An iOS (Investor Operating System) Built Over 20 Years and Counting
20 years. That’s how long I have spent (so far) studying markets and practicing investment management in some of the most sophisticated and complex environments, from teaching MBA students Investments at MIT to doing risk management at the investment office of Forbes-listed billionaires during the 2008 Financial Crisis.
And boy, if you’d told the 17-year-old Parisian kid with henna-dyed hair who came to LA to play guitar professionally that he would spend the next 20 years immersed in investment management, he would have said, “Mais, t’es fou!”
But it turns out that time does fly when you’re having fun, and the meter is still running.
After all these years and a few bruises along the way, I’ve concluded that managing money boils down to three fundamental things. And each of these gets magnified as the stakes grow. Experience in this business means understanding these three intimately and recognizing the magnification effect for what it is. Whatever comes after experience (is that wisdom?) helps prevent the wealth magnification effect from turning into an unhelpful distortion. Here are the three factors:
Really Knowing the Mechanics of Investing,
Digging in on the Psychology of Investing,
Getting Clean on the End Goal of Investing.
Really Knowing the Mechanics of Investing
I’m talking about the hard knowledge of how the “things” of investing actually work. Not just what you learn from a book, whether it’s an MBA textbook or a Doctoral dissertation. That alone won’t cut it. I mean really knowing it. The kind of knowledge you get from studying investments from every angle, engaging with them in hand-to-hand combat, and watching them misbehave in unexpected ways under highly unfortunate circumstances. That’s when you know it, for real.
Some of it is basic plumbing (like how bonds trade), some of it is electrical engineering (like how ETFs are put together), and a little bit of it is rocket science (like how options have dynamic “non-linear” risks). But it’s all about understanding how things actually work in the real world. Here are some examples of helpful knowledge:
It's helpful to know what tends to happen to the liquidity of various asset classes during a market crisis.
It's helpful to know that buying options must be treated with great respect because it involves putting money on the table that could vanish entirely. Selling options requires even more humility because you're effectively giving someone else in the market control over your future. Only do these things when you can handle the worst-case scenario.
It helps to understand the business of asset management, so you know to look at the top holdings of funds and ETFs (especially those expensive ones with fancy names like "Global XYZ" or "Future of Fill-In-The-Blank").
Plumbing can quickly become mission critical. At the risk of sounding unsophisticated, almost no one cares about what makes a toilet work, but things get dicey real fast when the contraption doesn't operate like it has in the past.
Digging in on the Psychology of Investing
Your own psychology and that of the markets, is what I mean. Your brain on money is a mess (I don’t mean being rich… I mean the moment you think about whatever money you have, it tends to mess with your brain). Money is too abstract, yet it’s connected to your experience of the world in a very real and immediate way. And financial markets give you new prices to process almost every day. No wonder people are willing to pay extra for illiquidity!
With time and experience, you start to condition yourself to see these prices for what they are: information, maybe, but definitely an opportunity for reflection. A friend recently captured a critical piece of that concisely when he said to me, “As always, the money is made in the buying.” But if you look at it as a gauge of your worth (either your literal financial worth or your implicit intellectual worth for investing in the things that you invested in), every bias from Psych 101 starts to affect your ability to make sound and objective decisions.
And then there is the aggregated behavior of everyone else. A common market saying is “be greedy when people are fearful and fearful when people are greedy.” I actually think the ideal state is to name fear and greed in yourself for what they are, recognize them, and tell them that they’re “not invited to this party” (as my wife says about unhelpful emotions).
But ultimately, fear and greed are connected to liquidity in the market. For any given asset at any given time, there is a more or less fixed supply of it, whether that’s shares in a company or the amount of a bond issued. When people get excited about something, that creates momentum, i.e., more eagerness on the buyers’ side of the ledger (by definition, the quantity of buyers and sellers is balanced – every share sold must be bought).
To join the party, you have to buy, which adds to the eagerness imbalance. That’s “taking liquidity,” in the parlance of markets. Taking liquidity is like cashing in favors to get a Saturday 7pm reservation at a popular restaurant. Providing liquidity is like having a reservation to resell to a more eager party. Liquidity provision is like providing a valuable psychic service to the masses and is a direct application of my friend’s saying.
Getting Clean on the End Goal of Investing
Ok, stay with me here, even if we get a little New Age for a minute. It really helps to articulate the “why.” Think of it as your mission statement or founding principle. It creates governance for your investment strategy and it helps you look beyond “the number” and outside of yourself. My kids just graduated from elementary school, and it’s hard for me not to think about what I hope for them as adults. I’ve been posting more about this recently. Here is one of those posts:
Why focus on whether your kids turn out to be well-balanced adults? Because the moment you do, you realize that whether interest rates spiked by 15 bps last Friday (which they did and is factually a big number) has arguably no bearing whatsoever on how your kids will experience adulthood. Sanity restored instantly…
As an aside, if you have a crummy day (or a crummy year) in markets, which will happen at some point, that may prove to be an important “legacy moment” of its own. It turns out it’s critical to share our ups and downs with our kids for their own well-being later down the road. Otherwise, they get to adulthood and think to themselves: “This is really hard for me, but I feel like it was easier for my parents. What’s wrong with me?”
Long way around the block to say: know what matters, practice vulnerability, and look way out past the horizon line.
An Application of the iOS: Investment Pre-Mortems
Before we close for today, I wanted to share this video audiogram we released last week on the concept of pre-mortems. Everyone knows what a post-mortem is, but investment professionals do pre-mortems to apply principles 1 and 2 above. This helps track down what could go wrong ahead of time based on how things work and reduces the emotional heat when things don’t turn out as hoped.
Thanks for reading; I know we pack a lot in. Feel free to share this post with friends and colleagues so they can join the over 1,000 subscribers who receive these insights directly in their inbox. They can subscribe here.
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