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% of correct investment decisions and % of investment income you spend?


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I was wondering if I could trouble you guys for some insight:

 

1) % of correct investment decisions - 50% in 2016

Do you mind sharing your experience and thoughts on a realistic, good percentage to shoot for?

 

For the past 3 years (after I sold my share in a business), I've actively tried improve at investing. I want to get from a C+/B- to a B. I now do my own analysis/research and spend 75% of my time (vs maybe 20% previously). I also reflect on weaknesses (for ex: position sizing & the emotional side) and attempt to address them by reading books or talking to people. I also do a lot experimentation. If it's not working but seems to have a chance I keep at it. If it's (I'm) hopeless I stop. I try to be zen and objective.

 

This week I tallied all my investment decisions in 2016. If I include companies I spent a lot of time on but didn't pull the trigger, I end up w only 50% right decisions. If I take those out I get to 55%. 50% is the grade for 2016 though. A right decision is for co doing well + stock price going up.  Another point for correct position sizing. If I didn't execute on a plan to add when there was the opportunity to do it, then I give a wrong decision (so a stock can make money but have 2 R and 1 W). I didn't have any co's this year where co didn't do well but stock went up.

 

I was kinda shocked at the 50% score vs Peter Lynch's 60%. Having said that, this year was my best (knock on wood) by a good margin.

 

For some background, I've been investing for 15+ years with a low teens return. If you add business returns + a little bit of RE, it would be higher. I measure across stocks, bonds, cash. We're generally 75-80% invested.

 

2) % of investment income spent

I hope this is okay to ask - if insensitive I apologize in advance. I also wanted to ask how you guys approach spending investment income. What % do you spend, do you spend more if you have a good year?

 

Generally we've not spent any portfolio gains and just rolled it over. Living + kids college expenses (no aid) takes about 80%-90% of salary (some income from a 1 day a week consulting gig), dividend income (from my wife's biz + my share in remaining biz). We are in our early 50s, have 4 years of college tuition left, no debt. We live sensibly, buy 1 yr old toyotas, fly economy or premium economy on long haul. Our main luxury is a 2nd home, which we built ourselves at 50% of what it would have cost. Both my wife and I like working and plan to do it as long as we can. We try to look after our health, 70% vegetarian, mostly eat at home, drink wine but at the toyota level mostly.

 

Thanks!

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Lots of good questions. I have been trying to assess and improve my investment decision making over the last 5 years in a little bit more systematic way.

 

Here are some thoughts:

 

I think it is better to focus on longer term business performance and your ability to assess that correctly. So looking at your own expectations of key business drivers of the business - loan growth, loss provisions, efficiency ratio, etc for a bank over a 3 to 5 year period and comparing them to the actual outcome.

 

Forget about stock prices completely and just measure yourself on the ability to assess a business and how it would perform over the long term. That is unless your strategy is based on predicting short term price movements.

 

Even here over a horizon of 3 to 5 years the reasons for the business drivers turning out the way they did might not because of the reasons you have identified and it might just be your luck. Or two errors might cancel each other out and the end result might be deceptively accurate. I got WFC and a few other banks final earnings to the first decimal point and cannot stop patting myself on the back until I realized that  I overestimated two factors one on revenue and one of expense that cancelled each other out.

 

But if you do this over many industries and many stocks over say a couple of business cycles you might get a better feedback on your performance. All this of course must be backed up by actual outperformance over the broad stock market. It would no good being 100% right on all the drivers and still underperforming the market. But it might point to other errors like portfolio sizing or psychological traps. Having an investment journal that documents your psychological state and why you made a buy or sell decision to go along with individual stock assessment would help.

 

I have been tracking 3 to 5 year expectations since 2011 and it had been really helpful in pointing out systematic biases that frequently show up.

 

Vinod

 

 

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A few useful things learnt over the years ....

 

Divide the pile into 3 - hits, misses, no change. Over a lot of investments the number of wins and misses should roughly cancel out, & your returns will come primarily from 1) how well you handle the no change, and 2) how effectively you hedged your various risks along the way. The 'art' and 'skill' of the profession as it were.

 

Overlap your hits and misses with your circle of competence; ideally its maybe a 2/3 overlap.

Most returns will come from knowing what you're doing, & fishing in the right places. Luck non-withstanding.

 

Withdraw 1/2 the capital every time the portfolio doubles; proceeds pay off mortgages, &/or buy treasuries. Alternatively pay yourself a 7% annuity over 10 years (rough time required to double the portfolio assuming rule of 72). The objective is the systematic withdrawal of capital from the casino; there are lots of ways by which to do it.

 

Our preference is lump sum withdrawal; simply because in the 'good times' we can often double in 12-18 months, & in the 'bad times' we can often be down 30-40%. If you've already withdrawn your capital (ideally a few times), you're also really working with house money - & the downside volatility becomes no big deal. 

 

Every withdrawal is truly a bonus, so once all your debts are paid off - do something life changing with it.     

 

SD

 

 

 

I was wondering if I could trouble you guys for some insight:

 

1) % of correct investment decisions - 50% in 2016

Do you mind sharing your experience and thoughts on a realistic, good percentage to shoot for?

 

For the past 3 years (after I sold my share in a business), I've actively tried improve at investing. I want to get from a C+/B- to a B. I now do my own analysis/research and spend 75% of my time (vs maybe 20% previously). I also reflect on weaknesses (for ex: position sizing & the emotional side) and attempt to address them by reading books or talking to people. I also do a lot experimentation. If it's not working but seems to have a chance I keep at it. If it's (I'm) hopeless I stop. I try to be zen and objective.

 

This week I tallied all my investment decisions in 2016. If I include companies I spent a lot of time on but didn't pull the trigger, I end up w only 50% right decisions. If I take those out I get to 55%. 50% is the grade for 2016 though. A right decision is for co doing well + stock price going up.  Another point for correct position sizing. If I didn't execute on a plan to add when there was the opportunity to do it, then I give a wrong decision (so a stock can make money but have 2 R and 1 W). I didn't have any co's this year where co didn't do well but stock went up.

 

I was kinda shocked at the 50% score vs Peter Lynch's 60%. Having said that, this year was my best (knock on wood) by a good margin.

 

For some background, I've been investing for 15+ years with a low teens return. If you add business returns + a little bit of RE, it would be higher. I measure across stocks, bonds, cash. We're generally 75-80% invested.

 

2) % of investment income spent

I hope this is okay to ask - if insensitive I apologize in advance. I also wanted to ask how you guys approach spending investment income. What % do you spend, do you spend more if you have a good year?

 

Generally we've not spent any portfolio gains and just rolled it over. Living + kids college expenses (no aid) takes about 80%-90% of salary (some income from a 1 day a week consulting gig), dividend income (from my wife's biz + my share in remaining biz). We are in our early 50s, have 4 years of college tuition left, no debt. We live sensibly, buy 1 yr old toyotas, fly economy or premium economy on long haul. Our main luxury is a 2nd home, which we built ourselves at 50% of what it would have cost. Both my wife and I like working and plan to do it as long as we can. We try to look after our health, 70% vegetarian, mostly eat at home, drink wine but at the toyota level mostly.

 

Thanks!

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Thanks for sharing. Sorry for the late reply but was traveling.

 

As a (now) passive investor I can only control effort & decision making.  Rather than targeting higher returns, I would like to target better decision making (and its components). I believe higher returns will follow. Anyway, I consciously worked on position sizing & emotional balance and was encouraged. So I want to push it some more.

 

At the same time, in going through 2016 investment decisions, I realized I still had quite a number of mistakes. So I feel I need to track and I really wonder what's a realistic batting average on decision making.

 

Some specific responses.

 

Waiting till selling, longer horizon - agree. In principle, I hesitate to count before a sale (which is why i knock on wood) but need something even if imperfect. Also, I would like to address obvious issues sooner.

 

Assessing business performance & drivers - Agree also. I try not to be too precise as I believe accuracy is limited by real life.

 

Business cycles, long term, etc - Yup been there. My first investment was 30yrs ago  a couple of years out of college - genentech at 14, sold at 26 a year or so later. DNA was acquired for 400 (split adjusted) 20 years later by Roche. Haha. I have a few of these. Bought NFLX at 9 and sold at 25. One could argue these were value investments then, based on traditional metrics.  Clearly these were more bad decisions (super stupid) than good ones. Well, I think I am pretty balanced now that I can smile at these without too much regret.

 

Anyway, been tracking portfolio actively since 2000. I think I've done ok. I do want to get better though. It's like cooking or making bread for me. If u are going to do it, may as well do it really well. I tend to look at overall portfolio multiple, all-in (including returns on bonds + cash), not hung up on CAGR and don't really compare except as a way to do better.

 

Circle of competence/industry cycles -  I spend years trying to learn an industry as much as one can 2nd hand. Some concrete results after a while & tuition losses. I look at industry cycles as a plus these days.

 

Investment diary - I suppose tracking & analyzing decisions is similar. The only thing is when i ask people to improve, the next question is improve from what? I need to measure.

 

Hits, misses, no change - This implies 50%+ right? (hits = misses, no change & hedges determine returns).

 

Withdrawals - Thanks SD. I appreciate the insight on spending. We have never really borrowed, we probably should have. I don't feel we are that old, but I find less material stuff interests me and I actually spend a lot of time trying to simplify. After years, I make really great bread but understand it's bad for you. We now only eat whole grain bread (flax,quinoa, nuts etc). I am interested in flying biz class when we travel long haul but at 4-5x reg economy and 2x prem economy (which is like the old biz class), dunno if sensible. Same for primary house upgrade or irresponsible car. I actually walk to office 3-4x a week.

 

Life changing - Biggest life changing thing past 2 years was losing 40lbs. Other than that, I feel we've created decent amount of employment. Also now, we try to be more generous with people around us. I would like to do some more interesting stuff, startup or co invest in startups - but lost on last 2, one still alive. I find, I can only do one or two things really well at a time.

 

Anyway, thanks everyone for the comments.

 

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Hits/Misses/No Change is 33 1/3% each.

On a history of 9 'ideas' - 3 work well, 3 are net neutral, 3 bomb completely. 2 ways to win 1) Winning $ >  loosing $, and 2) skill at 'working' the net neutral tranche.  9 'ideas' does not mean 9 different 'names' - you may have used 2-3 ideas on a single 'name' over the period that you've owned it.

 

Debt. Pretty much everyone had a mortgage when they bought their first house. Pay off your own mortgage, & maybe your kids as well - in return for grandkids, sooner. Life changing.

 

Simplification. All for it. Just keep in mind that it applies to discretionary income as well.

There are lots of ways by which to 'give back'. At this time of year, 'Secret Santa'  has a lot going for it.

 

SD

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How can you determine the number of correct decision you took? Serious question. Many decisions can be totally correct, yet have an unfavorable outcome because of bad variance.

 

Yes I can't do it as I never have access to perfect information, even after my investment end or many years after. There is a serious risk of acting on results here. You can make an investment and lose money (or not make the maximum) while having acted completely optimal and vice versa you can make money (even lots of it) with a stupid investment (and blind luck on your side).

 

Of course try to do a retrospective but I wouldn't count it this exact. The only exact thing to measure is rate of return (over a decade at least).

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For # of ideas, look at your trading history over the last 3-5 years (for most this will be on-line).

 

Every group of trades you did was based on an 'idea' - ie: 10 sales & repurchases of XYZ at different prices is one 'idea' - you were hedging XYZ against some future event. If you bought XYZ back at a big gain - it was a hit, if it was at +- 10% of the sale proceeds it was neutral. It's not hard.

 

Don't care what happened after you bought or sold - you didn't execute.

 

Look at the big losses.

Anything common? Why were they so big? What happened to the stock at each of 3, 6, 9 months later? For most, the cause will be panic - couldn't stand an unrealized loss of >15%. Had you done nothing, there might well not have been a loss. It will not be pretty, but it will point you to what kind of investor you really are - not what you think you are. If you suck at investing (most do), simply put your $ into a preferred share mutual fund - it will cost you a lot less, & make your life a lot more relaxing.

 

To get better - you have to stop doing the stupid; hence focus on the losses.

It may be as simple as a more realistic expectation, or buying an additional X% when you currently would sell - & taking that other guys lunch. Not big changes.

 

SD     

 

 

How can you determine the number of correct decision you took? Serious question. Many decisions can be totally correct, yet have an unfavorable outcome because of bad variance.

 

Yes I can't do it as I never have access to perfect information, even after my investment end or many years after. There is a serious risk of acting on results here. You can make an investment and lose money (or not make the maximum) while having acted completely optimal and vice versa you can make money (even lots of it) with a stupid investment (and blind luck on your side).

 

Of course try to do a retrospective but I wouldn't count it this exact. The only exact thing to measure is rate of return (over a decade at least).

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For # of ideas, look at your trading history over the last 3-5 years (for most this will be on-line).

 

Every group of trades you did was based on an 'idea' - ie: 10 sales & repurchases of XYZ at different prices is one 'idea' - you were hedging XYZ against some future event. If you bought XYZ back at a big gain - it was a hit, if it was at +- 10% of the sale proceeds it was neutral. It's not hard.

 

Don't care what happened after you bought or sold - you didn't execute.

 

Look at the big losses.

Anything common? Why were they so big? What happened to the stock at each of 3, 6, 9 months later? For most, the cause will be panic - couldn't stand an unrealized loss of >15%. Had you done nothing, there might well not have been a loss. It will not be pretty, but it will point you to what kind of investor you really are - not what you think you are. If you suck at investing (most do), simply put your $ into a preferred share mutual fund - it will cost you a lot less, & make your life a lot more relaxing.

 

To get better - you have to stop doing the stupid; hence focus on the losses.

It may be as simple as a more realistic expectation, or buying an additional X% when you currently would sell - & taking that other guys lunch. Not big changes.

 

SD     

 

 

How can you determine the number of correct decision you took? Serious question. Many decisions can be totally correct, yet have an unfavorable outcome because of bad variance.

 

Yes I can't do it as I never have access to perfect information, even after my investment end or many years after. There is a serious risk of acting on results here. You can make an investment and lose money (or not make the maximum) while having acted completely optimal and vice versa you can make money (even lots of it) with a stupid investment (and blind luck on your side).

 

Of course try to do a retrospective but I wouldn't count it this exact. The only exact thing to measure is rate of return (over a decade at least).

That doesn't answer my question. You can hedge against X, and X doesn't happen. Does that make it a bad hedge? Perhaps X occurring was a 50% probability event, and the coin just landen heads instead of tails.

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How can you determine the number of correct decision you took? Serious question. Many decisions can be totally correct, yet have an unfavorable outcome because of bad variance.

 

One answer that is promoted by a lot of people is that you only evaluate process rather than outcome. So a decision is "correct" if you followed the process (e.g. if you're a Buffetty investor: ensured that business had moat, was not in decline, trading at reasonable FCF, whatever else) irrespective of what the investment result was.

 

Of course, the problem with above is that you could have (almost?) perfect process and still crappy results. E.g. you could have bought AXP 5 years ago (arguably good Buffetty process?) instead of MA/V or even SPY and your results would be crap. Maybe not perfect example, but IMO somewhat reasonable one. So at some point you have to evaluate your results too. Or somehow evaluate the process results in comparison with what else you could have done. Not sure how this would work though.

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'That doesn't answer my question. You can hedge against X, and X doesn't happen. Does that make it a bad hedge? Perhaps X occurring was a 50% probability event, and the coin just landen heads instead of tails.'

 

If you lost $ - WHEN YOU CLOSED IT OUT - it was a bad hedge.

The hedge itself may have been bang on;  but it was put on too early/too late, lifted too early/late, or the event just didn't occur (as you thought it would). As with any tool, there is a cost to using it, & the skill is in how you apply it; in 20/20 hindsight you just made the wrong choice. 

 

But ... if you find that you mostly lose at hedging - either stop doing it, or go to cash.

You hire a plumber for a reason - he/she is good at it, you aren't, and the cost of the repair is a lot lower if he/she does it.

 

It's a brutal test ... but if you can learn from it, it will serve you well.

 

SD

 

 

 

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If a hedge is insurance, shouldn't it be a small cost to prevent large left tail risks?  Perhaps I'm thinking about this too literally, but the effectiveness of hedge trades (I'd assume) should manifest in the volatility of the portfolio vs the index.  No?

 

Also, process is more important than outcome IMO.  But not all process will produce good outcomes.  My process could be go overweight every time it is a full moon.  I could never break it but get terrible outcomes.  So the results should be holistically viewed not as just a bunch of outcomes, but also a function of the process.  Ideally the process should increase your success rate and you can tweak it over time to get better

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Agreed the hedge is a cost.

 

But think of a hedge as simply a sell (to protect against a price decline) & a later repurchase of the same number of shares. On entry, the cost of the hedge is unknown - it is the potential loss on repurchase + 2 commissions. However, if the hedge event occurs; the cost becomes negative - it is the gain on repurchase - 2 commissions. A successful hedge is a profitable hedge.

 

The purpose of process is to produce result, result matters. The question is what is the right metric, & right timeframe, by which to measure. Most would agree with time weighted return, but 1 trip around the sun is pretty meaningless.

 

SD

 

 

If a hedge is insurance, shouldn't it be a small cost to prevent large left tail risks?  Perhaps I'm thinking about this too literally, but the effectiveness of hedge trades (I'd assume) should manifest in the volatility of the portfolio vs the index.  No?

 

Also, process is more important than outcome IMO.  But not all process will produce good outcomes.  My process could be go overweight every time it is a full moon.  I could never break it but get terrible outcomes.  So the results should be holistically viewed not as just a bunch of outcomes, but also a function of the process.  Ideally the process should increase your success rate and you can tweak it over time to get better

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Don't have a perfect answer for scoring. Some obvious ones including for mistakes I still make -

 

1) Let's say you made a correct call on company/industry with respect to how it would go business wise + 1 and :

a) correctly sized in relation to your targets +1

b) too small position, don't add even if makes sense -1

c) sell too early (fear/panic, too short term, incorrect long term value assessment) - 1 (impact can be a - 10  :)) )

d) something unexpected happens - fraud, delayed earnings, disaster; neutral and it depends how you assess the situation (is it temporary WFC, existential VRX) and what you do; ideally you don't have too many of these 

e) lack of real understanding of value for ex do you invest at the peak of the auto cycle when it looks cheap -1

f) too optimistic, requires some things to go right - 1

g) too much risk/debt - 1

h) right call on industry/company but you bought the wrong company/instrument (debt vs equity for ex) -1

 

2) Let's say you made a wrong call on the biz/industry - 1 because u failed to:

a) identify problems in the biz model/co or industry - VRX, something probably quite wrong

b) admit a mistake & cut your losses - 1 again; + 1 if you cut

c) understand business/identify value drivers and just buy based on what numerically looks cheap

d) understand or underestimate competition existing + new or technology obsolescence

 

I guess this is where it makes sense to stick to what you know. I'm not really built that way. I like doing this because I learn new things. Can be maso at times.

 

3) Not enough homework for ex:

a) liking concept & guessing - 1

b) just following smart guys  - 1

c) overconfident because did really well past few investments - 1

d) don't ask what else could happen (10th man rule - World War Z :) )  - 1

e) relying on rules of thumb vs doing actual work - 1

f) not looking at entire industry chain over time - 1

g) not understanding valuation parameters, real risks, catalysts for business  - 1

h) not finishing analysis, lost opportunity - 1

 

4) Behavioral lots of these (lack of objectivity, stuck on regret, pride, hope to solve probs, analysis paralysis, d--k for a tick, not willing to stop if wrong, giving up after a few mistakes etc)

 

5) Overall portfolio errors

a) too many risky bets

b) all in the same industry or business cycle - financials + real estate + construction

c) too levered; scenario where u can go bust or get really hurt

d) don't understand or appreciate all the risks 

 

Sometimes takes longer to know, but we just do the best we can.

 

Making the wrong decision and being lucky...is not my karma. I have to work for/earn what I get which is ok and just fair. Lots to be thankful for.

 

Hedging is something I am maybe at a 4/10 level though I've been at it for a long time. I think there's something there though as I'm losing less on it now. Haha.

 

Cheers!

 

 

 

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