Gyroscopic Investing

I learned that the permanent portfolio works.

I learned that politicians understand less about economics and finance than I thought (and I didn't think they understood that much to start with).

I learned that there are far more promises in the world than there are assets to back up those promises.

I learned that in a liquidity crisis people will sell gold along with everything else (except treasuries).

I learned that riding out market declines is harder than it looks.

I learned that fear is contagious, even among very sophisticated people.

I learned that most risk management models have a larger degree of hubris built into their assumptions than most people imagine.

I learned that financial panics through history are not that different from one another.  In 2008, we just hadn't experienced one in the U.S. in a long time.

I learned that it's hard to completely terrify people with the same stimulus more than once.  If the identical scenario to 2008 started to unfold again today, I think it would be a lot less traumatic to most people, even if the damage was the same.  (As an illustration in another area, think about the first space shuttle crash and the outpouring of grief in the U.S., and then think about the second space shuttle crash and how it was a story that passed relatively quickly--same event, very different response.)

I learnt what correlated assets are.

I learned that it's a good idea to have a pile of cash on hand in order to be able to take advantage of opportunities (or avoid having to cash out of investments when they are at depressed levels).  I was keeping at least a year's supply of living expenses in cash.  Mr. Market offered me the opportunity to Rothify my Traditional IRA at a substantial savings in income taxes, and the cash I had on hand was sufficient to cover those taxes.  I didn't have to borrow money to cover them (which I was willing to do if necessary).  Now my goal is to have at least two years of living expenses, plus my insurance deductibles, in cash.

I learned that it's best to avoid investments requiring the regular borrowing of money to keep their business model going.  During the 1980s and 1990s, people were getting rich using their banker's money.  When the credit markets froze up, so did the borrowing.  I had been investing a portion of my portfolio in high-yielding BDCs (business development companies) that have to raise capital almost continuously on Wall Street (I earned high dividends while it lasted while also thinking I was diversifying into publicly-traded "private equity").  Now I look for investments that have a small and manageable debt load (ideally zero debt, but some debt is OK if I think it's manageable).  In the 2000s and beyond, having slack resources (extra cash and resources not being fully utilized) has replaced getting rich by leveraging on borrowed money.  I had already gotten out of debt before 2008 hit due to a little voice inside me that thought interest rates were going to go way up.  I was glad I did because I don't have to worry about debt service now even though interest rates are at record lows.

I learned that when things get really bad, the correlation among different asset classes goes to one.  Everything goes down in price together.  The long tail (the once in a hundred year flood) can occur right away rather than a hundred years from now.  My response is to have wider margins of safety.  Instead of a 4% safe withdrawal rate, I now go for a 2% safe withdrawal rate.  I now have more cash reserves on hand so that I can ride out future bad events longer.  I'm working towards "model diversification" by using more than the total return (index investing via managed accounts) model:  dividend growth, profitable hobbies (i.e., retirement businesses), permanent portfolio, and other ideas I'm exploring.  I expanded my search and stumbled on Fail-Safe Investing (among other things) as ideas I'm exploring and implementing.

There are a lot of other things I do that were reaffirmed by the experience.  I'm probably not able to see most of them because they are obvious to me.  But one of them might be to do my own homework and make my own decisions no matter what the rest of the world thinks about it.

LifestyleFreedom,

That's a really thought provoking post.

The potential for opportunistic Roth conversions and cultivating profitable hobbies are great observations.

Thanks.

Every one of us has learned about The Great Depression from history, but none of us have lived through it ourselves (unless you happen to be an octogenarian or older).  Many of us had noticed that our parents and grandparents were scarred for life after having lived through that dreadful experience, but we were also told that laws and regulations had been put in place to prevent such a thing from happening again.

Then 2008 happened.  Many of my assumptions about how the world was supposed to work were tested and some were shattered.  I now know that if something happened at least once before, it can happen again (perhaps worse than before) no matter what laws and regulations are in place.  Laws, regulations, and financial markets are the invention of humans, and humans are imperfect no matter who is in charge.

Now I focus on risk management and what can go wrong before I focus on upside potential and what can go right.  Slack financial resources (e.g., cash reserves, diversified incomes) are like slack physical resources (e.g., spare tire, extra batteries) -- you may never need them, but they are handy to have around if you should ever happen to need them.

2008 sorely tested the faith of many professed buy-and-hold adherents.  Those who bailed after holding on a for few months really got burned the worst.  Everyone knew that things could and probably would go bad, but after a year or so of ominous warnings coupled with new highs, the end still caught many by surprise.  FWIW, I look at the 2010 flash crash as being even more dreadful because it has yet to be fully explained, and left a very strong impression that the market can be gamed.  Thankfully, frustration with one's own best efforts and those of the pundits helps us all to better understand the wisdom behind the PP.

I learned that "risk tolerance" and "risk preference" are two different things.  I successfully held a still-stock-heavy allocation through the downturn and recovery, but was sweating bullets the whole time.  Just because I survived doing something difficult once doesn't mean I want to ever do it again.  Investing is supposed to make you less worried about your finances.

I learned that deflation can still happen, even though that problem was supposedly fixed.

I learned that a preventive measure can pay for itself by making you feel safe enough to avoid costly mistakes, even if the thing it protects against never happens.  A lot of people overreacted to the talk about the system collapsing and went to cash at exactly the wrong moment.  I bet a lot of them would've been able to stay put if they had a pile of bullion in the safe at home.  In that case the coins would've been worthwhile, even though there was no collapse and no hyperinflation.

You all were far more compos mentis than me. I still remember the shock and awe when I opened my bi-yearly investment statement in late 2008. The only thing I did right was not selling, but that was more to do with shock than judgement.

On reflection the thing that kept me out of trouble and I what you could say I learnt was that the financial advice given to me by my grandparents and parents was spot on. I'd wondered where their deep distrust of financial institutions and lifestyle based on debt came from, now I see.

Apropos, when clearing out our old (modest) family home ready for renting, amongst all the odds and ends accumulated over a few generations I found a few ounces of gold tailings (little flattened drips of gold left over from casting) that I suspect have been backward and forward over Europe a few times in the last 150 years or so.

What I liked about HB's WTBLIPUGW is that it presents a distillation of the attitude and extension of the solutions that I recognise from my parents and grandparents.

However what I'd like to learn from 2008 (as many of you say you have done) is that there is also opportunity in crisis. I'm not even close yet. 

gizmo_rat wrote: However what I'd like to learn from 2008 (as many of you say you have done) is that there is also opportunity in crisis. I'm not even close yet. 

Outside of a permanent portfolio-like allocation, there is definitely opportunity in times of crisis, but the problem is that when you are one animal in an enormous herd of animals, it's hard to be detached enough not to stampede when the rest of the herd starts stampeding.  This idea is consistent with the reason for stampedes in the first place--to flee some actual or perceived danger.

There are many sly people in the world who are disciplined enough to consistently buy when others are selling and sell when others are buying, but outside of the structured buying and selling imposed by the permanent portfolio (or other all-weather allocation), it's harder to do than it looks.

I think that it is tempting to consider the tendency to buy and sell at the wrong times as a weakness, but I think it is more like an unhealthy expression of a very healthy instinct.  To overcome this tendency, I don't think it is necessary (or even possible) for the average investor to develop nerves of steel (which is a difficult and often unnecessary modification to the average psychological profile) when there are strategies like the permanent portfolio that allow investors to profit without having to become master speculators.

As Clive notes, the permanent portfolio isn't the only game in town, but it does what few strategies seem to be able to do reliably: it protects the investor from himself while ALSO delivering nice gains.

MediumTex wrote:
As Clive notes, the permanent portfolio isn't the only game in town, but it does what few strategies seem to be able to do reliably: it protects the investor from himself while ALSO delivering nice gains.

Also the only strategy that could have been hand knitted by your Grandmother and makes you think of Bluegrass. Not qualities to be under estimated if you are phobic about investment babble.

I learned that I don't really know what will happen in the future.

I learned that neither does anybody else.  How confident they sound is irrelevant.

I learned that I hate losing money a lot more than I thought I would.  My brain automatically converted dollars into "hours worked" and quickly arrived at the conclusion that months of my labor had been stripped away from me in only a few days.  (My brain was right.)

I learned that although I am capable of riding out a downturn and buying more at (perceived) bottoms, the process is filled with stress.  It will be months before you know whether you have made a good move or even further screwed yourself.  Although "buying into the crisis" was a success, the worry took the fun out of it.  I have no wish to repeat this experience.

I learned that deflation can actually happen.  I thought that "deflation" was something that only happened to people in black & white photographs.

gizmo_rat wrote: What I liked about HB's WTBLIPUGW is that it presents a distillation of the attitude and extension of the solutions that I recognise from my parents and grandparents.

I agree.  This is exactly what Browne's "17 Golden Rules of Investing" remind me of.  It's like that old saying, "The older I get, the smarter my parents become."

LW,

The point about the stress is huge... Yeah, my buying stocks up like crazy at the bottom proved ok, but without some other asset classes in reserve to act as insurance, this wasn't fun for me at all.  Especially compounded with the fact that my employment prospects rise and fall with the same stock market I'm shoving my money into.

moda0306 wrote: Especially compounded with the fact that my employment prospects rise and fall with the same stock market I'm shoving my money into.

You're right... this is also when it occurred to me that the stock market and one's employment situation could become highly correlated.  When you think about that, keeping stock exposure at 25% doesn't seem quite so crazy.

Also, I don't know if you were like me, but my investment world view only had room for two asset classes: stocks and cash (aka money I had been too lazy to buy stocks with.)  I was fortunate enough to have a fair amount of the latter, but mostly due to procrastination.

Exactly.  Early in life you may have more time to recapture stock losses, but you're also much more exposed to the income-related consequences of a bad economy throughout the rest of your life.  I think one of HB's best points is that your job will provide you with most of your wealth, and to try to use investing as a way to become rich (gambling at that point) works for very few people. 

moda0306 wrote: I think one of HB's best points is that your job will provide you with most of your wealth, and to try to use investing as a way to become rich (gambling at that point) works for very few people. 

It only works if you own the casino.

I wrote a piece a while back entitled "The 401(k)asino"  that discussed the ways in which many 401(k) investors unwittingly throw their hard earned savings down on gaming tables where the odds are stacked against them (i.e., they pay high fees no matter what happens, and their emotions will normally cause them to buy and sell at exactly the wrong times).

moda0306 wrote: Early in life you may have more time to recapture stock losses, but you're also much more exposed to the income-related consequences of a bad economy throughout the rest of your life.

Also, young people tend to be more leveraged due to student loans and/or fresh mortgages.  And in general they are inexperienced investors which makes buy&hold more difficult.

I've come around to think that the general plan of tying asset allocation to age is a bad idea.  Young investors are generally in a delicate financial situation and are unlikely to have any formative experiences that prepare them for holding a volatile portfolio.

Usually we set new drivers up with a car that's safe, reliable, simple to operate.  An old Volvo with an automatic transmission or some such.  The 400 horsepower, rear wheel drive, stick-shift Corvette has to wait until you've proven that you can handle it.  Yet we give new investors the asset allocation equivalent of the Corvette, and give the Volvo to seasoned investors that have proven themselves by accumulating for years.  Huh?

Browne is right, everyone should start with a conservative portfolio as a default choice.  You can take more risk with a VP if you want, but you have to opt-in, presumably after deciding whether it's really a good idea.

I also think that age-weighted risk exposure is basically a dumb idea.

I think that risk tolerance is more a function of temperament than age.  For example, Warren Buffett is probably not evaluating investment opportunities in a different way from a risk/benefit perspective than he did decades ago.

Why would losing money at a younger age be any better than losing it at an older age?  As far as gains go, I think that the stock market cycle that you are in has a lot more to do with that than age weighting.  For example, in 2008 an investor in his 50s could have followed age-weighted portfolio advice his whole life and still experienced 30%+ losses in a typical age 50-60 portfolio.

If I knew when I was 18 what I know today I would have invested then exactly as I do today.

I learned the SEC is not on the job, SIPC "insurance" can be worthless if a long term and complex fraud (Madoff's feeder funds, etc) is involved, and to never put all of one's eggs in one basket.

I also learned the many nuances of words like "clawback" and "counterparty risk."

I learned that there is so much corruption built into our system that some of the biggest corporate welfare criminals are unlikely to be brought to justice.

The typical 401(k)'s omission of LTT's or gold etfs is really a shame.  Our plan recently got a commodity basket, a very small percentage of which carries gold.  While at least they're opening their minds to other asset classes, looking at a commodity basket as more diversified against stocks/bonds than pure gold is a novice mistake to make.  It's easy to think that way for someone not tuned into macroeconomics, but for somebody whose job it is to properly diversify their clients, especially after what we saw in commodities in 2008 for cripes sake, the continued "mirage diversification" just annoys me to no end.  

And LT bonds, whether corporate, muni, or treasury, are avoided like the plague in most of these funds, even as LTT's have proven themselves the savior of portfolios in 2008.

So here we have two assets that have proven two extremely important nuances that until this point were simply theory, and they still are all but ignored by financial "professionals" who feel like if they're not yield chasing or dummy-diversifying they're not doing their job.

moda0306 wrote: The typical 401(k)'s omission of LTT's or gold etfs is really a shame.  Our plan recently got a commodity basket, a very small percentage of which carries gold.

That's incredible.  They are giving 401(k) participants exposure to commodities (an inherently speculative play), but NO exposure to LT treasuries, which is a REAL investment that has provided a good return for decades.

401(k) participants in a commodity basket fund is just crazy.  Few people seem to grasp the differences between gold and other commodities.  People imagine that buying a commodity basket is the same as buying gold, but gold has a totally different dynamic than the rest of the commodity space; central banks don't stockpile pig iron and wheat. 

If one takes a more comprehensive look at what their "portfolio" is at age 23, they'll see that they have little money, but a LOT of time with which to offer their services to others.  The degree to which those services are demanded by others is often strongly correlated with the stock market.

What do most of them do though (including myself)?  Buy a home on credit (a negative bond), put aside maybe a few months worth of cash (usually paying a lower interest rate than their mortgage), and whatever else they invest they put all into the stock market while they slowly pay their house off over 30 years.

This is done by millions of people give or take a few details.  Hard to accept the inefficiency of the whole thing, but so easy to fall into if one isn't educated on diversication and the problems associated with leverage.

MT,

Coming from a personal hatred of gold about a year ago, I can now say that I am amazed at the inability of others to understand how its different from other commodities for fundamental macroeconomic reasons.  2008 said as much about gold as it did about LT treasuries in my opinion.  Here we are facing a deflationary spiral of credit contraction, and gold comes out 4% up for the year while every other commodity is imploding.  Accident?  I think not.  

moda0306 wrote: What do most of them do though (including myself)?  Buy a home on credit (a negative bond), put aside maybe a few months worth of cash (usually paying a lower interest rate than their mortgage), and whatever else they invest they put all into the stock market while they slowly pay their house off over 30 years.

This plan worked great from about 1982 to 2000 (favorable demographics helped).

Over other periods in the last 100 years, this approach would have been a disaster.

How about a young person who bought a house in 2007 and put the rest of his savings into the stock market?  It could be many years before he even gets back to even in inflation-adjusted terms.

The conventional wisdom is often incredibly bad advice.

People often hang on to strongly held beliefs about how the world works WAY past the time the beliefs become obsolete.  This process applies to both market optimism and pessimism.  As an example, there are people who lived through the Depression who would NEVER own any stock under any circumstances, even though this would be just as bad an idea as owning an all stock portfolio.

Oh, and to top it off my friends are getting duped into cash-value life insurance (as I did to some degree) for their "safe money" when their Roth limits are anything but being approached.  I literally want to run these insurance peddlers off the road.

I absolutely love buying LT bonds within my roth IRA (ok, I lie... TLT), effectively paying a higher rate than my mortgage and much more safe, liquid and flexible than mortgage paydown is to boot.

moda0306 wrote: Coming from a personal hatred of gold about a year ago, I can now say that I am amazed at the inability of others to understand how its different from other commodities for fundamental macroeconomic reasons.  2008 said as much about gold as it did about LT treasuries in my opinion.  Here we are facing a deflationary spiral of credit contraction, and gold comes out 4% up for the year while every other commodity is imploding.  Accident?  I think not.  

I think a much easier way of understanding the permanent portfolio is to label the assets as "Asset A", "Asset B", and so on.  Each asset gives you the protection you need under a certain set of market conditions.

That's all that really matters.

Like so many things in life, when we label things the trouble begins, because we now have all of our own preconceived notions about the label to deal with, which can make it hard to see through to the function of the item, whether it be stocks, gold, bonds, or cash.