A Way To Reduce Poor Financial Decisions And Build More Wealth

Sleeping man next to water fountainThings sure felt great at the top of the market in 2007. Stocks were on fire. Real estate could do no wrong. Turning 30 was only slightly depressing for several days. I even remember being surprised at how little then President George Bush was making vs. a third year VP in finance. Then the bottom fell out of in 2008 as Bear Sterns and Lehman Brothers went buh-bye. Friends were getting fired left and right and all of a sudden nobody wanted to spend money anymore.

Things got so bad that I finally stopped feeling sorry for myself as my net worth took a plunge and started Financial Samurai in the summer of 2009. I had been putting it off for a couple years since work was so busy. Writing was a cathartic way of easing the financial pain. Reaching out to others online helped me put things in perspective that the world was still turning despite what the media constantly reported. Eventually the worst passed and we began to recover.

The events of 2008-2009 serve to remind me how incredibly naive and stupid I was to think the good times would last forever. Up until 2008, nothing noticeably bad had happened to me. I got into a decent college, miraculously passed seven rounds of 55 interviews to land my first job, was able to get a promotion to a new firm in SF two years later, made VP in 2005, and finished up my MBA the very next year. What could go wrong but everything.

Remembering poor financial decisions is a great way to counteract frivolous spending as well as minimize greed when it comes to investing. The method I use is called “Financial Mean Reversion,” which states that in order to justify spending unnecessary money, I’ve got to first make up for my spending errors.

SOME DUMB FINANCIAL MISTAKES OVER THE PAST 10 YEARS

How To Know When To Take Profits In Growth Stocks?

Sina stock on fireFor those of you who bought SINA, BIDU, and RENN in May 2013 when I wrote “Should I Invest In Chinese Equities?” there are some great steak restaurants we can go to next time you’re in San Francisco. The stocks are up 35-65% in three months as the herd finally latches on to their potential!

The number one question we should ask ourselves when our unicorn stocks are going ballistic is: When is it time to take profits? Clearly such performance cannot continue indefinitely and at some point there will be a painful correction. The worst thing one can do is go from making big bucks on a stock to losing money.

One of the other mistakes I’ve consistently made in my 15+ years of investing is selling too soon. Anybody who invested in the mid-90s until now has seen the Asian crisis of 1997, the dotcom bubble of 2000, bird flu pandemic in 2003, and the mortgage market collapse of 2008 destroy a lot of wealth. We have been conditioned with fear to temper our greed, unlike those who just started during or after the latest crisis.

In this post I provide some psychology behind growth investing and when to lock in profits for maximum risk adjusted returns. Please note that executing on such insights is much harder than just providing a framework due to fear and emotion. I make suboptimal trades all the time.

KNOWING WHEN TO TAKE THE MONEY AND RUN 

How Do Hedge Funds Make So Much Money? An Inside Look At The Best Business Model In The World

888 Park Ave - Hedge Fund HQElephant hedge fund managers make $100 million a year CEOs look like mendicants. Guys like David Tepper from Appaloosa, George Soros from Soros, Ray Dalio from Bridgewaters Associates, and James Simons from Renaissance Technologies have all pulled in $1 billion+ paydays for one year’s worth of work before. Is there any wonder why some of the brightest minds want to rush into the hedge fund industry after getting their MBAs or PhDs in mathematics? Saving the world will just have to wait.

The reality of the hedge fund industry is that performance has been piss poor for a while now. Just take a look at the Hedge Fund ETF, HDG as one financial benchmark to gauge performance. The index is up a paltry 2% as of July 2013 while the S&P500 is up over 17%. To pay a 2% management fee and 20% of profits to underperform the broader index by 15% is a travesty. Investors need to demand better.

We only hear about the great hedge fund success stories and the spectacular failures like Long Term Capital Management and nothing in between. Much like in the startup business, most hedge funds fail because they are unable to outperform the markets over a three year period to raise enough capital to make a worthwhile profit. The industry is seeing fee compression given returns have been so poor. That said, all it takes is one or two years of hitting it out of the ballpark to make your mega-millions and retire.

I firmly believe the hedge fund industry has the best business model in finance, if not the world today. Those in the software industry might argue otherwise!

A VISIT TO 888 PARK AVENUE, NEW YORK, NEW YORK

The DVD Rental Method to CD Investing: The Only Way To Achieve Max Yield

When we first bought our $1,200 HDTV six years ago, we told ourselves never to go to the movies again until we watched enough DVDs to pay for the purchase.  Every time we went to the movies, we’d have to pay on average $20 for tickets.  A promise was made that only after we watched 75 DVD rentals ($1,500 bucks in movie tickets saved – $300 for Netflix fee), would we treat ourselves out to the theater. We reached our goal within two years, and in the four years afterwards we’ve only gone to three movies!

We realized that once we went through the initial 6 month waiting period for the latest movies to come out on DVD, all was fresh again.  We’re now programmed to watch movies with a 6 month lag, bringing us the same opening night excitement.  The annoyance of someone sitting right in front of you in an empty theater and jabbering away is no more!  Furthermore, a 52″ screen and six point surround sound system sure helps replicate the big screen experience!

THE DVD RENTAL METHOD OF CD INVESTING

Dealing With Fear And Greed To Become A Better Investor

Black Swan Event InvestingThe first half of 2013 closed up an amazing ~15% despite the recent volatility in the markets. We are tracking way ahead of where I thought we’d be (+9% for the year) and if things keep up we’ll return 30% by Dec 31. It’s unlikely the second half of the year will be as strong as the first half but we can always dream can’t we? I’ll be happy if we get back to 1,650 on the S&P 500 (3.5% upside).

The markets are currently in a transition period as the Federal Reserve reduces its quantitative easing. I’ve taken the sanguine view that higher interest rates are a positive reflection of the economy due to rising demand for money. Interest rates don’t move in a vacuum.

Housing is the big question mark now. Will a 4.5% 30-year fixed mortgage rate start curtailing housing demand given the rate was 3.5% only a few months ago? Absolutely. Add on a 12% nationwide increase in housing prices year over year, and buyers are getting squeezed. If housing slows down so do the earnings for major lending institutions. You can see a cycle where layoffs occur if there’s a drastic slowdown causing a decrease in demand for credit that ultimately hits earnings some more.

What I suspect will happen is that greed takes over by both home buyer and financial institution. Home buyers will simply borrow shorter duration mortgages through adjustable rate mortgages to get a lower rate. I’m absolutely fine with ARMs as the spread between short and long duration loans is excessive. Unfortunately, we will inevitably see buyers borrow more than they can afford so hopefully everyone sticks with the 30/30/3 rule for home buying. Financial institutions will figure out ways for borrowers to get their loans and sacrifice credit quality to meet their numbers.

BUCKLE YOUR INVESTING SEAT BELTS!