Questioning Fundamental Truths

I have lived a very lucky life so far. I love my family and my friends and they love me (I think.) Things have worked out well for me, but last night things were different. Fundamental truths that I believed, ceased to be. See below for this harrowing tale of shock, anger, and deceit.

At approximately 11:52pm on Saturday September 20th my friend Robert (names have been changed to protect the innocent) placed a Domino’s pizza order online for pickup. At 11:54pm, we were excited to see that our order had entered the “Prep” stage. I had confidence that things were under control, because I was assured that Domino’s employee Miguel was my pizza’s personal caretaker.

At 11:56pm, we saw the pizza enter the bake stage. At this point, Robert, Dan (another protected name), and myself left our home to pick up the pizza at place of incident. We arrived at place of incident at 12:09am, right at the time the pizza was supposed to be coming out of the oven. The quoted bake time was 8-13 minutes.

Robert and I exited Dan’s vehicle (a mint green 1997 Nissan Maxima) and proceeded to the place of incident. At 12:09am, much to our shock, we saw our pizza’s being finished AND PLACED INTO THE OVEN. This was directly contrary to our assurance that the pizza was in the oven at 11:56pm.

After a period of utter disbelief, Robert and I were in frantic search of Miguel, our only hope for an answer. We were informed by employees at the place of incident that there was no one by the name of Miguel employed at the establishment. I lost all ability to speak, or comprehend.

After hearing this story, I implore you all to now ask yourselves, if you cannot trust Domino’s pizza tracker, what can you trust?

I appreciate everybody’s support in this difficult time.

Tried and True Investing Advice

I’m often asked to provide investment advice. My advice is hardly revolutionary. It has been repeated by many others (e.g. John C. Bogle) yet is consistently ignored: passive index investing is the way to go. My goal in this article is to change this behavior for at least some people. I plan to do this by (1) laying out my own version of the advice, (2) providing the rationale for this advice, (3) pointing out behavioral reasons why people do not follow the advice, and (4) providing some tangible ways you can prevent yourself from falling into the trap of not following this advice. In my view the last piece is critical because it is a fundamental reasons why asset allocations are so poor.

Before I go any further, my disclaimer: I am not a licensed financial adviser and I am providing this write-up for informational purposes only as an expression of my opinions and views. Any investment actions you take as a result of reading this article are solely your responsibility. If it works out, feel free to thank me later. In case it does not work out, I take no responsibility. If you do not agree to that, then do not read any further.

My Advice

For most individual investors, I recommend a diversified asset allocation consisting of low-cost index funds. Factors to consider when making this allocation are your investment horizon, risk tolerance, and desire for simplicity. Let me briefly define the 5 key terms I have used:

  • diversified asset allocation – Diversification comes in many forms and the more dimensions you are diversified across, the better off you are in the long run. At the highest level, you should be diversified across asset classes (stocks, bonds, commodities, real estate, etc.) Furthermore, it is good to be diversified within each of the asset classes as well (by geography, market capitalization, type of commodity, etc.) At some point, more diversification has diminishing returns and you begin to create a portfolio that violates the final rule of simplicity. Where to draw the line is up to you.

  • low-cost index funds – The long-run impact of fees on investment returns is staggering, so you should seek to own funds with low expense ratios that seek to passively replicate the returns of an index. I will discuss why below. For some calculations on the impact of fees, you can read this post on Moolanomy.

  • investment horizon – This is a fancy term for how long you have before you will want to utilize the money you have invested. Most of this article is related to investment horizons of 5yrs or more. For shorter horizons, the advice is likely going to be different. That is beyond the scope of this article. If people want it, I can post on shorter time horizons at another date.

  • risk tolerance – How much risk are you willing to take? In the investing world, you cannot get a return higher than the risk-free rate unless you take on risk. Generally, the more risk you take on, the higher the potential you have for return.

  • desire for simplicity – We can run down a rabbit hole of complexity, but ultimately, you need to be comfortable managing your portfolio. A portfolio of 5 names is easier to manage than a portfolio of 15 names. We’ll constantly be trying to balance diversification and investment awesomeness with simplicity.

    • The Logic

    It is extremely difficult to beat the markets consistently and most managers cannot do it. Given the difficulty, “good” managers charge high fees. This means they must perform even better to outperform the market net of fees. As a result, I believe there are only a handful of people in the world that are capable of consistently beating the markets – and very few of them are likely to be reading this post. You may not believe me, but if you think you can beat the markets (or know someone who can), you are not only playing against the odds you are also likely on the wrong end of bias about your own abilities (more about this below).

    So you are left with a choice. You can either play the market and pay 0.25% in fees or you can try to beat the market (the expected value vs the market here is zero since for every winner there is a loser) and pay 1.00% in fees. This means that not only do you need to be a winner in your picks, you also need to consistently win big so you can overcome the extra fees.

    This is where people tell me all sorts of things that they think matter (they don’t really matter, trust me):

  • I am smarter than the average investor
  • My financial adviser went to a top MBA program
  • I have all sorts of cool tools from E*Trade to give me the edge
  • My strategy hasn’t lost money in 40 yrs
  • I am a really good stock picker, because I know a lot about the industry
  • My financial adviser has a great track record

    • So why does none of this matter?

    Behavioral Impediments

    There are behavioral impediments that obfuscate the difficulty of consistently beat markets in the long run. First and foremost is the overconfidence effect, which indicates that we are more confident in our ability to accomplish something than is warranted. Second, we attribute excessive weight to past performance because we fail to consider the likelihood of the manager’s performance being random. In other words, if I told you that I flipped a coin heads 5 times in a row, that might be impressive if I only threw the coin 5 or 6 times total. It would not be impressive, however, if I told you I flipped it 500 times. Not knowing “how many coins were tossed,” is a manifestation of survivorship bias. Survivorship bias is the idea that we do not know how many money managers attempted to match your managers track record and failed. Third, we tend to focus on what is sexy and cool, which in the investing world often means equities. For this reason, the equity markets are among the largest, most liquid, and efficient markets in the world – meaning they’re harder to beat. Other markets are far simpler to beat (the currency markets, as an example, includes many players who are not profit-maximizing). That’s not to say that beating the currency markets is easy, it isn’t. I digress…

    If you do not think you can beat markets, the low-cost index fund strategy is a great way to go. If you do think you can beat markets, you are probably wrong, but you can give it a try (consider your negative expected value the price you pay for the fun of spending your time looking at stock screens, reading 10-Ks or reading credentials of potential financial advisers.)

    If you’re an active investment decision-maker, be sure to check out ways to mitigate destructive cognitive biases for investors.

    Overcoming

    Overcoming these cognitive biases is difficult, but I have found these tangible actions and thought exercises have helped me come to grips with the fact that I will not beat the markets (I do what I described above for 90% of my asset allocation. The other 10% is for fun.)

  • Try running a paper portfolio – This is a portfolio with play money where you actually put on trades. This is a little bit more work than just writing down your ideas on a piece of paper, but it keeps you honest and prevents you from selectively ignoring losers because “I would not have actually put that trade on” or fudging the numbers.

  • Fun Allocation – Set aside a small piece of your asset allocation for fun bets (5-10%) that you do your research on and track. Over time, if you really are killing it, you can consider raising your allocation to decision-making.

  • People are lying to you (not maliciously) – Count the number of people who tell you about their good investing outcomes and the ones that tell you about their bad investing outcomes. They should presumably be the same, but they never are. The reason is because those who tell you about their killer investing strategies are conveniently ignoring their losses or they just got lucky (and you won’t know if it was skill or not unless they’re doing it consistently.) This should at least give you comfort that you’re not missing out (i.e. it’s not like everyone is out there killing it in the market except for you.)

  • Your time vs. Others’ time – Consider the time you spend thinking about your investments on a daily basis. Then consider the time spent per investment. Finally, consider that many people have full-time jobs dedicated to understanding the company you are researching better than anyone else. Then consider the vast resources they have to achieve this. Even if you did think you could beat them, is it worth spending all of that time to try?

    • Final Thoughts

    I do not mean to offend anyone by telling them they cannot beat the markets. While it is likely true, I could be wrong in any individual case. The main argument is that with a well-structured plan of saving from a young age, merely following the market passively is easy (very little work) and will provide a very reasonable nest egg for retirement. Trying to beat the markets is time-consuming and likely to fail, so I’m very content with the table stakes.

    Travel Tip: Wear flip flops

    The last few trips I have taken have been made a tad bit more comfortable and pleasant because I wore flip flops.

    First, going through security is a breeze since you don’t have to take off and put your shoes back on (I hate doing that.) Most of the time, they just let me walk through security with my flip flops, though in JFK I actually had to take them off, which wasn’t a big deal because of how easy the procedure is with flip flops. Second, when you’re actually on the plane, it is nice to be able to kick off the flip flops and walk around barefoot. Call me a hippy, but I quite enjoy the feeling of carpet on my feet.

    I think any flip flops will do, but I am partial to Rainbow and Reef. They mold to your feet over time and are extremely comfortable. I believe Rainbow has a lifetime guarantee on the soles of their sandals. Once they are worn out, they will replace them for FREE — the part that is molded to your feet stay on the sandal. Don’t quote me on that though.

    Give it a try.

    Power To The People

    I think we have reached a point where the technology that we have will allow masses of people to collectively solve problems that are yet to be solved by computers. I have seen some examples of this and am convinced that this concept will lead us to new frontiers in what technology can accomplish.

    Computers cannot perfectly perceive and recognize what the content of a picture is. It would be difficult for a computer to see a picture of a dog and recognize it as a dog. However, this process is very easy for humans. These simple facts are the basis for The ESP Game and Google Image Labeler. These sites use a “game” interface to pit humans against one another. Each player is showed an image and they are asked to type in tags that describe the image. Players receive points when their labels match labels of other players and over time as more and more images are labelled by multiple players, the labels for the images can become more and more precise. With enough players, enormous numbers of images can be indexed. Imagine the possibilities here…

    With the web being flooded with new blogs everyday, spammers have found an excellent place to spread their plague; in comments. In an effort to combat spam, many spam filters show users a word in scrambled print and require the user to type out the letters in the word. This prevents programs from spamming, since the programs cannot identify the words in the images and therefore cannot post. One such system is CAPTCHA. Relatively cool, but hardly worldly, right? Not so fast… Every time a human decodes the word in a CAPTCHA image, the response is entered into a database… The images produced by re-CAPTCHA are words that cannot be deciphered by OCR programs that attempt to scan documents into a computer and turn them into text. For projects like this, CAPTCHA helps to correct OCR mistakes and aids in the process of digitizing books, and you’re helping even though you don’t know you’re doing it.

    This is brilliant. I wonder what will be next. What problems will the collective power of the people help to solve?

    Poker Players are Unpleasant

    I have found that poker players as a generic group are more unpleasant than the population as a whole. Keep in mind that I am making this observation this despite the fact that I grew up in New York and went to school in Baltimore, two of the more unfriendly cities.

    I have observed that most (obviously not all) poker players are ruder, grumpier, and more arrogant than the general populace. For example, I have found that people who play poker seem to have a very inflated opinion of their poker playing abilities. How many games/sports do you know of in which absolutely no one is unskilled? How often do you meet someone who plays poker on even a sporadic basis that says they aren’t good? How is it possible that 85% of the people I speak to are “good” at poker? Everyone claims to be good at poker. What is up with that?

    In the real world, how often have you seen civilized, moderately intelligent people who barely know each other, yell at each other and call each other stupid for no reason? Not too often I would suspect. It happens on the poker table all the time. The game may be for money, but it is a game and people have a right to play it any way they want, as long as they play by the rules. You always get those belligerent know-it-alls who start berating the fish (unskilled player) for making a dumb move. Sure, you just lost some money but get a grip and show some manners — we should just be adults!

    For such a beautiful game, poker does attract its fair share of ugly people and degenerates. What a shame.

    Appreciation of Weekends

    It seems that I have a newfound appreciation for weekends now that I am out of college and out in the real world.

    Ethics of Fantasy Sports

    Today I will opine on equity and ethics in fantasy sports.

    I am a big fan of fantasy sports. I also think that fantasy sports, like all games, should be played by the rules. Fantasy sports can be ruined if members of the league do not play by the rules. I do believe that there is a fine line between good strategy and cheating in fantasy sports. I’ve been thinking about how to define it and here is what I have come up with: any action in which all managers involved are not making efforts to improve their team’s position is cheating.

    Rules vary from league to league and identifying nuances in the rules is critical to form an optimal team and an optimal strategy to perform optimally in the league. Ignoring the specific rules of a league is a sure way to stop yourself from taking home a league title. Again, strategizing based on the rules is very different than cheating. I will use some examples of excellent strategy that some people consider cheating (incorrectly, in my view).

    Hording Scarcity

    This strategy used to work much better in the good ol days when the only good shortstops were A-Rod, Jeter, and Nomar and Chipper Jones was a 1st or 2nd round pick because no other 3B could go 30-100. Additionally, the utility of this strategy is much lower nowadays since you see only 1-2 util slot as opposed to 2-3 various utility spots. The strategy was simple. Select the top players in scarce positions and get them early so other teams in the league would be forced to give you a beneficial trade if they wanted one of the premium players. This is smart drafting, hardly cheating. You’re trying to make your team better and no one else is trying to make their team worse by trading for a star in a scarce position.

    Unconscionable Trades

    You’ve all seen it at one time or another. One manager makes a trade with another player that clearly favors one side. The only questions that need to be asked are, “are both sides trying to improve their team?” and “Do both sides think that they are improving their teams?” If the answer to both those questions is yes, then there is nothing about the trade that constitutes cheating. Each manager in a league is an individual entity and they paid their entry fee to manage their team as they see fit. If they wish to make a trade that they think helps their team and the entire rest of the league disagrees with them, that is too bad I think. The league did not pay that manager’s entry fee, so they do not get a vote in whether or not that manager can make a trade they like.

    Pitcher Streaming

    This one’s a classic. In H2H category leagues without transaction limits and IP limits, this is a popular strategy (Anyone that plays in a roto league without inning limits is asking for trouble). Pitcher streaming is a simple process in which players drop pitchers and continually add new ones during a week when they are starting a game. If a team has a significantly higher number of starts than the opposing team, then it is relatively easy to win certain categories (W, K, S, IP, etc) and have a toss-up in ratio categories (WHIP and ERA). If you can guarantee a win in 3/5 pitching categories, you’re in great shape to cruise into the playoffs in almost any H2H league. Is this illegal? No. Do people get pissed off? Yep.

    An Experiment in Murphy’s Law and Probability

    I think I am unlucky. Not really, because I don’t believe in luck, but I figured I would try this experiment for amusement purposes. I have a little pouch with my 2 keys in it. The two keys are indistinguishable from each other at first glance, but only one of them opens the lock on my door. Every evening after work, I pick a key from the pouch at random and see if it opens the door. After 18 tries, one would expect around 9 first attempts to have been successful. But, naturally Murphy’s law prevailed, and that was not the case.

    Of the 18 attempts, ONLY ONE succeeded on the first try. WHAT?

    Google, Search Engine

    Can you imagine what the internet would be like without search engines?  How often do you use google?  If google and all other search engines disappeared of the face of the planet, how would it effect your life?

    Google has this neat little feature which is called “Personalized Search.”  It apparently optimizes your search results based on your clicks so when you run a search, articles that you’re more likely to want to read, come up higher in the search list.  Besides the privacy implications of this, it is a pretty neat feature.  According to Google, I ran 489 Google searches during the month of August so far.  That is an average of 18.8 times per day.

    If search engines disappeared, I think my world might collapse.

    Fantastic Things…

    I have yet to see something that I can classify as “Fantastic” in the baseball season.  Chase Utley’s hitting streak just got to 33 games today.  I think it would be fantastic if he got to 40.

    Let’s go Chase.

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