Shit Happens

When I was 18 I learned an investing lesson that most still don’t grasp.

As a fresh-faced 18-year-old, I was obsessed with saving. I wouldn’t spend money. At all. I don’t know what it was I just liked seeing my savings account tick up. But this money that I had been slowly accumulating was growing at a pathetic 5%. Yes, I was receiving around 5% on savings when I was growing up. Better days.

If I really wanted to see growth I would have to invest this money. And invest it, I did. I purchased a collection of ETFs (I knew even then that active management was largely a scam). I checked my account sporadically. I saw the total value grow. This investing lark is too easy, I thought.

Things changed after my first year of university. I learned a little more about economics and a lot more about how to spend my money. A group of friends had the magical idea to saunter off to South East Asia in the summer. This was a revolutionary idea for a group of 20-year-olds. It sounded like fun to me (it was) so I told them I would be joining.

There was only one problem. Where could I acquire the necessary funds to finance such an excursion? It would not be a cheap trip. Flights to Bangcock were in excess of £500, even with taking a 32-hour route which included a 9-hour layover in Istanbul. The very generous loan from The Student Loans Company had, unfortunately, been exhausted. The Bank of Mum & Dad was unwilling to provide an emergency loan due to refusal to comply with austerity recommendations. Friends were in a similarly barren financial situation. Fortunately, 18-year-old me was sensible. He invested (and non-idiotically). Luckily these funds could now be liquidated. Hoorah.

I didn’t care about my investment strategy. I didn’t care about where the market was. I didn’t care that I wouldn’t receive my dividends for that quarter. I needed the money. My investments had to go.

When I was 18 I had an idealised vision of investing. I would never sell, letting the returns compound. I even planned to use some of my student loan to bolster my account. But all that changed. And there lies the lesson: you never know what is going to happen in the future. Life gets in the way.

This isn’t a backtest. This isn’t an academic exercise. This isn’t theory. If you can access your account, you are always in danger of liquidating your positions at some point for some reason.

Now, when you read material by finance professors, finance gurus or your local bank making investment recommendations based on the long term returns of the market, beware. Even if their forecast were true (it isn’t), no person can get the returns of the market unless he has infinite pockets and no uncle points. The are conflating ensemble probability and time probability. If the investor has to eventually reduce his exposure because of losses, or because of retirement, or because he remarried his neighbor’s wife, or because he changed his mind about life, his returns will be divorced from those of the market, period.” 

– Nassim Taleb

He is talking here about ergodicity but the point outlined above applies to what I am saying. Your returns are heavily influenced by when you sell. You might not be in control of this time.

A rule of thumb:

Things that happen outside of your portfolio are just as likely to determine when you liquidate positions as your strategy.

Note how I said rule of thumb. Hence, not always true. For example, if you are somehow locked into your account (like your pension) this is not true. Similarly, if you have a significant mound of other liquid assets this might not be applicable. If your emergency fund is £1B then I think you’ll be ok. If you have non-human discipline and psychopathic commitment to not liquidating your account this rule may not be applicable to you. I wouldn’t want to go for a drink with you, but you may not need to worry about liquidating investments unexpectedly.

Even this, though, I question. People change. Are you the same person you were 10 years ago? I hope not. Is your life really that boring that you know for a fact that none of your plans will change over the net 10 years? Again, I hope not. Even if you are mentally composed in such a way, an exogenous event may force you to sell. If your ageing mother needs to pay for urgent medical attention I hope you don’t deny her this because it doesn’t fall in line with your investment strategy. You may say that the probability of this forced liquidation is too small to consider. But I would ask you how you knew this probability. It seems like a difficult assessment to make.

For this reason, investment time horizon must be viewed as not entirely deterministic. This stochastic element present in the time horizon adds a layer of uncertainty to the investment strategy which I believe has been neglected by most.

How should we act when this selling point is somewhat unknown? This is the question we should be asking ourselves. For a start, investments that offer fixed returns become more attractive. Instruments with a high level of fluctuation risk become less attractive. Investing in financial assets as a whole becomes waaaay less attractive. Maybe people should be committing capital more frequently but in lower volumes? Maybe people should be more focused on their emergency funds and have larger emergency funds? All questions that need answers.


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