Hello Houston

The Houston Chronicle recently started running my stuff, and I’m excited.

In honor of my introduction to Houston, I’d like to offer a personal story about my very first trip to Houston. Best of all, this anecdote has a pithy financial moral at the end.

In Spring 2001 I lived in New York City and sold emerging market bonds for Goldman Sachs. “Emerging markets” means Latin American, Asian, Eastern European, Middle Eastern and African bonds – all very volatile products. It was a super-fun job. I had recently picked up a new client – a couple of clever guys who operated a hedge fund within a successful pipeline company in Houston.

houston_chronicleI set up a visit to Houston because, of course, I already knew this company’s reputation. They dominated not only their pipeline business but had financially engineering their way into oil and gas trading, water-rights and paper-trading, and now a sophisticated, relative-value, emerging market bond hedge fund. (If the words “relative-value emerging market bond hedge fund” make perfect sense for you, then congratulations. If they don’t, then this column is for you.) Anyway, Fortune Magazine named them “America’s Most Innovative Company” for six years in a row. These guys were my kind of client.

First trip to Houston

We drank cocktails together in a fancy Houston bar while I listened to my clients describe the keys to their success.

“We just have the smartest guys in every business we tackle, and we know how to go after a business and make money off it.”

I was so convinced. I’m not kidding.

The smartest guys, with the best ideas, and all this awesome financial engineering? What could possibly go wrong? Personally, I planned to invest in the stock of that pipeline company as soon as I got my next bonus. Which, fortunately for me, was many months away.

For the next few months I spent a fair amount of my free time researching the company on my Bloomberg terminal. The amazing thing about Bloomberg terminals – for those of you who haven’t worked on Wall Street – is that I could find anything and everything about the company I could ever want or need. Historical earnings data and future projections. Analyst reports. News stories. Key executive bios. Charts and graphs and comparisons. I even personally knew key executives there! I loved my clients, and I loved this stock. And I couldn’t wait to get paid, so I could start investing in all those smart guys with all their innovative financial techniques.

enronBetter lucky than good

One of the most important lessons I learned in my Wall Street years is that it’s far better to be lucky than good. (That’s not the previously-promised pithy moral lesson, but it is true.)

Enron collapsed in the Fall of 2001 – before I got paid my bonus – so I never poured my own money down that rat hole. But boy was I eager to do it – only weeks before they collapsed.

Ever since then, whenever I hear people tell me about an individual stock they have bought, or plan to buy, and their reasons for doing so, I think of my clients at Enron.

What I learned from this Enron experience is that – not unlike Lord Commander Jon Snow – I know NOTHING when it comes to picking a good stock to buy. I thought I had access to EVERYTHING. And yet, I was completely wrong.

What I’d like you to know also – that promised pithy financial moral is right here – is that when it comes to picking individual stocks, you also know nothing.

My “I believe” speech, Bull Durham-style

annie_savoySo, I don’t believe in individual stock-picking when it comes to money matters and being smart.

“Well now,” you, as Susan Sarandon’s character Annie Savory in Bull Durham, might ask, “what do you believe in then?”

“I believe in getting wealthy,

Markets, cost discipline, the power of compounding,

Aggressive allocations, never selling, and neighborhood poker (if you like to gamble),

That Jim Cramer’s finance shows are self-indulgent, dangerous, garbage fires.

I believe Lee Harvey Oswald could not have acted alone.

bull_durhamI believe there ought to be a constitutional amendment outlawing variable annuities and the carried interest loophole.

I believe in index funds, entrepreneurship, selling investments only when you have to have the money and never for ‘timing” or ‘tax’ reasons, and long, slow, deep, soft automatic retirement-account dollar-cost averaging that lasts five decades.”

“Good night,” I whisper, as I turn and walk out the door, Crash Davis cool.

Leaving you/Annie/Susan Sarandon character breathless to say anything but:

“Oh my.”


A version of this ran in the Houston Chronicle and the San Antonio Express News.



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Risk and Uncertainty and Heuristics

riskI’ve become very attached to the “Five Year Rule,” which is my consistent rule-of-thumb answer to the question: Should I invest in stocks?

Five Year Rule

How does the Five Year Rule work? I answer the “should I invest question” with a question of my own.

Will you need the money in less than five years? If yes, then you can’t invest in stocks.

If no, then you should invest in stocks. It’s that simple.

I find this works better than more sophisticated approaches precisely because the stock market is just too darned uncertain for my little brain to comprehend.

A Risky World

Donald RumsfeldFormer Defense Secretary Donald Rumsfeld infamously quipped

“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.”

And although this sounded at the time nearly like a particularly strangled Dr. Seuss poem, and Rumsfeld stated it at a difficult point in the lead-up to the 2003 Iraq War, he had a point there.

Despite the guffaws at Rumsfeld and the catastrophe of that particular war, as an epistemological statement, I’d like to offer my thumbs-up to Rumsfeld.

A simpler but similar phrase – often attributed to Mark Twain – goes like this:

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

We all need better ways of sorting through what we know and what we don’t know, We need help with risky and uncertain situations.

Risk Savvy

I recently finished a book called Risk Savvy by Gerd Gigerenzer, a theoretician of decision-making who provided some of the research behind Malcom Gladwell’s better-known book Blink.

Although I don’t recommend Risk Savvy overall, Gigerenzer makes in important distinction between situations involving “risk” and other situations involving “uncertainty.”

Risk vs. Uncertainty

Decisions involving risk, I understand, are ones in which we try to reasonably calculate the chances for success or failure based on a set of known probabilities, and we act accordingly. My regular poker game with the neighborhood dads follows the logic of “risk” decision-making. I put my $20 into the kitty, and then I place bets based on reasonable guesses about what cards may fall and what my fellow players hold in their hands.

Risk management in this situation has to do with calculating odds, placing appropriate-sized bets (and also possibly limiting my alcohol intake.) I find this enjoyable, and to a degree, easily-managed risk.

Incidentally, to give you a sense of my poker track record, my youngest daughter collectively calls the neighborhood dads “the bad men who take Daddy’s money.”

The uncertainty of this situation, in the Gigerenzer sense, however, is distinct from the risk. It arises not from the cards, probabilities, and bets but rather from the chance that one of the neighborhood dads suffers a psychotic break and decides tonight is the night to upturn the table, grab the kitty full of twenties, and make a mad dash for the Mexican border.

poker_riskThat hasn’t happened yet, thankfully. But it would certainly fall outside the expected risks I thought I was taking when I showed up on any given Sunday night. “Uncertainty” in my example arises from risks I didn’t know I was taking. In a Rumsfeldian sense that neighborhood dad making a run for the border might be an “unknown unknown.” It’s hard to plan for that kind of thing.

Back to Stocks

As a student of the markets, I believe deep skepticism about whether we understand the risks we take is extremely helpful to keep top of mind.

We can approach a risky situation like the stock market, for example, with a scientific risk-management mindset. We try to solve the (known) unknowns. We calculate a firm’s past profits and model an estimate of its future profits. We estimate the effect of changes in interest rates and exchange rates. Growth curves. Technological changes. Management styles. Marketing strategies. Competitor analysis. Insider holdings. This is the stuff of the business section of all newspapers, magazines, television shows and blogs. All of these are known risks for any individual company and therefore any individual stock investment. And I would argue, deep knowledge of each and all of these risks might be nice, but sadly still leave you with woefully incomplete information. You still haven’t covered all the uncertainty.

No risk models in the world prepare you for commercial airlines to hit towers in a clear blue sky day in New York City. The model still won’t warn you about the following month, when Fortune Magazine’s winner of “America’s most Innovative Company” – 6 years in a row – will evaporate $74 Billion in shareholder value (Enron.) Or that that same month of October 2001 a product launch (iPod) by a tired, has-been tech company (Apple), is the key first step toward its future as the most valuable stock in the world.

Two faulty approaches we humans take in the face of all this uncertainty are 1. To avoid the uncertainty altogether and 2. To build increasingly complex models.

Avoiding the stock market altogether would be a shame since it’s one of the best tools for slowly building wealth over a lifetime.

Gigerenzer, the author of Risk Savvy, offers a helpful corrective to the traditional risk-management style of building increasingly complex models for calculating all the risks.


Gigerenzer’s advice is to substitute simple heuristics – also known as “rules of thumb” – to give you pretty good results in the face of extreme uncertainty.

Without knowing it, long before I read Gigerenzer, I’ve been cleverly substituting my Five Year Rule for all that fancy financial modeling. Not only are the market risks incalculable, the unknowns are really just too great. We probably don’t even know the things we don’t know.

The thing I can control, and that I do know, is whether I’ll need my money back within five years. If yes, I don’t put it in the stock market.

If I don’t need the money, well then, cowboy up!

A version of this ran in the San Antonio Express News

Please see related post


Book Review of Risk Savvy by Gird Gigerenzer



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