Friday, October 7, 2016

How ordinary investors achieve great wealth

I’ve been on a stretch of reading a bunch of investment books recently. This latest one provided some interesting insights.
I love reading about how ordinary people create extraordinary wealth. These are the sort of stories that the average person can relate.  It’s not as much fun reading how some rich kid with the trust fund has become a multimillionaire, or even how someone with incredibly astute investment acumen like Warren Buffett has become a multi billionaire.
The reality is very few of us have parents that have left us multimillion dollar trust funds or have an ability to generate run rates of return on invested capital in excess of 20% over multi decades. That’s just not very realistic.
It’s much more interesting and relatable to hear how the local librarian has left in an estate of $4M to his local school or how a widow willed an $8 million estate when she died.

Along the same lines I happen to read a book recently Ordinary People Extraordinary Wealth by Rick Edelman. This book profiles thousand clients of a financial planning firm who managed to achieve some measure of long-term wealth. Admittedly the book is a little dated but it still contains some interesting insight. I’m going to dive into a few of the observations that struck a chord with me.

Don’t pay off your mortgage

While I now understand the virtues of keeping mortgage debt, it took me some time to get comfortable with the fact of keeping a meaningful amount of debt in place while investing cash flow that would’ve otherwise gone to pay down that debt into more productive assets.
That’s something that I can relate to now with interest rates at all time lows and locking in that low cost of debt for a long time. However that wasn’t always the case. Culturally I have a major aversion to retaining any kind of debt and have always had a desire to have that paid down.
Edelman’s book emphasized that one of the key tenants to long-term wealth is maintaining a hefty mortgage, maximizing your interest deduction and after-tax position and using free cash flow to generate a productive return on other assets.

Avoid active money management

Active money management has almost become a dirty word over these last few years. It seems that there are more and more stories in the media about how dismal active money manager financial returns are net of fees, and how 80% of money managers typically failed to beat their respective indexes.
Frankly that’s a view I’ve always held, however this is another point that came through in the book. The majority of the investors profiled typically stuck to some combination of passively managed index funds and avoided all active management. When you consider the financial returns of active managers and the fees that are charged, it’s not hard to understand why this is the case.

Limited investment turnover

This is probably my favorite point in the whole book. I’ve long believed that we as investors can be our own worst enemy as far as becoming too inpatient too soon and wanting to constantly make changes.
Excessive handling of your portfolio is like handling a bar of soap too much. Eventually, the bar of soap would be whittled down into nothing if touched too many times. The most successful investors typically only turn over their portfolios once every 3 to 5 years.  And thats only very select assets within their portfolios.
This is a lesson that I have to remind myself on a regular basis and it was good to get some additional reinforcement from this book.
In fact the investors that were profiled were so dispassionate about their investments that they very rarely bothered to check the values of their holdings at regular intervals.
Electronic trading accounts and real-time access to stock quotes have done many investors a disservice by making it far too easy to move in and out of a position. We are trading businesses like we’re going to the supermarket to buy groceries. It’s all too spontaneous.
Reminding ourselves that successful investors very rarely trade positions, let alone check pricing on those positions, is a good reminder for us all.

Limited attention to media

The observation of paying limited attention to the financial press was a very interesting one as well.
I think part of the reason that investor turnover has increased so significantly in addition to the ease of making trading decisions is the 24 x 7 news cycle that we are exposed to in the financial press.
It’s hard to escape the blow-by-blow details on company stock price movements economic activity interest rates etc. that bombard you on a regular basis.
What was unique about the successful investors was that they rarely gave new stories attention and if they did it was more for curiosity than anything else.
More often than not the financial news was typically just entertainment. Stock recommendations weren’t acted on. This provided a very useful reminder to me.
In the current period we have constant fears about poor economic activity, interest rates increasing, China spiraling into recession, Brexit, European economies going into recession.
The number of negative news flow stories at a macro level let alone on a company specific level would be more than enough to make most people fearful and panicky.
The fact of the matter is high-quality businesses continue doing exactly what it is that they been doing irrespective of economic events or the new cycle around them.
As investors we would do well to heed this advice also.
On balance I really enjoyed reading Edelman’s book. While the insights themselves were fairly basic it provided a refreshing reminder of all the basic blocking and tackling that one has to do to become a successful investor. Sometimes we lose sight of the basics and make investing more complicated than it needs to be.
This book was a very useful reminder of why it’s important not to lose sight of the basics

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