Thinking through consequences

2019-07-16 08.01.59A friend confided in me that his FOMO (fear of missing out) is running hot. Stories of easy money have got to him and he wants to get in on the action!

This reminded me of 2005 – a year when I was planning a future life of luxury. I had a road map for how I would spend my paper profits… a house in Santa Barbara, a flat in Paris, summers in the high-country. The constant focus on acquiring more should have tipped me off, but I didn’t notice.

For Christmas 2005, I bought myself a copy of Fooled By Randomness.

It humbled, and deeply concerned, me. You should (re)read it.

In my business life, I had a personal guaranty outstanding. The guaranty was a modest amount of my “paper” assets but more than 100% of my liquid assets.

In my personal life, I had established a line of credit to pay my living expenses.

I realized I could be wiped out.

2019-07-16 08.21.00Taleb’s teaching…

There are some games you don’t want to play.

Some risks we should never take.

Across 2006/2007/2008, I secured my financial life. This decision saved me from ruin.

I had NO idea about what was going to happen (still don’t).

I had a clear idea of the scenario that would wipe me out. Approaching 40, with a new wife, I didn’t want to get wiped out.

I addressed what I controlled: my cash flows, my debts and my obligations.

Do you know what could wipe you out? Look to your borrowings, your obligations and your cash flows.

2019-07-16 07.57.56

Do you notice triggers that could create a shock to the system? In what ways is the recent past skewing our vision of the future?

  • Debt-fueled political stability in Asia
  • Negative yielding sovereign/corporate debt in Europe
  • Easy money at a time of multigenerational employment highs in the US
  • Global debt double 2008 levels

Across all markets, a low-interest rate policy:

  • Delaying the consequences of poor decisions
  • Pulling forward future returns
  • Reducing interest service obligations => while global debt has doubled the price of debt has more than halved

It impossible to predict when the credit cycle will play itself out.

It is possible, and advisable, to understand how you are exposed to ruin.

  1. Cash flows compared to fixed commitments (taxes, debt service, core cost of living)
  2. Asset purchases via debt finance => particularly negative yielding luxury purchases
  3. Credit quality => Who can go bust and hurt you?

Things go wrong when people build assets, and debts, to the top of the credit cycle.

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The photos were taken on the Twin Sisters in Rocky Mtn National Park – mountains provide an opportunity to teach about consequences.

How Bad Ideas Get Funded

2019-06-26 14.43.54After a decade of asset price inflation, I’m tempted to shuffle the deck. I remind myself:

  1. Each time I change, I crystalize tax liabilities, pay transaction fees and introduce the possibility for error.
  2. A key benefits of an attractive position is the freedom NOT to change it.
  3. NOT following through on a mediocre idea => can be a great decision.
  4. My greatest investing weakness is the desire for change, for change’s sake.

Against the above, I’ve developed a hunch that assets are going to be cheaper 2 to 3 years from now.

Fully invested, with yields at historic lows, there’s little reason to rush into changing strategy.

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Costly mistakes happen when we overpay late in an expansionary cycle.

Where are we?

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Start with yourself => write out your ten largest items for the last year.

  • Childcare
  • Ski Season Accommodation
  • Food
  • Mortgage
  • Taxes
  • Healthcare
  • College and Retirement Accounts
  • Disney Cruise
  • Ski Passes & Gear
  • Insurance
  • Harry Potter World

How does your current rate of spending compare to 2009/2010? I’m double my bear market rate. Sitting at a 2007/2008 rate of spending (with 3 more dependents).

Are you considering any big-ticket items?

I am:

  1. Vacation property
  2. Trading up my home
  3. New vehicle

There is information in what you are willing to consider. #1 and #2 are rarely on my radar.

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What’s happening locally?

We are doing well in Boulder County, 2% unemployment, significant investment in schools, parks, and recreation facilities.

Some things stand out at the margin,

  1. multi-million dollar homes being left empty by seasonal residents
  2. houses being purchased for ~$1.25 million then torn down
  3. properties selling for double 2007/8 valuations
  4. local governments seeking to borrow HUGE and take technology risk on utilities / broadband

There are many people choosing risks they do not need to take.

There are many people sharing stories about quick money being made.

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Risk being ignored across all levels of society.

State => We have an active State Assembly passing laws and regulations as fast as the Governor can sign => at the margin… they are seeking the repeal of TABOR so they can spend money even faster.

Federal => in the news… medicare for all, national student loan forgiveness and a war of choice with Iran. No constraint on the ambitions of government.

Interest rates => at the top of the cycle, moving away from rate increases and a yield curve showing sub-2% money five years out.

VC to Public Markets => rapid internal dealing to ramp valuations prior to IPO => weak post IPO performance. The smart money is shifting risk, fast.

Every political viewpoint, local to global:

  • acting as if capital is unlimited
  • taking on risks of choice
  • increasing debt burdens
  • agreeing to future commitments of unknowable magnitude

These conditions are how bad ideas get funded.

  • Asset prices at all-time highs => a price umbrella influencing EVERYTHING
  • Cost of debt back at a generational low => easy money

If you are smart then the marginal idea that gets funded might be your own! Right now is THE time to raise money, sell businesses and unload illiquid positions.

If you are concentrated then consider taking money off the table (link is a blog of mine that’s worth your time).

Stay variable.

Cash Holdings in Context

2019-06-09 07.03.52The Algebra of Happiness is a great read. Professor Galloway has a hit on his hands.

In the book (page 83), Professor G says “I’m 80% in cash.”

I am used to hearing about wealthy guys’ portfolio allocations, I didn’t give it much thought.

However, his statement caught my wife’s attention (Big Time) and I spent a while explaining why I’d give the Professor an “incomplete” on this short section (of an excellent book).

Here’s what I said…

Start by laying out your sources of income:

  • Social security
  • Day job
  • Consulting gigs
  • University professorships
  • Unearned portfolio income
  • Rental property income
  • Tech fund consulting
  • Royalties from bestsellers
  • Spouse’s income

The segments, and the total, are useful to review.

These are figures you should know, roughly, off the top of your head.

Now, consider the information against your core cost of living.

I guess Professor G’s core cost of living is well covered by his sources of income. I’d further guess that his balance sheet has his family’s living expenses covered for the next hundred years. He is unlikely to be hurt by any investment strategy he selects.

The spread of your income sources will show concentration and diversification. Concentration can ruin life as you know it. You are likely to have skin in this game.

Addressing concentration can save you from ruin. Tweaking asset allocation, less so.

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Next, consider the areas of your life that hold option value:

  • Youth
  • Education
  • Ownership (bi-coastal real estate, start-ups, portfolio investments)
  • Wealthy relatives
  • Carried interest in tech firm general partnerships
  • Fame
  • Bestsellers
  • The ability to spend less
  • Equity stakes people toss you for being an entertaining non-executive director
  • World-class skills in well paying, niche specialties

When successful people talk about holding a lot of cash, they rarely mention the MASSIVE option value in the rest of their lives.

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What is cash?

As I write this I have six weeks’ living expenses in cash.

Seems really low!

  1. What if I add my US government bond portfolio?
  2. What if I net my unearned income sources from my core cost of living?
  3. What if I take a part-time job in one of my niche specialities?
  4. What if I downsize my house by moving?

In that case, my six weeks of cash should see me through to my 75th birthday.

Incidentally, I did all of the above 2009-2012 after my professional life was crushed.

Thankfully, I had a large cash holding at the time! 😉

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What should you hold in cash?

When allocating capital, most people want to receive a forecast of the unknowable.

Avoid pundits, forecasters and the predictions of others. They are worse than useless.

Each time I make an important decision, I write a file note to myself. Sometimes I publish these notes! Do this for 30 years and you’ll have a written record of your strengths and blindspots.

I use my limited attention to consider the implications of being wrong.

Overweight in cash and I am right:

  • Rich already => no implication, if you’re not satisfied with what you have today then you will not be satisfied with more tomorrow
  • Rest of us => Need to decide when to invest
  • Rest of us => Need to decide what to invest

The track record of “rest of us” is clear. We do an awful job at market timing and dynamic asset allocation.

Overweight in cash and I am wrong:

  • Rich already => no implication, my unborn grandchildren inherit less unearned capital
  • Rest of us => my widowed wife runs out of money in her 80s
  • Rest of us => I become a financial burden on my adult children

Some games you don’t want to play.

 

Memories of a credit crunch

2019-05-28 06.43.39I’ve been offline for a bit.

Spending time with my family in Mexico.

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I’m fond of reminding myself that the cost of the status quo is hidden.

I like to take breaks from my “status quo” and pay attention to what I have been missing.

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Since last July, I’ve been pulling the plug on the internet for 5-7 days at a time and writing notes in a memo pad.

Via my breaks, I am able to see the cost of constant connectivity…

….reduced creativity, clarity and cognitive ability!

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It’s tempting to think great opportunities will never come again.

It’s also human nature to forget anything that is further back than about three years.

So I’d like to share memories of what happened coming out of the 2008/2009 credit crisis.

Ancient history in the collective memory!

2019-05-28 13.59.14

In 2010-2012…

  • I bought two buildable lots, one with an older house, for under $300 per sq ft.
  • I then bought a two-unit downtown site for $375 per (very, very old) square foot. This seemed like a stretch. I didn’t expect the deal to show much progress for a long time.
  • I was able to buy Tucson condos at $49 per sq ft. Shouldn’t have furnished these! Sold them early as I was running tight on cash (due to living in a big house with no yield).
  • My last decision was NOT to buy a 5,000 sq ft house in Gunbarrel (City of Boulder) because I was concerned about the “hassle” of cleaning it up. This deal could have been had at $99 per sq ft! What was I thinking! Instead I put everything I had into a well-constructed home at $244 per sq. ft.

Cost to build (excluding land) is now around $400 per sq ft.

The figures above included land and building.

In hindsight, for three years, Mr. Market was giving land away in the City of Boulder.

Are you ready for the next tightening of the credit cycle?

A Little Economic History

2018-10-31 07.52.14It is much easier to position your life before, rather than during, an economic crisis.

It’s also truly amazing how fast a credit crunch can sweep across markets.

This month, a decade ago, was the mid-point for the toughest 90-day stretch of my financial life. Taking it back to October to December 2008…

  • My prospective earned income went to zero at a time when…
  • My Business/Personal cash burn rate was $10,000 a week. Simultaneously…
  • My net worth dropped by 67% and…
  • I was facing a potential claim 20x in excess of what remained. The one bright spot was my family life…
  • Our first child was born and we were very happy within our marriage.

The only reason I didn’t follow a friend into bankruptcy was a pre-crash restructuring. I had been scared by four events :

  1. The US was offering loans without income verification.
  2. The UK was offering loans without bank covenants.
  3. Down in New Zealand, I used both of the above and borrowed to pay my living expenses at a time when…
  4. I had a personal guarantee outstanding that covered most my assets, and all my net worth.

There is a line in Fooled By Randomness about Russian Roulette. It goes something like…

Even if the gun has a million chambers, there are some games you don’t want to play.

I was enjoying my life and didn’t want external circumstances to force a financial reboot at 40-years old. So… 2005-2007 was a time of significant change.

The restructuring took three years (2005-2007). It prevented ruin, but still resulted in a lot of pain when credit markets slammed shut in 2008.

At the time I was working in the UK. The entire chain of my business life went from Great-to-Insolvent in 180-days (bank, joint venture partner, developer, general contractor, sub-contractors, employer, CEO).

Just like that.

Gone.

2009-2012 were spent clawing back.

Key steps:

  • Downsized family home, spending and aspirations. Embrace Your Hubris!
  • Invested the downsized capital into a Downtown Boulder rental property. Two units, where the little unit’s rental income would enable us to live for “free” in the larger unit.
  • Invested our remaining funds in a redevelopment opportunity that I could hold FOREVER, because it was debt-free and cash flow positive.
  • Turned a loss making triathlon hobby (draining $75k annually) into a cash generating consulting business ($4,000 per month).

By 2013, we achieved cash flow break even. We were so blasted from our young family (up to three kids) that I don’t remember appreciating the significance of what we achieved.

Within my financial peer group, our story is not unique. Lots of people had a similar ride. However, they don’t necessarily blog about it.

Financial memories are short.

Remember.

You don’t get killed by prices falling — price volatility is emotionally painful but not financially fatal.

Companies, Your Personal Ethics, Friends and Families… All can get crushed by running out of cash in a banking crisis.

Where’s your cash flow statement?

Being Wrong

IMG_4015Some of what I know to be true is false.

Being (somewhat) wrong is a natural state of being.

It rarely harms me.

But when it does…

Boom!

What to do?

Pay careful attention where error has the greatest impact on my life.

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Blindspots – what are the areas where I am unlikely to be right?

In a marriage, a business partnership, an investment, a sport… the greater our personal, emotional investment… the bigger the fall when a new reality slams against our old beliefs.

Often a feeling of righteous anger comes forth, and along with it, a desire to lash out.

When these feelings arise I remember:

  1. I fooled myself. Make a note! It is going to happen again!
  2. Acknowledge, we all want to be fooled. I am not alone, nor am I the first to experience this situation. Nothing personal, bro.
  3. Further energy invested into a (clearly) losing situation is better spent creating the life I want, within my new reality.

It is easy to get hooked into a cycle of mutual retribution – it might even feel good, for a while…

…but you might not be aware of the harm you are creating.

Sleep, skin, hair, mood swings, cravings… all useful signals when we are off-the-path.

Tough to point this out directly to someone! The people who have been effective with me have said something along the lines of…

“I wonder if there might be a better way to handle this…”

“You’re right, of course, but you might feel different later…”

Attention

What’s the penalty for being wrong?

  • Marriage partner
  • My last haircut
  • Sports with a high degree of concussion risk
  • Sunscreen
  • Business partnership
  • The shirt I wear
  • Personal guaranties
  • The color of my socks
  • Borrowing money
  • What I am having for dinner
  • The ability of my children to teach themselves
  • My choice of car
  • My temper

Be willing to talk about what matters, with the people who matter to you.

What were we thinking?

IMG_0501Late-cycle is when we tend to make unforced errors in our financial life. My spidey-senses have been tingling due to a series of macro-events that I’ve noticed.

  • Wars of choice (trade, diplomatic and conventional) on multiple fronts
  • Tax cuts and borrowing increases into a strong economy
  • Rising interest rate environment — across all durations
  • Blockchain implosions
  • A study noting 76% of newly-minted IPO companies were loss-making at listing

I last felt like this in 2005. Then, and now, the party can continue for a long time.

What to do?

Rebalance – once a quarter, reset to my target weightings.

Consider leverage – don’t borrow to buy stuff you don’t need. Pay cash, or wait.

Stay invested – Stay the course. Each time you make a change, you introduce an opportunity for error to enter your life.

Do you remember 2009-2012? It probably seems like ancient history to many. There will be great times for new investments in all of our futures.