A New Model for Successful Investing

There is a saying that the way of thinking that got us to where we are today will not be sufficient to get us to where we need to go in the future.

This is a long post (perhaps my longest to date on this blog) but is utterly needed given the crazy state of the financial world we are living in. In the following words, you’ll see my approach for navigating this mess, and how you can also do the same – while getting a great night’s sleep in the process!

Why should you listen to me?

I am not an investment professional. Everything in this post is simply my opinion. However, I have spent a long time educating myself in this topic. I have a degree in Finance, worked briefly at one of the world’s (formerly) esteemed asset management firms (Merrill Lynch) and was at one time a fairly active “investor.” I say “investor” with “” because I now know too well that speculator would have been a far more fitting term. I’ve gained and lost money and think that people can learn from my experience.

My goal in this post is not to scare you, but simply to shed a little light on what I think might be a way out of this mess for many of us.

There Is Always A Bigger Fish.

Let’s first talk a little about the whole finance industry itself. It’s all built on trust. Specifically, the trust that a financier needs to earn from their investors. It’s a business based on sure things. After all, why would anyone throw their hard earned dollars after something that might not work out in their favor?

While in reality, there are no sure things, in the world of finance, people make a boat-load of money trying to sell you stuff like it is. To close this inherent gap between possibility and reality some of the brightest minds on our planet are employed (or at least were) in this task. It is no surprise that funds invested in equities, commodities, derivatives and other arcane asset vehicles reached epic proportions over the past decade.

Just imagine if the thousands of brilliant MBA/PhD-types applied their skills to political, non-profit or environmental causes instead of going to Wall Street……wow, what a different world we would be in…but I digress…

I have learned that in the world of finance, as in most things, there is always a bigger fish than you. Even if you are a billionaire, there is someone who has more money or more pull (e.g. a foreign government). In finance, it’s the big fish that get paid first when the sky starts to fall. So when Wall Street starts to melt down, unless you are one of them, you better expect to be last in line holding your tin cup.

Since early 2000 – after starting work full-time, I changed my investment approach in a major way. In place of managing a complex array of stocks and options in my portfolio, I started selling my individual stocks and replaced them with more manageable (and in my mind less risky) diversified mutual funds, sector-based ETFs  (exchange traded funds) and other value-oriented funds developed using computer models through FolioFn.

I wanted to get out of the game of stock-picking – realizing too well that the so-called experts trying to sell stocks using overly complicated analysis were using models built by kids that graduated college at the same time as me, and were just as clueless about how businesses really worked. It didn’t make sense, so I wanted to get out of the game.

I felt like I was being chased by far bigger fish, and it was true. I had little to no information advantage for any of my trades.

I continued this trend for a few years, moving a large chunk of my investments into index funds tracking the S&P 500 or the Morgan Stanley International Index. Again, I didn’t want to be in the game of researching and trying to pick individual stocks.

A little over a year ago, seeing the housing hysteria reaching an absurd peak (and starting to crumble in areas like Miami) I started liquidating. Eventually, half of my net worth was sitting in cash or cash-like assets. I even bought a CD for the first time in my life.

It felt a bit odd owning a CD. I even called my brokerage one day to check on the maturity date for it and they commented that someone my age could really stand to have more equities in my portfolio. Yes, the salesmen were just doing their job.

Even more odd, every evening I would look out from my balcony in downtown Bellevu, Washington (one of the most affluent suburbs in the country) at the half-dozen cranes building luxury condos for people who needed yet-to-be-created high paying jobs to afford their crazy mortgage and HOA dues. I saw people who made far less than me spending far more. Again, things just didn’t make sense. So I wanted out of the game. I sold, sold, sold.

Last fall, when the shoe finally dropped, the remaining 50% I had invested in the market got hammered, just like everyone else. Whenever there is panic, I find that the best thing to do it nothing. So I just sat tight, at least initially. Emotions generally do not lead to the best decisions when it comes to financial matters. This much I learned from my early days as a speculator. I am ever grateful for that experience.

However, now that a few months have passed, I’ve been able to re-adjust my portfolio to align with a new way of thinking that in my mind is far more capable of taking me to where I need to go financially in the future.

I now have almost all of my net worth in 100% cash or cash-like fixed income investments. For those of you who think “wow, Ravi’s really setting a low standard when it comes to wealth mastery,” read on to really understand how this could just be the most powerful strategy around for sustainable and long-term wealth accumulation.

In A Bull Market Everyone Is A Genius.

I majored in Finance. I traded my first stock before I could drive a car. I started reading the financial news practically every day since the 5th grade. When I was 10 years old, I entered USA Today’s stock market contest and did very well, placing at the state level against kids years older than me. I got my picture in the paper. I was hooked.

In college, I traded stocks using my savings, making and losing a fair sum in the process. Lucky for my ego it was the late-90′s. A bull market is forgiving on the foolish. In retrospect, I realize that my gains were at most dumb luck though in the euphoria of the late nineties I quickly devised my own theories about how I was just better at it than everyone else.

Over the summer after my sophomore year of college I went to work at Merrill Lynch, where I worked with people who didn’t seem to know that much more than me, but these very people were creating investment products that were supposed to deliver great returns. Everyone seemed to know how to beat the market. Again, things didn’t make common sense but I figured I was just to naive to understand everything, and went along for the ride.

I remember one day during my time at Merrill Lynch  (I worked as an intern in their asset management division in New Jersey) going to a reception with some of the investment banking interns in Manhattan. These kids, some of whom knew far less about finance than me, were pretending like they actually understood how to dissect arcane financial statements and build models showing how some emerging technology would grow over the next 5-10 years. Everyone thought they had some special gift and were in the know. In a bull market I guess everyone is a genius.

Mind you, some of these kids were english literature majors (no joke) and hadn’t traded a stock in their life. Yet here they were thinking they knew everything about business and high finance. It made absolutely no sense, but no one would admit it.

You Think You Know? You Have No Idea.

During my Junior year in college I had my first real experience with a trading environment, in our derivatives class. It was a more advanced finance elective, and a few days a week we’d crowd into the computer lab where we’d proceed to make or lose a lot of play money while putting to use the strategies learned in the lectures.

Straddles, spreads, strangles….once you learned how to apply them it was easy to go on auto-pilot. You turn into a robot, looking at the numbers on your terminal and just applying the right strategy when it met the requirements that the text-book called for. It wasn’t particularly hard. You just had to put your emotions aside and follow rules, ruthlessly.

Then things took a twist. One day in the lab, Professor Hathaway – a man in his late-thirties who retired from trading derivatives as a professional trader (apparently torturing college students was more fun), started dishing our information to certain people at random times during class. Those who understood how to capitalize on the information would see their profits skyrocket. I remember working with my team-mates (we worked in pairs or triads usually) when he sauntered over and handed a slip of paper with some bad news regarding the underlying stock whose derivatives we were trading.

We pulled the trigger and sold a boat-load of calls before the rest of the class saw the news flash across their screens…we went from almost last place to near the top of the class in profits in just a few minutes! Since our results impacted our grades for the class, this was a big deal. We made a few enemies in class that day :) .

Leaving the computer lab that day I realized that information was really king. Unless you know more than the other investors out there, and have the resources to do something with that information, you can and will get taken for a ride. There is also someone more informed.

The gal next door spending all weekend pouring over Investors Business Daily. The stockbroker spending 50 hours a week reading analyst reports. The analysts spending 80 hours a week researching business models and speaking with CFOs. The investment banker spending 100 hours a week meeting with senior execs gathering inside information. The corporate execs themselves who are actually creating the futures for the companies you are considering putting your hard earned money into. They are all think they know more.

There is always someone who knows more. That person has the edge. Keep that in mind. You might do OK  when the coffers are overflowing, but when times get tough, you’ll be the last one in line holding the tin cup.

Cold Hard Cash

I now have practically 100% of my net worth invested in cash and cash-like assets (includes fixed income CDs, Money Markets). I do not own corporate bonds, stocks or any other asset that is not insured by the government. I do not own real estate (this is as much a lifestyle choice as an investment choice right now for me). This model for investing is not risk averse, it is simply designed and optimized around a different set of criteria.

First of all, this approach is not wholly unique, there are many others out there (search the web) who talk about the strategies I will describe. Specifically, two successful business-people and bloggers Tim Ferriss and Marc Cuban both discuss the issues with buy and hold investing and the equity market in general. You can read their thoughts on their blogs, or just poke around the web and you’ll run across others who strike a similar chord.

I’ll lay out the logic for my new model for success investing. I hope that no-body reads this post and immediately sells all their stocks. That is not the goal. The goal is to get you to think hard about where you are investing your hard earned money. Think about those investments that have been sold to you as sure things or safe investments, and really consider their true nature. Be conscious of where your money is going, and then make adjustments from an objective point of view. Perhaps your own assessment will lead to the same conclusions as me.

A New Model For Investing

Here are a few considerations for my new model for investing. I’ve already put my money where my mouth is. We’ll see how things fare over the coming years. There may be few sure things, but one thing I do know is certain, with this approach I am going sleep darn well at night! Read on to see why…

1. Cut Spending to Increase Your Rate of Return

The biggest return on investment someone can make is through saving. People are always out looking to make a quick buck in the stock market, but nobody looks at their own checkbook or credit card statements. In today’s market, people would do back-flips for the chance to get as little as an 5-10% return this year on their investments. With interest rates so low and the equity markets in duress, that is not likely for most investors.

However, just imagine if you could cut just 10% out of your monthly expenses. Suppose you spend on average $1000 a month on surplus spending outside of basic living expenses. Perhaps by packing your lunch, skipping your afternoon latte and renting movies instead of going to the theater every week you could cut $100-200 a month from that. There you go, save the difference and you’ve just increased your portfolio by 10-20%! Get hardcore about budgeting and cutting back frivolous expenses and you can surely grow your portfolio by 10% or more this year by just saving more.

2. Invest In Yourself

I spend a lot of money and time on personal development. Between yoga training, personal development seminars, books and other things, I spend thousands of dollars a year on training to improve my own skills. Instead of investing money in some company that you think you might make a quick buck from, how about investing a fraction of that money is real skills training for yourself.

These skills: be it a language, leadership, sport, instrument, marketing, presenting or whatever else…..can be parlayed into money-making opportunities down the road. Who knows, maybe the presentation skills training might help you land a far better paying job. Maybe that language training might make you more relevant to a prospective employer. Maybe the martial arts class will give your the confidence to ask for a well-deserved raise. Investing in yourself is the best investment you can make.

3. Invest Where You Are An Insider

Warren Buffet does not buy 100 or even 1,000 shares of a company. He buys enough to get the attention of the executive staff of the companies he targets, and in most cases he invests enough to actually have controlling interest in the company. If you are going to invest in a company, you need to have an information advantage. This can either come through really and truly knowing more about an industry, or perhaps through investing in a small company where you actually have a say in the vision and future product direction of the firm.

4. Put A Value On A Good Night’s Sleep

The models we use to calculate rate of return on our portfolios are woefully inadequate for the modern world. What if your portfolio had a 1 in 9 chance of doubling this year….but an 8 in 9 chance of dropping by 20%? What if you have to live like that year after year for 10 years? How well would you sleep? Contrast that with being guaranteed a 3-6% rate of return in low-risk income products. How well would you sleep with that guarantee?

For the past year I have slept very well, and now that I am in all cash I really really sleep well. There is a huge value in this. Most of us never think about it, but I urge you to factor your own stress and sanity into your financial planning. It is priceless.

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So there you have it. I hope this has given you a fresh perspective for navigating the financial mess we are in right now.

It does not have to be scary.

You can be in control.

Just take some time top think about what you are really after financially, get hardcore about your expenses and budgeting, and at the end of day just be sure to set a little something aside for the biggest investment opportunity available to you right now, yourself.

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5 thoughts on “A New Model for Successful Investing

    • My tune has changed since I wrote this article, though a few things have stayed the same:

      I have my assets invested in an ultra low cost index fund (balanced across US/global stocks) with a small percent of assets in bonds and cash. In addition I do own a home.

      I still do not own a single individual stock, and haven’t purchased one since I wrote this article. My investments are passive. I don’t gamble with savings.

  1. Good article! I myself am a financial engineer and I have seen a lot of people get caught in the hype of certain stocks. The psychology behind the movement of stocks is fascinating.

    But if there is one thing this debacle has thought us (which should have been learned after the demise of Long Term Capital Management) is that Financial Modeling is and Risk Management modeling is such an amazingly small part of the equation, yet it is being relied upon as a lifeline of most financial institutions out there! NONE OF IT WORKS during times of duress (I know because I’ve worked on such models)! Lehman Brothers were thought to have the best Risk Management practices, and were heavily hedged against adverse movements.

    “Crap in crap out!”

    I especially agree with point nr. 2 in your article. I heard Jim Rohn say sth that stuck with me and that is “work harder on yourself than on your job”. And regardless of the fiscal gains I believe investing in yourself is the ultimate way of living! Like Tim Ferriss says, we are not looking to make the most money, we are seeking to obtain the lifestyle money enables us have.

    Best regards,

    Darri

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