#019 - The Wealthy Fiduciary
A wealth manager ponders the pursuit of true wealth, wisdom, & meaning.
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Welcome to the 19th edition of The Wealth Letters, an epistolary novel (collection of letters) from people of all walks of life (Titans of success to everyday unknowns) on the pursuit of true wealth.
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The following is a letter written by Jesse Cramer for The Wealth Letters community, where he ponders the pursuit of wealth, wisdom, & meaning. Jesse provides a handful of his “mini thoughts” crammed into one essay.
Who is Jesse?
Before reading or listening to Jesse’s letter…
Be willing to be vulnerable and open your mind to ideas and suggestions that have proven worthwhile in another’s journey. Do not blindly accept any and all advice given, but rather take in the information and distill it down to if & how it can be applied to YOU and your unique self.
Michael Jordan said that he imitated Dr. J.
Kobe Bryant said he studied and imitated Jordan.
But, they mixed in their own uniqueness.
While not everything will relate directly to one’s current situation at the exact moment, there may be some gems that will be worthwhile in time.
The Pursuit of True Wealth, Wisdom, & Meaning
By: Jesse Cramer
Jordan asked me to ponder, “the pursuit of true wealth, wisdom, and meaning.”
When I look back at 4+ years of writing on The Best Interest, it’s hard to condense my thoughts on wealth, wisdom, and meaning into one letter.
So, for better or worse, here are a bunch of mini-thoughts crammed into one essay.
Money is the means. Not the end.
What’s your end?
More time with your kids and less time at the desk? A healthier body and mind? More experiences, big and small? Something different altogether? The end is unique to each of us.
But the means to get there is (relatively) universal. It’s money. We sacrifice our time to accumulate money. Then we use that money to buy back time. We invest money in the interim, hoping our investments act as a force (and time) multiplier.
One of the ever-present challenges in personal finance is balancing that money is an essential means-to-an-end, but not the end itself. That money is a “great servant but a bad master.”
Last year, my parents’ neighbors’ house caught fire. There are a few great lessons to learn from that tragedy. Perhaps the strongest is that old age comes for us all. Physical deterioration is unavoidable. But I pray my body will always permit me to escape a burning building. And I hope these salads and 8-mile runs actually work as intended.
You only get one mind and one body. And it’s got to last a lifetime. But if you don’t take care of that mind and that body, they’ll be a wreck 40 years later. - Warren Buffet
Take care of your mind and your body.
Temperament > Intelligence
Outsiders think investing is about intelligence.
“Warren Buffett is just smarter than everyone else.”
“Wall Street knows more than anyone else.”
“You don’t know math? You’re screwed.”
But insiders know investing is about temperament. And it’s an understandable misconception! After all, the most popular investing book of all-time is…
The Intelligent Investor! It’s not The Well-Tempered Investor.
But one of the great ironies of The Intelligent Investor is that its most famous chapters and quotes are all about…temperament!
“…investing isn’t about beating others at their game. It’s about controlling yourself at your own game.”
– Benjamin Graham, The Intelligent Investor
Sure, intelligence doesn’t hurt your investing outcomes. But, paradoxically, the most important knowledge an investor can possess is meta-knowledge. That is, knowing that knowledge has diminishing returns. Or as Buffett put it, that investing is “not a game where the guy with the 160 IQ beats the guy with 130 IQ.”
Panic-selling is not a decision of intelligence. It’s temperament. Same with chasing the hot stock or fund. Or dumping your college loan money into Tesla stock.
Investing is about decision-making. That’s a good thing: we’re all experienced decision-makers! We all know certain decisions are based on synthesizing evidence (“intelligence”). But many decisions are based on gut feel, behavioral biases, or simple hormonal drives.
Was that donut the intelligent thing to eat? Or was it a temperamental decision? Intelligence vs. temperament is the difference between knowing the nutrition facts of every food and implementing good eating habits.
Personal Finance is a “Negative Art”
98% of people I work with, either professionally or through the blog, would improve their personal finances by removing their bad financial habits and being more boring.
I’ve made my share of mistakes. But “too boring” wasn’t one of them. In fact, most of my personal finance success is directly attributable to getting the boring stuff right. I’ve written at length about these boring basics, so here are some great links to learn more:
Personal finance is a negative art. Removing bad habits is more important than acquiring new skills. If that wasn’t the case, you’d need a PhD to be any good at this stuff.
But you don’t need to know the math behind the “efficient frontier” to know diversification is helpful. You don’t need to write your own budgeting software to track your spending a few times a month. Focus on the fundamentals. Remove errors. Allow the boring basics to carry you to victory.
Most Investors Are Plagued By Overconfidence and Overaction
Daily decisions to buy or sell hurt our long-term returns. Personally, I’ve made 3 or 4 investment decisions in the past decade. All of those decisions involved buying diversified assets in small increments, or dollar-cost averaging, and holding them for many decades. I was lucky to have read John Bogle and Burton Malkiel before going down the wrong rabbit hole.
This is the liquidity premium. It only rewards you if you recognize it and choose to ignore it.
Therein lies the rub. Can you ignore the short-term noise – the media headlines, the loudmouth at the office coffee machine, your suddenly rich neighbor who bought Tesla options – and hold your simple investments for the long term?
Easier said than done. But it’s the easiest money investors ignore. And there’s a big premium if you get it right.
One of my big goals with The Best Interest is arming you with the right balance of confidence and humility. It takes both attributes to say, “The stock market is a great investment…but we might not see it for 5, 8, 10+ years.” That’s infinitely better than the more typical opinions of:
“The stock market is easy. Come learn my system of doubling my money every month.”
“The stock market is a Ponzi scheme and will soon crash to zero.”
Room for Error is Essential
Room for error is one of my favorite problem-solving frameworks. To describe what I mean, Morgan Housel recently wrote:
“Room for error is underappreciated and misunderstood. It’s usually viewed as a conservative hedge, used by those who don’t want to take much risk. But when used appropriately it’s the opposite. Room for error lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor.” - Morgan Housel
I don’t know what the future holds. Neither do you. But leaving room for error ensures I can roll with the punches. I don’t know all the answers right now (…do you?). But room for error means I’ll be ok.
In personal finance, the most basic “room for error” is your emergency fund.
When in Doubt, Zoom Out
How has the market performed in the last week? The last month? Or previous year?
I’m here to tell you: it doesn’t matter.
Stocks are a 10+ year investment. Performance over shorter periods is meaningless.
When starting from a market bottom, the resulting returns are going to look phenomenal. It’s like analyzing an athlete’s year-over-year performance the season after he broke his leg. Of course he’s going to look better this year. His leg isn’t broken anymore!
If you keep zooming out, you get closer and closer to “truth.” After adjusting for inflation (which is smart) and assuming dividends get re-invested (also smart), we conclude that the S&P 500 has historically returned ~7% per year.
…Because Risk and Reward are Intrinsically Linked
One of the basic tenets of investing is the relationship between risk and reward.
High reward comes from taking risks
Small risks or no risk lead to small rewards
You can control your risk preference, your time horizon, and your financial goals. But if you demand satisfaction from all three, you might be disappointed.
People searching for the “low risk, high reward” investment are seeking the mythical “free lunch”
……though diversification might be that free lunch you’re looking for
Risk is scary. We don’t want to lose our money! And risk implies we might do just that. So when faced with a risky investment, the intelligent investor says, “I demand a bigger reward. If I’m going to take this big risk, I need to earn a big return.”
This leads to an essential relationship in investing between risk, reward, and price.
Risk is built into the investment itself. Reward is something that investors must demand. And they make these demands via the price that they’re willing to pay.
When a reward overcompensates for the risk, intelligent investors will pour their money in. When a reward doesn’t justify the risk, intelligent investors will sit on the sidelines. This demand (or lack thereof) will push the price up (or down).
In other words, price acts as an equilibrium mechanism between perceived risk and expected reward.
The chart below (via Howard Marks) illustrates this relationship for popular asset types. Risk-free bonds (e.g. Treasury bonds) are backed up by the full faith and credit of the U.S. government, and are considered to have zero risk. They also have the lowest reward.
As we move towards the right, we encounter higher-risk assets. These assets could suffer permanent loss of capital, or even go to zero. Therefore, investors demand higher rates of return.
But there’s another way to view this same concept.
We can view the “risk equals volatility” definition below (again, from Howard Marks). Low-risk assets tend to have low volatility. Their values stay near their original purchase price. But as risk increases, so does volatility—even to the point where an asset could go to zero (crossing the x-axis of the plot), losing 100% of all investors’ dollars.
You have financial goals and a preferred time horizon to meet those goals. Ideally, you can adopt a particular risk preference to do just that—to meet your goals on time.
But people—including my readers—have run into trouble when:
Their goals are too lofty
Their time horizon is too short
Or their risk preference is too conservative.
Everyone wants a high return for no risk. They want the proverbial “free lunch.” But it doesn’t exist.
If you need high returns (due to lofty goals or a short time horizon), then you need to take risks.
If you can’t stomach the risk, then you need to soften your goals or lengthen your time horizon.
Robert is 30. He earns $80,000 a year and saves 20% of that. He wants to retire with $1.5 million dollars at age 60, and he doesn’t mind some volatility along the way.
He has a long time horizon, reasonable goals, and is willing to take on risks. Robert’s in good shape. He has flexibility in the triangle diagram above. This spreadsheet shows how Robert can reach his goals—even after adjusting for inflation—by investing as simply and conservatively as a traditional 60/40 portfolio.
I’ve neglected to tell you one secret.
There is a way to reduce portfolio risk while maintaining returns. The secret is diversification. A well-constructed portfolio is less risky than the sum of its parts. This is the essence of modern portfolio theory, for which Harry Markowitz won a Nobel Prize in Economics.
The idea is to create a portfolio of risky assets, but to ensure those assets are non-correlated or anti-correlated. In other words, to ensure that the various assets do not rise or fall in tandem with one another.
Markowitz proved that a diverse portfolio has the same expected returns as a non-diverse portfolio, but at significantly less risk. Less chance of going to zero. Less volatility. This can be measured using the Sharpe ratio, the most widely-accepted measure of risk and reward.
Portfolios on the “efficient frontier” represent the best possible expected return for a given risk level.
Credit: Guided Choice
Risk and reward are intrinsically connected. As risk increases, investors demand more reward.
In your investing life, you can control your risk, your goals, and your time horizon. But it’s impossible to optimize all three. You’ll have to sacrifice one in pursuit of another.
And while there’s no free lunch, diversification comes close. A well-constructed portfolio can provide investment returns at reduced levels of risk.
I don’t want to bore you. I’ve probably gone too far already. But if you’re interested reading more of my thoughts on wealth, wisdom, and meaning, you can join 6000+ weekly subscribers over at The Best Interest.
Thanks to Jordan for this opportunity and thank you for reading!
- Jesse Cramer
My Takeaways from Jesse
Jesse asked the question, “What’s your end?” As he stated, this is different for everyone. For me, my end is understanding that I have been created for a reason, which is ultimately to love (love God and love others). With this as my “end,” it helps to navigate the journey along the way.
Temperament > Intelligence. In investing, panic-selling is not a decision of intelligence. It’s temperament. In my letter to my daughters, remember how I went against all intelligence and got out of our investments at the worst possible time? I consider myself to be an intelligent person. Yet, in that moment, my intelligence didn’t matter. I was in fight-or-flight mode, and my emotions took over. I wasn’t prepared for the feeling of “losing money” until I went through it in real time. I didn’t fully understand my risk tolerance and how I would react. If I took more care in understanding my temperament, this could very likely have been avoided on my part.
What are your takeaways?
Connect with Jesse
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