Random Musings – Investing

Email#1 – What to expect

[I will copy and paste the English version of emails from a financial advising monthly email project I’m doing for my friends every month’s 1st Monday after the 1st weekend. If you want to subscribe, click here.]

(Image by Matt @ PEK from Taipei, Taiwan (Expectation) [CC BY-SA 2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons)

Thanks for the trust and interest in my monthly email project, I really appreciate it and it means a lot to me!! As Warren Buffett once said, “It’s so much fun when you’re trusted and worthy of trust.” I will do everything I can to ensure that that trust is warranted.

So what do I want to achieve with this project? I want to achieve two things:

  • Monthly update on valuation of US stock market
  • Food for thought on personal finance (a hugely underrated topic in the topic of wealth preservation / growth) and of course investing

As this is the first email in hopefully a very long list of future emails, besides giving everyone a monthly update on valuation of US stock market, I want to explore thoroughly why I strongly favor incorporating valuation into investing in index funds, why this is the only strategy so far that I am comfortable in recommending to friends, and what I’m going to do to ensure my interests are aligned with yours regarding this strategy (hint: I’m going to put money where my mouth is).

So before you doze off, let me go straight to the monthly update on valuation of US stock market and what the actionable implications are. If you are still interested, then you can proceed to read on to hopefully learn a thing or two about why I only recommend such a strategy for friends.

[Monthly update on valuation of US stock market]

So how does the US stock market’s valuation look like? You are in luck, because for the 1st time since April this year [1] you can finally find the US stock market undervalued enough to start buying.
Market Value - 5Nov2016.PNG
The US stock market is currently 4% undervalued (I will explain in next month’s email why I use Morningstar’s Market Fair Value for valuation purposes), which using my formula of X% undervaluation X2, means you should invest 8% of money you can invest in (exclude emergency fund money [2]).
Bob #1.PNG
So let’s use imaginary Bob as an example of how this works:
As you can see, Bob has $10,000 in net worth (for simplicity sake, let’s assume it’s all in cash), but he has $3,000 in his emergency fund because his monthly expenses is $1,000, so all in all his investable fund has only $7,000.

Since the US stock market is 4% undervalued, he should at most invest only 8% of his $7,000 in the S&P 500 Index ETF (stock code is 3140 in Hong Kong stock exchange).

One thing to note is, if the “should invest ($)” is less than $6,250, wait until the “should invest (%)” is big enough that your “should invest ($)” is greater than $6,250 before you invest. This is to ensure that commissions you pay for buying stocks doesn’t kill your returns [3].

[Food for thought on personal finance and investing]

So let’s refer to the 3 points I wanted to make about this investment strategy:

  • Why do I strongly favor incorporating valuation into investing in index funds
  • Why this is the only strategy so far that I am comfortable in recommending to friends
  • What I’m going to do to ensure my interests are aligned with yours regarding this strategy

Why do I strongly favor incorporating valuation into investing in index funds

Warren Buffett once commented that “Among the various propositions offered to you, if you invested in a very low-cost index fund — where you don’t put the money in at one time, but average in over 10 years — you’ll do better than 90% of people who start investing at the same time.

And the reason why you shouldn’t put the money in at one time? You don’t want this to happen to you:
Nikkei Lost Decades.PNG
This is the stock price of Nikkei 225 (Japan stock market), and as you can see, if you had put all your money into the Nikkei 225 in 1990, even 26 years later you would’ve still lost money.

And the reason? Valuations were nose-bleedingly high, with investors willing to pay prices which would give them only 1.7% yield [4] (in comparison, you could’ve bought super safe 10 year US treasury bonds at 8% yield).

I’m a strong believer in the power of investing in index funds, but there are times where even index funds aren’t the best choice and it would be prudent to just stay in cash. This is why I take valuation very seriously.

Why this is the only strategy so far that I am comfortable in recommending to friends

Successful investing requires two elements:

  • An investing strategy that works (eg. Investing in index funds)
  • Being able to stick to the investing strategy through thick and thin

And timing your entry into the US stock market through valuation is one great way to ensure you are able to stick to the investing plan through thick and thin.

Let me talk about why being able to stick to the investing plan through thick and thin is important before I delve into why this strategy makes it easier for you to stick to the investing plan through thick and thin.

A study by Barron’s and Morningstar showed that even though the best performing mutual funds had 18+% return / year, investors who bought funds on average had -11% return / year.

Investors performance hurt by jumping in and out.PNG
The reason? Investors bought when performance was good but sold when performance was bad, which meant that because of mean reversion, they bought precisely when performance most likely would turn bad and sold precisely when performance most likely would turn good.
Don’t be that kind of investor. Once you’ve bought an index fund at a good price, hold it until you really need the money and thus must sell, because on average over a 5 year holding period, if you were out of the market for 30 days where stocks had their biggest gains, a theoretical $100,000 would have turned from $341,722 to a mere $153,792 [5]. Don’t jump in and out of the US stock market unnecessarily lest you want to miss out on your best paydays.

And so how does this strategy of gradually entering the US stock market based on valuation help you better stick to the investing strategy through thick and thin?

The keyword is this: Cash.

The number one reason why investors aren’t able to stick to an investing strategy through thick and thin is that psychologically speaking, the pain you feel from losses are much more than the joy you feel from gains [6].

By virtue of following this investment strategy, you will hold cash (and lots of it relative to your net worth) for long periods of time because the US stock market is never always on bargain sale. What this implies is that if the US stock market does drop 10%, 20% or even 50%, while everyone is panicking because they are fully invested, you would feel much more calm as the bulk of your portfolio is in cash and thus doesn’t get as hurt by the drops.

In the ideal case, not only you gain from the benefit of being calm while everyone panicks because of the amount of cash you’re holding, you will definitely beat the majority of the people who end up being on panic sell mode, and also perform better than people who are 100% invested in the US stock market (and have nerves of steel to still hold onto their investments even during a 2008-2009-esque 50% price drop) because you avoid the huge drops that are hugely detrimental to your investment returns [7]. In the worst case, you match or slightly undeperform the US stock market, but you have the peace of mind and ability to stick to the investment strategy through thick and thin.

What I’m going to do to ensure my interests are aligned with yours regarding this strategy

I’m a strong believer that you should prioritize advice where the person giving the advice has skin in the game. The reason is simple: if I were to give you advice which I follow myself, I better make sure it’s some good advice lest I get screwed over by the quality of my own advice.

So here’s my commitment to all of you: I will follow my own formula of X% under-valuation X2, I will show a monthly snapshot of my portfolio as proof that I put my money where my mouth is, and if I ever do sell the S&P 500 for non-investment reasons, I will disclose in the monthly emails.

This shows how much I believe in my own advice, and ensures that I will do my best to ensure the advice is good, do my best to update the advice if needed to make it better, and if the advice hurts everyone I will hurt as much as you do.

[Closing Remarks]

So I think that’s enough information for the 1st email. I hope none of you are dying from information overload… And I hope this email was informative and helpful 🙂

For next month’s food for thought, I want to explore on the topic of valuation so that in the event that I die or am unable to issue monthly emails anymore, you can independently make a judgment of when to enter the US stock market yourself through simple understandings of valuation. After all, my goal is to let you be equipped with the knowledge to make better financial decisions, and if one day you don’t need me anymore to make good financial decisions, that means I’ve succeeded.

[1] This assumes that you buy on the Monday following the 1st weekend of the month, which is the release schedule of this monthly email project
[2] My advice for emergency fund money has always been to keep at least 3-6 months of living expenses in cash for emergencies. I personally keep 6+ months of living expenses in cash for emergencies.
[3] Costs is the only component of investment return you can control, so being as cost efficient as possible is crucial to your investment success. The $6,250 figure comes from the fact that at most you should allow for your costs in investing to be 0.5% / year since that’s the lower end of annual costs you can get from most funds. Assuming you hold the stocks for at least 5 years, the Vanguard S&P 500 Index ETF‘s annual costs is 0.18% / year, and most banks charge minimum $100 / stock purchase, then that means you can afford to pay $100 commissions for a $6,250+ stock purchase since that amounts to 0.32% annual costs / year if you hold the stocks for 5 years, which means on aggregate your costs over 5 years is 0.5% / year.
[4] The P/E ratio was 60 times earnings, which meant that in an ideal world where you were the owner of the company and could pull out 100% earnings out of the company every year, it would take you 60 years (!!!) to get back your money, thus 1.7% yield (100 / 60).
[5] One Up On Wall Street: How To Use What You Already  To Make Money In – Peter Lynch (Location 303 of 6290)
[6] The human mind is designed to survive, so if you are feeling pain from losses from investment, it is equivalent to the brain of threats like running out of food, so your brain is tempted to cut losses and run so that you can survive another day. This is a temptation you need to train yourself out of, not something most people naturally can just emotionally disconnect from.
[7] It’s far easier to lose money than win money percentage wise in investing. 10% loss means you need 11% to break-even, 20% loss means you 25% to break-even, 33% loss means you need 50% to break-even, 50% loss means you need 100% break-even.

[Disclaimer] Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured

Questions on US Bancorp

By David Shankbone (Own work) [CC BY 3.0 (http://creativecommons.org/licenses/by/3.0)], via Wikimedia Commons

In my last post I mentioned that US Bancorp is arguably the best run US bank in terms of metrics, beating the golden standard Wells Fargo in ROA, ROE, and Efficiency Ratio.

What has eluded my comprehension is why US Bancorp can have such a low cost efficiency ratio.

Fitch thinks that US Bancorps’ low cost efficiency stems from two sources:

  • Low-cost deposit base
  • Corporate culture focused on operating expense management

The natural follow-up questions that confuse me right now are:

  • Why is US Bancorp’s deposit base lower cost than its peers?
  • What does it mean to have a corporate culture focused on operating expense management?

Let’s start off with my first confusion, which is “Why is US Bancorp’s deposit base lower cost than its peers?”

It’s definitely not because of having deposits making up a huge part of total assets, since for the top 20 banks in asset size, the average deposit to total asset % is 73.2% compared to US Bancorp’s 74.5% [1].

It’s not really because of size because all of the top 20 banks in asset size have past the threshold of $1 billion in assets, which marks the threshold where anymore assets doesn’t really contribute to cost efficiency.

It’s also not really unit-level economy of scale (which is supposedly another aspect that drives higher operational efficiency). There does seem to be a correlation (but not very strong) between deposits / branch versus cost efficiency (as seen in graph below) when looking at the top 20 banks in # of bank branches, but considering there are a total of 10 banks with higher deposits / branch but still possessing higher cost efficiency ratio than US Bancorp in this group [2], unit-level economy of scale isn’t a sufficient explanation.

Correlation Between Deposit per Branch to Cost Efficiency.png

What’s left is the illusive concept of culture being the source of lower cost deposit base, which I find to be extremely hard to judge, which is why I ask the question “What does it mean to have a corporate culture focused on operating expense management?”

And why is culture hard to judge? Well I’ve went through US Bancorp’s annual reports from 2000-2015, and all of them describe how cost efficient US Bancorp is and how cost efficiency is a key focus for US Bancorp, but none of the annual reports delve into details of how they do it.

The closest thing I have to gauging US Bancorp’s culture of focusing on operating expense management is US Bancorp:

But I don’t know enough about other banks to know if this already constitutes a culture of focusing on operating expense management that’s much more superior to peers, because in my mind, what US Bancorp can do with the aforementioned initiatives, its peers can also copy. The questions thus becomes:

  • Are US Bancorp’s peers cost cutting in the same way, same degree and same effectiveness?
  • If not, what’s stopping US Bancorp’s peers from following suit?


[1] As of Jul 9th 2016 (http://www.bankregdata.com/allIEmet.asp?met=EFF) + (http://www.usbanklocations.com/bank-rank/total-deposits.html)

Ranking by Asset Size – Bank – Cost Efficiency Ratio (%)

  1. JPMorgan Chase – 62.10
  2. Wells Fargo – 55.39
  3. Bank of America – 59.68
  4. Citigroup – 55.68
  5. U.S. Bancorp – 54.32
  6. Capital One Financial – 57.63
  7. PNC Bank – 65.15
  8. Bank of New York Mellon – 70.32
  9. Toronto-Dominion Bank – 72.26
  10. State Street Bank – 80.08
  11. Branch Banking and Trust – 61.60
  12. HSBC Holdings – 71.15
  13. SunTrust Bank – 59.29
  14. Morgan Stanley – 21.45
  15. Charles Schwab Bank – 16.98
  16. Citizens Financial Group – 65.15
  17. Goldman Sachs – 33.14
  18. Fifth Third Bank – 59.47
  19. M&T Bank Corp – 58.63
  20. Regions Bank – 60.26

Above Average Cost Efficient Bank- Deposit % of Total Assets – Deposits ($) / Assets ($)

  • Wells Fargo – (75.87%) – 1,285,439,000,000 / 1,694,163,387,000
  • Citigroup – (70.53%) – 947,446,000,000 / 1,343,346,509,000
  • U.S. Bancorp – (74.48%) – 315,187,684,000 / 423,203,763,000
  • Morgan Stanley -(66.48%) – 119,548,000,000 / 179,838,000,000
  • Charles Schwab Bank – (92.32%) – 135,753,000,000 / 147,039,000,000
  • Citizens Financial Group – (52.67%) – 77,780,394,000 / 145,687,025,000
  • Goldman Sachs – (64.71%) – 92,800,000,000 / 143,403,000,000

Below Average Cost Efficient Bank- Deposit % of Total Assets – Deposits ($) / Assets ($)

  • JPMorgan Chase – (64.47%) – 1,391,743,000,000 / 2,158,702,851,000
  • Bank of America – (77.39%) – 1,297,680,000,000 / 1,676,743,000,000
  • Capital One Financial – (56.33%) – 208,821,499,000 / 370,739,538,000
  • PNC Bank – (72.46%) – 254,089,464,000 / 350,643,006,000
  • Bank of New York Mellon – (77.03%) – 249,861,000,000 / 324,382,710,000
  • Toronto – Dominion Bank – (78.13%) – 213,629,023,000 / 273,414,002,000
  • State Street Bank – (79.77%) – 190,872,030,000 / 239,277,838,000
  • Branch Banking and Trust – (76.40%) – 158,050,500,000 / 206,874,891,000
  • HSBC Holdings – (72.84%) – 144,846,147,000 / 198,852,159,000
  • SunTrust Bank – (81.53%) – 154,833,252,000 / 189,907,589,000
  • Fifth Third Bank – (75.58%) – 105,781,664,000 / 139,966,392,000
  • M&T Banking Corp – (75.40%) – 95,316,346,000 / 126,407,811,000
  • Regions Bank – (79.95%) – 99,645,528,000 / 124,637,433,000

[2] As of Jul 9th 2016 (http://www.bankregdata.com/allIEmet.asp?met=EFF) + (http://www.usbanklocations.com/bank-rank/total-deposits.html) + (http://www.usbanklocations.com/bank-rank/number-of-branches.html)

Ranking by # of Branches – Bank – Cost Efficiency Ratio (%) – Deposit $ / Branch

  1. Wells Fargo – 55.39 – 205,440,147
  2. JPMorgan Chase – 62.10 – 251,217,148
  3. Bank of America – 59.68 – 270,350,000
  4. U.S. Bancorp – 54.32 – 97,672,043
  5. PNC Bank – 65.15 – 91,202,248
  6. Branch Banking and Trust – 61.60 – 69,198,993
  7. Regions Bank – 60.26 – 60,870,817
  8. SunTrust Bank – 59.29 – 105,257,139
  9. Toronto-Dominion Bank – 72.26 – 160,865,228
  10. Fifth Third Bank – 59.47 – 82,706,539
  11. KeyBank – 63.74 – 75,790,871
  12. The Huntington National Bank – 61.50 – 60,283,489
  13. M&T Bank Corp – 58.63 – 110,192,308
  14. Citizens Financial Group – 65.15 – 90,653,140
  15. Capital One Financial – 57.63 – 252,810,531
  16. Citigroup – 55.68 – 1,174,034,696
  17. Woodforest National Bank – N/A – 5,886,650
  18. Santander Bank, N.A – 88.47 – 91,801,086
  19. Compass Bank – 72.06 – 102,387,717
  20. BMO Harris Bank – 72.74 – 127,469,966


I currently own US Bancorp (USB) stocks, and intend to keep increasing my position size of USB.


Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

Questions About Banks

By Noël Zia Lee (Flickr: Big Pink) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons

There’s no answers or explanations, just a few questions that I haven’t finished thinking through:

  • What is it about Wells Fargo that Warren Buffett and Charlie Munger love so much about than US Bancorp? (Wells Fargo have much bigger position sizes than US Bancorp for both their portfolios (As of Jul 6th 2016, Warren Buffett – 18.04% Wells Fargo vs 2.69% US Bancorp; Charlie Munger – 67.4% Wells Fargo vs 4.98% US Bancorp) yet US Bancorp beats Wells Fargo in ROA, ROE, and Efficiency Ratio)? Isn’t US Bancorp a better run bank in general? Or is purely a valuation matter?
  • What does Warren Buffett and Charlie Munger’s position sizing in respective portfolios of US Bancorp reveal / hint to anyone’s appropriate position sizing for US Bancorp in their portfolio (eg. Is it a 90% position size stock? Is it a 33% position size stock? Or is it just one of many stocks like 5-10% position size?)
  • How do I know if a bank I now own stocks on is no longer as prudent as it should be? At what moment do you go “screw it, I’m leaving this stock”? (Wells Fargo is now entering Investment Banking, an area that’s fraught with much bigger dangers than just sticking to simple retail banking)
  • How strong are the moats of Canadian and Australian Big Banks? The Big 6 Banks in Canada have similar cost efficiency ratio (57.9%) as well run US banks like Wells Fargo (52.6%) and US Bancorp (52.1%), while the Big 4 Banks in Australia have an even more ridiculous low cost efficiency ratio of 45.9%. The questions I have in mind are:
    • Why are these banks so cost efficient on aggregate? (US Banks’ cost efficiency on aggregate is 70.8%…)
    • What’s the differentiation between the Big 6 in Canada and Big 4 in Australia? (I see not much)
    • How are the Big 6 and Big 4 able to keep a highly profitable oligopoly when differentiation is low between the banks? (What’s stopping them from one day going nuts and price war the crap out of each other?)
    • How well would the Big 6 and Big 4 fare if politicians suddenly changed their minds and banned all regulations that currently favor such domestic bank protectionism?
    • Is a moat that has a significant chunk of it upheld just because of favorable regulations really a moat? Or does the catastrophe risk inherent in it make it a great pillar to have but not something to entirely rely on?


I currently own US Bancorp (USB) stocks, and intend to keep increasing my position size of USB.


Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

Treat Yourself As a US Technology Company

By Heiti Paves (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

Going into the US stock markets on Jun 24th after Brexit was confirmed made me confront the issue of how much cash to retain for emergency reserves, which then determines how much cash I can deploy to take advantage of the correction.

And I realized as a person who’s income is mainly from one source (employment) and would be completely obliterated in the event of a lay-off, I displayed characteristics like a typical US technology company – Once a disruption happens (technological disruption such as digital cameras for technology companies like Kodak, or economic recession after 1929’s Black Thursday that had 19% unemployment for people like me), income sharply drops to zero.

One could even argue, anyone who relies heavily on employment as their source of income displays characteristics of a typical US technology company on steroids. Any technology company that gets disrupted has their income sharply drop to zero, but it doesn’t drop to zero over night. For people like me, the income goes to zero over night once I’m laid off and receive my severance payment.

And that’s terrifying. Conventional advice for emergency reserves has always been around 6 months of cash. Let’s be generous and double it, but for the emergency reserves to work it assumes you can find a job within 12 months. Under normal economic conditions, the search for a new job could easily take 24 months, let alone during bad economic conditions where the economy was the reason that you got laid off and the reason why the job search gets prolonged.

So if the top 10 cash hoarding companies (IT and pharmaceuticals) have an average current ratio of 3[1] (which means if they had zero income they could survive for 3 years), and they have multiple lines of products / services that reduce the probability of all sources of income going to zero, shouldn’t employees like me who rely almost exclusively on employment for my source of income hold even more cash?

After all,wasn’t the book name of Intel’s Co-Founders Andrew Grove called “Only the Paranoid Survive“?


[1] As of Jul 1st 2016, the current ratio of the following companies:

Apple – 1.28

Microsoft – 2.90

Alphabet – 5.14

Cisco – 3.27

Oracle – 3.74

Pfizer – 1.44

Johnson & Johnson – 2.83

Amgen – 4.95

Intel – 1.56

Qualcomm – 2.87

Tax & Cost Efficient Fundamental Trading Strategy

See page for author [CC BY 4.0 (http://creativecommons.org/licenses/by/4.0)], via Wikimedia Commons

I must admit, my temperament isn’t suited for Charlie Munger’s Sit On Your Ass investing style or Joel Greenblatt’s Magic Formula style.

The reasons are as follows:

  • (Charlie Munger) In theory it’s great (only buy great businesses at great prices and be idle most of the time), but in practice it’s damn hard regarding the “great price” aspect. I don’t have Charlie Munger’s golden touch of sitting idle in cash for a decade and suddenly buying stocks at the perfect rock bottom of the 2008-2009 bear market. Attempts at this strategy myself with the lack of Charlie Munger’s aptitude, temperament and experience would be near suicide as I’m most likely going to keep second guessing on whether prices can get any better and miss out the whole bear market entirely.
  • (Joel Greenblatt) I also can’t execute Joel Greenblatt’s strategy because his strategy essentially forces each position to be 3% – 5% without the option to average down lest you become overweight. This drives me crazy because every time a stock’s price drops my head keeps telling me “Buy more! It’s even more of a bargain!”

So I have to adopt my style to suit my temperament while still incorporating the principles of both styles.

My strategy now is more of a high turnover strategy that still takes company quality and valuation into consideration, but instead now takes market sentiment into consideration as well to approximate Charlie Munger’s golden touch of hitting perfect rock bottom:

  • (Charlie Munger) Still identify great businesses that I would be comfortable to invest 90% of my net worth in. That way I can happily average down like crazy on the most under-valued of the great businesses shortlist of mine if the stock market keeps dropping
  • (Tax Efficiency) Further filter the list of great businesses shortlist by taking out any company that pays dividends. As a non-US investor I pay 30% tax on dividends and 0% on capital gains, and in a long term it would absolutely kill my compounded returns if I had to keep bleeding away with dividend taxes
  • (Charlie Munger) Let market sentiment guide half the decision on how much of your portfolio should be in stocks or cash. This will be my proxy to Charlie Munger’s golden touch by overweighing my portfolio more and more into stocks as the market sentiment turns sour. I won’t hit perfect rock bottom, but by the time rock bottom happens my cost basis has been averaged down so much it would good enough for my purposes.
  • (Joel Greenblatt) Let valuation guide the other half of the decision on how much of your portfolio should be in stocks or cash, with the potential upside (1 / discount %) of the most under-valued of the great businesses shortlist being the yardstick.
  • (Joel Greenblatt) Rebalance constantly as market sentiment and valuation changes, so that my investments always reflect the most up to date information and is concentrated in the most under-valued opportunity. Rebalance frequency is ~bi-weekly to monthly, which is similar to Magic Formula’s rebalance frequency
  • (Cost Efficiency) Only rebalance in increments of fees being max. 10% of returns [1]. I determine the returns based on typical amount of stock market fluctuation in a month, which is 2.6%.

As for my list of great businesses that don’t pay dividends, I’ve only identified 3 that I would be comfortable investing 90% of my net worth in, namely Amazon, Berkshire Hathaway, and Fiserv (why these 3 would probably be for another post).

What I’ll be doing in the next couple of months is read the annual reports since inception of each of these 3 companies, books / videos about these 3 companies and their management team, and just any dis-confirming evidence I can gather to better assess the catastrophe risk of these 3 companies.

Since Berkshire Hathaway’s the most undervalued of the 3 right now, I’m starting to read Warren Buffett’s letters to shareholders since 1965. I’m currently up to 1978 and it’s been a wonderful gateway to understanding why Warren Buffett operates the way he does today, and how Berkshire Hathaway’s competitive advantage that he’s built over half a century will endure now and beyond Warren Buffett.


[1] Determined by my best alternative, which is S&P 500. If I used Vanguard’s S&P 500 which costs 0.05% annual management fee and also costs 0.9% in dividend taxes if S&P 500 was 3% dividend yield and the potential S&P 500 return is 9%, then essentially my best alternative’s implied okay amount of costs is fees being max. 10% of returns


Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

A Slight Shift in Investment Strategy

By Nick Hobgood (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

I’m still very blue-chip stock oriented and I’m still hedging based on some form of indicator on market sentiment.

The only difference is that I’m much more diversified (44 stocks as of May 10th 2016), I only exclusively hold world class companies’ stocks (Wide Moat + Exemplary Stewardship Rating by Morningstar) and I hedge not only on market sentiment but also on market valuation as well (Fear & Greed Indicator and Shiller P/E).

The reason behind this shift in investment strategy were as follows:

  • Even though I was generating 30+% annualized returns between the period of March to May 2016 for my stocks (I was ~2/3 hedged in cash, so ~10+% actual returns), the volatility that came in investing heavily in the most undervalued stocks still made feel very uneasy
  • Another thing that made me uneasy was that even though majority of very undervalued stocks I invested were blue-chip stocks (wide moat or narrow moat by Morningstar definition), I still had a sizeable portion of no moat stocks as well which made me uncomfortable as they could easily die during an economic recession
  • The shift to a diversified portfolio of world class companies was simply because of two statements that Charlie Munger and Joel Greenblatt made (I unfortunately can’t find the sources for both statements, but I definitely remember reading them):
  • I’ve also taken market valuation into consideration when considering how much cash to hedge because even though the overreaction of market sentiment is good (over-fearful = great buying opportunity and vice versa), I could have easily mistook an over-fearful reaction to the beginning of a bear market as a great time to go all in, when it would’ve been more prudent to wait longer while the bear market kept raging on
  • Every time I wrote an equity research report and compared it with Morningstar’s equity research report, I’ve always been impressed at how much better their research is versus an amateur like me. So to not let my ego get in the way, I now use Morningstar’s research extensively so that I can focus on portfolio management
  • Since I am heavily relying on research not from me, it provides a further reason to be widely diversified since I can’t guarantee that Morningstar is right on each stock, but I know on aggregate that Morningstar would be right based on my due diligence on each equity research report.

Until I somehow have a lot of time to research companies in-depth myself and beat Morningstar in their game of research, this will be the investment strategy that I will deploy.


Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

Eating My Own Cooking for Financial Advice

By Madhu15121992 (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons

Any friend I have a conversation with which ends up on the topic of investment or retirement savings would always end up with advice for investing which would be that “if you don’t have the interest, time, energy or competence to invest, stick with index funds”.

The rationale is simple, 90% of fund managers fail to beat the market.

But here comes the problem with my advice. Even though the advice is sound (read The Little Book of Common Sense Investing for a detailed explanation of why, I don’t get paid for referring you to John Bogle’s book), a lot of people always ask me, “well but what about you? Do you invest in index funds?”

And I think that’s the problem. I don’t invest in index funds, because I think I’m the statistically improbable few who can beat the market, and that sets a bad example to my friends of do as I say and not as I do.

Sure I have friends who say “well you did say if you don’t have the interest, time, energy or competence to invest you should stick with index funds, but you obviously have the interest, time, and energy”, but I’m pretty sure quite a few are actually convinced by my actions that they might be the statistically improbable few who can beat the market as well.

And generally speaking, for the majority of friends who hear my advice but go their own merry way to trade stocks with disregard to fundamentals or valuation, many have been burned badly. Still they remain deterred and continue stubbornly without index funds.

So when a friend actually told me that he took heed to my advice and was socking away a regular amount of money into the Hang Seng Index every month, a sense of responsibility and an epiphany dawned upon me.

For my friend who believed in me, my sense of responsibility compelled me to match the amount of money he’s invested so far in the Hang Seng Index and his monthly contributions to the Hang Seng Index as well. I wanted to eat my own cooking since if my advice of investing in index funds was shit, I’d suffer too.

The good thing about aligning interests was that it would also force me to closely monitor the fundamentals and valuations of the constituents of the Hang Seng Index since I absolutely hate overpaying for things and losing money. This way I could also give advice to my friend when to pause monthly contributions if overvalued, or even when to sell if the Hang Seng Index is ridiculously overvalued.

The epiphany part was basically that if I wanted my advice to be taken seriously, I needed to walk the talk. Sure the Hang Seng Index would never give me great returns, but it would still guarantee a good return at the right valuation, and that’s the lesson I want my friends to learn regarding index funds, that a good return is still good in a world of sub-market returns of active investing.

So that’s it, I’m officially indexing for a part of my stock portfolio so that I can eat my own cooking and walk the talk. The idea still kind of drives me crazy that that amount of capital would never generate potentially market beating returns (there’s still a decent amount of wide moat companies that I deem under to fairly valued), but if it helps me be responsible for the financial advice I give people and allow people to take my financial advice seriously, then so be it.

After all as mentioned earlier, a good return is still good.


Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

I Thought Operating Income was Conservative…

By LaurMG. (Cropped from “File:Frustrated man at a desk.jpg”.) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

But I’ve decided that even Operating Income isn’t conservative enough when used for valuation.

The reason being that even though Operating Income is more conservative than Net Income due to the lower room for accounting manipulation, it’s still susceptible to accounting manipulation that masks the true picture.

An example is Exxon Mobil (3.41% of my net worth as of this writing).

If judged by a 5 year average Operating Income / (Market Cap – NNWC), it’s currently yielding at ~12% [1], which is a bargain for long term oriented shareholders (eg. The Operating Income maybe muted last year and for the next foreseeable 2-3 years, but Oil prices must rise again in the long term due to increasing demand globally).

But I don’t want to talk about speculations on when Oil Prices will rise and by how much, I want to talk about the shortcomings of Operating Income.

You see, even though 5 year average Operating Income / (Market Cap – NNWC), Free Cash Flow / (Market Cap – NNWC) is at an astonishing 3.02%[2]!!

The reason why this is astonishing is two-fold:

  • Free Cash Flow (FCF) is a company’s Operating Cash Flow – Capital Expenditures, which means that’s what shareholders would expect to receive after deducting from the Cash Flow what’s required to keep operations going if shareholders required the company to distribute 100% what’s leftover (a.k.a. True Earnings)
  • As of 2015-12 Annual Report, Exxon Mobil’s dividend / share is $2.88 while its FCF / share is only $0.98, which means the dividends are nowhere nearly as safe as the 60% payout ratio indicates

Which makes me uncomfortable, because what we’re looking at is a potential double whammy to my original Exxon Mobil investment thesis, which bet on Exxon Mobil using its disciplined capital allocation streak and strong balance sheet to make distressed investments. Based on the burn rate of dividends on FCF, it seems unlikely Exxon Mobil would be able to make any distressed investments without damaging its Triple A credit rating since the amount of cash needed to do both investments and pay an increasing dividend must come at a cost of balance sheet health deterioration due to the insufficiency of FCF to cover both activities simultaneously.

So I’m exiting Exxon Mobile (thankfully at a profit if I can sell at today’s price of $84.20), since I no longer see it as an attractive investment due to the better insight I have on hand.

And I will be looking at 5 year average FCF / (Market Cap – NNWC) in the future for any non-financial company for valuation.


[1] 5 year average Operating Income ($56.9 Billion); Market Cap (Mar 21st 2016 = $349.7 Billion); NNWC (2015-12 Annual Report = -$137.8 Billion)

5 year average Operating Income / (Market Cap – NNWC) = 11.67%

[2] 5 year average Free Cash Flow ($14.7 Billion); Market Cap (Mar 21st 2016 = $349.7 Billion); NNWC (2015-12 Annual Report = -$137.8 Billion)

5 year average Free Cash Flow / (Market Cap – NNWC) = 3.02%


Poor Charlie’s Almanack Notes

By Nick (Charlie Munger) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons

I’ve finished reading Poor Charlie’s Almanack, and wanted to jot down some notes that I would continually reference upon without the book since I’m about to lend it to someone.

25 Common Tendencies of Human Psychology Misjudgments:

  1. Reward and Punishment Superresponse Tendency
  2. Liking / Loving Tendency
  3. Disliking / Hating Tendency
  4. Doubt-Avoidance Tendency
  5. Inconsistency-Avoidance Tendency
  6. Curiosity Tendency
  7. Kantian Fairness Tendency
  8. Envy / Jealousy Tendency
  9. Reciprocation Tendency
  10. Influence-from-Mere-Association Tendency (Steroetypes)
  11. Simple, Pain-Avoiding Pyschological Denial
  12. Excessive Self-Regard Tendency
  13. Overoptimism Tendecy
  14. Deprival-Superreaction Tendency
  15. Social-Proof Tendency
  16. Contrast-Misreaction Tendency
  17. Stress-Influence Tendency
  18. Availability-Misweighting Tendency
  19. Use-It-or-Lose-It Tendency
  20. Drug-Misinfluence Tendency
  21. Senescence-Misinfluence Tendency (Affected by by old age)
  22. Authority-Misinfluence Tendency
  23. Twaddle Tendency
  24. Reason-Respecting Tendency
  25. Lollapalooza Tendency

10 Examples of Eliminating / Minimizing Common Tendencies of Human Psychology Misjudgments:

  1. Carl Braun’s communication practices (5Ws for each communication)
  2. The use of simulators in pilot training
  3. The system of Alcoholics Anonymous
  4. Clinical training methods in medical schools
  5. The rules of the U.S. Constitutional Convention (totally secret meetings, no recorded vote by name until final vote, votes reversible at any time before end of convention, one vote on whole constitution)
  6. The use of Granny’s incentive-driven rule to manipulate oneself toward better performance of one’s duties
  7. The Harvard Business School’s emphasis on decision trees
  8. The use of autopsy equivalent at Johnson & Johnson
  9. Double blind studies required in drug research by F.D.A.
  10. Warren Buffett rule for open-outcry auctions: Don’t go.

Charlie Munger’s Recommended Books:

  • Deep Simplicity: Bringing Order to Chaos and Complexity (John Gribbin)
  • F.I.A.S.C.O.: The Insider Story of a Wall Street Trader (Frank Partnoy)
  • Ice Age (John & Mary Gribbin)
  • How the Scots Invented the Modern World: The True Story of How Western Europe’s Poorest Nation Created Our World & Everything in It (Arthur Herman)
  • Models of My Life (Herbert A. Simon)
  • A Matter of Degrees: What Temperature Reveals About the Past and Future of Our Species, Planet and Universe
  • Andrew Carnegie (John Franzier Wall)
  • Guns, Germs and Steel: The Fates of Human Societies (Jared M. Diamond)
  • The Third Chimpanzee: The Evolution and Future of the Human Animal (Jared M. Diamond)
  • Influence: The Psychology of Persuasion (Robert B. Cialdini)
  • The Autobiography of Benjamin Franklin (Benjamin Franklin)
  • Living Within Limits: Ecology, Economics, and Population Taboos (Garrett Hardin)
  • The Selfish Gene (Richard Dawkins)
  • Titan: The Life of John D. Rockefeller, Sr. (Ron Chernow)
  • The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor (David S. Landes)
  • The Warren Buffett Portfolio: Mastering the Poewr of the Focus Investment Strategy (Robert G. Hagstrom)
  • Genome: The Autobiography of a Species in 23 Chapters (Matt Ridley)
  • Getting to Yes: Negotiating Agreement Without Giving In (Roger Fisher, William Ury and Bruce Patton)
  • Three Scientists and Their Gods: Looking for Meaning in an Age of Information (Robert Wright)
  • Only the Paranoid Survive (Andy Grove)

Peter D. Kaufman’s Recommended Books:

  • Les Schwab: Pride in Performance (Les Schwab)
  • Men and Rubber: The Story of Business (Harvey S. Firestone)
  • Men to Match My Mountains: The Opening of the Far West (Irving Stone)

How to Navigate the New Born Global Bear Market

By Mark Betram [Public domain], via Wikimedia Commons

An index of global stocks closed the day more than 20 per cent below its record high last May, satisfying the definition of a global bear market

The first question you need to ask is what’s your investment universe and how are the fundamentals holding up versus the stock market’s sentiment.

For example, I invest primarily in stocks in the S&P 500. Even though “Foreign sales accounted for 33% of aggregate revenue for the S&P 500“, it’s safe to say that of the 3 major economies in the world, USA is actually doing surprisingly good versus Europe or China. And one thing to note is the US economy is very self sufficient, with only 13% of US GDP export based and <8% exports shipped to China.

In other words, I’m not very worried since the underlying environment that my stocks perform is doing not bad.

If you were invested in China or Europe… then I would start worrying and would dig deep on how the underlying economy’s weakness would potentially affect the fundamentals of your stocks.

The second question you need to ask is where is the stock market in relation to historical valuation and market sentiment.

I covered very extensively before how you can hedge or leverage based on historical stock market valuation and market sentiment using the Samuelson Share, but I never explained why this is important.

The reason why this is important is because timing + price paid determines return.

It’s why in the book “Margin of Safety”, Seth Klarman talks about the danger of investing too soon into a bear market.

Sure, you can lock in a very certain return at a certain price if you do your analysis correct, but why be in such a hurry to lock in a very certain rate when it’s very likely you can get a better bargain very soon?

Even if you’re not risking permanent capital loss, it’s prudent to always be aware that it’s far harder percentage wise to gain than to lose (50% loss requires 100% return to break-even).

Many times, the opportunity cost of investing immediately is far higher than holding cash in times of a fresh bear market.

The third question you need to ask is how much of your portfolio is already in stocks.

If it’s mostly in cash already before the bear market began, that’s great news. I suggest dollar cost averaging the total amount of cash you intend to invest in the stock market over 18 months (assuming the cash makes up 30+% of your portfolio when you start deploying cash).

What you’re trying to achieve is take advantage of increasingly lower prices without prematurely running out of dry powder.

And the act of gradually entering the bear market is important because if you don’t possess the ability to forecast the bottom of a bear market like me, gradually entering the bear market means that you would have a high or maximum exposure at the bottom (Thanks to Whitney Tilson’s sharing for that insight).

If it’s mostly in stocks already before the bear market began, ask yourself whether the existing stocks you own were bought at a price that already has a very certain excellent / good return locked in.

If the price bought already locks in a very certain excellent return, sit tight and hold on.

If the price bought already locks in a very certain good return, check to see if you’ve made a profit or not.

  • If you’ve made a profit, sell
  • If you’ve made a loss but you are unable to find investments with much better prospects during the bear market, hold
  • If you’ve made a loss but are able to find investments with much better prospects during the bear market, sell

With the amount of cash you’ve raised from liquidating existing positions combined with any extra cash you already hold or plan to add upon through income streams or debt, gradually move back into the stock market over 12 months as mentioned earlier.


Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)