t buy it.” “In fact, anytime anybody offers you anything with a big commission and a 200-page prospectus, don’t buy it.”

“If I were running the civilization, compensation for stress in worker’s comp would be zero—not because there’s no work-caused stress, but because I think the net social damage of allowing stress to be compensated at all is worse than what would happen if a few people that had real work-caused stress injuries were uncompensated.” Allowing fraudulent claims for hard-to-diagnose ailments invites otherwise honest people to game the system.

In a discussion of Coca-Cola, Munger describes Coke as giving “harmless pleasure.” I can see where he’d like to believe Coke is harmless given the massive returns he has received from Coke stock, but the evidence says that soda is a large part of the blame for obesity and type 2 diabetes.

We have a tendency to overweight things that can be measured and underweight the things that can’t be measured accurately. I saw this in the justifications for open office plans for software developers. The money saved on floor area and walls is easy to measure. Harder to measure is the lost productivity due to programmers constantly being interrupted by noise and their unwillingness to work collaboratively lest they disrupt others’ work.

Munger likes to ask people for examples of cases where raising prices allows you to sell more of something, which violates the simple price-quantity curve we learn in introductory economics. His favourite answer is mutual funds when you raise commissions “to bribe the customer’s purchasing agent.”

When you shout ideology, “you’re ruining your mind, sometimes with startling speed. So you want to be very careful with intense ideology.” This is a good warning from those who get drawn into either conservative or liberal Facebook nonsense. If you can’t come up with both good and bad things to say about some politician, you’re ideas aren’t worth listening to.

“You do not want to drift into self-pity. I had a friend who carried a thick stack of linen-based cards. And when somebody would make a comment that reflected self-pity, he would slowly and portentously pull out his huge stack of cards, take the top one and hand it to the person. The card said ‘Your story has touched my heart. Never have I heard of anyone with as many misfortunes as you.’”

A large section of the book is devoted to Munger’s list of 25 psychological tendencies we have that steer us to poor decisions. In many ways, this list resembles much of the work in behavioural economics.

To illustrate our tendency to misreact to contrasts, we have a “reprehensible” real estate broker trick: “The salesman deliberately shows the customer three awful houses at ridiculously high prices. Then he shows him a merely bad house at a price only moderately too high. And, boom, the broker often makes an easy sale.”

“Light stress can slightly improve performance—say, in examinations—whereas heavy stress causes dysfunction.” I recall the feeling of reaching a higher mental level during stressful exams. However, I definitely saw many other students who fell to dysfunction. I guess we differed in how much stress we felt.

Anyone interested in a serious study of how to make better decisions about investing or anything else would do well to read this book.

Friday, November 8, 2019

Short Takes: Future of ETFs, Canadians’ Debt, and more

Here are my posts for the past two weeks:

Now We Know What Followed the Lost Decade for Stocks

The Clash of the Cultures

Here are some short takes and some weekend reading:

The Rational Reminder Podcast looks at the future of ETFs in a very interesting interview with Dave Nadig, founder of etf.com. Nadig also has some pragmatic ideas for how to pay for financial advice.

Robb Engen at Boomer and Echo says Canadians have an income problem, not a debt problem. This is undoubtedly true for some people. However, there are others who are going to outspend whatever income they get. The question in my mind is how is viewing the problem this way going to help? Probably the biggest effect is that it allows people with big debts to decide the problem is someone else’s fault. This is more likely to trigger giving up than solving anything. On the positive side, it might spur some people to seek higher income. I find the change in expectations since I was a young adult interesting. Houses and cars are expensive today. When I was young, it wasn’t unusual at all for young people to rent an apartment and not own a car. This was common, even for married couples with young children. Fortunately, the standard of living has risen since then. But living standards apparently haven’t risen enough yet for every family to have a house and two cars.

The Blunt Bean Counter explains the tax implications when a spouse dies.

Wednesday, November 6, 2019

The Clash of the Cultures

John C. Bogle was passionate about helping average investors get their fair share of the wealth produced by the stock market. In his book The Clash of the Cultures, he describes what is wrong with our financial system and what should be done to fix it. Unlike many who shout complaints from the sidelines, Bogle devoted his career to fighting for necessary change.

When it comes to those who invest other people’s money, Bogle “observed firsthand the crowding-out of the traditional and prudent culture of long-term investing by a new and aggressive culture of short-term speculation.”

Bogle devotes much of the book to the history of mutual funds to make his points. Most modern mutual funds have a “double-agency” problem where managers have to serve both the fund investors and the shareholders of the management company. Sadly, investors lose out on the conflicts of interest; management companies can only make money by dipping into investor assets. Stewardship has given way to salesmanship.

“The expense ratio of the average equity fund, weighted by fund assets, rose from 0.50 percent of assets on the tiny $5 billion asset base of 1960, to 0.99 percent for the giant $6 trillion equity fund sector as 2012 began.” Annual expense ratios can be misleading; the corresponding 25-year expense ratios have risen from 12% in 1960 to 22% in 2012. These are U.S. figures; Canadian mutual funds are much more expensive.

“The leaders of the mutual fund industry, and its trade association, the Investment Company Institute, purport to represent mutual fund shareholders. But in fact they represent the management companies that operate the funds.”

To combat this double-agency problem, Vanguard mutual funds actually own their own management company. This is the reason why Vanguard has always kept their fees low. Bogle had hoped that this ownership structure would spread to other mutual funds, but this hasn’t happened.

Short-term thinking is pervasive among companies. “When a corporation’s focus on meeting Wall Street’s expectations (even its demands) takes precedence over providing products and services that meet the ever-more-demanding needs of today’s customers, the corporation is unlikely to serve our society as it should.” This criticism definitely applies to a former employer of mine whose focus on stock price became so all-consuming that making products was barely on the minds of top management.

Bogle bemoans the loss of bright minds from useful pursuits as they head to the investment industry. “‘financial’ engineering, which is essentially rent-seeking in nature, holds sway over ‘real’ engineering, ... which is essentially value-creating.”

We’ve seen a revolution in equity ownership by institutional investors. Their ownership of U.S. stocks has risen from 8% in 1945 to 70% in 2011. Given the extremely high turnover in stocks, institutional investors “act less like owners of stocks than renters.” Collectively, they own a high percentage of publicly-traded companies, and they tend not to oppose company management in proxy votes.

I was surprised to read that “the shift from DB [defined-benefit pension] plans to DC [defined-contribution] plans is not only an inevitable move, but a move in the right direction in providing worker retirement security.” I see the problem with chronically underfunded DB plans, but DC plans force the masses to make their own, often terrible, investment choices. It turns out that Bogle’s optimism about DC plans is conditional on a long list of suggested improvements to mutual funds and the entire system of DC plans. “Our existing DC system is failing investors.” I think we’d be better off with a hybrid system that shifts some of the investment risk from employer to worker, but leaves assets invested at low cost by a pension plan.

The book closes with ten rules for investment success. The first is “remember reversion to the mean.” This means don’t give up on our investments when they go down, because they’ll come back, and don’t shift a higher percentage into stocks when they’re flying because they’ll come down again. The final rule is “stay the course.”

I wouldn’t call this book an easy read, but its broad messages are important, and they come through loud and clear. If you like to pick your own stocks or look for mutual funds that will outperform, you should read this book to see what you’re up against.

Monday, November 4, 2019

Now We Know What Followed the Lost Decade for Stocks

A decade ago I wrote about the lost decade for stocks from 1999 to 2008 when the S&P 500 total return failed to keep up with inflation. Since the depression, this also happened in periods that ended in 1947 and 1983. At the time I wondered what happened in the decades after these lost decades.

Here were the answers:

1948 to 1957: 14.4% per year above inflation
1984 to 1993: 10.7% per year above inflation

At the time I wrote “As you can see, those first two decades were spectacular! There is no guarantee that the upcoming decade will match these impressive results, but it does give us some hope.”

The results are now in:

2009 to 2018: 11.4% per year above inflation

This is in line with previous results, but is more than I could have hoped 10 years ago. S&P 500 stocks have nearly tripled in real terms (above inflation). Those who give up on stocks after weak periods pay a high price.