Being Wrong

  Over the last 20+ years of helping families maximize risk-adjusted investment returns, I have found that effective investing is technically quite easy but psychologically difficult for most people. The average person does not have the psychological autonomy to execute a functional risk-adjusted investment strategy through all the ups and downs of capital markets, politics, and personal life; sustainable financial independence is inseparable from psychological autonomy.  

Let me give you a real-life example of how these things can play out due to a certain psychology around money. 

  I once worked with a family with a net worth of approximately $50 million. After establishing a relationship and analyzing their finances, I told them they were not wealthy enough to target the 20% compound average growth rate (CAGR) they had somehow convinced themselves to be a rational return target. 

As a family, they did not have the psychological capacity to accept that while $50 million may sound like a lot of money, the family's balance sheet could not support both the kind of spending that they were accustomed to and the kind of volatility that the desired 20% compound average growth rate performance target implies. They thought I was the problem. I made it clear to them that their way of thinking about money and investing was the problem, and we soon parted ways. 

Psychology about money, needing to be right, and difficulty with relationships was the problem, not the math and probabilities of markets. 

Why, what and how. 

Why do you invest? Why do you want to become and remain financially independent? These are questions that only you can answer, but I can help you arrive at those answers. 

  Progress on the path of financial independence is made by knowing why we want financial independence and why we should exclude and include certain things in the right measure. The how and when should only enter the discussion after the why has been clearly defined. I could try to explain why conventional financial planning and investing tend to fail by explaining non-stationarity, ergodicity, Markov chains, human psychology, and the exploitative structure of the financial services industry, but what you really need to know in practical terms is that capital and time are always and everywhere limited.  

We can control some things pretty well, and we can only control others by limiting our exposure to them. You and I are in the risk management business. We get paid for taking risks that other market participants cannot or do not want to take, and we must manage this process carefully. Risk capacity is primary, return is secondary. 

The structure I have created at Blom Levy & Co. is a risk management structure with one objective: to establish and maintain financial independence for you. I did not build it to market and sell products and services that promise irrelevant things like "outperformance."  

I designed our structure to monitor material changes in the major socioeconomic systems that the modern world depends on and to plan, prepare, and adapt to those changes methodically. 

Randomness in our lives and finances can be minimized. 

Chance in nature is well understood. Biology tells us that systems will generally behave randomly in the short term and on a small scale but relatively predictably in the long run and at larger scales. This knowledge can make relatively accurate forecasts about a system's behavior in the long run and on a larger scale. 

Modern socioeconomic systems and financial markets behave similarly because the relevant agents in the system are human beings whose behavior is determined by Biology in aggregate. Here, it's important to note that free will or agency, as it has been generally understood in the West for the past 400 years, is not an accurate model for understanding human behavior and, therefore, not an accurate model for understanding markets and the economy. 

With this knowledge, we can plan, prepare, and adapt. We can manage our investment portfolios to minimize the influence of random chance and maximize reliable yield (cash flow). We can also manage known and unknown risks that ebb and flow beyond our sphere of influence. 

We don't know what will happen in the short term, but we can develop an excellent understanding of the prevailing trend and what will happen in the long run if the system stays on its current trajectory. As we can see in the news, many private and public institutional structures have failed to adapt to significant changes in the underlying technological and environmental systems over the last half-century; we must do better. 

What and how. 

 You can have any investment return you want; all you need is a household balance sheet capable of withstanding the volatility associated with your chosen return target. Whether your return target is high or low, we can meet it using bonds alone. Unlike stocks or real estate, bonds provide contractual agreements with reliable cash payments and predictable returns, and they are much easier to analyze, control, and combine into functional portfolios than stocks and real estate. 

Our expertise is creating bond ladders that optimize reliable cash flow tailored to your unique household balance sheet. Bonds allow us to engineer a portfolio that meets your specific performance targets. By examining the current yield curve, we can determine how to maximize reliable periodic cash payments over time, balancing yield and volatility. Generally speaking, we seek to extend the maturity of a bond ladder until the yield curve flattens out while adjusting for each household's financial risk capacity. 

This process is dynamic, akin to navigating a ship through the ocean. However, with bonds, we have significantly greater visibility and control over maximizing returns in line with your financial capacity compared to using stocks or real estate. 

Time, place, people and questions of degrees. 

Our structures must be resilient and adaptive, or we may get swept up in socioeconomic events and lose everything we have worked for. Household budgets, savings, spending, how much, and what types of risk to shoulder in the markets are examples of things we have a great deal of control over. Love, health, relationships, jobs, the economy, financial markets, geopolitical events, and the weather are examples of things that we have little to no meaningful control over. Indeed, we can eat well, exercise, get advanced degrees, work hard, and be kind to others. Still, ultimately, there's a high degree of chance and randomness in life. 

To become and remain financially independent, we must first focus on the things we have a degree of control over and, second, minimize chance and randomness by insuring against catastrophic losses due to events that are primarily out of our control. The first is relatively straightforward: we must live within our means. The second is more challenging, but that's where I can add the most value: risk management. 

For the last few decades, "goal-based financial planning" has been a significant profit center for the financial industry. The problem is that this approach puts the "return cart" before the "risk horse." Conventional goal-based financial planning is nonsensical because markets, society, and individual situations are subject to much greater ongoing changes than these models assume. Your risk capacity depends entirely on the health of your balance sheet as it exists today. 

  Therefore, we do not use conventional goal-based planning, which targets buying a home or saving for retirement. We use cash flow-based planning.   

Instead of setting arbitrary return goals, we begin with your balance sheet as it exists today and establish your actual risk capacity. Then, we construct an investment portfolio designed to maximize risk-adjusted cash flow based on how much volatility your balance sheet and minimum income needs can tolerate.  

Planning must begin with your current balance sheet because the balance sheet determines your risk capacity, not wishful return goals.  

  If properly managed, positive cash flow will increase your net worth over time. You can then decide what to do with disposable cash as it accumulates.  

Once you know how to make money in capital markets, and it's genuinely not a mystery how to do this, the only thing between you and financial independence is the always limited capital, time, and psychological capacity we all face. 

 Talk Soon!