|As Charles Ellis explained in his investment book Winning the Loser’s Game, in professional tennis, 80% of the points are won with exceptional shot-making. In amateur tennis, 80% of the points are lost with unforced errors. Investing, for most people, seems to be correlated with amateur tennis play.
Your ability to improve your results has more to do with decreasing the number of errors than it does with consistently hitting winners.
In a recent paper, Michael Mauboussin (author of The Success Equation – Untangling Skill and Luck in Business, Sports and Investing) provided insight on how to reduce unforced errors through better decision-making methods.
Three of the methods Mauboussin outlined are particularly compelling when building a prudent investment process.
1. Use a checklist
Operating from a checklist of pre-defined criteria should improve decision-making. It will ensure that the options and opportunities involved in the buying and selling of investments apply to your pre-determined preferences. Theoretically, following a quality-control checklist can improve outcomes without actually improving your level of skill.
2. Conduct a pre-mortem
Rather than waiting until after an outcome to dissect what happened, review potential outcomes before taking action. Begin with the end in mind. What could go wrong from a variety of angles? How well do you know what could go wrong? What is the probability things could go wrong compared to the probability that they will work out as you intend?
3. Use a “Red Team”
Our decisions are shaped by confirmation bias. We tend to find support for what we already think and use it to solidify our decision. To combat this, it can be useful to bring in someone who does not have the background on the decision, or the biases, that you do. They can provide a fresh-eyed view of strengths and weaknesses that you have not considered and possibly identify gaps in your own thinking. The “red team” originated as a journalism tactic to poke holes in a story to make sure it is well-covered before publishing.
To partly address these methods, we operate from an Investment Policy Statement for each client and gain clarity about the life goals and obligations that need to be funded by the investments before we make decisions about what the individual investment holdings should be.
These methods can also be applied to many other money decisions (home purchase, career change, etc.) and we expect to make wide use of them in evaluating opportunities for our clients.
If you have any questions about how you are invested, please let us know.
All the best,
Gary Brooks, CFP®
Allyn Hughes, CFP®, ChFC®, CLU®, CAP®
|The Money Architects Idea Roundup for March
What is the purpose of your money?
One item that should be on every person’s investment decision checklist is: Does this investment fit with my broader investment purpose?
This would require you to understand the objective your capital is being managed toward. Beyond retirement income security, what is the desired impact of your savings and investments?
Many people have a hard time articulating the purpose of their money. This is where it can help to think like an institution. In a recent interview with The Manual of Ideas, Nate Chesley of the Massachusetts Institute of Technology Investment Management Company (the endowment managers for MIT), defined the purpose of their investment approach clearly. He said nothing about earning X% return. Rather, he and his team are guided by the knowledge that “the capital we manage is reinvested in world-class scholarship, research and global problem-solving.”
Thinking beyond terms of performance, what is the purpose of your money?
Market facts and figures
15-year recovery for Nasdaq
The technology-dominated Nasdaq index of U.S. growth stocks received such a brutal beat down during the 2000 Tech Wreck that it just finally moved back above 5,000 on March 2.
This time around, the price of the index does appear to have some basis in reality.
From Barron’s: “What was propelling the Nasdaq in the year 2000 was a dream. What’s driving the Nasdaq today is reality,” says Gavin Baker, who runs the Nasdaq-focused Fidelity OTC Portfolio fund. “The current valuation is very well supported by earnings and cash flows and if those earnings and cash flows continue growing, the Nasdaq should continue going up.” In March 2000, the Nasdaq traded at well over 100 times earnings. Today, the Nasdaq has a price/earnings multiple of 21, a few ticks above the Standard & Poor’s 500, at 17.5.
Annual update from Washington’s Guaranteed Education Tuition (GET) program
Some observations from the GET annual report, which you can access here.
The program is currently more than 100% funded, due mostly to investment gains and frozen tuition the past two academic years at Washington state universities. The program was only 79% funded in 2012 but actuaries now place funding at 106% of obligations. This is good news on the surface but there is some less promising detail under the surface.
The number of enrolled participants has gone up since 2009, but the rate of growth has slowed each year.
When investment returns don’t do the heavy lifting and tuition increases return, it is likely to require stronger participation growth to keep the program fully funded.
The program has paid out $567 million on behalf of participants since 1999. Many early participants have had a terrific return on their money. It seems unlikely that the forward experience will work out quite as well.
Purchasing new units still requires paying a significant premium over current tuition. This year’s purchase price is $172 per unit. The 2014-15 school year payout value is $117.82. The unit price is made up of $124.74 expected tuition cost, $20.51 reserve funds, $20.82 amortization and $5.93 operating expenses.
In order to overcome the 46% premium of unit cost over today’s payout value, you need to experience several years of growth in the payout value. This is why it may not make sense to buy GET units for any student older than about 12. And with the payout value having been frozen along with state-school tuition the past two years, the breakeven period to catch up for the premium paid for units is extended further into the future.