Why investors are no better than lab monkeys
If an investment opportunity seems too good to be true, it probably is. In his latest post, Mark Ford shares some cautionary tales for investors, and the three> READ MORE
If an investment opportunity seems too good to be true, it probably is. In his latest post, Mark Ford shares some cautionary tales for investors, and the three> READ MORE
As a parent, I often struggle to teach – by example and by word – my kids about money. To set myself straight, I sometimes remind myself of what I learned> READ MORE
This week, Mark Ford passes on a reminder that it’s not your salary that makes you rich – it’s what you do with what you earn. Below are some examples of> READ MORE
Today I’m sharing an article written by my friend Tama Churchouse, who with his father, Peter, runs Churchouse Publishing in Hong Kong. Peter and Tama write The> READ MORE
If an investment opportunity seems too good to be true, it probably is. In his latest post, Mark Ford shares some cautionary tales for investors, and the three essential rules for rational, profitable investing.
Are investors no better than lab monkeys?
By Mark Ford
It’s because you are “one of his favorite people” that Melvin, your broker, is telling you about it.
It’s AgriCorp, a little-known company that has developed a new natural herbicide that’s 150 percent better than the chemical treatments currently used.
“But get this,” he whispers furtively into the phone. “In three months, a bill goes to Congress banning most of the herbicidal chemicals currently used. When that passes, AgriCorp’s revenues will skyrocket.”
“Where do you see the share price going if that happens?” you ask.
“Based on projected P/E ratios,” Melvin says, “our analysts figure 3,000 percent. Every thousand invested will become $30,000!”
“But I can only give you 500 shares,” Melvin says apologetically.
Some primitive part of your brain is upset to hear about this scarcity. It fears starvation. But another part, the rational part, is saying, “Be cautious.”
You double-check the story. Melvin’s account of both the product and the pending legislation are accurate.
“What did I tell you?!” your greedy, primitive brain shouts. You buy 500 shares at $10.
Three months later, Melvin calls to tell you that “some big chemical companies have temporarily held up the bill.” There is frustration in his voice. “But it’s going to happen.”
But the share price drops to $5. So your $5,000 investment is now worth $2,500.
“You should double down,” Melvin tells you.
“I can get you another 1,000 shares. Invest another five Gs. It will bring down your average cost from $10 to about $6.65. It’s safer, don’t you see?”
“Plus, with three times as many shares at $6.65, you stand to make more than three times the money!”
“Go for it!” your greedy brain is screaming. “Take caution,” another part of your brain whispers.
“This law,” you say. “You’re sure it’s going to happen?”
“It’s a lock,” Melvin says confidently.
Your primitive, greedy brain likes the sound of “lock.” You write Melvin a check for another $5,000.
Two years later the bill finally passes.
No. In the meantime, another company, AgriStar, has developed a similar product that is better and cheaper.
You call Melvin for advice.
“Just to be safe, put five Gs in AgriStar,” he says.
Great. Your $10,000 investment is now worth $800 and sinking. Melvin wants you to invest more. But you have no more. Life sucks. You consider selling but the $800 won’t exactly change your life. You decide to hold on to those shares and hope for the best. But you know, deep down inside, that you’ve lost a small fortune. You can’t figure out whether you are angry or embarrassed. Probably both.
Picking up pennies in front of steamrollers
There’s a moral to this story, and it’s one thing every wealth builder should know:
When the outcome of an investment depends heavily on some expected future event, it is inherently risky. When that anticipated event comes with a time frame, the risk is exponentially greater.
The good news: You can shorten those odds by being rational.
The bad news: It will be hard for you to do this because your brain is wired to respond to investment opportunities in non-rational ways. (We’ve written about this here).
Many studies have shown this. One of my favorites was conducted at the UNSW Australia Business School by Elise Payzan-LeNestour.
She tracked the decisions of investors given speculative opportunities. And then she compared their behavior with the responses of lab monkeys.
The monkeys were presented with two levers. One always dispensed a small amount of sugar. Another sometimes provided double the sugar and other times gave an electric shock.
Time and time again, the monkeys took the gamble and ended up with lots of shocks and less sugar than they would have received from the safe lever.
The same pattern was evident with the investors. When given the choice between risky investments that offered high returns and safer investments with lower returns, they favored the risk. As Payzan-LeNestour put it, “Investors pick pennies in front of steamrollers because they overlook the possibility of a loss.”
When it comes to choosing safe versus risky investments, Payzan-LeNestour concluded that investors are no better than lab monkeys.
Trust me… I know. I’ve done it. And it’s embarrassing…
I’ve made my share of monkey-brained investments in my life. And almost every one of them involved speculation—the anticipation of some future event with a specific time frame.
My first real estate investment is one that comes to mind. When I was starting our family in Washington, D.C., our landlord came to my wife and me with a “fantastic” moneymaking opportunity.
She showed us charts and graphs illustrating how local real estate prices had been rising for years with lines projected into the future. She also gave us lists of facts that seemed to prove a continuing bull market in property.
According to her calculations, I would double my money in less than three years by buying one of her properties. Knowing nothing about real estate at the time, I acquiesced. I invested about five grand, which was the entirety of our savings at the time, and waited expectantly.
You can guess what happened.
The market went the other way. I quickly lost my $5,000 and continued to lose money as property values tanked. It took me several years and $30,000 to dig myself out of that hole.
I have a recent example and this one is particularly embarrassing. On the advice of a colleague (a very well-known and respected investment guru), I met with a businessman who spent an hour telling me about how much money his business was going to make. He pitched to me based on deals he was making with people—very influential people in our industry that I knew were “good.” He showed me the numbers. They looked promising. So I had one of my businesses lend him a hundred grand.
A month later I learned he was a serial con artist—that he made his living suckering wealthy, successful business people (like me and the guy that recommended him), taking their money, spending it, and then declaring personal bankruptcy. He did it two or three times before he did it to us. Now I’m spending money trying to put him in jail.
What was my mistake?
I collateralized the loan on his business. But the valuation I gave it was not based on its then-current income but on what he persuasively argued it would become.
Had I obeyed my rule about sticking to the present and not betting on the future, I would have asked for some other form of collateral or said no.
Shame on me.
And here’s one final example: I was a member of an informal group of investors for about a dozen years. These were all investment insiders and experts—business owners and specialists and analysts and several financial gurus.
Every so often, one of us would bring something to the table. They were always speculations. But they were within the scope of the expert’s knowledge, so they all seemed like good bets.
How did we do?
I like to say that our track record was “perfect.” We lost 100 percent of our money on every deal.
Rules for rational investors
I said before that when it comes to investment opportunities, most of us do not act rationally, however much we tell ourselves that we do.
Here’s why: Neurobiologists say the human brain is really an organic network. Some parts of the brain do the rational thinking, others facilitate our emotional and primitive instincts.
Emotional intelligence can be extremely useful. And good decisions are made when our rational conclusions, emotional impulses, and primitive instincts line up.
But to make good decisions consistently, we must control our primitive instincts. The part of us that always goes for more sugar and ignores the possibility of loss.
We must tether our impulses to some rational thinking and emotional constraint. As Seth Godin put it, “The amygdala isn’t going away. Your [primitive] brain is here to stay, and your job is to figure out how to quiet it and ignore it.”
And the best way to do this, when it comes to investing, is to adhere to rules of engagement that reduce risk.
I’ve developed three such rules:
Don’t invest in anything you don’t understand. This one is probably the most important, but also the easiest to ignore. The challenge here being that it’s sometimes easy to convince yourself that you understand something when you don’t. When I say you should “understand” a business, I mean you must know it inside and out. You must know how it makes its money, which products are most profitable, what particular problems it faces, what sort of financing it needs, etc.
Never invest a lot of money in any single asset. When it comes to stocks, this is called “position sizing.” You might say, for example, that you will not spend more than 5 percent of the money you have allocated for stocks on any particular stock or no more than 1 percent of your net worth on any particular stock.
To reduce risk further, always diversify your investing across a broad range of asset classes. This is called asset allocation, and some studies suggest it is the single most important factor in long-term wealth acquisition.
These rules are what will prevent my monkey-brained instincts from getting the better of me.
(We’ve written a free report about how to prevent your emotions from getting in the way of your investment decisions… click here to learn more.)
As a parent, I often struggle to teach – by example and by word – my kids about money. To set myself straight, I sometimes remind myself of what I learned about money as a child from my parents…
This is my father’s catchall advice. Going to Mexico with a backpack on your back and a whiff of a job in a town you’ve never heard of? Think before you do anything stupid. Plunging down a new career path with no safety net where you’ll be doing something completely new? Think about where it takes you. Have some cash burning a hole in your pocket? Think about the best possible way you can use it – for today and for tomorrow. It sounds obvious, but thinking (especially about money) is actually quite hard for most people – so they don’t do it when they really should.
2. What money is… and what it isn’t
I learned to believe a few things about money…
A. Money is a way of keeping score. But it’s only one way of keeping score – and it’s one of the less important ways of keeping score. Other things matter a lot more.
B. Money is a tool. It’s a way of getting what you want – whether that’s time, travel, space, or a diamond-encrusted chess set from the Gobi Desert. And usually it helps to have money to make more of it.
C. Money means options. If you have money, the range of opportunities available to you – what you can do with your time – expands dramatically.
D. Conversely, no money equals fewer options. If you’re struggling to make ends meet, your menu of opportunities is limited because you’re focused on making rent or the car payment tomorrow. You can’t choose what to do, because your money requirements are dictating to you what you have to do.
But money is not an end in itself. The day that the number in your bank or brokerage account defines you, is the day that you need a money enema to straighten your head. Hearses don’t have luggage racks.
3. Spend – on things that matter
My mother always did – still does – religiously check prices. Whether it’s for a litre of milk or for a flight to Johannesburg, she’s always wanted to get the best value for her money. So as a kid, I was never wanting for clothing or shoes. But lots of kids had far nicer wardrobes and went on fancier holidays, and their parents drove flashier cars.
However, when it came to education – and to spending on other things that mattered – no expense was spared. My sister and I went to the best schools we could get into – and we escaped (unlike many kids in the west) the millstone of student debt.
4. Have patience
It’s easy – especially when you’re younger – to crave instant gratification. But patience is one of the most under-appreciated, and important, traits that you can instill in a child. Patience is the main ingredient of self-control… and its kissing cousin, delayed gratification – which is one of the best indicators of success later in life. (If you’re not familiar with the Marshmallow Test, you should read this.)
Chances are, if you don’t have patience, you’ll be bad at managing your money. I learned early on about compounding, the most powerful force in finance – which is based on time and patience.
My parents also taught me that it’s OK to have money – and to do nothing with it. A lot of investors feel like they have to use their cash, and they’re compelled to buybuybuy or sellsellsell. As I’ve written before, cash is the best hedge there is: It’s cheap and it’s liquid. At least as importantly, cash represents potential, and options (see above).
5. Talk about it
Most people feel that if you ask someone how much money they earn, what they owe, or how much they’ve saved, it’s like asking them about their deepest and darkest secrets. But in my family, talking about money was normal. That helped take money and financial matters out of the closet for me – and it helped me develop reasonable expectations about my own money life. If it’s a hush-hush secret, money can become part of a twisted psychology of guilt and shame. Air and light from an early age removes that.
6. No one cares about your finances more than you
My parents always told me that the only person you should rely on to look after your money and your financial future is yourself. (This is one of the reasons I started Truewealth Publishing in the first place.)
The financial-industrial complex – the financial media, private bankers, so-called trading gurus, and all the rest of them – wants to “help” you take care of your money. But their “help” often enriches them, far more than it enriches you.
So if you want to make sure your finances are well looked after, then by all means do get input from a professional. But remember that it’s you who is accountable for your own money – and you should be overseeing everything about your own money.
Maybe you learned very different money lessons — and maybe you’re imparting different lessons to your children, if you have them. But these six teachings have served me well.
This week, Mark Ford passes on a reminder that it’s not your salary that makes you rich – it’s what you do with what you earn. Below are some examples of the out-of-control spending habits that have brought some of America’s wealthiest athletes to their financial knees – and how you can avoid a similar fate.
How to spend yourself poor
By Mark Ford
Making more income is the best way to build wealth. So long as you don’t spend it as fast as you make it.
In other words, the short-cut secret to getting wealthy quickly and efficiently is to:
What do I mean by “the lion’s share”? Between 70 percent and 90 percent depending on how close you are to your Magic Number.
(Net investable wealth is the term I use what you have after you deduct two asset classes from your net worth. One includes the money you have set aside in your “start-over fund” (cash, coins, etc.). Another includes the value of your house and any other tangible assets (such as jewelry or family heirlooms) that you want to keep for the rest of your life.)
(Your “magic number” is the amount of money you need to have saved and invested in order to quit work and enjoy retirement. That is, a lump sum of money that can provide enough interest income to live off of.)
Most people don’t do this. As their income rises, so too does their spending. Some actually spend more than the extra money they make.
Why? Because having extra things—a bigger house, a newer car and assorted luxury toys—is what we’ve all been told wealth is about. We work hard to buy this stuff. And then we are happy. The more stuff we buy, the happier we are.
That’s true in Hollywoodland, but in real life the truth is very different. Spending more on “happy” stuff is a junkie’s habit: to get the same thrill (in this case, ego thrill) you need to take bigger hits.
I like to use Mike Tyson as an example. He had career earnings of over US$400 million. And yet, amazingly to me, he ended up tens of millions of dollars in debt. He accomplished this financial feat by spending his money on US$2 million bathtubs, US$3.4 million worth of clothes and jewelry, and two Bengal tigers that cost more than US$10,000 per month to feed, train, and insure. Iron Mike also made some bad “investments” and ran up a multimillion-dollar bill with the IRS.
Recently a friend sent me an article from Sports Chew that provided other amusing examples of out-of-control spending habits. Although these are examples of American sports stars who seem to want to spend themselves poor, there are dozens of similar stories from the rest of the world too:
These are not isolated examples. In fact, according to Wyatt Investment Research, 78 percent of NFL (American professional football) players and 60 percent of NBA (professional basketball in the U.S.) players file for bankruptcy within their first five years of retirement.
Lest you write this off as a “poor dumb jock” problem, consider this: The average American has more than US$200,000 in total debt and less than US$1,000 in savings.
There are several lessons to be drawn from this:
Wealth acquisition, as I said in the beginning, has everything to do with increasing your net investable income and saving an increasingly larger percentage of it. When you boost your income, give yourself a reward. Buy or do something fun. But don’t spend more than a small fraction of that extra income. The rest you should put into savings.
Today I’m sharing an article written by my friend Tama Churchouse, who with his father, Peter, runs Churchouse Publishing in Hong Kong. Peter and Tama write The Churchouse Letter, a monthly publication about investing in Asia, along with a free email called Peter’s Perspective, which you can sign up for here. Today, Tama writes about bitcoin, the (possible) currency of the future, and how you can learn to trade it.
Why you should buy US$100 of bitcoin
By Tama Churchouse
Do you remember the first time you ever bought a stock? I do. I remember being nervous as I drafted and re-drafted that first buy order email to the broker.
I wanted to make sure I got it right. I didn’t want the broker at the other end to see me for what I was, a naïve teenager out of his depth.
I remember I’d come across the term GTC, short for “Good ‘til Cancelled”, an order that is in force until either the stock is bought, or the order cancelled.
So, I threw in a “GTC” at the end of my order for good measure. That way, I thought, he’d know I was a pro.
Over time, buying and selling stocks has become routine. Now it just takes a few clicks of a mouse, and tens or hundreds of thousands of dollars of stock can be bought or sold in an instant.
I used to feel a little surge of adrenaline when I placed an order. But that has long faded.
I bring this up, because recently I went through the process of buying an asset online that rekindled the feelings I had all those years ago as a teenager placing his first stock buy order.
I was a nervous. It wasn’t a small amount of money at stake. But more importantly, it was not a process I’d been through before.
But over the past few months, as I’ve traded a bit more, and gained some familiarity and comfort with what I’m doing, and I’m now at ease at moving around this asset, and trading it.
As the title of this short missive suggests, I’m talking about bitcoin.
A bit about bitcoin
Bitcoin is digital money that is created and held electronically. At the core of bitcoin technology is a kind of super database called the “blockchain.” The blockchain is public and accessible to anyone, just like the internet.
The blockchain contains every transaction in the history of bitcoin, and is constantly growing. When you use bitcoins to buy something, a global network of computers checks the blockchain database, verifying that you own the bitcoins. It’s like thousands of computerised notaries automatically checking, authenticating and guaranteeing every transaction.
This is different from using a credit or debit card. When you buy something with a credit card, a financial middleman, like a bank, verifies every transaction. This takes time, and they charge you a fee for the “service.”
In a bitcoin transaction, the verification and transfer are performed instantly by the blockchain. There is no middleman. A lot of people think that as bitcoin-like technology matures, it will be used to process everything from stock trades to voting. These more efficient, less costly transactions could end up saving individuals and corporations billions of dollars – while making them far more secure.
As the possibility of a bitcoin ETF grows, so does its price
Bitcoin and blockchain are all over the news right now, with bitcoin currently hitting all-time highs, in part on speculation about the possible approval by the U.S. Securities and Exchange Commission (SEC), the American stock regulator, of the first bitcoin ETF.
If the ETF is approved, it’s assumed that plenty of buyers will flock to the ETF, which in return will bid up the price of bitcoins, the ETF’s underlying asset.
I don’t think you should buy bitcoin because you think the price will go up. And I don’t think you should start allocating any meaningful portion of your portfolio to bitcoin either.
But I think you should go out and buy some bitcoin in order to familiarise yourself with how it works and how to trade it.
You see, bitcoin is here to stay. And what’s more, so are cryptocurrencies.
Now is the time to get to know cryptocurrencies
Cryptocurrencies aren’t just alternatives to bitcoin. They’re blockchain-based digital assets created, increasingly, as a means of ownership of a blockchain-based business.
Some of the most exciting early-stage investment opportunities in the months and years to come will come in the form of cryptocurrencies. So if you don’t even know how to buy a bitcoin, you will automatically be at a disadvantage.
Bitcoin is the “on-ramp” to buying these cryptocurrencies.
Let me take a recent example.
You might have heard about Ethereum. It’s a virtual currency network that’s been in the press recently as a wave of top blue-chip I.T. and financial companies (including J.P. Morgan and Microsoft) have announced the formation of an alliance that will use Ethereum for blockchain related opportunities.
Ethereum is up 40 percent in less than 2 weeks.
But if you want to buy Ethereum, you have to buy bitcoin first. Bitcoin is the “reserve” currency of cryptos.
So, it makes sense to understand bitcoin first. And if you just bought US$100 worth of bitcoin, you’d already be well ahead of the pack. Most people I know haven’t taken the time to figure it out yet, but this train shows no sign of slowing down so you should take some time and get on board early.
How to buy bitcoin
There are two things you need to start trading virtual currency:
An “on-ramp” is simply a website where you can convert fiat currency (i.e. U.S. dollars), into bitcoin.
Bitfinex is one I’ve used. You create an account, go through a simple verification process, deposit some dollars, and buy some bitcoin.
The “wallet” is where you store your bitcoin.
Whilst a platform like Bitfinex allows you to trade (along with other exchanges like Poloniex, my favoured exchange), I don’t like storing much bitcoin with an exchange.
I’d rather keep it in my bitcoin wallet. Exchanges can (and do) get hacked. My wallet of choice is Bitcoin Core.
Having spent months looking into blockchain and the cryptocurrency space, I’m convinced that this technology will only grow in scale and opportunity, and being on the outside (and not understanding it) will limit your ability to profit from it.
Going through the process of buying a few hundred bucks of bitcoin, transferring it to a wallet, and maybe transferring it to an exchange to buy another cryptocurrency (say Ethereum) is an excellent way to put yourself way ahead of the pack.
I’m glad I did it.
P.S. “The Truth About Blockchain” from the Harvard Business Review is one of the best articles I’ve read on the topic in recent months – I highly recommend taking a look.
P.P.S. Would you be interested in me providing an onscreen recorded demonstration of how to buy, move and trade bitcoin and cryptocurrencies? If so, please reply and let us know. If there is enough demand, then I am happy to create a simple step-by-step video and walk you through it.
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