Ask Nick Sample 2022

Sample 2022

 

November 2021

NO THIRD STRIKE

Is there an objective answer to the question: how many times do we talk someone off the ledge? We are reviewing our policy on this, only to find that we don't really have one: our responses have been ad hoc, and uncomfortably inconsistent.

I don't know that there's an “objective” answer, but I can certainly suggest a consistent one. Succinctly stated: no third strike. The reasoning is this: At onboarding, in writing, the client was told that under no repeat no circumstances would we liquidate the equities in our plan because of current events and/or falling markets. We said that the only way we could capture the full permanent returns of equities—which are essential to the success of the plan—is to ride out the temporary declines.

We required the client to pledge allegiance to this, knowing that, being only human, his faith would one day be tested, and found wanting. He went out on the ledge; we talked him back in by taking him back to the plan. Renewing his pledge, he came back in. Strike one.

If it happens a second time, we now have two arrows in our quiver. The first, obviously, is the plan/pledge. But now there's a second, and we invoke it quite seriously: “You'll remember we talked this through a year (or two, or three) ago, during (the apocalypse of yesteryear). You hung in there, as we encouraged you to do, and the storm passed. THIS IS NO DIFFERENT.” In this scenario, let's say he comes back in off the ledge again. Strike two.

And now, because of (the pandemic/the election/the inflation/whatever), he's out on the ledge again? I vote no. “Nigel, we've been over this. Our best judgment is that your retirement plan cannot survive your getting out of equities, nor could we advise you about when/where to get back in. You have our best advice; we have nothing to add. You must do what you think best.” No strike three.

Is this “objective”? Surely not. But it's logical, it's consistent, and it will free up important reserves of time and energy that you can devote to other, more deserving clients.

 

September 2021

INVESTING VS. SPECULATING

Will you please give me your best definitions of investment and speculation, highlighting the essential difference between the two as you perceive it? I have found myself trying to explain the difference a lot recently, as it pertains to crypto, gold and other speculations. I'm not happy with my explanation, nor do my clients seem particularly beguiled by it. I'd appreciate any enlightenment you can offer.

I don't suppose this is very rigorous, but the way I think of it—and the way I'd convey it to an individual investor—is that investing involves placing long-term capital into securities and/or businesses that have some productive capacity, and which thus lend themselves to rational analysis of value based on that capacity.

For example, a common stock can be valued on the basis of the company's earnings, cash flow and dividends; a corporate bond can be valued on its coupon, the creditworthiness of the company, and the bond's position with respect to its claim on the assets. Income producing real estate lends itself to analysis of its rent roll and operating expenses, as well as the nature of its mortgage indebtedness. Farmland can be analyzed as to its crop yields, estimated market prices for those crops, and the expenses of growing the crops and bringing them to market—all leading to a projected cash flow before debt service.

Speculation to me is simply betting on the continuation (or, for that matter, the reversal) of a price trend in something that has no intrinsic value. Crypto, to me, is the essence of this standard; I can see it (just barely) as a medium of exchange, but not as a store of value, in that it doesn't produce anything. Moreover, its extreme price volatility together with the total absence of regulation place it outside any sphere of rational analysis I can understand.

Gold, which also has no productive capacity and therefore no intrinsic value, at least lends itself—if only by common consent—to analysis in relation to inflation. Options, futures and other derivatives are speculations on the price performance of the underlying assets or securities; they have no value apart from that.

I grant that this differentiation can blur somewhat when one is attempting to value the common stock of a company with a new technology or business model, a very limited operating history, and/or no credible record of turning a profit; in my judgment that's more speculation than investment, but this is obviously arguable.

In a sentence, then: The presence or absence of intrinsic productive capacity that lends itself to rational valuation seems to me the dividing line between investment and speculation.

Beyond that, at the level of an advisor responding to clients, my position would always be that I can't ethically advise them—nor even comment intelligently—on anything I don't understand. Thus, if a client wanted to speculate in crypto, for example, I would quite happily profess my ignorance and urge him/her to do so online, with money he/she could afford to lose.

May 2021

Just say no to individual stocks

I wanted to get your opinion about what to do with clients who wish to hold individual stocks in their portfolios. Most of my clients are delegators. They leave security selection to us, and we only use active and passive funds.

But a handful of clients want to put their own stamp on things by holding some individual equities. When they ask, “What do you think about XYZ company?” I want to scream, “I don't!” My firm only follows about 250 names, and issues buy ratings on maybe 100 of these. I can't understand how the inclusion of any one company at such a small percentage of the overall portfolio could possibly matter.

Do you recommend that I only seek delegators as my clients, or should I allow the inclusion of individual stocks, but tell those clients that they are on their own?

As is almost always the case, the simplest answer is the correct one. It is (rendered into your own words), “I have no capacity to analyze individual stocks, and do not believe that serious investors should attempt stock-picking.” If someone persisted in asking about an individual stock, I'd say, “As I've told you, I have no opinion on individual companies, because I have no capacity to analyze them.” I might add, ritually, “My work involves investing my clients' serious capital in broadly diversified equity portfolios.”

If someone genuinely wanted to try stock-picking, I'd encourage him to take, say, five percent of his portfolio and open an account with some discount brokerage. I would certainly not refer him to your firm's buy list, because that would suggest you're in some way willing to be responsible for its recommendations, which you must never for a moment appear to be. If you consistently and politely refuse to engage with the issue of individual stocks, some people will stop asking and some will go elsewhere; both will have made the right decision.

Going forward, in your client acquisition process, you probably need to stress your belief in managed/pooled portfolios more strongly than you have in the past. If I may say so, though I'm hardly objective, Simple Wealth, Inevitable Wealth makes this point with clarity and force.