What do Dark Suits and Research Analysis Have in Common?

My philosophical question of the day: why do research analysts have to wear dark suits to work?

Using the assumption that good, disciplined stock selection is really based on reading and creating mathematical formula, what an analyst (of any discipline really) wears to work should be totally irrelevant. The thought has bugged me enough to get out of bed tonight. What does a $5,000 Brooks Brother suit say about your ability to research equities? Absolutely nothing. The problem lies in the causal inference that we deduce from that $5,000 suit. The analyst can afford a $5,000 suit. They must make a lot of money. They probably make all their money picking stocks. They must be a good analyst.

The Brooks Brothers suit and one's ability to research equities are totally unrelated. One might say that the guy who comes to the office dressed down is the best potential analyst or money manager. He is so confident in what he actually knows, he doesn't need a suit to overcome anything. Now I'm not saying wearing the suit is a bad thing. If it makes somebody feel good, feel confident and they can afford such a suit, why not? But I know I'd rather report to the office in khakis and a polo.

So what's with the suit? It's a confidence game. If the guy down the hall is wearing a suit to work and looks good, I better wear a suit and look good. It impresses the office. It (may) impress the boss. It impresses clients. But in reality, it says nothing about performance. It's actually counter to the underlying principles of investing. A $5,000 suit is a lot of money that could have been reinvested in oneself to generate more money in the future (your job). Impressions are everything when they are used to cover weaknesses. No outfit can define an athlete, musician or engineer. Their talents are raw and not masked by impressions. But the business world is stuck in impressions. Impression about how much money one (or a company) makes is irrelevant and fundamentally a negative indicator for how much one could actually make.

Don't buy the man in the suit.

Note: For future business interactions where I have the upper-hand and know my shit, dress like I don't. The adversary will underestimate my abilities.

Minimum Wage: A Short Perspective

Today, the minimum wage bill failed to pass through the Senate. The bill would have raised the federal minimum wage from $7.25 to $10.10. While I don't necessarily agree that an act of Congress should be the best motivator to pay your employees a living wage, something needs to be done, and fast. Certainly there is no easy solution. Raising the minimum wage could put thousands of small businesses across the country in danger of going out of business. On the other side of the coin though, there is a great abomination happening in big business. The two biggest (or most visible) offenders are McDonald's and Wal-Mart. Deservedly or not, they are the poster boys for this argument. They posted profits of $6B and $16B in 2013 respectively. While those are slim margins based on sales, billions are still billions. How can they post profits in the billions while hundreds of thousands of their workers require government assistance to live?

The federal bailout of the financial crisis of 2008 was unfortunate. The biggest and smartest names in the financial business took risks too large; failing to account for a black swan-esque occurrence. And then it happened, the government had to step in to keep our economic system afloat. Americans went bananas that these "fat cats" were getting bailed out. But isn't the situation at McDonalds and Wal-Mart equally worse? Everyday, the executives of these two companies and their shareholders know they are making a profit only because our societal social nets are catching the minimum wage workers who can't afford to live. Which is the worse of the government bail-outs? Who is the bigger offender?

Controlling Your Destiny

I've been working on this post for a week and still don't feel satisfied with it. I expect many updated versions to follow this initial post but I wanted to put something out there. 

Controlling Your Destiny                        

I went on a run this afternoon in Encinitas, CA. Being a random Wednesday afternoon; how many middle-aged men out and about enjoying the day surprised me. It’s quite obvious that the men I saw are more athletic, have more free time and probably just have a higher quality of life than the average American. It is also quite apparent that these men are not middle managers in corporate America (not to mention the average home price in Encinitas is over $1M). They control their own destinies.

The most fulfilling move I have ever made in my life was to leave corporate America. Being an entrepreneur, for all the ups and downs that comes with it, allows for one to control their life. Being a sole proprietor, you never have to answer to anyone but yourself (or maybe the bank). As I look forward, I don’t envision how I could ever answer to anyone else again in my life. I want to control my own destiny. 

Common wisdom is that entrepreneurship is risky. There’s no guaranteed paycheck, no health insurance, and no co-workers to bitch about the first two with. But is it more risky than having your future controlled by someone else? Or worse: controlled by the market. If you go to work everyday and do a diligent job, it’s most likely you won’t lose your position. But what if the knuckleheads down the hallway are underwriting mortgages to people without jobs at 100 to 1 leverage? Those knuckleheads are putting your job at risk. You are not in control.

Worse than job security is the income limitations imposed by being an employee. A good situation on any investment would be to have minimal downside risk with unlimited potential to make return. Being an employee is the exact opposite. The downside risk is getting fired and having nothing to show, the upside is a 5% raise every year (or as your manager deems fit). What a terrible scenario. As an entrepreneur, you are able to control risk. Risk, in this scenario, is probably best defined as permanent impairment of capital. As an entrepreneur, how much you spend and in what capacity is entirely up to you. How much you make on that spending, the return, is boundless.

Some people are not cut out to be entrepreneurs. They enjoy job security and health care. They like leaving the office at 5pm everyday. They enjoy their guaranteed four weeks vacation a year. But if you can sacrifice those minor luxuries, why would you continue to have your life dictated to you by someone else’s agenda? Take hold. Control your destiny.

Book Review: Fooled By Randomness

My anti-library has grown (and is growing) at a substantial rate. I was fortunate to ignore my usual forced FIFO indexing system and pick up Taleb's first work as soon as it arrived on my doorstep. A few years ago I read  The Black Swan and related many of Taleb's thoughts. He is an individual and deeply reflective thinker. I finally got around to ordering Fooled By Randomness and was not disappointed. This truly is a seminal work. One, I believe, will lead to Taleb winning the Nobel Prize someday. It would be wise to review the notes from this work the next time hubris in thinking sets it. The highlights:

Nero's objective is not to maximize his profits, so much as it is to avoid having this entertaining machine called trading taken away from him. Blowing up would mean returning to the tedium of the university or the nontrading life. Every time his risks increase, he conjures up the tinge of the quiet hallway at the university, the long mornings at his desk spent in revising a paper, kept awake by bad coffee.

Trading forces someone to think hard. Those who merely work hard generally lose their focus and intellectual energy. In addition, they end up drowning in randomness; work ethics, Nero believes, draw people to focus on noise than the signal. 

"never ask a man if he is from Sparta: If he were, he would have let you know such an important fact - and if he were not, you could hurt his feelings"

One of the attractive aspects of my profession as a quantitative option trader is that I have close to 95% of my day free to think, read, and research (or "reflect" in the gym, on ski slopes, or, more effectively, on a park bench). I also had the privilege of frequently "working" from my well-equipped attic.

A mistake is not something to be determined after the fact, but in the light of the information until that point. A more vicious effect of such hindsight bias is that those who are very good at predicting the past will think of themselves good at predicting the future, and feel confident about their ability to do so. 

The argument in favor of "new things" and even more "new new things" goes as follows: Look at the dramatic changes that have been brought about by the arrival of new technologies, such as the automobile, the airplane, the telephone, and the PC. Middlebrow reference would lead one to believe that all new technologies and inventions would likewise revolutionize our lives. But the answer is not so obvious: Here we only see and count the winners, to the exclusion of the losers. 

Finally, I reckon that I am not immune to such an emotional defect. But I deal with it by having no access to information, except in rare circumstances. Again, I prefer to read poetry. If an event is important enough, it will find its way to my ears.

Page 100

the more information you have, the more you are confident about the outcome. Now the problem: By how much? 

So why do we consider the worst case that took place in our own past as the worst possible case? If the past, by bringing surprises, did not resemble the past previous to it, then why should our future resemble our current past? 

whenever I hear work ethics I interpret inefficient mediocrity 

The major problem with inference in general is that those whose profession is to derive conclusions from data often fall into the trap faster and more confidently than others. The more data we have, the more likely we are to drown in it.

As we are cut to live in very small communities, it is difficult to assess our situation outside of the narrowly defined geographic confines of our habitat - Here I will make note: I recently read an interview with Andreesen where he discussed the adaptability of ideas that are produced in silicon valley - tech entrepreneurs there are caught in a bubble where they have no idea what will work in the rest of the country. On the flip side of that, Schultz was enamored with Italian coffee shops and thought they could be very successful in his adopted hometown of Seattle (also FP) some place he knew very well. 

Aside from the misperception of one's performance, there is a social treadmill effect: You get rich, move to rich neighborhoods, then become poor again.

The mistake of ignoring survivorship bias is chronic, even among professionals. How? Because we are trained to take advantage of the information that is lying in front of our eyes, ignoring the information that we do not see.

Remember that nobody accepts randomness in his own success, only his failure

Page 159

The exact same task of looking for the survivor within the set of rules that can possibly work. I am fitting the rule on the data. This activity is called data snooping. The more I try, the more I am likely, by mere luck, to find a rule that worked on past data.

People overvalue their knowledge and underestimate the probability of their being wrong

A journalist is trained in methods to express himself rather than to plumb the depth of things - the selection process favors the most communicative, not necessarily the most knowledgeable.

The epiphany I had in my career in randomness came when I understood that I was not intelligent enough, nor strong enough, to even try to fight my emotions.

Dialectitian - someone who never committed himself to any of the premises from which he argued, or to any of the conclusions he drew from them.

There is no rational reason to keep a painting you would not buy at its current market rate - only an emotional investment. Many people get married to their ideas all the way to the grave. 

Certainly, the odds in games where the rules are clearly and explicitly defined are computable and the risks consequently measured. But not in the real world. For mother nature did not endow us with clear rules. The game is not a deck of card (we do not even know how many colors there are). But somehow people "measure" risks, particularly if they are paid for it. 

At the limit, you can decide whether to be (relatively) poor, but free of your time, or rich but as dependent as a slave.

Rereading those sections after a week away from them was incredibly enlightening (again). I just ordered Taleb's newest book and can't wait to jump my FIFO system again.

The Real Cost of Home Ownership

I have recently begun the process of purchasing a house for the purpose of living in myself. I have always publicly denounced the age-old wisdom that, "a home is your largest investment". Largest and worst I always say. I know this but there is some sense of Americana to home ownership and I'm getting sucked in. I've done extensive research and there are a myriad of articles pertaining to "Rent vs. Own". Most talk about the emotional satisfaction of owning embattled against the excessive secondary costs of owning the property. I could not find one that actually went into, well, the math.


A home is a horrible investment. More so, a mortgage is a terrible investment. The obtainer of a mortgage is paying interest to get principal. That's an astonishing fact, let me elaborate. When one obtains a mortgage, they are paying let's say 5% to get their payment back. To make matters even worse, the banks have stacked the chips against the obtainer. Mortgages are front loaded to pay interest off before principal. Let's look at a scenario:

Your wife fell in love with this beautiful 3 bedroom, 2 bathroom ranch that will be the perfect starter home for your (soon to be) family. You've punched some numbers and found your monthly payment on the $250,000 home will be comparable to your current rent payment: $1,100 at the market rate of 5% after your put 20% down ($50,000). You think, "Great! Home ownership here we come!"

So you're ready to do it! Then your agent tells you your closing costs will be $4,000, your insurance will be $750 a year and property tax will be about $2,500 a year. Bummer. But at the cost of owning a home and obtaining your largest investment, no big deal. You've done it! Closed on your first home.

Month one rolls around and you write your $1,100 check. Where does that money go? Well, $850 goes to interest (rounding) and $250 goes to principal. This is great. Instead of throwing away the $1,100 expense a month like you were with renting, you got $250 in equity back. And this goes on religiously for 30 years, each month you gain incrementally, a little more equity in your house. At the end of 30 years, you are free and your expense column looks somewhat like this:

So to obtain that $250,000 house, you ended up paying $613,011 (total payments + down payment + closing costs + taxes + insurance). Ouch. For real ouch this time. But what is your house worth? It must be worth much for than you bought it for, right? Well I don't have a crystal ball but it's some output of (population growth / new home builds) mixed with a bit of psychology and location preference. Robert Shiller famously documented that home prices from 1900-2000 increased by 0.2% a year over inflation (but no one believes that). So let's be fair and say your home increased in price by 2% annually (which may or may not be the rate of inflation). Now your home is worth $452,840. Awesome!!!

On the flipside, you have to live somewhere so instead you decided to rent through the 30 year period and invest the money from the downpayment, taxes, and insurance in an S&P 500 index fund. You were fortunate to gain the historical 10% per annum over the holding period!

Over the 30 year period, your landlord (wise in the field of purchasing power) also kept up with inflation, increasing your rent 2% per annum for the 30 years bringing your total payments to $537,491. Ouch. But what about that money you have been investing? You put $54,000 down at the start (downpayment and closing costs) and continued to contribute $270 per month (taxes and insurance)  Well, that little nest egg is now worth $1,457,228.

Seeing it on paper is almost surreal. The author will be the first to admit there are many assumptions in this example and a major difference between empiricism and reality (new roof, accelerated payments, renter's insurance, moving costs etc. etc.) that could skew the numbers a few points one way or another but the results provide a large margin of safety:

Owning - ($156,171)
Renting - $919,737

Over a $1,000,000 difference on that $250,000 house that your wife fell in love with. Incredible.

Book Review: The Most Important Thing

I've gotten away from a good habit recently: writing book reviews. I will try to go back and recap my

highlights from recent book readings starting with Howard Marks', "The Most Important Thing". I was initially rubbed the wrong way with Marks being a descendant of the University Of Chicago's oft incorrect EMH. I stuck with it and Marks does a good job explaining the baseline of semi-strong efficiency and then getting into personal interpretations of alpha. Overall, impressive work from a storied investor. While he doesn't ever come out and say it, his underlying investing rational is spot on: don't lose money. The thought-provoking highlights (all quotes):

Like opportunities to make money, the degree of risk present in a market derives from the behavior of the participants, not from securities, strategies, and institutions. Regardless of what's designed into market structures, risk will be low only if investors behave prudently.

When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it's not risky at all. Broadly negative opinion can make it the least risky thing, since all optimism has been driven out of its price.

When everyone believes something embodies no risk, they usually bid it up to the point where it's enormously risky.

Whatever few awards are presented for risk control, they're never given it out in good times. The reason is that risk is covert, invisible. Risk - the possibility of loss - is not observable. What is observable is loss, and loss generally happens only when risk collides with negative events. 

The worst loans are made at the best of times. This leads to capital destruction - that is, to investment of capital in projects where the cost of capital exceeds the return on capital.

When buying something has become comfortable again, its price will no longer be so low that it's a great bargain. Thus, a hugely profitable investment that doesn't begin with discomfort is usually an oxymoron. 

You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a fixed notion as to what you want to own. An opportunist buys things because they're offered at bargain prices. There's nothing special about buying when prices aren't low. 

Mujo means cycles will rise and fall, things will come and go, and our environment will change in ways beyond our control. Thus we must recognize, accept, cope and respond. Isn't that the essence of investing? (Potential fund name)

The critical observation is that the [investor] pursues high returns, even in a low-return environment, and bears the consequences - increased risk - although often unknowingly. 

Investors are right (and wrong) all the time for the "wrong reason." Someone buys a stock because he or she expects a certain development; it doesn't occur; the market takes the stock up anyway; the investor looks good

I don't think many money manager's careers end because they fail to hit home runs. Rather, they end up out of the game because they strike out too often - not because they don't have enough winners, but because they have too many losers. And yet, lots of managers keep swinging for the fences.

Investing defensively can cause you to miss out on things that are hot and get hotter, and it can leave you with your bat on your shoulder in trip after trip to the plate. You may hit fewer home runs than another investor...but you're also likely to have fewer strikeouts and fewer inning-ending double plays. 

In heady times, capital is devoted to innovative investments, many of which fail the test of time. Bullish investors focus on what might work, not what might go wrong. 

When investor psychology is at equilibrium and fear and greed are in balance, asset prices are likely to be fair relative to value. In that case there may be no compelling action, and its important to know that, too. When there's nothing particularly clever to do, the potential pitfall lies in insisting on being clever.

In good years in the market, it's good enough to be average. Everyone makes money in the good years, and I have yet to hear anyone explain convincingly why it's important to beat the market when the market does well. No, in the good years average is good enough. 


The Most Important Thing