Using credible experts to help clients stick to their plans

Wednesday, January 25th, 2012

War­ren Buf­fett has said it only takes two things for investors to suc­ceed — hav­ing a sound plan and stick­ing to it…and it’s the stick­ing to it part where most peo­ple struggle.

Along sim­i­lar lines, the key for advi­sors in help­ing clients suc­ceed is not devel­op­ing the right plan, it’s putting in place strate­gies to help clients stick to the plan once it’s developed.

That’s typ­i­cally not a big prob­lem when peo­ple are mak­ing money and investors feel rewarded for being in markets.

But it’s a huge issue in times like these, when it’s easy for Cana­di­ans to become anx­ious and discouraged…to go to cash with their exist­ing invest­ments and stop mak­ing RRSP contributions.

In light of that, here’s a strat­egy that can help clients main­tain con­fi­dence and stick to their plans.

Pro­vid­ing perspective

In my con­ver­sa­tions with Cana­dian investors, almost all want to deal with advi­sors who are gen­er­ally pos­i­tive but at the same time pro­vide a bal­anced per­spec­tive; so don’t fall into the perma-bull “don’t worry be happy” camp.

That’s why you can’t dis­miss the issues that global economies and stock mar­kets are facing.

And with many clients, you can’t rely on just your own opin­ion or your firm’s research — in times like these, it’s help­ful to pro­vide sup­port from trusted, third party sources.

The lead­ing voices in the val­u­a­tion debate

That’s the rea­son that in early July I con­ducted video inter­views with both Jeremy Siegel and Robert Shiller, the two lead­ing voices on the mar­ket val­u­a­tions, with a view to pre­sent­ing both sides of the argu­ment on mar­ket valuations.

Both Siegel and Shiller are highly cred­i­ble — they each called the tech melt­down and take a fact-based approach to their analysis.

Here’s the link to a March Wall Street Jour­nal front page story that high­lighted these two aca­d­e­mics as the lead­ing voices in the under­val­ued vs. over­val­ued debate: http://​online​.wsj​.com/​a​r​t​i​c​l​e​/​S​B​1​0​0​0​1​4​2​4​0​5​2​7​4​8​7​0​4​7​0​6​3​0​4​5​7​5​1​0​7​4​9​2​6​3​2​5​6​7​8​0​2​.​h​tml

Using the videos with clients

Last week, videos of the inter­views with Siegel and Shiller were posted to the Cli​entin​sights​.ca website.

There are a cou­ple of ways to use these interviews.

One is to email clients the one that sup­ports your point of view.

Alter­na­tively, you might want to send clients not just the one you agree with but both videos — and then talk about the con­trary case that has been presented.

By demon­strat­ing that you’ve looked at the full gamut of views rather than telling just one side of story, your ulti­mate rec­om­men­da­tion has more power.

So if you’re rec­om­mend­ing clients stay fully invested, it’s impor­tant to show clients you’ve exam­ined the neg­a­tive case.

And if you’re cau­tious and rec­om­mend­ing cash, it’s help­ful to demon­strate that you’re not ignor­ing the opti­mistic voices.

Doing this entails a longer, more detailed con­ver­sa­tion — but it’s this kind of con­ver­sa­tion that helps clients stick to their plan at the inevitable time when the mar­ket goes against the stance you’ve taken.

To watch videos of two of the inter­views with Jeremy Siegel, click here:

Why stocks are undervalued

http://​cli​entin​sights​.ca/​v​i​d​e​o​/​j​e​r​e​m​y​-​s​i​e​g​e​l​-​w​h​y​-​s​t​o​c​k​s​-​a​r​e​-​u​n​d​e​r​v​a​l​u​e​d​/​t​y​p​e​:​i​n​v​e​s​tor

Respond­ing on mar­ket concerns:

http://​cli​entin​sights​.ca/​v​i​d​e​o​/​j​e​r​e​m​y​-​s​i​e​g​e​l​-​r​e​s​p​o​n​d​i​n​g​-​t​o​-​m​a​r​k​e​t​-​c​o​n​c​e​r​n​s​/​t​y​p​e​:​i​n​v​e​s​tor

And these inter­views sum­ma­rize Robert Shiller’s views on the market:

A cau­tious out­look for stocks:

http://​www​.cli​entin​sights​.ca/​v​i​d​e​o​/​r​o​b​e​r​t​-​s​h​i​l​l​e​r​-​a​-​c​a​u​t​i​o​u​s​-​o​u​t​l​o​o​k​-​f​o​r​-​s​t​o​c​k​s​/​t​y​p​e​:​i​n​v​e​s​tor

The impact of con­sumer confidence:

http://​www​.cli​entin​sights​.ca/​v​i​d​e​o​/​r​o​b​e​r​t​-​s​h​i​l​l​e​r​-​t​h​e​-​i​m​p​a​c​t​-​o​f​-​c​o​n​s​u​m​e​r​-​c​o​n​f​i​d​e​n​c​e​/​t​y​p​e​:​i​n​v​e​s​tor

To watch a dozen dif­fer­ent inter­views with Jeremy Siegel and Robert Shiller, go to www​.cli​entin​sights​.ca.

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Tags: Academics, Balanced Perspective, Canadian Investors, Canadians, Conversations, Credible Experts, Global Economies, Happy Camp, Jeremy Siegel, Market Valuations, Meltdown, Party Sources, Perma, Place Strategies, Rrsp Contributions, Stock Markets, Video Interviews, Wall Street Journal, Warren Buffett, Wsj
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“The pendulum never stops……”

Sunday, September 19th, 2010

Occa­sion­ally, some­thing we hear sticks in our minds and stays with us.

When I was in busi­ness school in the 1970s, my finance prof used a phrase that I often find use­ful in con­ver­sa­tion with clients and investors — espe­cially in mar­kets such as we’re in today.

That phrase: “The pen­du­lum never stops in the middle.”

My finance pro­fes­sor was one of the big names in the field — he con­sulted with many of the Wall Street firms and was fre­quently quoted in the press.

He used this phrase in the con­text of mar­ket val­u­a­tions and mar­ket sen­ti­ment. He talked about the his­tor­i­cal real­ity that mar­kets inevitably swing from one extreme to another, from peri­ods of out­landishly ele­vated val­u­a­tions to ridicu­lously beaten down lev­els, from peri­ods of unques­tion­ing eupho­ria to absolute pessimism.

“The pen­du­lum never stops in the mid­dle” applies in lots of other cases as well.

Look at the market’s and media’s atti­tude to risk and lever­age — a year ago com­pa­nies that used insuf­fi­cient  lever­age to boost prof­its were pun­ished for being “dull and bor­ing”, today even pru­dent risk has become a dirty word. (The most pop­u­lar arti­cle in the online New York Times last week was a piece lay­ing out Cana­dian banks as the model for the global bank­ing sys­tem — a notion that six months ago would have been com­pletely absurd.)

Con­sider investors’ atti­tudes to own­ing resource stocks — where not long ago load­ing up on these was all that many investors wanted to talk about, today they don’t even want to hear about own­ing resources.

This is also reflected in expec­ta­tions on oil prices. A year ago, the “peak oil” the­ory held sway and demand from China and India was going to push oil to $200 by year end. Today we’ve begun to hear about the “peak demand the­ory”, the view that demand for oil peaked last year and we’ll never, ever see demand at that level again.

Recall all the invest­ment fads and “flavour of the day” investments.

And think about the wild swing in con­sumer sen­ti­ment on appro­pri­ate spend­ing that’s taken place in the last lit­tle while– from the norm of lav­ish expen­di­ture to “the new frugality.”

The key point that my finance prof made was that while the stock mar­ket may be effi­cient and ratio­nal in the mid and long term, in the near term the “swing­ing of the pen­du­lum” cre­ates ter­rific oppor­tu­ni­ties for com­pa­nies and for investors who can main­tain their perspective.

That was true thirty years ago … and it’s arguably even truer today

So when talk­ing to investors who are spooked by recent events and dire eco­nomic fore­casts, con­sider talk­ing about the fact that “the pen­du­lum never stops in the middle”.

We may not be all the way to the extreme of despair and pes­simism, but we are almost cer­tainly well past the mid point — and into the area that we’ll look back on years from now and rec­og­nize that the dras­tic shift in sen­ti­ment has cre­ated sig­nif­i­cant value for those bold enough to look past the swing­ing of the pen­du­lum and rec­og­nize it.

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Tags: Banking System, Business School, Canadian Banks, Demand Theory, Dirty Word, Euphoria, Fads, Finance Prof, Finance Professor, Flavour, Global Banking, Market Sentiment, Market Valuations, New York Times, Oil Prices, Peak Demand, Peak Oil Theory, Pendulum, Pessimism, Resource Stocks
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Helping Clients Stick to Their Plans

Wednesday, July 28th, 2010

War­ren Buf­fett has said it only takes two things for investors to suc­ceed — hav­ing a sound plan and stick­ing to it … and it’s the stick­ing to it part where most peo­ple struggle.

Along sim­i­lar lines, the key for advi­sors in help­ing clients suc­ceed is not devel­op­ing the right plan, it’s putting in place strate­gies to help clients stick to the plan once it’s developed.

That’s less of an issue when  peo­ple are mak­ing money and investors feel rewarded for being in markets.

But it’s a huge issue in times like these, when it’s easy for Cana­di­ans to become anx­ious and dis­cour­aged … to go to cash with their exist­ing invest­ments and stop mak­ing RRSP contributions.

Here are two tac­tics that might help clients main­tain con­fi­dence and stick to their plans:

Pro­vid­ing perspective

In my con­ver­sa­tions with Cana­dian investors, almost all want to deal with advi­sors who are at the same time gen­er­ally pos­i­tive but also pro­vide a bal­anced per­spec­tive, so don’t fall into the perma-bull  “don’t worry be happy” camp.

That’s why you can’t dis­miss the issues that global economies and stock mar­kets are facing.

And with many clients, you can’t rely on just your own opin­ion or your firm’s research — in times like these, it’s help­ful to pro­vide sup­port from trusted, third party sources.

You also have to be care­ful about only telling one side of the story — in fact by demon­strat­ing that you’ve looked at the full gamut of views, your ulti­mate rec­om­men­da­tion has more power.

So if you’re rec­om­mend­ing clients stay fully invested, it’s impor­tant to show clients you’ve exam­ined the neg­a­tive case.

And if you’re cau­tious and rec­om­mend­ing cash, it’s help­ful to demon­strate that you’re not ignor­ing the opti­mistic voices.

That’s the rea­son that in early July I spoke to both Jeremy Siegel and Robert Shiller, the two lead­ing voices on the mar­ket val­u­a­tions, so that I could present both sides of the argu­ment on mar­ket val­u­a­tions — and so that advi­sors could present both sides to clients.

Both  Siegel and Shiller are highly cred­i­ble — they both called the tech melt­down and take a fact-based approach to their analysis.

And if you’re going to use one of these inter­views with clients to sup­port your case, you might want to send clients not just the one you agree with but both videos — and then talk about the con­trary case that has been presented.

Doing this entails a longer, more detailed con­ver­sa­tion — but it’s this kind of con­ver­sa­tion that helps clients stick to their plan when the mar­ket goes against whichever stance you’ve taken.

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Tags: Balanced Perspective, Canadian Investors, Canadians, Compendium, Confidence, Conversations, Gamut, Global Economies, Happy Camp, Investments, Jeremy Siegel, Market Valuations, Negative Case, Optimistic Voices, Party Sources, Perma, Place Strategies, Rrsp Contributions, Stock Markets, Target, Third Party, Warren Buffett
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The Best Books on Investing

Wednesday, July 14th, 2010

The arti­cle below by U.S. fund man­ager by Vitaliy Kat­senel­son first appeared on U.S. advi­sor site Advi­sor Perspectives.

It’s a reminder of the con­stant need to be alert for the oppor­tu­nity to learn more.about invest­ing — and to be open to how much we don’t know on this topic.

In crazy times like today, all one could and actu­ally should ask for is san­ity. Yes, san­ity — a clear mind free of noise to deal with the insan­ity that is thrust upon us by a volatile and noise-making machine also known as the stock market.

We find our­selves glued to the com­puter screens or CNBC wait­ing to find out what the Dow’s next tick is going to be. Unfor­tu­nately, we are left with only a headache and wasted time. What’s next? Here is my advice: read. Read books that will bring you san­ity, the ones that will snap you back into the dis­ci­pline of an investor and out of the sorry shell of a ner­vous observer of the daily stock mar­ket melo­drama. The fol­low­ing books are excel­lent choices and come with plenty of san­ity and sage advice.

I orig­i­nally wrote this list of rec­om­mended books last year; recently, I updated it and added a few more books. I hope to keep adding to it every year. It con­tains six sec­tions: Sell­ing, Think Like an Investor, Behav­ioral Invest­ing, Eco­nom­ics, Stock Mar­ket His­tory, and Books for the Soul. I hope you enjoy it.

Sell­ing

I’ll start with Its When You Sell That Counts, 3rd edi­tion, by Don­ald Cas­sidy. Sell­ing is usu­ally as pop­u­lar as candy the day after Hal­loween. Dur­ing sec­u­lar bull mar­kets sell­ing is frowned upon as buy-and-hold turns into invest­ing reli­gion. And since sell­ing vio­lates the “hold” covenant of that reli­gion, the investor who buys and sells is labeled a non­be­liever, or even worse, a trader (if you say “trader” fast enough it sounds like “traitor”).

In sec­u­lar bull mar­kets, on aver­age, sell deci­sions are not as reward­ing as hold deci­sions, as mar­ket val­u­a­tions are expand­ing and even second-rate dogs (stocks) start look­ing like pedi­greed cocker spaniels. Every investor is now a “long-term” investor and sell becomes a four-letter word. But being a long-term investor is not about the longevity of your hold deci­sions, but rather it is an atti­tude. Hold­ing a stock because you bought it is a fal­lacy; you should only hold a stock if future risk-adjusted return war­rants it.

War­ren Buf­fett has been mis­tak­enly pro­moted (though, I’d argue, demoted) into deity sta­tus in this buy-and-hold tem­ple. Let’s cor­rect this mis­take. War­ren Buf­fett became a buy-and-hold investor when his port­fo­lio and posi­tions got big enough, push­ing $60 bil­lion, so that sell­ing became a dif­fi­cult under­tak­ing. In his early career, before “Ora­cle of Omaha” was his moniker, he was a buy-and-sell investor. As he joined the boards of some of his biggest hold­ings (like Coke and Wash­ing­ton Post), it made sell­ing even more difficult.

One doesn’t need the ben­e­fit of hind­sight to know that at 55 times earn­ings Coke was tremen­dously over­val­ued in 1999. Coke, like the major­ity of Buffett’s top pub­lic hold­ings (Wash­ing­ton Post, Proc­ter & Gam­ble, John­son & John­son, and many oth­ers), did not go any­where for a decade. I dare you to take a look at his top pub­lic hold­ings and tell me whether he would have done a lot bet­ter if he had sold them when they became fully val­ued (or slightly over­val­ued). In most cases, that would have been a decade ago.

Emo­tions assault us from dif­fer­ent direc­tions when we face a sell deci­sion: If it is a los­ing invest­ment, we want to wait to break even. This is the wrong atti­tude. Our pur­chase price and sell deci­sion should not be related (the only excep­tion begin tax sell­ing). Or when it comes to sell­ing a win­ner, we want to sell only at the top. Again this is the wrong atti­tude: the top is only appar­ent in hind­sight, when it is usu­ally too late.

We should sell the stock when it reaches our price or val­u­a­tion tar­get, deter­mined at the time of pur­chase. We (our emo­tions and false goals, to be exact) are our biggest enemy when it comes to invest­ing, and espe­cially sell­ing. Cassidy’s won­der­ful book has been writ­ten to fix this. Its objec­tive is to recal­i­brate your mind and free you from the impris­on­ment of past deci­sions, to break you free from the buy-and-hold state of mind and turn you into a buy-and-sell investor.

OK, this is a bit of a long intro­duc­tion to this book, but it’s a ter­rific and a very impor­tant work. A proper sell dis­ci­pline will decide between great or mediocre returns for even the best-crafted buy deci­sions. Pros may want to skip a few chap­ters, but it is an impor­tant read for every­one, espe­cially in today’s environment.

Think and behave like an investor

The fol­low­ing books should help you to think like an investor, forc­ing you to think beyond stock tick­ers and focus on what is under the hood: the busi­nesses and the peo­ple who run them. The first one is The Essays of War­ren Buf­fett. It’s a com­pi­la­tion of War­ren Buffett’s let­ters to share­hold­ers from annual reports dat­ing back to the 1970s. Before this book came out (or at least before I was aware of its exis­tence) I had my grad­u­ate stu­dents at Uni­ver­sity of Col­orado read Buffett’s annual reports, which as you may expect were very rep­e­ti­tious. His wis­dom doesn’t vary that much from year to year. This book orga­nizes the main con­cepts and removes annoy­ing redundancy.

Another good book is The Entre­pre­neur­ial Investor: The Art, Sci­ence, and Busi­ness of Value Invest­ing, writ­ten by my friends at West Coast Asset Man­age­ment. It accom­plishes many objec­tives of Buffett’s essays, plus has plenty of cul­tural ref­er­ences, humor, and com­mon sense. All of these things make it a fun and enjoy­able read. I made this book sug­gested read­ing in my grad­u­ate invest­ment class

The Super Ana­lysts by Andrew Leem­ing is a book I think few peo­ple have heard of. The author inter­views suc­cess­ful investors (not aca­d­e­mics), and they dis­cuss their approach to invest­ing and analy­sis of com­mon stocks and some spe­cific industries

You Can Be a Stock Mar­ket Genius: Uncover the Secret Hid­ing Places of Stock Mar­ket Prof­its by Joel Green­blatt is one of those books that should be read more than once. Joel shares very unique approaches about how to find under­val­ued stocks. On top of being a very good investor, he has a healthy sense of humor. Joel also has writ­ten The Lit­tle Book That Beats the Mar­ket (Lit­tle Books. Big Prof­its). I plan to read this book with my son when he gets older, as it is a great intro­duc­tion to invest­ing. At the end of the book Joel offers a “magic for­mula,” a screen that has beaten the mar­ket over a long period of time

The magic screen is very sim­ple: buy low price-to-earnings stocks that have a high return-on-capital. Low P/E is an indi­ca­tion of cheap­ness, while high return-on-capital is an indi­ca­tion of com­pet­i­tive advan­tage (at least in the past) and the pos­si­bil­ity to grow earn­ings at high rates. Here is the book’s Web site, which pro­vides a weekly list of stocks that score high on both measures.

The Busi­ness of Value Invest­ing: Six Essen­tial Ele­ments to Buy­ing Com­pa­nies Like War­ren Buf­fett by Sham Gad. Wiley sent me the man­u­script to review, and it hap­pened to arrive on my birth­day in June. I opened the man­u­script when guests showed up at the door; I set it on the kitchen table. My niece, a recent grad­u­ate from busi­ness school, who had lit­tle inter­est in invest­ing, picked it up, and I did not see her for the whole evening. She loved it! It is hard to make value invest­ing inter­est­ing, but Sham did. I’ve read it too, and thought it was an excel­lent intro­duc­tory book to value investing.

Pil­grim­age to War­ren Buffett’s Omaha: A Hedge Fund Manager’s Dis­patches from Inside the Berk­shire Hath­away Annual Meet­ing by Jeff Matthews. This is not another biog­ra­phy of War­ren Buf­fett, but rather the most insight­ful and crit­i­cal (fair and bal­anced) analy­sis of Buf­fett and Berk­shire I’ve ever read. I also encour­age you to read Jeff’s mus­ings on his blog; I’ve been read­ing it for years.

The Lit­tle Book That Builds Wealth: The Knock­out For­mula for Find­ing Great Invest­ments (Lit­tle Books. Big Prof­its) by Pat Dorsey. Michael Porter wrote Com­pet­i­tive Strat­egy: Tech­niques for Ana­lyz­ing Indus­tries and Com­peti­tors a few decades ago; quite deserv­ingly it turned into a bible of indus­try analy­sis at all busi­ness schools and taught in all man­age­ment pro­grams. Pat Dorsey took Michael Porter’s con­cepts and in this very lit­tle book applied them directly to invest­ing. To be hon­est, if this book had been out when I was teach­ing my invest­ment class, I’d be using it instead of Michael Porter’s (sorry Michael), as it is writ­ten for investors.

More Mort­gage Melt­down: 6 Ways to Profit in These Bad Times. This book was writ­ten by Whit­ney Tilson and Glen Tongue, who are excel­lent investors. I’ve seen their pre­sen­ta­tion that is the core of this book sev­eral times; in fact you can down­load the lat­est ver­sion here. Invest­ment ideas of how to profit from today’s cri­sis have already played out for the most part; so this book will not give you fish, but under­stand­ing their ana­lyt­i­cal process will teach you how to fish.

Behav­ioral Investing

The right tem­pera­ment is cru­cial in invest­ing. Being a crit­i­cal thinker and know­ing how to value stocks is impor­tant, but it is all a waste if your emo­tions get the bet­ter of you. The fol­low­ing books will help you to rec­og­nize the short­com­ings of your hard-wiring and help you to devise strate­gies to deal with it.

Psy­chol­ogy of Invest­ing (3rd Edi­tion), by John R. Nof­singer, is short and to the point. You’ll become an expert on behav­ioral invest­ing in about an hour. Well, not quite, but close.

Why Smart Peo­ple Make Big Money Mis­takes And How To Cor­rect Them: Lessons From The New Sci­ence Of Behav­ioral Eco­nom­ics, by Gary Bel­sky and Thomas Gilovich. This is a fun and easy read. It also addresses how short­com­ings in our wiring impact money deci­sions, like buy­ing cars and stereos.

Your Money and Your Brain: How the New Sci­ence of Neu­roe­co­nom­ics Can Help Make You Rich, by Jason Zweig, is another selec­tion. I have to admit that the two books above cover many top­ics in this book (though this one offers new angles and insights) and are likely to be more excit­ing reads, but Chap­ter 10 is what makes this book a must-read: it addresses hap­pi­ness — yes, hap­pi­ness. Although, as most of us know, money doesn’t buy hap­pi­ness (unless you are starv­ing or liv­ing on the street), money spent on acqui­si­tions — things — brings a burst of hap­pi­ness that quickly fades away. Think of your level of hap­pi­ness when you bought the car of your dreams. Money spent on expe­ri­ences — being — brings a higher util­ity of hap­pi­ness. Rec­ol­lect­ing expe­ri­ence brings hap­pi­ness. I plan to reread this chap­ter at least a cou­ple of times a year. Zweig also pro­vides a list of things you can do that will make you happy, and none of them require you to spend a penny, which is a big pos­i­tive in today’s economy.

Rem­i­nis­cences of a Stock Oper­a­tor (Wiley Invest­ment Clas­sics), writ­ten in 1923 by Edwin Lefevre, gives a first-person per­spec­tive of the fic­tion­al­ized tale of the early years of the great trader Jesse Liv­er­more. It is rumored that this book was actu­ally writ­ten by Jesse Liv­er­more and edited by Lefevre.

Though traders and value investors fish in the same pond — the stock mar­ket — and they may even catch the same fish at times, their approaches and ana­lyt­i­cal time­frames are dia­met­ri­cally dif­fer­ent. How­ever, they do share a com­mon ele­ment: both are done by humans and thus are impacted by emo­tions. This book pro­vides a great intro­spec­tive look inside a trader’s mind and teaches many behav­ioral and common-sense lessons. Here are some quotes:

Another les­son I learned early is that there is noth­ing new in Wall Street. There can’t be because spec­u­la­tion is as old as the hills. What­ever hap­pens in the stock mar­ket to-day has hap­pened before and will hap­pen again.

and

A man must believe in him­self and his judg­ment if he expects to make a liv­ing at this game. That is why I don’t believe in tips. If I buy stocks on Smith’s tip I must sell those same stocks on Smith’s tip.

and

The recog­ni­tion of our own mis­takes should not ben­e­fit us any more than the study of our suc­cesses. But there is a nat­ural ten­dency in all men to avoid pun­ish­ment. When you asso­ciate cer­tain mis­takes with a lick­ing, you do not han­ker for a sec­ond dose, and, of course, all stock-market mis­takes wound you in two ten­der spots-your pock­et­book and your vanity.

and

One of the most help­ful things that any­body can learn is to give up try­ing to catch the last eighth or the first. These two are the most expen­sive eighths in the world. They have cost stock traders, in the aggre­gate, enough mil­lions of dol­lars to build a con­crete high­way across the continent.

Another good book about Liv­er­more is called Jesse Liv­er­more: World’s Great­est Stock Trader, by Richard Smit­ten. I quoted this book in my book — here is the quote:

After sev­eral months of despair, Liv­er­more finally sum­moned up the courage to ana­lyze his behav­ior and to iso­late what he’d done wrong. He finally had to con­front the human side of his per­son­al­ity, his emo­tions and his feel­ings.… Why had he thrown all his mar­ket prin­ci­ples, his trad­ing the­o­ries, his hard-earned laws to the wind? His wild behav­ior had crashed him finan­cially and spir­i­tu­ally. Why had he done it? He finally real­ized it was his van­ity, his ego.… The out­stand­ing suc­cess of mak­ing more than $1 mil­lion in one day had shaken him to his foun­da­tions. It was not that he could not deal with failure-he had been deal­ing with fail­ure all his life-what he could not deal with was success.

Eco­nom­ics

Politi­cians, God rest their souls, always try to appeal to the low­est com­mon denom­i­na­tor. They try to “pro­tect” us from evil doers by insist­ing on minimum-wage laws or rent con­trols, or threat­en­ing wind­fall taxes on oil com­pa­nies. They sound like heroes fight­ing for the lit­tle guy against the evil doers. How­ever, all they are doing is feed­ing on the eco­nomic illit­er­acy of the Aver­age Joe. This is why the fol­low­ing two books should be required read­ing in high schools and col­leges: Basic Eco­nom­ics 3rd Ed: A Com­mon Sense Guide to the Econ­omy by Thomas Sow­ell and A World of Wealth: How Cap­i­tal­ism Turns Prof­its into Progress by Thomas G. Donlan.

You may think Alan Greenspan had a hand in today’s cri­sis. I know I do. He took inter­est rates down to incred­i­bly low lev­els and kept them there for too long, caus­ing the real estate bub­ble. He also did not think Wall Street needed reg­u­la­tion. But that doesn’t make his book, The Age of Tur­bu­lence, any less of an excel­lent read. It is not writ­ten in Fed-speak. It seems that Sir Alan, after he left the Fed, learned how to use Eng­lish in a very clear and engag­ing way. This is not just another auto­bi­og­ra­phy, either. The book goes far beyond that. It cov­ers the work­ings of the Fed, lessons on macro­eco­nom­ics and his­tory, and per­spec­tive on Amer­i­can pol­i­tics from an insider who served under or worked with the last eight presidents.

Atlas Shrugged by Ayn Rand. This is a novel, not an eco­nom­ics book; how­ever, it accom­plishes a lot more than most eco­nom­ics books could ever accom­plish. It vividly illus­trates what hap­pens to the econ­omy when the invis­i­ble hand of cap­i­tal­ism is replaced by the “fair” and “com­pas­sion­ate” hand of social­ism: the econ­omy collapses.

Ayn Rand immi­grated to the US from Rus­sia in 1927 when she was 22, when her father’s busi­ness was seized by the Russ­ian gov­ern­ment, osten­si­bly for the greater good. I left Rus­sia 64 years later, a decade after Rand died, and my fam­ily suf­fered a lot less than hers. How­ever, we (as well as mil­lions of Rus­sians) both saw the ugly con­se­quences of socialism.

In Atlas Shrugged, Ayn Rand defines her phi­los­o­phy: indi­vid­u­al­ism. Indi­vid­u­al­ism is not a polit­i­cally cor­rect term today (if ever) in our soci­ety. One doesn’t make a lot of friends by adver­tis­ing his self­ish­ness and greed. So call it anti-collectivism, where inde­pen­dence, self-reliance, and indi­vid­ual pur­suit of hap­pi­ness are supe­rior goals, as opposed to col­lec­tivism, where pur­suit of com­mu­nal and national goals is often under­taken at the expense of indi­vid­ual liberty.

Accord­ing to Jen­nifer Burns, who recently pub­lished Ayn Rand’s biog­ra­phy, Rand’s pop­u­lar­ity surges dur­ing every polit­i­cal cycle, when the mer­its of our polit­i­cal sys­tem are being debated. Win­ston Churchill said it well: “Cap­i­tal­ism is the worst of all pos­si­ble eco­nomic sys­tems, with the excep­tion of all the oth­ers.” I hope we only see the alter­na­tive sys­tem to cap­i­tal­ism — a com­pas­sion­ate social­ism that is often offered to us as an alter­na­tive to our dis­pas­sion­ate sys­tem — only on the pages of Atlas Shrugged.

Stock Mar­ket History

I’ve really enjoyed read­ing Stocks for the Long Run by Jeremy Siegel, but it took me a while to rec­og­nize how dan­ger­ous this book is.

It is well-written and pro­vides a very good overview of the per­for­mance of dif­fer­ent asset classes over last two cen­turies. But the book needs a dif­fer­ent title, maybe some­thing like “Stocks for the Really, Really… Really Long Run.” This way, it would not lure investors into a false sense of secu­rity when it comes to stocks. Prob­a­bly unin­ten­tion­ally, it preaches that stocks (and the stock mar­ket as a whole) are always a buy, no mat­ter what val­u­a­tions are, as they do bet­ter than other asset classes in the long run; and that a 7% real rate of return is a birthright for stock investors, no mat­ter if the stock mar­ket is extremely cheap or ridicu­lously expen­sive. This is very true if your time hori­zon is 30 years or you plan to live for­ever. It is also true if you can tol­er­ate see­ing your port­fo­lio go nowhere for a decade or longer. Unfor­tu­nately, most of us don’t have this long a time hori­zon. We need to send kids to school, pay for wed­dings, boats, etc. I don’t know any­one who has the patience to see their port­fo­lio of stocks do noth­ing for decades.

That is why Siegel’s book should only be read with the fol­low­ing anti­dote: Stocks for the Long Run, 4th Edi­tion: The Defin­i­tive Guide to Finan­cial Mar­ket Returns & Long Term Invest­ment Strate­gies, and Unex­pected Returns: Under­stand­ing Sec­u­lar Stock Mar­ket Cycles which is a truly ter­rific book by Ed East­er­ling. Unlike Siegel, East­er­ling shows that despite stocks being a great invest­ment for the (really, really) long run, they have peri­ods when their returns are unspec­tac­u­lar. Ed calls these peri­ods bear mar­kets. I call them range-bound mar­kets, which is just a dif­fer­ence in seman­tics. Those bear (range-bound) mar­kets take place after sec­u­lar bull markets.

What is the appro­pri­ate way to look at risk?

The fol­low­ing two books, Fooled by Ran­dom­ness: The Hid­den Role of Chance in Life and in the Mar­kets and The Black Swan, are by Nas­sim Taleb. These books address risk and rare events (the Black Swans)

Fooled by Ran­dom­ness is my favorite non­fic­tion book, period. I’ve read it at least five times. This book turns the way we are taught to look at risk upside down. Nas­sim rebels against the cur­rent estab­lish­ment of finance that mea­sures risk with ele­gant for­mu­las that receive Nobel Prizes but lack com­mon sense.

Any model that solely focuses on past obser­va­tions and dis­misses out­comes that lie out­side of what hap­pened in the past is worth­less and, more impor­tantly, dan­ger­ous. One way of under­stand­ing how ran­dom­ness works is by study­ing alter­na­tive his­tor­i­cal paths. This means more than just focus­ing on what took place in the past — the def­i­nite (since it already hap­pened), observed his­tory, but one that before­hand was actu­ally still just one of many pos­si­ble ran­dom out­comes. One should focus on what could have taken place, what alter­na­tive paths might have existed. This allows us to think cre­atively about what could have hap­pened, and with that added insight to then pre­dict and pre­pare for what might hap­pen in the future.

Let’s take the cur­rent cri­sis: Wall Street and rat­ing agen­cies dis­missed the pos­si­bil­ity that hous­ing prices might decline nation­wide. This hadn’t hap­pened since World War II — well, then, it wouldn’t hap­pen in the future. There­fore, Wall Street took sub­prime (risky) mort­gages orig­i­nated in dif­fer­ent parts of the coun­try, lumped them together in mortgaged-backed secu­ri­ties, and — voila! — the risk had been diver­si­fied away. Junk was turned to gold. Since rat­ing agen­cies used the same under­ly­ing assump­tion — hous­ing never declines nation­wide — they announced to the world that the junk was AAA and should be bought in truck­loads — and it was. We know how this story ended.

The Black Swan is a follow-up to Fooled by Ran­dom­ness. Nas­sim takes a lot of the con­cepts dis­cussed in Fooled by Ran­dom­ness and explains them in greater detail, pro­vid­ing new and unex­pected insights. I have to warn you that The Black Swan is not easy. This book has more insights per page than most, but is not a beach read.

In this lec­ture Nas­sim cov­ers major con­cepts described in both books in great detail.

Books for the Soul

What would you do and what would you share with oth­ers if you only had months to live? This is the theme of the fol­low­ing two books: Tues­days with Mor­rie: An Old Man, a Young Man, and Life’s Great­est Les­son by Mitch Albom and The Last Lec­ture by Randy Pausch and Jef­frey Zaslow. In both books ter­mi­nally ill teach­ers share their life lessons with read­ers. Also, Randy Pausch, who sadly passed away last year, gave this great lec­ture on time man­age­ment; and here is his last lec­ture.

Another book I’ll add to this cat­e­gory is The Snow­ball: War­ren Buf­fett and the Busi­ness of Life, by Alice Schroeder. This is an autho­rized biog­ra­phy of War­ren Buf­fett. I am not sure this is the best book to read if you want to learn to invest like Mr. Buf­fett, but it gives a very dif­fer­ent and inter­est­ing view of his life. There are many great lessons we can learn from Mr. Buf­fett that go far beyond invest­ing, such as about hon­esty and trea­sur­ing one’s rep­u­ta­tion. But I thought this book was impor­tant for a very dif­fer­ent rea­son, in that it shows that War­ren Buf­fett is not a per­fect human being and that we can learn from the mae­stro, but in a dif­fer­ent way: by not repeat­ing his mis­takes. He achieved his unpar­al­leled suc­cess in his busi­ness life at the expense of his per­sonal life, unfortunately.

Espe­cially in today’s envi­ron­ment I find myself want­ing to work 24/7 (and I prob­a­bly do). This is truly a stock picker’s mar­ket. I bring my lap­top home, read The Wall Street Jour­nal at the din­ner table, and my work life starts push­ing out my per­sonal life. This book made me real­ize that no pro­fes­sional suc­cess is worth regret­ting 20 years down the road that you didn’t spend enough time with your kids. Unfor­tu­nately, Buf­fett has that regret.

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Vitaliy N. Kat­senel­son, CFA, is a port­fo­lio manager/director of research at Active Value Invest­ing: Mak­ing Money in Range-Bound Mar­kets (Wiley Finance) (Wiley 2007). To receive Vitaliy’s future arti­cles my email, click here.

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