When I decided to get serious about retirement, I thought, “I need a financial advisor.” Dave Ramsey strongly advocates getting a financial advisor and I was inclined to follow his advice. First and foremost Mr. Ramsey recommends that one select someone “with the heart of a teacher.” I strongly agree.
Happily, Mr. Ramsey’s web site was set up to take down my zip code, then give my contact information to one of his “endorsed local providers.” Problem that. I have been blowing off telemarketers for 30 years. And I prefer “Don’t call me. I’ll call you.” So, when the fellow who got stuck with me called, I blew him off.
A week later I realized what I had blown off someone I wanted to talk to. So I called back. The Dow decided to plunge 100 points that day, so he didn’t call back. This happened again a few weeks later. And the third time I reached out, I joked with him that he should expect a big sell-off.
My wife and I made an appointment to meet with him where I would show him all my financials and he’d tell me what he could do to improve my investing strategy. I have a couple degrees in Mathematics, but none in Finance, so when he started talking about alpha and beta, I was geeking out on something new and shiny to learn. He started talking about Modern Portfolio Theory and I was in heaven.
What can I say? I’m a geek.
I took notes and asked questions about all the mathy bits. A lot of things I’d never heard of before. He promised to beat the market. (I didn’t realize what a bad idea this was at the time.) He talked about using a diversified portfolio to smooth the rough ride that one can expect when investing in equities. All along the way he was talking about risk. Getting the best return for a certain level of risk.
I can see this. If you’re a credit risk, then you should expect to pay a higher rate of interest. Same thing goes for stock in the company with an unproven technology that may go bankrupt. But when this financial advisor dude was talking about risk, he was referring to something completely different: variance.
I never studied finance, but I do understand variance. You may have seen variance discussed in classes that graded on a curve. And I did a fair amount of probability and statistical pattern recognition in my ill-spent youth. Variance and covariance are quite familiar notions to me. I have an interest time-series analysis from work in digital signals analysis. Algorithms hold no terror for me.
I raised my hand, “Excuse me, but you keep saying ‘risk’ when you are pointing to ‘variance.’ Is that right?”
Here, the wheels on the financial planner’s wagon started to wobble. “Yes, I suppose it is.”
“And this thing you call ‘beta’ is just the price variance of an equity normalized by the variance of the S&P 500?”
He gave me a blank look and mumbled an assent.
So, all this Modern Portfolio Theory stuff is built upon the notion that price-variance === risk. I posed a thought-experiment: Suppose two companies, the first is at death’s door. It’s share price is dirt cheap. Since everyone knows it’s doomed, it hasn’t varied from that in the last year. The second company has been around for decades, it is regularly profitable, and pays dividends during provitable quarters, but its business is seasonal. This shows up as seasonal variation in the company’s stock price. People buy the stock, collect the dividend, then sell the stock.
If price-variance equals risk then I should buy the death’s door company and eschew the seasonal company.
Price-variance is not so much a measure of the risk that a company will go belly up, but my risk that I’ll sell an asset at a bouncing-around price during its down-bounce. Yeah, that is a legitimate risk that I should avoid. It’s a bigger risk if I like churning equities purchases to rack up commissions for my broker, too.
Conventional wisdom is to avoid this risk through balancing a portfolio of distinct asset-classes. Just make sure the asset-classes are different enough so that when one asset goes up, the other goes down, and vice versa. Suppose you own an umbrella company that makes money on rainy days, and a sunglasses company that makes money on sunny days. The future is unknown, but you can be reasonably certain it will either rain or be sunny. If I hold two bouncing assets where one goes down when the other goes up, I can always sell one or the other at a good price.
Traditionally, this meant a retirement portfolio should balance stocks and bonds.
But they don’t have to be. You could own apple orchards and Apple stock. They aren’t price-correlated. My daughter, who is smarter than I am owns real estate through something called a Real Estate Investment Trust (REIT) index fund.
I’m toying around with the crazy notion that a stock index mutual fund could be balanced with a basket of Initial Coin Offering (ICO) tokens. Today I perceive ICOs like science-fiction junk bonds, because I do not understand them well enough to perceive their perils. If I were in my 20s, I’d balance VTSAX equities with ICOs.
But cryptocurrencies are not something to retire on. THIS is risk, real risk, not a mathematical assumption.
The financial advisor dude did not think like this.
I asked him for a bibliography so that I could do my homework and be able to get up to speed on all this finance stuff he was talking about. He made some noises about FINRA not letting him do so. His answer didn’t make sense. Maybe I didn’t hear him correctly. All I got was a handful of jargon terms that I later googled.
Remember how Mr. Ramsey talks about having the “heart of a teacher?” What teacher have you ever met that wasn’t always foisting reading assignments onto you? I can’t imagine any prof in any class I’ve ever taken who wouldn’t have eagerly gone on and on and on listing book after book until my eyes glazed over.
This was strike two.
I went away and started googling jargon terms. My googling led me to read four books,
- The Little Book of Common Sense Investing, by John Bogle,
- The Intelligent Investor, by Benjamin Graham,
- The Four Pillars of Investing, by William Bernstein, and
- A Random Walk Down Wall Street, by Burton Malkiel.
I also made a point to read every personal finance, investing, and early retirement blog I could find. Among them,
- The Simple Path to Wealth,
- Mr. Money Mustache,
- Financial Samurai,
- The Green Swan,
- Ten Factorial Rocks,
- 1500 Days to Freedom.
I strongly recommend the following site, but you may find it is too much like drinking from a fire hose:
I learned about SWR, the 4% Rule, various decumulation strategies, and most importantly: Index Investing. You REALLY need to know about Index Investing.
Armed with this knowlege, I came up with a three index fund portfolio that I believed would improve upon my existing haphazard collection of IRA, 401K and Roth accounts. I dutifully took note of the portfolio’s alpha and beta. Then gathered up all my figures to meet a 2nd time with the financial advisor dude. He had come up with an improved portfolio he wanted to show me.
We sat down together and he showed me a mix of a half-dozen loaded and no-load mutual funds consisting of equities, bonds and some international stuff, too. Very good. It would beat the market! But its beta was higher than my proposed portfolio. Its expense ratios were all higher than mine. Its alpha was lower than mine. (My stock index wasn’t but Vanguard’s S&P 500 index fund.)
“Oh, but you have a higher beta with that.”
“Uh, this here is the S&P 500 Index fund. Beta is defined in terms of the S&P 500. It has to be 1 by definition.”
He didn’t get it. Maybe I’m obtuse, and he was right, but he couldn’t convince me otherwise. I politely dismissed myself and went my own way. He didn’t get a 1% percentage of my net worth for the privilege if giving advice I don’t trust.
Even with Warren Buffet advising you, you must understand enough finance and investing to understand him and competently judge whether his advice is good and why you should follow it.
Maybe the financial planner dude who didn’t get my business was offering good advice, but since he failed to meet my expectations that someone with “a heart of a teacher” will have a long reading assignment, I didn’t just take his word for it. Instead, I read those other guys I mentioned above, and their advice led me to a different conclusion.
About a month later, Mr. Ramsey ended his “endorsed local provider” program for financial providers. He went through a rebranding effort and ow it’s called something else. I have one datapoint that may indicate why.