The Hidden Trade-off: “Risk-adjusted Returns”

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You surely have noticed this by now: we disagree with conventional ways of doing many things. Modern Portfolio Theory (MPT) forms the theoretical underpinnings of a lot of investment practice today, without adequate understanding of its deep flaws.

MPT defines volatility as risk. We believe, as Warren Buffett does, that volatility is just volatility – the normal ups and downs – for long term investors. So one common practice is to promote the advantages of getting 80% of the market returns with only 50% of the risk (for example). This supposedly is a superior “risk-adjusted return.”

But you could use the same statistical methodology to show that it may cost you about one third of your potential wealth in 25 years to have a 50% smoother ride on the way. For an investor with $100,000 in long term funds, this might be a $250,000 future shortfall. The question might be, “What fraction of your future wealth would you sacrifice in order to have less volatility on the way?”

The idea of sacrificing future wealth is a lot different than the idea of reducing risk. But they are two sides of the same coin. This is the hidden trade-off in superior risk-adjusted returns.

Our experience is that people can learn to understand and live with volatility. We believe investors get paid to endure volatility.

Of course, our philosophy is not right for everyone. Volatility is easier to tolerate for investors with a longer time horizon. But we believe everyone should see both sides of the coin before making a decision to forego significant potential future wealth for a smoother ride, less volatility, along the way.

Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Letters To Our Children #6: Investing, A Tale of Three Buckets

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We talked about human capital, the traits, characteristics and skills you possess which others value. This is the source of your earning power. When you spend less than you earn, you develop savings. Our topic today is how to manage those sums.

Think of having three buckets. The first one you have is short term. This is where you go to find money to deal with emergencies. You also use the short-term bucket to save for annual expenses like real estate taxes or insurance premiums. This bucket must be stable and liquid, to provide money when you need it. Returns are secondary.

On the other end, you have a long-term bucket. If you ever hope to retire instead of going to work every day, or accumulate wealth for other long-term goals, you need one of these. Unlike the first bucket, this one may endure more volatility in the hopes of garnering higher returns over a long time horizon. You should plan on not tapping this bucket except for those long term goals, short of an emergency which can be met no other way.

Naturally, the third bucket is in between. You may have goals for things that happen in a few years, on an intermediate time horizon. It might be for a major purchase like a boat or camper, to meet educational expenses for a child who is a few years away from college, a down payment on a home you intend to buy at some point in the future.

Not surprisingly, the third bucket may balance stability and higher returns with a middle of the road approach. This is in between the strategies of the short-term bucket and the long-term bucket.

There are other aspects of investing that we will explore in future letters. But the idea of three buckets is a helpful way to understand the functional purposes of investing. You will need to know something about the basic kinds of investments, styles of investing, some tax considerations, and the options available in retirement accounts.

Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Our Digital Communications: 4th Anniversary

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As we complete four years in the world of digital communications, it makes sense to take stock. What have we gotten done, where are we headed?

We began with three thoughts. We had the intent to be able to communicate at the speed of light when events demanded – sort of a civil defense system for times of stress. And we wanted to communicate with all of you each week about our current thinking on a wide variety of topics. Finally, make available a complete archive of our philosophy and strategies, for you to find and read on your schedule, available 24/7.

We worked out a way to deliver these things with a combination of three methods. Nobody needs to access all three, but we can reach more of you by being more places.

228Main.com hosts our blogs, nearly 400 already published, one or two new ones each week. Daily posts in social media offer additional features, plus links to the blog articles, comments about developments in our thinking, and weekly short videos. And weekly email newsletters provide links to the new blog posts and videos, along with schedule notes.

We love the way you forward emails or like or share our Facebook or Twitter posts. Some of your friends and relatives have gotten to know us this way, at their leisure, with no threat of us bothering them with unwanted approaches (as if we ever would!) The 21st century is a great place to live if you like to communicate.

We are working on consolidating selected blog posts into books, thinking about a YouTube channel to make our video library more searchable, and continuing to explore new ways to communicate.

21st century communications played a key role as we met the challenges of the last few years. But instead of being a pale substitute for the way we had done business before, we learned that more communication is just plain good for you and good for us.

If you would like to talk about this or anything else, please email us or call.

Letters to Our Children #5: Your Human Capital

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One investment supersedes all others: invest in yourself. Renowned investor Warren Buffett promoted this idea in a 2017 interview. It cannot be taken away, it adjusts for inflation, it helps you have a more interesting life and earn more money.

Interestingly, Buffett’s prime example of this is not an Ivy League education, but a simple public speaking course, one that many thousands of others have also pursued. Early in life he realized a crippling anxiety about public speaking would impair his career. Beginning long ago with the help of Dale Carnegie, he is now at ease in front of tens of thousands of shareholders, high powered interviewers, presidents, other business leaders, or any other situation required of him.

When we invest in our selves, we are seeking to improve our value to others. The more valuable we make ourselves, the more an employer or customer will pay us. The collection of attributes that create this value are called human capital.

Many aspects of human capital are free. Years ago I became acquainted with a senior officer of a large publicly traded company whose most obvious super power is kindness. After he moved on to a leading role elsewhere, people familiar with him always remembered that trademark feature, and how he had helped them in the past, how he made them feel.

Kindness is free. So are dependability, punctuality, being true to your word, enthusiasm, diligence, and all the other traits we seek when we deal with others. Others desire those same traits in us.

Some aspects of human capital require time and money, sometimes lots of both. Think of the education and training required of surgeons, for example. Educational paths and career planning are beyond the scope of this essay, but the value and wisdom of all of your choices ultimately comes down to whether you figure out how to add value to the rest of society.

We have heard the idea of “follow your passion” debated back and forth. Understand the difference between doing what you are passionate about, and being passionate about what you do. One of them has a wider range of opportunity than the other.

The source of our wealth is our earning power, which arises from our human capital. In future letters we will talk about how to manage the fruits of your human capital, but it all starts here.

Clients, if you would like to talk about this or anything else, or suggest ideas for future letters, please email us or call.

Toxic Negativity, Interest Rate Edition

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Economic theorists are devoting a lot of analysis to the extraordinary exertions of central bankers, recent and planned, in their attempt to shape the economy to their wishes. Increasingly, we read and hear justifications of negative interest rates in connection with potential future “policy tools.”

Our life experience has taught us all that interest is the price of money. If you borrow money, the price you pay is interest. If you lend it out or deposit it, the price you receive is interest. A lot of things go upside down when you make interest rates go negative.

Can you imagine your bank balances declining every month because the bank charged you interest on your deposit? Or being paid every month to owe on a home mortgage?

Some Federal Reserve officials seem to have convinced themselves that this would all work out very well. The Federal Reserve would be able to distort things so we would spend more money than we otherwise would, which is often its goal. But we believe they are ignoring a huge problem, one that is right out in the open. It may take a little common sense to see it.

One of our bedrock beliefs about money, perhaps for most of us, is that we know how bank accounts work. There have always been special features attached to money in bank accounts. We understand it to be guaranteed, safe, and it will always be there. It is backed by the government via F.D.I.C. It does not fluctuate or lose value. We all know how this works.

But in the world of negative interest rates, money in bank accounts would no longer be like “money in the bank” as we have always understood it. It would not be safe, it would lose value, it will not always be there. Negative interest would eat it up part of it over time.

We have questions. As we watch our saving get chipped away, would we patiently listen to the theories of the economists about how it was all good? Would the average person conclude that the money has been ruined by the government? Would there be resentment against the Federal Reserve for taking action to impair our savings when it decides we are not spending enough?

Bottom line, part of the magic elixir that makes the modern world run is faith in our institutions. Destroy our traditional idea of how bank accounts work, and see if that lasts. We don’t know.

As we monitor this troubling trend, we’re formulating ideas about how to deal with it. Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Letters to our Children #4: Create Your Own Adventure

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Narratives, or stories, are how we understand the world and our place in it. They may play a powerful role in helping you form and reach your major aims. For example, my own narrative about working to age 92 has given our enterprise a vitality and dynamism that those coasting toward retirement may lack—among other benefits.

While your story is highly personal and unique, we often see these three patterns:

1. Younger clients are often aiming at building financial security, establishing homes and careers, within the longer term goal of becoming financially independent.
2. Some of our clients are retirees whose narratives involve being a good steward of their wealth, enjoying life by living modestly but well, and aiming at leaving a legacy to succeeding generations.
3. Others are more focused on travel or other things that were not possible during their working years, and having the cash flow to comfortably support those things.

The foundation of your narrative is your core principles, or what you are trying to do with your life. When your story connects with the most fundamental thing about you, it may be more likely to become true. What are the three most important things in your life?

Where and how do you want to live? What role will family play in your activities? How will you spend your time? Will you work at something you enjoy for pleasure in later years? Is entrepreneurship in your future?

You do yourself a big favor when you realize that life is your own adventure. You can create it.

Sometimes your story has to change because life happens. One chapter ends and a new one begins. We are almost never done with new chapters and new stories. Resiliency and adaptability, making the most of what you have to work with, are useful additions to any story.

Clients, if you would like to talk about your story or anything else, please email us or call.

Saving for a Successful Retirement

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When you picture a successful retirement, what does that look like to you?

To some people a successful retirement means luxury cruises, European vacations, and a big house with a pool for the grandkids. To others a successful retirement might mean a quaint cabin with a porch to watch the wildlife from. Some people picture retirement as never having to work again, others might view retirement as a new stage in their working career where they can focus on their hobbies and passions.

The answer to this question is going to have a lot of impact on your retirement planning. If you want to build your dream house and have a second vacation home on the beach, you will need to save a lot more than if you just want a quiet cabin near the fishing hole.

When you go looking for financial planning advice some sources will recommend saving as much as 25% of your earnings for your entire working career. We have known some impressive savers in our day and watched them build incredible nest eggs through the magic of compound returns. We know many more who saved far less than that, though, and not many of those would consider their retirement a failure.

A cynic might conclude that financial planners have a vested interest in trying to convince you to save and invest as much money as possible with them. A more charitable interpretation might be that they want to make that luxury retirement lifestyle possible for you. That takes a lot of money, and if that is the retirement you want you would do well to heed those aggressive saving recommendations. But you might also consider whether that is the retirement lifestyle you want or need and adjust your financial plans accordingly.

There is no one size fits all plan for retirement, and you might not even know what you want to do with your retirement at this point. Obviously, the more you save, the more options you will have in retirement. But we think it is also important to have a little fun every day. You never know how long you have left, and it does you no good to live like a monk to fund a retirement you may not get a chance to enjoy.

Clients, if you would like to discuss your financial planning, please call or email us.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Letters To Our Children #3: The Outlines of Planning

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The object of planning is to figure out your primary aim or goals in life, and what you need to do to get there. The habit of rethinking these things from time to time and assessing your progress keeps you on track.

It is helpful to think in terms of narrative – stories – that describe what you are thinking about. For example, if your story involves retiring to a home in the mountains, your life between now and then will be shaped by that goal. You might vacation in your intended destination, get a feel for the lifestyle, the real estate market, activities, how your life might look in retirement. The narrative may motivate you to do what you need to do to make it a reality some day.

No matter how distant your goal, you’ll be better off if you know how much wealth you might need to get where you want to go. So there is some arithmetic and financial planning to do.

Getting down to details, we think there are several broad categories that need attention in a comprehensive plan. People are better off when they think about and manage:

• Human capital, or earning power, and careers.
• Investing wisely, managing financial assets.
• Spending well, managing the budget and liabilities.
• Residential plans, where do you want to wake up every day?
• Educational funding plans for children or other relatives.
• Retirement intentions.
• Exposures to loss.

In subsequent letters, we will get down to details in each of these areas. Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Convention Time Again

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One of the best and biggest gatherings of financial professionals is coming up. LPL Financial’s annual Focus Conference presents a number of opportunities to gain education, perspective, and more.

Because we 16,000 registered representatives are free to build our businesses in accordance with our own principles and interests, a wide range of presentations are held. These are conducted by an incredible array of company and industry talent, as well as peers.

Our investment philosophy and portfolio management operations are mature. We’ll be looking for ways to enhance our productivity and speed of execution, as well as potential new research and information sources.

We have a deep interest in communications theory and practice as applied to the 21st century venues we use to keep in touch with you. Fortunately, some of the most talented people in the industry (maybe the world) will be available. They understand what we’re doing at 228Main.com, they have helped us all the way along, and we expect to make more progress on our plans for the future.

The cast of characters includes communications professionals in LPL departments, as well as specialized consultants like Scott McKain and Amy Florian. McKain is the author of ‘Create Distinction,’ a business best-seller that has inspired us over the years. Florian is an expert in helping advisors communicate more effectively with those who have experienced loss or difficult transitions. I’m looking forward to working with them again.

Over my long association with LPL, I’ve been fortunate to build close relationships with the leadership team. Most of this happened in the last four years, as many people in managing director and executive roles became readers and followers of our blog and social media. As we sort out the best structure for our business going forward, these connections are a great help.

I have breakfast and lunch meetings scheduled each day of the conference with key players on my LPL team. With all this, plus gatherings with friends and colleagues from around the country, it looks to be another exceptional experience.

Clients, if you would like to talk about this or anything else, please email us or call.

Letters to Our Children #2: The Journey

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This project is rewarding, from our perspective. We are crowd-sourcing the topics for these letters to our children about money and life. Your response has been terrific.

A wise person among you suggested ‘enjoy the journey’ is key. It makes sense to talk about this early in our series, since it has everything to do with how we go about life. The implication is that the journey, not the destination, is the important part.

When you think about it, arrival at a destination (or achievement of a goal) is a temporary thing. Once the goal or destination is reached, you’re there. Then what? A new goal, a new destination. We spend far more of our days on the way than in actually arriving.

In financial terms, the satisfaction of saving something every payday is a way to enjoy the journey. The destination, perhaps a pot of wealth big enough to retire on, is a long way off during the early and middle phases of your career. It is hard to focus on a destination that may be decades away. It’s much easier to get in the habit of enjoying small steps along the way – the journey.

Recently, in the security screening line at the airport, a fellow traveler in an adjacent line loudly inquired why the conveyer belt on the baggage scanner up ahead was stopped. The identification checker replied they did not know. “Well, don’t you think you better go find out?” Of course, the belt frequently stops when additional scrutiny of an item is needed.

The traveler immediately in front of me got to the identification checker, who asked “How are you today?” The fellow quietly replied, “Terrific. I’m grateful I’m not THAT guy,” nodding toward the foot-tapping, sighing, unhappy person. All within earshot were smiling; the dyspeptic was unconscious of his role in the conversation.

This vignette is a case study in literally enjoying the journey—or not. It’s about making the most of where you are, what you are doing, who you are with.

Our focus in this series will be more on the process, the getting there, the journey, not checklists of goals one ‘should’ accomplish. We believe this is the happier path.

If you have questions about this or anything else, or more topic suggestions for this series, please email us or call.