Finance


These are my notes on various finance topics and experiences.

Quote:

“When somebody says it’s not about the money, it’s about the money” – H.L. Mencken

“A cynic is a man who, when he smells flowers, looks around for a coffin” – H.L. Mencken

“Listen, here’s the thing. If you can’t spot the sucker in your first half hour at the table, then you are the sucker.” – Matt Damon in Rounders

Microfinance:

There is a pretty good explanation of Microfinance in http://en.wikipedia.org/wiki/Microfinance   I am poking around in this space to see if there is something I can try out.  I will post more on this topic based on my findings.

Index Funds vs. Actively Managed Funds:

There is a good write-up on the topic, forbes_index.  A notable point made in the write-up is investor behavior having an impact on performance.  Chasing returns and over reacting to market news have the same negative impact on fund performance as individual stock performance.   If you can put your money away for an extended period of time into a low cost, tax efficient index fund, you can sleep easy at night.  This perspective on mid cap equities is interesting.  mid cap

If you really want to do some analysis and pick a stock or fund on your own, I think it is possible to pick something that gets you ahead of the thousands of other people analyzing opportunities to out perform the market.  You can find opportunities in less efficient markets such as emerging markets or small caps.  But I think you need to do your homework.  I see a lot of people get a tip from someone or jump on a bit of news as the driver to buy a fund or stock.  That type of homework is not going to get you consistently beating the market.  I am the first to admit that I am not keen on doing the necessary homework to identify the next great investment.  Maybe you can find a fund manager that can do that work for you.

Survivorship Bias:

Survivorship is the idea that your data can be skewed if you only look at the survivors.  An example of this idea at work is when you are presented with mutual fund data.  Over a period of time, poor performing mutual funds are closed or replaced.  You end up with better performing fund numbers because only the better performing funds survived.

You can see how many funds in a chart I got from Forbes: Index Funds get better with Age.

mutual_closed

A mutual fund company can leverage this bias by launching a number of different mutual funds with various aggressive strategies.  After a couple of years, you close the all but the best performing funds and market the surviving funds to the consumers.

Pay Yourself First:

There is a line of thought called ‘Pay yourself first’ that a number of self help coaches push. The idea is that you should take money to pay yourself (could be automatic paycheck deduction into savings plan or taking your pay before you pay any other expenses for your business). I don’t really see why this is such a big deal. But if this little ‘trick’ gets people on the right track, that’s fine.

As I evaluate potential business to buy, I notice a number of small business owners base their valuation as multiples of net profits. The problem is that may business owners don’t include paying themselves in this calculation. When I look at what a reasonable salary should be for their contribution to the business, the business is worth very little or even losing money. If the business cannot run successfully without your labor, I think you are fooling yourself if you don’t ‘pay yourself first’. Many owners don’t seem to agree with my line of thought.

Small Bets:

I like to think about small bets in the way a casino thinks about their operating model.  The odds are stacked so that over the medium to long term, the house should win.  Over the short term, there is volatility which gives players the perception that they can win and gets them to play.  The operating model for the casino is to get the players to play as many hands as possible as quickly as possible.

Although the odds on profitability of investments are all over the place, I would act on assumption of odds in your favor and making small bets vs. making over sized bets on your good investment.  My own experience on this line of thought is in poker games.  When I evaluate my bet, I compare the potential pay out vs. the odds of the winning hand.  So, a 3-1 winning hand is a good bet if the pay out is better than 3-1.  But I might have to reconsider if I need to put all my bank roll into the bet.  A loss of my entire bank roll means I am out of the game.  If I feel that the table presents a good opportunity and I have the time to spend at the table to take advantage of the opportunity, I should focus on making smaller bets over a series of games.  This reduces my volatility but, more importantly, it keeps me in the game.

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