Considering Wealth at the Real World Risk Institute

2019_HalloweenTo shake up my thinking and expose myself to highly-believable people, I attended the two-day program at Nassim Taleb’s – Real World Risk Institute.

You can find my daily notes here. Cleaned up digital version of my notes here.

What follows is my thinking on wealth inspired by what was presented. Mistakes are my own. I can hear things differently than what was actually spoken, so don’t assume my attributions are strictly accurate.

To prepare for the clinic, I re-read the Incerto and I’m glad I did it. Each pass through Taleb’s work provides additional insight. You can find his lectures and lessons on YouTube => well worth your time!

We live in a world where a single bad decision can have massive costs => a few thousand dollars and four days of my time is a small price to (try to) think better.


One of the aspects of my job is guiding the transition of wealth between generations. This sounds sophisticated but it’s a role played by elders and parents in every family system.

My personal greed makes me too focused on financial wealth. It takes effort to step back to see wealth as including:

  • The ability to say “no” to others
  • The ability to keep promises to myself
  • Control of my schedule
  • Health, athletic functionality and contentment within my body
  • Love and companionship – the ability to share experiences
  • Engagement via teaching (my kids, my students, anyone who’s open to implementing what I’ve learned)

What I’m shooting for is creating a strategy, so effective, so straightforward, that an idiot could execute it and preserve wealth access generations.

This is what Taleb calls “Zero Intelligence Investing” but we are focusing on a broad definition of family wealth, across generations, through time.


The impossibility of prediction

Joe did an excellent job of demonstrating how complex systems (even those built on very simple rules, defined by the observer) can be impossible to predict. More specifically, certain systems can only be understood, defined, by running them forward in time. He laid out a host of reasons, any one of which could prove the folly of prediction.

Consider your own life. Cut your age in half, how would you have defined wealth at that age? In my case (25 years ago) the list might have looked like:

  • Wine, women and song
  • A ton of work that pays well
  • Watching my personal balance sheet grow
  • Being very strong in the gym
  • Travel to new places

There was no way to predict my values (today) without living through the 25 years from then to now (the divorces, the insolvencies, the setbacks, the pain of toddlers, the post-traumatic growth).

Because of the role of time in life, we can not predict the future.

However, we can have useful ideas about what not to do. We can get a handle on what might ruin our families.


So if my goal is to preserve, ideally grow, the collective wealth of my family system what can I do.

  • Be vigilant about ruin (in fat tailed environments)
  • Spot, discuss and remove fragilities
  • Position the family to benefit from positive optionality

One of the things Taleb does best is consider his best ideas across domains, gain insight then translate his insight to the reader via real-world examples. It is the secret sauce of his success.

BUT, reading great ideas doesn’t improve my life! I need to go the next step and tinker with a limited number of outstanding ideas.

Who gets the benefit of your best ideas?

Taleb’s best ideas…

Ruin via the fat tail hitting my fragilities => fancy way of saying don’t blow yourself up! I’ve written about this a lot: Taleb’s written about Russian Roulette => his 1,000,000 chamber gun story in Fooled by Randomness changed the direction of my life.

In the seminar we talked about the non-zero risk of a “zero-risk first cigarette.”  Why does a (near) zero-risk choice have a non-zero risk in our lives?

“In life, you must assume that you’re going to take the risk again, and again, and again.”

This completely changes the calculation with regard to the “first” taste of risks that might ruin you: alcohol, rage, opiates, cocaine, sleeping pills, infidelity, felonies, roulette, recourse leverage, luxury spending, unnecessary capital projects… things with the potential for large and unpredictable downsides. Bad habits are always trying to seep into my life!

So, to preserve wealth, you need a process to remove your fragilities, because these are what’s going to ruin you. My family history has persistent, recurring fragilities that hit us hard.

The first step is to gain control of your schedule and create space so that you’re able to think more clearly about what can ruin you. Simplify.

Another great insight – life is not about avoiding risk…

“Take chances, lots of them, and focus on areas where volatility works for you.”

In an uncertain world, one of the best sources of optionality is non-recourse finance.

My first career (Private Equity) could be described as getting overpaid to hold a call option over other people’s work, using other people’s money, without recourse.

Negative action is powerful medicine, with low side effects.

It’s tempting to ask Taleb “what to do.” I did, twice, and he didn’t seem keen on advising positive action with regard to an unknowable future. That’s probably good, as I’m not equipped to implement, or even understand, his technical advice. However, his negative advice (on what to remove) generated huge wealth for me => my total cost was the price of buying Fooled by Randomness on Amazon ($10.17 in December 2005 – my Christmas 2005 reading list, you can skip the flat earth book, the rest were great).

There are many sources of optionality:

  • where I have limited competition
  • where I understand the domain as well as anyone
  • where the cost to enter is small

A few ideas:

Get married, have kids, then take excellent care of everyone (!) => dementia is in my family tree => doing well by my family is the “cost” of a call option for times of future stress => an option that has a constant payoff in companionship, personal growth and a semi-captive audience for teaching.

Technical education in a robust field => look back in time for Lindy professions => spend time and effort for continuous education

But be careful, the “honors” part of my college education (1st class honors Econ/Fin) proved to be technically useless. However, it helped get me a seat at the table in Private Equity. The overall degree taught me valuable skills with regard to financial accounting, programming, mathematical finance and calculus.

Knowing how to count, and being exposed to the way people seek to cheat you, these are useful life skills to prevent ruin. – quote mine

Other sources of optionality => tinker within your social network, attend conferences (and force your introverted self to speak to people), write (then publish), talk to believable people that disagree with you, donate time to people who might benefit from your technical skills (especially within your local community)…

Your body can be a call option on: future mates, future physical experiences, the ability to lift your carry-on overhead as you age…


So the “how do I stay wealthy” answer is about removing fragilities => cutting back a high cost of living, habits with large potential downsides, physical weakness…

The “how do we best grow wealth” answer is about exposure to opportunities that open up the possibility of growing True Wealth (connection, experience, engagement) => each generation can, and should be encouraged) to, contribute based on their current, unpredictable and changing definition of wealth.

Together the family creates its own definition of wealth.

Each generation re-defines wealth based on its collective values.

I would have learned more if I stayed for the entire week but it’s Halloween tomorrow and I got more than enough from the experience.

What I Talk About When I Talk About Building Wealth

SuperGirl

When people ask me about asset allocation, I guide them towards family wealth.


Over your life, you will see things blow up.

  • Jobs will be lost
  • Divorces will happen
  • Guarantees will be called
  • Companies will fail
  • Investments will go to zero

Certain habits make us more prone to blowing up:

Debt – fixed obligations can ruin you in bad times.

Lack of emotional control – this runs deeper than, say, anger management.

People who make a habit of rationalizing a lack of control in one domain (elite sport, closing a sale, acting in a client’s best interest) rarely have the capacity to control themselves across domains. If you might get caught, then you’re fragile.

Substance Abuse – it’s more than the cost of sorting yourself out – it is the lost opportunity of a life well lived and the impact on the rest of your family, especially your kids.

Spending vs Cash Flow – personal spending, burn rate and fixed costs => the more spending you have relative to cash flow, the more fragile your finances.

The above is a long way of asking, “What aspects of your life might blow up?

Which is a polite way of saying, “I’m not sure asset allocation is the most pressing issue in your life.

If you work in an ethically-challenged field, have a lot of borrowings, have a high burn rate or are surrounded by peers with issues…

…then tweaking portfolio construction is a lower priority item than immediately removing what might ruin your life.

I’ve done it. You can do it. It’s better on the other side.


How large is your current portfolio when compared to your lifetime portfolio? – AKA you might have more wealth available in your career than your portfolio.

Investing is different at 25, 40 and 55 years old.

The nature of “different” depends on your personal circumstances.

#1 => Consider your Core Capital. The single best thing I did out of college was save four years of personal living expenses, $100,000 in the mid-1990s. It sat in a bank account, while I worked my ass off at my career.

Having that money enabled me to choose better and choosing better became a habit.


Very, very, very (!) few people can be professional investors – AKA can I get rich by beating the market?

Take an honest look at the people that you know in finance. How many of them “got rich” from their own money? Remember these are the experts.

In finance, most people get rich due to the rules of their game and collecting pools of other people’s money (your money, by the way).

With your portfolio, keep it safe, simple and low-cost. A target-date fund makes a nice core holding.

Having my Core Capital enabled me to take more risks in my career path, and life experience => not with my Core Capital.


Once-in-a-lifetime opportunities happen once a decade – AKA great deals happen when credit markets are shut

Here are the assets I own and why I own them:

  1. Index funds => long-term, diversified, not linked to my home real estate market
  2. US Treasuries/Core Capital => 5 to 10 years family expenses
  3. Boulder real estate => A relative value play against California, a cost-effective way to raise a family and a fantastic outdoor life. Think very carefully before locking yourself into any location. As a young man, my lack of ties enabled me to jump at great opportunities.
  4. Cash => my early retirement was funded by three deals I did coming out of the last credit crisis. Once you have your Core Capital (say, five years living expenses) then building up a pool for “great opportunities” is a consideration.

Starting out? Read this PDF.

Be wary of home bias => you can see it in my portfolio => even more risky is having your balance sheet, retirement and job reliant on the success of your employer.


Switching Costs – AKA think carefully before you sell good assets

I have assets in my portfolio that I would not buy at today’s prices. Financial theory tells me I should sell these assets.

  • I have zero confidence in my ability to predict the future.
  • If I sell assets then I pay taxes and commissions.
  • After selling, I have to figure out where to put the capital.
  • I doubt any “new” plan will be better than my current plan, which is simple and low-cost.

Release yourself from constant optimization => good enough is good enough.

Put your efforts into being a better version of yourself.

 

Years, Leverage, Time and Ruin

2019-09-10 07.55.51The benefit of creating a good position is you can choose not to leave it.

Each time I change strategy, I open the door for error.

2019-09-10 06.08.38A quick review, I calculate financial wealth as:

Net Family Assets [divided by] Annual Cost of Living

The formula spits out an answer in years, not dollars.

To figure out if an idea is “worth it,” I convert to years.

I also consider:

  • Leverage: do I have to borrow, what’s the total dollar value of my exposure, how large/far can things move against me?
  • Time: I have control of my schedule – might this idea change my ability to control my schedule?
  • Ruin: reputation, relationships, finances, health… how does this idea change my exposure to ruin?

I have a lot of (bad) ideas. Thankfully, most don’t get through my filters.

These filters work with EVERYTHING… alcohol & drug use, mistresses, felonies, off-balance sheet financing, sleeping late, losing emotional control, binges…

2019-09-07 06.15.45

How can I put “years” into family wealth without increasing my risk of ruin?

In 2009, we executed a four-year plan that put us in a better position.

A key part of that plan was downsizing, borrowing (30-years fixed at 3.25%) and pulling 65% of the equity out of our primary residence.

It was highly inconvenient to change and we expected the smaller place to be a step down. However, our minds adjusted and we love our existing place. The move paid off in “years”:

  • Our current place runs at half the cost of our old house.
  • The capital we withdrew, earns enough to cover the cost of our current place.

I looked at moving again but there wasn’t any benefit to us after taxes, commissions and hassle. So we’re going to wait and watch.

Remember, “doing nothing” maintains an option to (make a better) change later.

2019-09-05 19.33.32The Elephant(s) in The Room

Childcare and school fees have been a fixture of the last six years. It has been a big number – about double what we pay in housing costs.

Our youngest is in Grade One (yay!) and we just lost our favorite sitter (not so yay). The result is a big slice of the family budget gone.

My first thought was to replace help with even more help. I have a habit of throwing money and other people’s time at my problems. It’s a carryover from my days in finance – where I aimed for maximum subcontracting in my personal life.

Then I had a thought…

  • Consolidate the kids’ schedules (we often have three in three different places)
  • Help out in the afternoons (I’ve done nothing for a few years)
  • Take over the cleaning (ditto on my lack of input)

It’s ~20 hours out of my week => prior thoughts on money and time.

The other elephant in the room is my cash flow deficit. It’s been rolling at 4% of assets for years. I’ve ignored it because our assets have been appreciating at a faster rate. My comfort with deficit spending reminds me of 2004-2008.

So I could “buy” the family a shift from a cash flow deficit to a surplus. Worse case, I crack a bit and hire local kids to help me out. I’ll still cut my cash burn by ~80%.

When I explained my plan to my wife she asked if my plan would make me happy. I said,

“I don’t expect to be happier but I noticed that being a better man never made things worse.”

When Assets Become Liabilites

noodlesThis Q&A with Warren Buffett is packed with gems like the following:

Money has no utility to me anymore as I am very happy with what I have but it has enormous utility to others in the world. More possessions to me would actually be a liability than an asset.

I don’t know Mr. Buffett but I am friends with a well-adjusted member of his demographic.

Last spring, I asked my wealthy friend if I could store a bike in the garage of his 22,000 sq ft house and he shared…

You know, I already have way too much stuff in there. So best if you keep it at your place.

For what it’s worth, my pal’s garage is less full that my own!

What’s going on here?

Another story… last year, I was helping a friend put together a financing for his business. The money was raised and I was invited to a lunch with the key investor. The investor is about twenty year older than me. He’s a fascinating guy with a son that’s in private equity. We had a lot in common, including enjoying health and wellness.

Over the course of the lunch, I learned he had a house locally, a cabin in the mountains, an ocean-going yacht and a winter home in the Southern Hemisphere. In 2005, I was trying to create his life situation for myself!

So what’s it like?

He said with a laugh…

We travel the world repairing things.