Understanding Asset Allocation

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This week, we’ll dig a little deeper into the questions that I ask myself when allocating capital.  I created the chart (above) to show the difference between my optimal, and my actual, capital allocation.  Similar to a business plan, or training strategy, the optimal plan isn’t always optimal.

First, let’s examine the terms.  If my SOLE objective was investment return then a reasonable strategy to follow would be:

  • Drive personal expenses as low as possible;
  • Invest in broad index funds with low fees; and
  • Keep whacking cash in the funds on a monthly basis.

Funds that I’d like for that purpose might be Vanguard (Total International Stock Index; Total Stock Market Index; and Total Bond Market Index).  The main thing that I’d need to figure out is how often I wanted to rebalance my portfolio.  This strategy is about as close to a sure thing as you can get over a lifetime.

For many people that I come across, this strategy would be far, far better than whatever else they could dream up.  For a population of investors, it is the optimal solution.  As a group, we can’t beat the average — we are the average.  Additionally, when we take an average return and overlay standard financial advisory fees, and transactions costs… an active strategy is doomed to underperform.

My current personal allocation is a bit cryptic, so I’ll explain:

  • Cash – easy one… that’s capital waiting to be allocated at some stage
  • Real Estate – I wrote about Real Estate Valuation before Christmas
  • Nominal – assets that I suspect will hold their absolute value; as any increase in value will be balanced by their cost of ownership.  An example would be my house (when I factor in taxes, insurance, maintenance).  I’ll end up getting back what I paid for it.
  • Psychic – assets that make me happy, or enable me to execute my life plan in harmony.  These include: depreciating assets (bikes, cars, RVs, trailers) as well as assets like art/jewelry where it’s difficult to justify any financial rationale for their purchase.

Why do I have half my net worth sitting in the Nominal/Psychic category?  I do wonder at times!

The simple answer (or rationalization) is life isn’t solely about financial return.  What I’m seeking to optimize is a life with meaning, rather than a number when I die.  That said, I over-invested in my house and given transaction costs/hassle factor/psychic returns… it’s too painful to change course.

The reason I like Real Estate has to do with information and cycles.  Like all markets, mortgage and property markets move in cycles.  Right now they are cycling down.  The unique thing about real estate over, say, stocks… is the opportunities for (me to have) superior information.

That said, even if I am right, with agent fees on real estate… as an asset class… it is a lousy place to be a trader.  So, I’m not looking for trades, I am looking for reasonable deals with a fair return.

So what’s the right answer for you?  I’ll offer four tips.

  1. aim to be reasonable, rather than right.  You don’t need to hit a home run, you do need a reasonable, long term strategy.
  2. any strategy that requires lots of change will prove sub-optimal due to taxes, transaction fees and our collective inability to outperform each other.  If you happen to “win” then you got lucky with your speculation.
  3. understand, deeply, what makes you happy and what causes you pain.
  4. invest on the basis that, collectively, we suck at forecasting.  

Quirks that help me stay happy:

  1. Movements in the value of my real estate are hidden from me.  What I see is the rent checks coming in.  
  2. I set my expenses up so that I can feel good about writing checks to my friends and local businesses.  I write checks to Monica and my financial assistants and they handle paying bills that might cause me irritation.  When I go on holiday, Monica pays for everything — together we agree an overall budget then I remove myself.
  3. If I buy a low return asset then I make sure that it has a huge psychic return for a member of my inner circle.
  4. I treat myself with time, not trinkets.  My luxuries are training with friends, writing and reading books.

If you are deviating from the optimal plan then be wary that you aren’t chasing return so that you can consume more.  When things go wrong, it’s nearly always borrowed money combined with a desire for unreasonable consumption.  

Similarly, if you are an endurance athlete then use this exact rationale to examine your relationship with training stress.  Injury and burnout come from being greedy.  The patterns that repeat in your training life have already dictated your current life situation.  In this sense, past performance is very likely to indicate future results.

While we are motivated by consumption, a life with meaning flows from service, personal excellence and harmony.

g

The Big Steel Challenge

Over at Endurance Corner, we were looking for an idea to spice up our winter.  So for January, we came up with the Big Steel Challenge.  Goal is simple. Lift as much weight as you can in a month.  We had AC run the math on a few popular lifts to arrive at conversion factors.

Just in case you want to try, here’s the scoring from a sample session that I did yesterday.

Weigh In = 171.4 lbs

  • 18 palms away chins = 3,085 lbs
  • Squats, 15 w/ bar and 40 with 100 lbs = 4,675
  • 95 push-ups score 5,428 lbs with 1/3 body weight factor
  • 40 reps of leg press sled 100 lbs scores 4,000 lbs – ignore sled weight due to 45 degree angle
  • 40 reps of single leg press at 55 lbs scored 2,200 lbs
  • 80 single leg extensions at 12.5 lbs scored 1,000 lbs
  • 48 single leg calf raises scored 823 lbs converting at 10% of body weight
  • 15 dips scored 2,571 lbs
  • 40 straight arm pulls on the cable cross scored 1,040 lbs
  • 20 reps of 65 lbs dead lift scored 1,300 lbs
  • 40 single leg hip bridges the conversion factor for these is still under consideration

Roughly, it took 28 minutes to shift over 25,000 pounds and here’s a link to my standard program.  That link also contains some video clips of me doing the exercises.

Shifting 50,000 lbs per week, using only an hour of my time… That has to be the single greatest return on investment in my entire program.  I’m not talking about an athletic return of being fast at forty.  I’m talking about a life return of being fully functional at eighty!

Follow along on twitter and I’ll tweet up a google doc where we can track ourselves. If you need any tips then tweet me or @Alan_Couzens and we’ll help you out.

With a bit of luck, I might get over 250,000 lbs for the month!

Four Ways To Improve Your Life

When I think about the choices that have had the greatest impact my life, they stem from being able to follow a path of personal excellence.  Excellence can seem a distant quality, probably because our flaws are most visible to ourselves.  Consider these tips as stepping stones towards your path of personal excellence – as Coach Wooden said, perfection is impossible but striving towards perfection is available to everyone.

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TECHNOLOGY

The single greatest change I made this year was improving my relationship with technology, in general, and email, in particular.  The changes I’ve made have given me an extra 500 hours per year (!) of available time, which I chose not to fill immediately.  Here’s how I did it:

Acknowledged that I was hooked on the reactive nature of email.  That was a big step.  I need to discipline myself not to check email constantly.  It’s a huge time sink.

When I check email – I have four actions that I do:

  1. Unsubscribe/filter/delete – I unsubscribe from as many automatic emails as possible (if you miss them then operate on a go-to basis).  I set up filters for repeat emails that I want to batch review at a later date (athlete workouts, financial notifications, subscriber updates).  I also set up filters for banned senders.  I’m running two levels of spam protection software (SpamSoap and Mail Client).
  2. Move To Action – For items that require me to think, or type more than a short answer, I move to an Action folder.  I batch process these (mainly on Wednesdays and the Weekend).
  3. Reply Immediately – There are some emails that are time sensitive – I reply to those immediately.  Using my iPhone for gMail has proven to be a blessing because I don’t have the keyboard to over-reply.  I pause, think about what the writer needs and reply directly.
  4. Refer – As I wrote in my Structuring Your Business article, we’ve set up a team forum.  This leverages both the expert replies to our team as well as the combined knowledge of the team, itself.  Its proven to be a high effective resource for improving knowledge and leveraging everyone’s time. 

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OPPORTUNITY

The next tip stems from a shift in my business and investing philosophy.  In 2010, I deepened a choice to shift my focus towards creating opportunities for people to use their skills successfully.  When we founded Endurance Corner, the original motto was “helping people help themselves”.  The method has changed as we’ve learned more about ourselves.

I’m still very focused on cash flow – however, I think beyond pure profits and use my time/capital/energy to support the team in making positive changes in their life.  This belief drives many aspects of my own life, including asset allocation.  When I moved to Asia in 1993, I was advised:

  1. Be willing to make less money to maintain your principles; and
  2. Learn, succeed, then return home.

Seventeen years later, the wisdom of those tips is becoming more apparent.  By the way, Bogle’s book on Enough, is as good an explanation as I’ve read.  Having completed Mr. Bogle’s book the week before riding Hillsboro Beach to Jupiter Island made the message even more apparent.  The contrast, of the strip on Daytona Beach vs the castles of Palm Beach county, reminded me of pre-revolutionary France.

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STILLNESS

I’ve continued to find it difficult to improve my listening and this is probably because I’m not focusing on the step that comes before listening.  So, I’ve been trying to cultivate stillness.  I’ve found that I listen best when my mind is still.  Five tips that help me reduce the noise in my life:

  1. Turn off the television/computer
  2. Mute/power down the phone
  3. Exercise without music
  4. Schedule less
  5. Walk rather than drive

My relationship with technology will remain a focus.  There’s a lot of upside for mental clarity if I’m not filling my head with my twitter feed every eight minutes!

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SHARING

My ride across Florida last week made me realize how much of an outlier I am, as well as the sheltered life that I lead.  The basis of populism (dismissed in my peer group) becomes clear when riding Key West to Panama City.

As endurance athletes we have unique definitions of fun as well as our fair share of idiosyncrasies – (lists and schedules for everything). I remind myself (with a list and schedule, of course) to be willing to compromise to share experiences with people that are close to me.  I allocate my time deliberately and share fun things with the people close to me.  This requires effort as I’ll simply work, work, work – if I don’t schedule down time.

Looking at the big picture, it all boils down to:

  • reduce noise;
  • serve others; and
  • demonstrate love.

Happy Holidays,
G

Valuing Real Estate

In the property markets that I follow, the second half of 2010 saw a material change in price expectations. Asking prices as well as achieved prices are heading down, significantly.

A number of factors are driving this phenomenon:
Time: our memory of the past is dominated by our experience over the previous three years.  The property market is in its third year of poor performance.  As a result, we are starting to trend the recent past to future expectations.  While things have been awful, I don’t think that awful will continue indefinately.

Cash: refinancing became difficult in mid-2008.  Many owners have been writing mortgage checks for the last 30 months and each of those checks can cause a little bit of pain.  Foreclosures and unemployment remain high – more pain.

Sentiment: deals that are being completed, in all markets, are being done at 25-60% off peak values.  Residential real estate is very much a word off mouth market.  While people used to brag about how much their property was worth, current chattering centers around repossessions, downward price adjustments and low entry prices.

Availability of Debt: I dropped by my bank this week to talk mortgage and business loans.  Suffice to say, it is a very difficult debt market right now. Lack of funding drives prices down.  Remember that money will not always be tight.

Expectations for residential property are as bad as I can remember.  The last time things were this negative was 1990, when base rates were in the teens and I was working in London.  Interestingly, imagine what would happen to the market if long rates return to historical averages?  It would be a short term disaster and a fantastic buying opportunity.  If the big moves in rates (over the last three days) continues then there will be a lot of pain around.

Why buy real estate?
The Great Inflation of asset prices ran from 1992-2008 in most markets.  If you are under 45 then those market conditions are the only ones we have ever known.  It’s worth reading a copy of Irrational Exuberance to understand how assets normally behave.  Pay particular attention to mean reversion of returns and long term rates of real return.

I want to own real estate for a number of reasons:

  • The option value of land;
  • To receive a net yield; and
  • As a store of real purchasing power.

Personally, I benefit through the option to downsize where I live by moving into one of my rental units.  This option is not available with a bond/stock portfolio.

What’s a reasonable net yield?  Ten year US govt bonds are ~3.5% (big moves this week).  Safe but no upside in the value of your capital.

What I do is compare a range of bond benchmarks to the prospective net yield of the target property.

When I calculate yield, I factor in the broken furnace, the roof repair, the tree trimming, the radon mitigation, the gas leak with the stove, insurance, taxes and vacancy period.  Many people forget about these sorts of issues and overestimate their true net CASH yield.

With properties that I bought in 2010, my net cash yield for 2010 will be zero.  That’s ok, as it links to my current year benchmark (check your savings account yield).  My prospective net cash yield is about 3%.  Not massive but considering my alternatives, and goals, sufficient.

Now my yield expectation is 3% but I priced the deals at 4-10% to achieve that net.  That is my margin of safety and reflects that, even with appropriate due diligence, stuff always pops up when you shift from buyer to owner.  By the way, stuff pops up in all types of markets.  Remember to insure your Black Swans.

The target yield that’s appropriate depends on:

  • Your alternative use for the funds;
  • Your view on the prospects for the people that live in that neighborhood and the local economy; and
  • The amount of land with the property, alternative uses for that site and redevelopment/subdivision opportunities.

The better the prospects, and the greater the option values, the lower the current yield I am willing to accept.

There are no fixed rules but with research and common sense you can decide on a fair deal.  That fair deal is your valuation.  The amount under valuation (that you pay) is your margin of safety.  Try to arrive at your valuation independent from asking prices.  What I do to figure my target yield for different types of deals.  Then I head to the market to find those deals.  I am selective with the type and look in a narrow geography (down to specific streets and developments).

Be careful with property investments.  They are easy to get into and can be difficult/expensive to exit.

Applying Your Personal Plan

This week’s article comes from an offline discussion with Mike about my personal planning writing.  What started the discussion was Mike’s question, “tell me more about how you build your personal plan.”

You can find a historical summary of many years worth of Personal Planning writing via the search function over on the EC site.  Here’s the article summary as well as the main post on my personal review list.

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– So you have your priorities set.  How do you break down the year into sections that you review?  You mentioned in one post that only after six months do you have enough time to actually track meaningful progress. How do you establish a feedback loop?  Are there people involved?  

I try to do 1-3 things in each 6-12 month block and I make it REALLY simple.  In my experience, successful people have the ability to consistently focus on a limited number of things that have a direct impact on getting stuff done.  The high achievers that I work with can tell you exactly what they are trying to do (Clarity) and structure their lives to get it done (Simplicity).  

When I work with folks that struggle to get stuff done, it’s nearly always because they are seeking to achieve a shopping list of items.  Just because it’s simple, doesn’t mean it’s easy.  Let’s use me for an example in three areas.  If you’re reading this blog then we’re going to overlap in at least one, I hope.

Athletic Performance:
  • Train Daily
  • Get Up Before 7AM
  • Don’t Drink
If I can do that then there’s only a handful of 40+ athletes in the world that are likely to beat me.  Clearly it takes much more than just these three for me to perform.  That’s true but I already know what it takes.  In triathlon, I need to focus on the items that might screw up my ability to perform.  So my athletic performance list is really a “not to do” list.

Financial Security:
The first two points cover what’s required to run into trouble in life – excessive spending and leverage.  The final point is the most fundamental aspect of investing (and life).  The Key Five of Investing (article from October) are my way of ensuring that I have a suitable margin of safety. I’ll come to valuation in due course.

Successful Marriage:
  • Be Kind
  • Create Frequent Opportunities for Communication
  • Do Fun Stuff Together
We avoid friction by doing the opposite of what causes friction.  This involves an element of compromise but, if I think about it, it’s not that hard to… to be kind, communicate and have fun with my wife!

My feedback loop is daily/weekly/quarterly.  I like written plans and the tactics that I use are so simple that it’s easy to remember them.  If I’m trying to change direction then creating signs (I see daily) works well for me.  I had a sign that broke down an 8:29 Ironman visible for two years before I managed to achieve that goal.

I also think you want to understand why you have goals.  Working towards goals shapes the type of life I want to lead on a daily basis.  It’s not about the goal.  It’s about enjoying the life that’s required to work towards the goal.  My life satisfaction is linked most strongly towards knowing that I’m on the path, rather than hitting the destination.  Simple, clear goals enable me to feel like I am making daily progress.

At times, I can miss my former life as an elite athlete.  I used to think that it was the training that I missed.  With the benefit of a several years of perspective, I’ve realized that what I miss is the clarity of purpose and daily victories that workout completion gave me.  The most rewarding periods of my life have been characterized by clarity of purpose and simplicity in execution.

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– I’d love to hear your thoughts on building a personal brand within a corporate environment.  What are the things that people with a great brand to that other with a poor brand don’t?  

Whether we realize it or not, we all have a personal brand.  When I was younger I was far from perfect!  My manners weren’t great and I was aggressive.  I used to joke that I competed on all fronts all the time and wasted a lot of energy.  Now my focus is helping my inner circle achieve their goals so they support the life I want to lead.  Let other people be successful so you can lead your life successfully.  Much different focus than beat everyone, all the time!

When I started in finance, I had three things going for me: I was reliable; worked hard; and was cheap. I did a tremendous amount of work for the partners and made their lives easier with little cost to the firm.  My goal was productivity, not promotion.  I ignored politics and did as much work as I could manage.

Interestingly, I probably learned 80% of the technical aspects of my job in the first two years I was at the firm.  Flipping that on it’s head, I made 80% of my financial return from private equity in my final two years at the firm. I ‘sold early’ with my financial career and left a lot of money on the table.  That said, in terms of my life, I timed my departure very well for participation in elite sport.  The guys that hung around aren’t going to be beating me at any triathlons (and my net worth will never approach their level).

In terms of my coaching brand, the approach is identical.  Good advice, offered reliability to the public.  To spread, the message must be authentic and effective — I write about what I really do and it works.  Good brands market themselves.

Focus on reliability above all else — it’s a fundamental building block of any relationship.  

People with high standards will do a good job of letting you know when your reliability slips — work for those people as they will make you better.  Be open to bad news as that sort of feedback is painful, but essential, to improve and tailor your brand

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– It looks like you have worked with some great mentors/coaches.  Did you proactively go and try to create such relationships or did you randomly fall into them?  I am guessing that you were very particular in your approach and would love to hear about that.

The initial meeting has often been random but my extraction of knowledge has been deliberate and intense!

Make it easy for your coaches/mentors to work with you — geographically, financially and technically.  I tried to be their ‘best’ client in as many different ways I could muster.  

Do whatever it takes to get alongside the very best teachers and spend time working shoulder-to-shoulder where they have a passion.  My success with that approach, as well as feedback from my students, is why we believe our camps business is so effective for athletes.

When I started in Private Equity I was the lowest paid person in the building.  Likewise, I’ve paid up to $1,000 per day for consulting advice.  The gains from becoming world class are material – don’t be cheap with situations that have the capacity to change your life.  

Money can be effective to get people’s attention but most of us aren’t motivated by money alone.  That’s the reason for my advice on figure out where your mentors have a passion and do that passion with them.  World class people are surprisingly easy to track down.

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