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Fathers, Sons and Money

In this month’s Things I Didn’t Learn in School podcasts, I share two conversations with men who have each had remarkable and quite different journeys. Pierre-Yves Bonnet was born in France and has lived in the US, Mexico, Spain and China. A key moment in his life came when his father insisted he learn two foreign languages. Roger Johnson was raised in Bridgeport, Connecticut, lacked the daily presence of a father, served time as a young man and went on to found an organization that helps get ex-cons and others on their feet and also became an involved father and minister. In both conversations, the relative impact of a father’s presence or absence is a thread. Click on their names above to listen or go to my website or Apple podcasts. (And if you like these conversations please submit a rating on Apple).

These podcast conversations grow out of my experience with readers following the publication of Raising a Thief. Many readers said, “your story reminds me of…” something in their own upbringing. I realized many people could write a memoir about their family, work or both. Shameless plug: if you’ve read Raising a Thief and posted a review, thank you. If you haven’t, the audio book is now available as well as the print and e-versions. Spread the word.

In terms of investment thoughts, my 26-year-old son recently asked me a simple question. “Dad, you used to do this for a living, what’s your advice to my generation about how to invest?” Similar conversations typically mention things like Tesla or bitcoin. What follows is my answer. Feel free to forward to others if you find it useful or tell me where you disagree.

My short answer to my son: have an investment framework and deviate from it consciously, knowing the risks. 

Here is a stripped down version of framework, which I’ve consciously made more digestible, aimed at a mainstream audience rather than investment specialists. 

1.     To invest, you have to save. Adjust your lifestyle so you spend less than you earn. Money = freedom. If you value your liberty, save early and often.

2.     Investing money is like nutrition. Aim for a mix of ingredients. A combination of assets that spreads risks is called a diversified portfolio.  

3.     Wealth is created and destroyed via concentration. Most of today’s billionaires, like Bill Gates, made their fortune by founding a company. But it cuts both ways. People go bust when their investments are concentrated, wealth is preserved via diversification.

4.     Losing periods are costly because money compounds. If I have $100, a 10% return gets me to $110, 10% the next year gets me to $121. A steady 5% return means your wealth doubles in 14 years.   If my portfolio drops by half, I need to earn 100% to get back to flat!

5.     The basic investment ingredients are stocks, bonds and real estate. 

6.     Each major investment category has sub-categories. Stocks can be divided into emerging market, tech, value, or cyclical. Bonds into government, corporate, emerging, inflation linked, etc.   

7.     Assets compete with one another and their prices inter-relate. If bonds get expensive it makes stocks, as an alternative, comparatively more attractive and vice versa. 

8.     It’s easier to compare investments if you put them in similar terms. Conventionally, socks are quoted in terms of price and bonds in terms of yield. I put everything in yield terms (more on this below).

9.     Stock, bond and real estate pricing is mechanically tied to the interest rate set by the central bank. The Federal Reserve or PBOC if you are in China determines very short-term interest rates, called “policy” rates. The policy rate helps determine the interest rate on government bonds, which helps determine the price of stocks due to point #7, assets compete. 

10.  A currency allows you to own assets in a country you don’t live in. A currency adds risk (it can lose value) to a portfolio but doesn’t add return.  

11.  Stocks, bonds and real estate do well in different scenarios. By and large, government bonds perform well when the economy is weak, stocks when it is strong and real estate can be particularly useful when there is inflation.  Almost nothing does well when a central bank is raising interest rates because all prices need to re-set to this new reality.

12.  To predict whether stocks outperform bonds or which stocks outperform other stocks is hard. Unless you are willing to dedicate your life to figuring this out, don’t try. Typically, people brag when they make money and are mum when they lose.   

13.  A useful starting off point is to put 1/3 of your money stocks, 1/3 in real estate and 1/3 in bonds with a greater than 10 year maturity.  You could put more or less in each asset class if you have a belief that one of them will do better than another, but recognize the gamble. It can be fun to gamble and very gratifying when you win, but know the odds of each bet you place because you will definitely lose much of the time. The best investors (like Warren Buffet) are wrong about 40% of the time.

14.  Borrowing money and buying assets increases your wealth and your risk. If you, say, buy an apartment or a house with borrowed money and lose your job, a painful squeeze can ensue.

15.  Always have a margin of error. 

Where we are right now. 

1.     Governments are on war-time footing. The enemy is Covid. Governments are using whatever levers face the least institutional constraints. In China, top-down control and capital controls permit rigid movement controls that have largely stopped Covid in its tracks. As a result, the economic damage is less intense and the stimulus being offered is less intense. In the US and Europe given weaker population control Covid has done more damage forcing them to stimulate more than China.  The US is stimulating the most for a number of reasons I won’t get into here.

2.     In practice stimulation means the US Federal Reserve (the central bank) creates zeroes on a computer and uses that electronic ledger to go out and buy assets. The US Treasury can issue a bond and the Federal Reserve can print money and buy that bond. Presto! The US has created money and given it to the US government to spend on whatever it wishes, like stimulus checks. 

3.     When the central bank is printing money and buying assets, it drives up their price, which is reflected in the low yield on all assets.  For instance, the yield on the house I live in is around 4%. The yield on a US 30-year bond is around 2.2%. The yield on the S&P 500 stock index is around 3%. All these yields are historically low and relatively close to one another. The house is “illiquid” meaning difficult to sell, so it isn’t surprising the yield is higher. US bonds look expensive compared to stocks.  

4.     Yields in emerging markets and China are higher. The yield on Chinese 10-year government bonds is around 3.3% and the yield on the Chinese stock market is closer to 5% (none of these calculations are precise and there are many different ways of doing them). 

5.     We are in the midst of a wave of rapid technological innovation that is touching manufacturing, bio-tech, industry and many other spheres that is disruptive and difficult to predict.

6.     As a result of this framework and these conditions, I have more money in stocks than bonds, and half my stocks are held outside the US, particularly China. I’ve sold bonds (what’s known as going short, or profiting from a decline in prices) in the US and bought them in China and other emerging market countries. I don’t own any bitcoin or Tesla, whose yield is 0.1%.

7.     There are always risks. One of them now is that bond yields shoot higher. If they get get above the yield of stocks, money is likely to come out of the stock market fast.