“Blind geloof in autoriteit is de grootste vijand van de waarheid.” — Albert Einstein
“Blind belief in authority is the greatest enemy of truth.” — Albert Einstein
“Blind geloof in autoriteit is de grootste vijand van de waarheid.” — Albert Einstein
“Blind belief in authority is the greatest enemy of truth.” — Albert Einstein
The documentary Stress, Portrait of a Killer below is highly recommended, because it shows the enormous negative consequences of near-continuous stress on daily lives and also gives clear guidelines how to improve the situation.
My most important notes:
Stress evolved as natural and positive reaction of the body to crisis situations. It is the way the body handles challenges, whether they be life threatening, trivial or fun. Fun stress is what we call stimulation, like the good tension you feel before and during a sports match. We want to keep this kind of stress in our lives. The continuous bad stress in our current society (worrying about the mortgage, getting annoyed about traffic jams, high workload, etc.) has many negative consequences on our lives:
The consequences are more discomfort, less joy, worse performance, and a less healthy and shorter life.
Stress is strongly related to social hierarchy: the lower on the hierarchy you are, the more stress you experience. Much stress is self-inflicted (multi-tasking) and society-inflicted (social hierarchy). Lack of control and predictability lead to lots of stress. Think for instance about people in a low rank at work or who live in a neighborhood with lots of criminality and violence.
What can we do to reduce stress and lead a more comfortable, longer and healthier life?:
Scientific research points the way to a stress-free utopia which has the conditions for people to thrive. A group of baboons has shown that it is possible to radically reduce the amount of stress that all members experience on a daily basis in just one generation. If baboons can do it, then sure we humans can. But do we have the courage to learn from baboons?
The world owes Marshall Goldsmith a big thank you for the excellent, practical and transformative book What got you here won’t get you there.
The main premise of the book is that if you are already good and want to get better at anything in which other people are involved, the thing that is probably holding you back is some flaw in your interpersonal behavior. The behavior that you need to change is not so much good things that you should start doing, but bad things that you should stop doing. Although it is never easy to change habits, it is usually a lot easier to stop doing one bad habit than to start doing a bunch of good habits. As Goldsmith mentions in the book, it is a lot harder to become a nicer guy than it is to stop being a jerk.
Goldsmith presents an overview of the most common bad habits. We are often not aware that we exhibit this bad behavior and if we are, we probably think that it helps us, even though the opposite is true. If you look closely at the list of bad habits, you will probably come to the conclusion that you also exhibit one or more of the habits. I certainly did. This is a humbling experience and is the start of improvement. You should enlist the help of people who know you well to find out your negative behaviors, since they are very likely to have a more accurate view of you than you have yourself.
Now you are ready to choose the behaviors at which you want to improve and the author then gives you a process to achieve lasting improvement. The main steps are apologizing for your past errant behavior, advertising your intentions to change, following up, listening and thanking, and using a process called feedforward to elicit others help in improving.
The essence of the book is that you are taught how to identify where you are now (here), how to choose where you want to go (there), and how to get from here to there.
Although Goldsmith mainly targets people who are already successful with this book, it is for anybody who deals with people (who doesn’t?) and wants to improve. The principles mentioned are applicable in any area of your life. They will help you to improve your relations with others and become more successful as a result at work, at home and everywhere else.
Do yourself a favor: Buy this book now. Study it carefully. Internalize it. Take action. Enjoy success. Spread the word.
Below is a video of a nice presentation by Marshall Goldsmith in which some principles mentioned in the book are discussed.
Josh Kaufman of the Personal MBA attended his subscribers to the following excellent article titled ‘Why Blacksmiths are Better at Startups than You’.
The article talks about start-ups and learning a difficult craft in general, and the necessary emotional intelligence which is necessary. The moral of the article: It is very difficult and scary to start a company, but if you are prepared to develop the necessary knowledge and skills, the world is at your feet. Emotional intelligence (perseverance, patience, dealing with setbacks and critique, discipline to do what is necessary and important, and not what you like to do at that moment, learning to follow advice of experts, etc.) is absolutely essential for success.
The importance of emotional intelligence in this area is comparable to investing. The necessary knowledge is easy and almost all the knowledge for successful long-term investing can be summarized in two simple steps:
The difficulty in investing is almost 100% in the emotional component: Do you have the faith that the chosen strategy will work in the long run? Do you have the fortitude to stick with your strategy, even in challenging times? Do you have the determination to stick with your strategy even when everyone around you is telling your you’re wrong? Do you have the patience to wait for the strategy to work? Do you have the discipline do nothing when you would like to be active?
The lack of basic knowledge and especially the lack of emotional intelligence of many investors, from time to time produces enormous opportunities for long-term investors to beat the market.
Many modern people lack the necessary emotional intelligence to learn difficult crafts. We want something for nothing and we want it now (instant gratification). This, of course, is nothing new, but what is new, is that we are ‘abstracted people living abstracted lives’. Because many of us have lost touch with nature, we have lost touch with nature’s laws. A farmer knows that he cannot reap before he sows, and that he can’t wait until September to start sowing. But students may think that they can get good grades in school without studying or with waiting until the last moment before a test to start studying. Buyers don’t seem to think it is a bad thing to buy stuff on massive amounts of credit.
Business is a reality engine:
Don’t work on the basics every day? You’ll fail.
Don’t market constantly? You’ll fail.
Don’t solve your customer’s pains? You’ll fail.
Don’t ship? Ha!
There you go: business in four sentences.
When modern people get confronted with a reality where results are the only thing that matters and where nature’s laws rule, our ego doesn’t know how to handle this, just like a spoiled child, with all kind of bad behavior as a result. However, once we accept and internalize this fact, life becomes a lot easier (both for us and our teachers), and we can actually achieve something.
Mastering a craft, is ‘incredibly fucking hard’. You’d better be sure you what is awaiting you, so you can decide for yourself in advance if you are prepared to make the necessary sacrifices:
If you’re not in it for the long haul, though, don’t bother. If you’re too special to practice the basics, don’t bother. If you’d rather feel validated than achieve a result, don’t bother. If you’d rather defend the status quo than grow, give up now.
On the other hand, if you know what is awaiting you, that may prevent your from starting…
We need to make difficult decisions:
Do you just want to splash about in the kiddie pool and rebel at the first sign of seriousness…
Or do you want to craft a real business and a real life, with reality as your favorite ally? Do you want to surprise yourself with how much you can achieve?
Just finished reading Contrarian Investment Strategies: The Classic Edition by David Dreman.
My impression of Dreman before reading the book wasn’t very good: I saw some of his TV interviews and was very unimpressed. Also I remember some of his fund’s holdings coming into the financial crisis absolutely got killed.
But I realized that the impression a person makes in the media need not have any relation to his knowledge and skill, and I read some positive reviews on his books in multiple places, so I decided to give it a try. The desire to read the book was also strengthened by my interest in quantitative investment strategies.
Having read the book, I must say I’m quite impressed. Dreman really knows what he’s talking about, having invested himself for many decades, and also having performed good scientific research.
I had expected that the book would be mostly about quantitative investing, but it discusses many more subjects. For instance it explains clearly what is wrong with technical investing and the Efficient Market Hypothesis (EMH). It also has a whole section on behavioral investing, which is quite good, and also goes into the subject of how to define risk and what would be the main risk investor face today. (I skipped many of the sections on technical investing and EMH, because nobody has to convince me what’s wrong with them.)
The best part of the book are the sections on quantitative investing. Most important conclusions of this part:
(Note: the last point conflicts with some other results I’ve seen, see for instance the website Validea and StockScreen123, which show that higher rebalancing frequencies lead to higher annualized returns before taxes and transaction costs.)
A critique of the book, especially for an investor who already knows a lot about value investing, is that the book is long (it has 450 pages). A person only interested in quantitative value investing could find 90% of the information in Dreman’s book in the excellent article What has worked in investing by Tweedy, Browne Company.
Many good articles on quantitative value investing can be found on the blogs Greenbackd, Fat Pitch Financials and Magic Diligence. And of course, you should read The little book that still beats the market and The big secret for the small investor (see my summary here). Both book are very good and short reads, and both have been written by legendary investor Joel Greenblatt. But I digress…
Back to Dreman’s book. As said, the book is quite long, but many subjects are covered in depth, and I learned some things that I didn’t know before, and also got some good ideas. Some of the main points:
If you are a relatively inexperienced investor and want to know whether you should do technical investing, index investing, value or growth investing, focused or diversified investing, fundamental or quantitative investing, small cap vs. large cap investing, portfolio management, and many other subjects, read this book cover to cover! You will also get a very good summary of behavioral investing at the same time.
If you are mainly interested in quantitative investing, then first read the article by Tweedy, Browne Company and the two books by Joel Greenblatt I mentioned. Then, if you still want more, you can read this book. You may may want to skip some sections and skim some other sections, though. Still, there is a lot of valuable information in this book. David Dreman did a great job, and I’m happy to have read the book.
If you are more interested in the Warren Buffett style of focused investing in great companies at good prices, this is not the right book for you.
The Efficient Market Hypothesis (EMH) which says that markets are efficient, and therefore it is not possible to beat the market, other than by luck, is false. Still, beating the market can be very difficult, even for highly intelligent, hard working people who have attended top business schools. The secret to beating the market is in learning just a few simple concepts that almost anyone can master, and that serve as a road map. Even though the concepts needed to be a successful stock market investor are simple and most people can do it, it’s just that most people won’t.
The secret to successful investing is to figure out the value of something and then pay a lot less. The ‘a lot less’-part is called the margin of safety. The value of a business comes from how much that business can earn over its entire lifetime (20-30 years). (Actually it is better to use cash flow instead of earning, but in the book it is assumed that earnings are a good approximation for cash received.) The earnings need to be discounted to the present, which is called a Discounted Cash flow analysis (DCF) to get the Present Value (PV). The problem with a DCF is that 1) it is almost impossible to predict earnings for the next 30 years and 2) small changes in growth rates and discount rates end up making a huge difference in the present value.
Besides a DCF, there are also other ways to determine the value of something. For instance, you can use a relative value, acquisition value or liquidation value analysis. For larger companies with multiple divisions, you can use a different analysis for each division, and then combine the values of the divisions to get a sum-of-the-parts value. But each of these valuation methods has its own drawbacks and difficulties. So the main point is that it is not so easy to figure out the value of a company. And if we can’t determine the value of a company, we can’t determine an amount that we’d be willing to pay where we’d have a margin of safety.
An important part of investing is capital allocation: you compare different investment possibilities to find that ones that are most attractive, that is which you think will provide the best risk-adjusted returns. The first hurdle an investment in a stock must pass, is an investment in a 10-year US government bond, for which we assume the interest is at least 6%. The interest rate on a 10-year US government bond, we call the risk-free rate. If the earnings yield (earnings/price) of a stock is much higher than the risk-free rate, then it might be a good investment depending on how certain we are of our estimates of future earnings of the company. If the first hurdle is passed, we can compare the attractiveness of investing on stock A to different stocks. If we can’t make an estimate of future earnings of a company, we just skip that investment.
If you’d want to beat Tiger Woods, it would be best to choose a different game than golf. If you’d want to beat professional money managers in investing, it is better to choose a style of investing where they can’t or won’t compete with you. Some possibilities are investing in small capitalization companies (small caps), focused investing (where you analyze and invest in just a few companies where you have a special insight or some deeper knowledge) and special situations investing (spinoffs, bankrupties, restructurings, etc.) The drawbacks of investing in special situations, is that they still require a reasonable amount of work and you still need to have some valuation skills.
If you don’t want to do your investing yourself, you can invest in mutual funds. Mutual funds come in two flavors: active and passive. In an active mutual fund an manager tries to invest in a basket of stocks that will beat the market. In a passive mutual fund (also called an index fund) the approach is to try to replicate the returns of an index such as the S&P 500 by buying all or most of the stocks in that index. This chapter focuses on active mutual funds. Managers of mutual funds earn money through the fees paid by investors: the more money they manage, the more they generally earn. So managers of mutual funds try to get investors to invest as much money as possible with them, but this effectively excludes them from investing in small caps (especially focused investing in small caps). Focused investing in large caps is still possible, and though this has the chance to outperform the benchmark, it also has the chance to underperform the benchmark for long periods of time. And since investors in mutual funds usually don’t have a lot of patience, they flee the mutual fund before it has the chance to outperform. Since this is not what the managers want, they will generally not invest in a focused way. Investing in special situation is also no option for mutual funds due to a variety of reasons.
Conclusion: some of the most effective ways to beat the market (as explained in chapter 5), can’t or won’t be used by mutual fund managers. Therefore, most mutual funds don’t beat the market, and because of fees, they don’t even match the market. Although there are some superstar managers who manage to beat the market over longer periods of time, 1) it is difficult to finds these managers ahead of time and 2) most investors time their investments in the fund poorly: they come in after the fund has performed well and they leave after the fund has performed poorly, thereby realizing a much worse return than if they had stayed with the fund for a long period of time.
As we’ve seen above, it’s almost impossible for most investors to value companies on their own, and hiring experts (active mutual fund managers) also doesn’t work because most funds underperform the market and it’s very difficult to find that funds that will outperform the market ahead of time. A good alternative is to buy an index fund, like a fund which tracks the S&P 500 index. The advantage is that can be implemented very cost-effectively and efficiently. The problem is that investing this way is fundamentally flawed: since the index is market-cap weighted (the larger the market capitalization of a company, the larger the part of that company in the index), the more overvalued a company is the more overweighted it becomes (and vice-versa). So you end up systematically owning too much of the companies that are overvalued and systematically too little of the companies that are undervalued.
A better alternative to market-cap weighted indexes are equally weighted indexes in which each company has the same weighting. This adds on average 1-2% of return per year over market-cap weighted indexes. The problem with equal weighting is that these indexes can’t handle too much money due to the smaller constituents in the index. Another alternative is fundamentally weighted indexes, where the weighting of a company in an index is determined on the basis of one or more fundamentals like earnings, sales, dividends, book value, etc. This also adds on average 1-2% of return per year, and –unlike equal weighted indexes– it can handle large amounts of money, since larger cap companies are still overweight in the index, and also requires much less trading within the fund. So fundamentally based indexes are a better way to replace market cap weighted indexes than are equally weighted indexes.
An attempt to improve upon fundamentally based indexes, is to use the value effect: companies that appear cheap relative to earnings, book value, etc. have been shown to beat the major market indexes by as much as 2-3% per year over long periods of time. So we could design a value-weighted index in which the cheaper a company appears, the larger its weight in the index. And while we are at it, why don’t we add the philosophy of Warren Buffett and Charles Munger to the mix, and look for companies that are not just cheap, but cheap and also good. Trailing earnings yield (the earnings yields based on last fiscal year’s financial data) can be used as a proxy for cheapness and trailing return on capital as a proxy for quality (see ‘The little book that still beats the market’, also by Joel Greenblatt). Had you done this over the last 20 years, you would have beaten the S&P 500 by about 6% annualized (trading costs and market impact modeled, but fund fees not included). When you use a value-weighted index, you not only remove the systematic error that is present in a market-cap weighted index, but you also add to the performance by buying more of stocks when they are available at bargain prices.
The first part of the big secret for the small investor, is to have the right strategy, which is to invest in companies that are both cheap and good. The second part is that we need to stick to the strategy over long periods of time. This is very difficult for many investors to do, because –as research on the subject of behavioral finance has shown– most investors are practically hardwired from birth to be lousy investors: among other things they are impatient, loss-averse, have a herd mentality, are focused on recent events and are overconfident. As we have already seen above, value investing strategies can underperform the market for periods of multiple years. For very good investors this is a blessing in disguise: if a strategy would work every week, every month and every year, everyone would be a value investor and eventually the strategy would stop working, because in that case the market would be truly efficient. For all other investors, long periods of underperformance are a curse, because they will be tempted to abandon their strategy much too soo and probably at precisely the wrong time.
To help us deal with our human flaws in the area of investing, we need a policy in which we first define what part of our portfolio should be allocated to equities, and then how much that part may vary over time. After we have done that, we need to stick to our policy.
When we combine the strategy and the policy, we have The big secret for the small investor: a new route to long-term investment success.
Last week, I was reading the letters Warren Buffett wrote to the partners of his Buffett Partnership Limit (BPL) between 1957 and 1970. In these letters he stresses over and over that the goal of BPL is to outperform the Dow Jones index (DJ; Dow) by as a high a margin as possible and with as low risk as possible over periods of at least 3, but preferably 5 years.
Buffett stresses that for both professional money managers and individual investors, measurement is key: how do your investment results compare to the benchmark? Also, he shows that it is very difficult to outperform the index, even if you are very smart, work very hard, have integrity, etc.
The records of Warren Buffett, George Soros, Peter Lynch, John Templeton, and others have shown that it is possible to outperform the market over longer periods of time. The article written by Warren Buffett in 1984 titled ‘The Superinvestors of Graham-and-Doddsville’, has shown clearly that this is the case, so the market is definitely not efficient all of the time.
But how difficult is it to beat the market? I decided to compare the results of some well-known investors today, with some benchmarks to see whether they outperform and if so, by how large a margin.
This article will first look at mutual funds investing only in the US, then it will look at mutual funds investing globally. After that, a comparison will be made with formula investing, and finally there will be a discussion.
The table below (click on the picture to go to the Google Spreadsheet) shows the 10 year records (period between 18 August 2000 and 13 August 2010) of some well-known funds compared to the S&P 500 index. The results are sorted on their results (descending).
A period of 10 years has been chosen, since investment results should not be viewed over the short term, because plain luck can play a large role over the short term. Also risk is not properly accounted for: had you invested in dot com and telecommunications stocks in 1999 and 2000 (especially if you had used leverage), you would have done very well during that period, but you would have had enormous losses in 2001 and later. What is the point of having huge gains and then losing it all?
Continue reading →
Some remarks with regards to the table and the data:
Investors are always looking for a system to achieve higher returns with less risk. How to find such a system? Why not start by looking at what one of the world’s greatests investors, Warren Buffett has been doing for many years? Buffett has said many times that he likes to buy companies with the following characteristics:
The people at Gurufocus have tried to convert the last 3 characteristics in rules for investing, thus creating a system. They also conducted a back test study of parts of their system and also the system as a whole over the period between 1998 and 2008. In this post, I will give a summary of their publication. The original articles can be found here:
Buffett-Munger style investing means buying stocks of great companies at good prices. (Actually Buffett also invests in different ways, like buying companies outright, but this is not possible for the average investor. Also he invests in other securities like bonds, but this is not the focus of this post.) Good companies will continue to increase their earnings per share in the future and the stock value will eventually increase to reflect the growing earnings (in the long the stock market is a weighing machine). If the stock can be bought at good prices, you have now found a good investment. We are searching for a system to help us find Buffett-Munger type investments. The system should work in all markets to help us find investment which have a high potential return while simultaneously having a low risk for permanent loss of capital. That is, it should follow Buffett’s rule number 1: ‘Never lose money’. The 2008/2009 recession is a great period to test the system, since if the system contains fundamental flaws, these will probably be exposed in this crisis.Continue reading →
I found this great speech of Jamie Dimon, CEO of JPMorgan Chase & Co.
I liked every part of the video, and think that one of his final remarks was right on the mark: that the whole solution to all our energy problems, is taxation on energy. If people are willing to make this sacrifice, energy usage will go down, renewable energy will be more competitive compared to non-renewable energy.