Friday, March 16, 2018

On Nicholas Taleb, leverage and ruin

Skin in the Game by Nicholas Taleb is not finance book per se but some of its ideas are interesting enough to challenge some of my ideas of leverage. I think Taleb's ideas are worth grappling with because they can potentially change your approach towards personal finance.

One particular idea is that ensemble probability is very different from time probability. If the model reflects the ruin of a few participants out of many, it is conceptually very different from the reality where there's only one participant who has to stop permanently the moment he is ruined by the markets.

One of the better things I did last year was to open a margin account. I wanted to continue to obtain high yields from REITS but I also wanted to buy higher quality REITs with a good story and stable management. The only way to resolve this paradox is to borrow $1 for each $1 I have and invest it in the better REITs on SGX.

When I talk about my approach towards leverage, I usually begin with a back-test. The models I ultimately employ for leverage always have a yield which exceeds on average 6.5%. After accounting for the borrowing fees, I tend to get 10% yields on my invested capital.

The more interesting feature of the models I employ is that I use semivariance which I combine with the expected return to figure out what happens in a 1 in a 40 year freak market. In a typical model involving REITs, I can backtest a modest 10% return with around 13% semivariance. So there is a 2.5% chance that I will drop 2 standard deviations down on a freak year or (10 - 2 x 13)=16% lose about 1/6 of my portfolio. ( But of course, market returns are non-normal so this will happen more frequently than what my models predict. )

As a 16% drop is only about half of the margin call of 30% ( Since I  limit my leverage to 200% ), I should not have to worry so much about hitting a margin call anytime soon as the probability is less than 2.5%.

Which brings us to the problem : So long as I maintain this leverage, there will be a chance that I will bust one day. Over time, this probability is 100%. Taleb says that "in a strategy that entails ruin, benefits never offsets risks of ruin."

This is where Taleb's insight comes in useful. If I am ruined, or gets a margin call, I can't play anymore. This is what Taleb calls the uncle point. Millenials will just say GG.

The moral of the story is this. If you leverage, you will definitely be ruined over time. In your universe, there is only you ! Your ruin may even drag down members of your family if you are not careful.

But I only leverage less than 20% of net worth and can comfortably live on the dividends of my un-leveraged portfolio. Furthermore, a margin call will only wipe out 60% of my original cash outlay into my margin account.

So the moral of the story is this : Leverage only your excess portfolio. Otherwise have a plan to eventually wean yourself out of a margin account.

Monday, March 12, 2018

The Art of the Good Life #14 : Circle of Competence

The last chapter was easy to read because Fuck You money agrees with me so much.

This week's chapter is the opposite because it really exposes just how dumb my latest career moves are.

The harsh truth is this  - Most of us have a really small circle of competence and this chapter reminds us that we should really just stick to it. If we know what we're good at, we should just focus on it and build a career around our personal strengths.

I think in the absence of passive income, this is something which I would have done. I would slowly retool myself into an IT Compliance professional and possibly try to stay that way for as long as possible. There are endless IT certifications to attain, in fact just before Law School, I got TOGAF certified so I am able to talk convincingly about Enterprise Architecture ( Most epic bullshit in the IT world which I'm glad did not catch on ).

But Fuck You money sometimes make you do really dumb things, often because you can and most folks, well, can't.

Legal work is so disjoint from my circle of competence as an engineer and a personal finance hobbyist, that I think I've been striving to promote my incompetence and being a sucker for punishment.

So, this chapter has a good point. I've been too focused on my deficiencies. But a lot depends on how you see what your circle of competence is.

If I see my circle of competence as IT, then I'm probably a real idiot for running to SMU to do my JD program. If I see my strength as learning new things and find synergies in different disciplines regardless of what kind of career I will eventually have, then I might have something to console myself with.

But still, thank god for Fuck You money. Nothing make idiocy viable as much as passive income.

A training contract is tough and pays less than what a domestic help gets, but I can survive this !

And I think there's a seminar on Legal Tech this weekend.

Maybe I'll find my niche there...

Saturday, March 10, 2018

Why Singaporeans tolerate inequality.

You see that parade of academics and rhetoricians rail about inequality in Singapore. Social commentators, however, are less willing to discuss the actual solutions to reduce the effects of inequality.

My personal belief is that Singaporeans on the whole are fine with inequality.

Yes, some Singaporeans will become scholars and yet some turn out to be merely statistics.

Nicholas Taleb's latest book Skin in the Game shed some light about the kind of inequality that we tolerate against the kind of inequality that should not be tolerated.  As it turns out the gap between the rich and the poor is a distraction that liberations employ to justify massive wealth transfers between the rich and the poor.

The is a more insidious kind of inequality at work. The concept Taleb employs is ergodicity.

Singaporeans can tolerate inequality so long as access to the upper classes is not blocked. Another words, the son of a taxi driver or a single parent family can rise up in society to become a Minister today.

This not only means allowing smart and capable guys like Chan Chun Sing to rise, it also must allow the so-called rich to fall.

Four years ago I retired because I was effectively financially independent. As a deliberate tactic, I ensured that my monthly dividend flows were about the same as the Singaporean household income statistic when my whole family got off the salary bandwagon. Four years later,  after law school, my dividend flows have gone up and so has my portfolio size ( thanks to some of my dabbling with leverage ).

At this juncture, I can imagine a liberal reading this and declare that a passive income investors will need to be redistributed to the poor.

But as it turns out, my dividend flow has been dropping relative to the household income for the past 4 years. There is a steady $1000 gap between what I collect and what most households earn every month now. This is one of the reasons I want to return to the workforce in spite of spending well within my investment income, Singapore society is the kind of society that does not let it's people rest. Even financial independence mean a gradual dropping of one's ranking relative to others.

So I have to pick up a McJob to remain average and respectable in this society !

So while our system introduces a substantial gap between the haves and have nots. Membership of the haves is open to everyone.

Which brings us to solutions which can make us uncomfortable and require the sacrifice of political capital.

The government cannot just create a system where the poor can rise to the ranks of the rich.

The rich must be able to fall.

Like many of you investors, wealth redistribution is something I would never support. I earned my wealth and my family has been becoming "poorer" over the past 4 years while I retooled myself to become a lawyer. Getting rid of assortative mating and mandating RGS girls take on ITE husbands is also impossible given that assortative mating contributes to 40% of inequality.

For a start, I can think of two subtle changes :

One possibility is that legacy admissions must be banned in Singapore. It does not make sense for the ACS boys who bullied me in the 1980s get a free pass to admit their kids to the ACS franchise and continue to benefit from being part of such an illustrious and well-connected alumni. This has to be earned and should not be a right based on a person's bloodline.

Another possibility is that Government Gebiz system limit some bids to companies of a specific range of sizes rather than favour larger companies. If some tenders are so big that a company needs to meet a paid up capital threshold to bid for the project, we have to accept that some projects can be so small that only a company that is small is allowed to bid for it. Readers in government can confirm with me as to whether this practice already takes place.

You see, you don't see Kuik Shiao Yin fighting to discuss these reforms in Singapore society.

It's always about the problem, never about solutions beyonds raping our reserves.

Thursday, March 08, 2018

Two abuses of words and labels

Let's go back to Budget Debate and how much Western educated liberals are working so hard to convince policy makers to start opening up our coffers spent the monies painstaking raised by the Singaporeans who came before us.

My first example is this stinker from the LKYSPP.  It is disgusting that this drivel is even associated with the name of our first Prime Minister.

The thought experiment is simple : Three children are fighting over a flute. Child A can play the flute. Child B made the flute. Child C cannot play or make flutes. The idea is that different people have a different ideas as to who should own the flute.

My personal belief is that the flute can either be given to Child A or Child B, but if given to Child A, then Child A is obligated to play sit o that all children can get to enjoy the music.

What I took offence about is that the analogy uses children implying that all policy decisions made by the powers to be impact only innocent parties.

Humanity is seldom innocent and blameless. I know because I now spend time in Family Court.

Find me a poor person struggling to overcome their personal circumstances and I will find you an irresponsible father who spends his days in Geylang and then complains that his children do not want to look after him.

I could have used a different thought exercise. You have three tumours but only the budget to remove one. Tumour A is benign. Tumour B is benign but awful to look at. Tumour C is cancerous and awful to look at. Which tumour do you eliminate ?

This evokes a different set of emotions entirely.

My second example is Kuik Shiao Yin who probably thinks that real life is as easily solvable as simply writing a GP essay. Some articles on her latest speech can be found here.

My beef is that allocating 50% NIRC is an arbitrary figure. Who died and gave Kuik the right to say that decreasing spending on the present is pragmatism whereas the opposite is being idealistic ?

I think no one has right to arbitrarily label a mathematical exercise. I think decreasing the NIRC cap to 40% is prudent and increasing it to be irresponsible. Does that make my label better than Kuik Shiao Yin?

Anyway, win or lose, we can always duke it out at the ballot box during the next elections.

Oh, except that Singaporeans never did elect Kuik Shiao Yin.

And Happy International Woman's Day !

So liberals, can we stop encouraging the rape of our reserves for a change ?

See the use of words matter !

Monday, March 05, 2018

The Art of the Good Life #13 : Fuck You Money

Because this is a financial blog, I would say that this chapter is the only disappointing one so far.

The author positions fuck-you money as having one year of living expenses so that you can say "Fuck You" to your asshole boss and then storm out of the office never to come back to a dysfunctional workplace. 

What a horribly bad idea. In this age of tech disruption, some knowledge workers may be unemployed much longer than a year and this idea might only work in a welfare state. Alternatively, you can get an Uber license.

A better solution is to accumulate enough fuck you money so that your dividend income is equivalent to the salary where future salary increases lead to diminishing returns in personal happiness. This translates to about $75,000 in annual income. As it turns out, investing a million dollars at a return of 7.5% will be able to do exactly that which is why it is unwise to scoff at people who aim to become millionaires in society today.

A million dollars is not very meaningful, but $75,000 in annual income without lifting a finger is quite a remarkable

For most ordinary people who are not investing superstar, thanks to Budget 2018, the Lion-Philip SREIT ETF no longer pay 17% taxes, so you can invest your money tax-free and receive dividends of more than 5% with a reasonable prospect for capital gains. To generate $75,000 a year, you will need a portfolio size of $1,500,000. This is challenging for a single person but for a working professional couple.

The rest of the chapter has some down to earth advice for people :

a) Don't react to minor fluctuations to income or assets. I think it's easier to avoid thinking about market volatility if you have a day job and a large asset pool.
b) Don't compare yourself to the wealthy. Also hard because you are trying to become wealthy. I think its better not to compare yourself with the poseurs because the truly wealthy are quite frugal and have very little to show.
c) Live modestly. Which I thoroughly agree.

Saturday, March 03, 2018

The Influence of Religion on Personal Finance

Today's topic is going to be a teensy bit controversial, so I put up a picture of controversial person. Some other financial bloggers have commented that I am a Kong Hee like person when I give my talks, I am quite flattered by that remark. In fact, I followed Kong Hee even as an atheist when he talks about modern topics like postmodernism. There is something mesmerising about his speaking quality, something I was unable to experience even after spending 10 years with the Toastmasters movement.

The working paper is entitled Randomizing Religion : The Impact of Protestant Evangelism on Economic Outcomes by Bryan, Choi and Karlan. This paper is making huge waves in social science circles and have been mentioned by Tyler Cowen and the Economist.

Internal Care Ministries (ICM) collaborated with a team of economists to spread religious teachings to 6000+ Filipino families, then based on what was taught, the economists tracked their economic outcomes. This study would confirm the impact of religious values on economic outcomes.

To a personal finance geek like me, this is seriously awesome shit !

The religious values curriculum is covered by a pastor. There is also a livelihood segment on what good works should be where some common sense advice of money is taught. The researchers are highly meticulous and a large part of their work was done to disentangle the effects of religious values against livelihood advise.

The results are a goldmine that can lead to future study :

Having stronger religious values do, indeed, lead to higher incomes largely because it makes religious followers grittier. However, this effect does not translate to greater wealth, the researchers argued that there was no time to measure this effect.

However, religious values training made participants more aware about their relatively economic statuses and made believers a lot more discontent with their lot in life. Religious training reduces a participant's perception of well-being. ( These are poor Filipino villagers, after all. )

I am going to just stop here because I don't want to kick a hornet's nest and draw any conclusion that is not written in the working paper.

I leave it you readers to think about how your personal values has affected your relationship with money this weekend.

The effects of your religion and values cannot be discounted when you think about how they have shared your economic destiny.

Thursday, March 01, 2018

The Influence of Language on Personal Finance

This is the single most momentous event in Fantasy Literature with Legend of the Condor Heroes being successfully translated into English. Translation of this work is so difficult and thought to be previously impossible, even the Economist published a book review last week. I was never able to watch a complete series on this storyline so I was kept mostly in the dark when it comes to Jin Yong's work, having only completed the Duke of Mount Deer series which starred a young Tony Leung Chiu Wai in the 1990s.

Reading this in book form is epic. Imagine the possibilities - we could read the same book as part of English Literature class but also as part of Higher Chinese. This will resolve the issue of CL2 being boring. Dream of the Red Chamber is about an effeminate man-child and his side chick, nothing can make you lose interest faster than being forced to read this kind of drivel. Legend of the Condor Heroes features non-stop Kung Fu fighting that pits the Seven Freaks of the South against the Twice Foul Dark Wind. Even Tolkien is boring compared to Jin Yong.

I see my daughter's love for Mandarin being killed slowly by the current education system where every mis-stroke is being cruelly penalised in Primary 1. This is slowly driving my daughter to become a banana person like me.

Ok, let's talk about language and personal finance.

The impact of language on personal finance is profound and social science is only coming to grips to this new reality. In a working paper entitled The Effects of Language on Economic Behaviour : Evidence from Savings Rates, Health Behaviours and Retirement Assets by Keith Chen of Yale University, thinking in particular language can shape your savings behaviour.

Some languages, like English and French, have a specific grammatical framework to mark out a future event. eg. I will be going to a seminar. Clearly the seminar will happen in the future.  Other languages like Mandarin, do not have a future tense, Wo3 Qu4 Ting1 Jiang3 Zuo4 does not clarify whether the speaker is going to seminar right now or in the future. You preface it with Ming2 Tian1 if you want to specify the time as tomorrow.

Social scientists discover that people who think in a language like English and French have a tendency to distinguish their future selves from their present selves. As a consequence of that, the savings rate and accumulated assets of these people are low. In contrast, folk who think in Mandarin, German or Malay have higher savings rates and larger accumulated asset base because the delineation of the future self with the present self is less clear. Even within a country like Switzerland, German speakers were found to have higher savings rates than French speakers.

The current explanation is that we will take action that will benefit our future selves if the future does not seem to distinct from the present.

Some findings within the paper is really surprising.

There are larger proportion of English speakers in Singapore compared to Malaysia. And as a consequence of that the paper reports that the savings rate of Malaysians exceed Singaporeans !

I'm sure the folks who are most excited about this finding might be the old school Nantah Graduates because it vindicates the bilingual policy. 

But can making your children act and function in Mandarin or Malay make them more conscientious and money savvy?

This is, indeed, a possibility.

Hopefully, this weekend, we can explore the influence of religion on our personal finances.