I have a retirement account with TIAA-CREF and a personal brokerage account with Tradeking. Back in late 2007 and early 2008, after seeing the market react to bad news, the Fed cutting rates, and reading as much as I could, I was conflicted on how I should manage both accounts. The retirement account was nearly 100% in stocks just like the personal account.
Unable to decide one way or the other, I chose to leave my personal account alone and make some serious allocation changes with my retirement account. In March 2008, I shifted the allocation away from stocks and into the money market, fixed income, and TIAA’s guaranteed. Then in mid-December I changed my allocation yet again and now I am 70% in stocks, 15% money market, and 15% guaranteed. With this allocation shifting, my retirement account only suffered a 6.9% loss for 2008. Quite good considering everything that happened.
Unfortunately, I did not do this with my personal account. It suffered losses similar to everyone else.
Looking back, I want to try to understand why I did two different things. I should not have treated my personal account any differently from my retirement account. I had worked hard to accumulate the money that I deposited into both accounts, but I still treated my personal account almost as if it was money I had won with a lottery ticket. Also, acting in such a way seems to be indecisive. Or maybe I was just hedging my bets?
As I’ve been studying value investing and value investors, nearly all have said that efforts to predict the future are wasted. The same goes for trying to time the market. The same goes for trying to understand macro events. But timing the market and taking into consideration macro events are exactly what I did made a drastic reallocation of my retirement account.
I’ll definitely have to do some more reflection on this.
A few weeks ago I purchased The Smartest Guys in the Room, a book about the rise and fall of Enron. I found the book in the bargain bin for $10, which was about roughly 65% off list price—a great example of what one should do as a value investor: look for great things selling at great bargains!
As I began to read, a lot of things stand out in just the first 80 pages, mostly the business practices that the home loan and financial industries mirrored in the past five years that eventually brought about this current crisis.
For example, the compensation structure of Enron’s international division and the home loan industry are quite similar in that both were fatally flawed and both structures eventually helped lead each to their downfall. Enron International made money by building power plants and energy-related infrastructure to developing nations. However, the fatal flaw was the compenstation structure:
Developers got bonuses on a project-by-project basis. The developers would calculate the present value of all the expected future cash flow from a project…. When the project reached finanancial close—that is, when the banks lent money but before a single pipe was laid or foundation poured—they were paid. No wonder the developers were so eager to move on to the next deal; they had no financial incentive to follow through on the one they’d just completed…. The more deals Enron International did, and the bigger they were, the richer the developers got. The system encouraged international executives to gamble without risk.
Just like the compensation structure of Enron’s international division encouraged volume regardless of quality, so did the compensation structure of the mortgage and home loan industry. This structure also helped bring about the downfall of many lenders, banks, and financial institutions. Whether you’re in the energy infrastructure business, insurance underwriting, or home loan business, a compensation structure that values volume over quality seems to eventually lead to financial hardship or ruin over the long term.
In September 2005, Malcolm Gladwell wrote an article about auto safety and the rise in popularity of SUVs. It’s an interesting article. Two important facts to take away from the are: (1) perception is reality and (2) feelings often trump facts. If people can acknowledge these two human tendencies, they will at least be more self-aware, and perhaps even more rational and thoughtful. The following are snippets from the article that illustrate these two central points.
Perception is Reality
Then there’s this notion that you need to be up high. That’s a contradiction, because the people who buy these S.U.V.s know at the cortex level that if you are high there is more chance of a rollover. But at the reptilian level they think that if I am bigger and taller I’m safer. You feel secure because you are higher and dominate and look down. That you can look down is psychologically a very powerful notion. And what was the key element of safety when you were a child? It was that your mother fed you, and there was warm liquid. That’s why cup holders are absolutely crucial for safety. If there is a car that has no cup holder, it is not safe. If I can put my
coffee there, if I can have my food, if everything is round, if it’s soft, and if I’m high, then I feel safe.
Feelings Trump Facts
The truth, underneath all the rationalizations, seemed to be that S.U.V. buyers thought of big, heavy vehicles as safe: they found comfort in being surrounded by so much rubber and steel. To the engineers, of course, that didn’t make any sense, either: if consumers really wanted something that was big and heavy and comforting, they ought to buy minivans, since minivans, with their unit-body construction, do much better in accidents than S.U.V.s. (In a thirty-five-m.p.h. crash test, for instance, the driver of a Cadillac Escalade—the G.M. counterpart to the Lincoln Navigator—has a sixteen-percent chance of a life-threatening head injury, a twenty-percent chance of a life-threatening chest injury, and a thirty-five-percent chance of a leg injury. The same numbers in a Ford Windstar minivan—a vehicle engineered from the ground up, as opposed to simply being bolted onto a pickup-truck frame—are, respectively, two percent, four percent, and one percent.) But this desire for safety wasn’t a rational calculation. It was a feeling.
