Tag Archives: erik-conley

All I Want In Life Is A Small Unfair Advantage

New business ventures often face the challenge of how to be truly innovative and use that in a way that gives them an advantage in the marketplace. For investors, an unfair advantage can come from a number of sources, including inside information (the legal kind, not the kind that will land you in jail). Don’t settle for the conventional wisdom when it comes to making investment choices. Hank “Ace” Greenberg, former chairman of insurance giant AIG (NYSE: AIG ), once said “All I want in life is a small unfair advantage.” As it turns out, he had one – and it was a whopper. Do you have one? Yes, you do. But you may not be aware of it. “Having the time, willingness, and ability to do original research is a true unfair advantage. Unfortunately, very few individual investors are able to pull it off.” – Jesse Livermore New business ventures often face the challenge of how to be truly innovative and use that in a way that gives them an advantage in the marketplace. In his book Running Lean, Ash Maurya offers a new take on the idea by introducing the concept of a small unfair advantage. A true unfair advantage is one that cannot easily be copied, stolen or bought. Anything that is worth copying will be copied, so how do you establish an advantage? By building something that is difficult or impossible to be copied. For investors, an unfair advantage can come from a number of sources, including inside information (the legal kind, not the kind that will land you in jail). The way to gain access to this kind of information is by networking with people who are experts in the area that you’re interested in. Here’s an example of what I mean. The last time I bought Starbucks’ (NASDAQ: SBUX ) stock was right after I heard my barista talking about how the company was going to make a special contribution to the employee retirement plan. Hmmm… Why would they do that unless they knew they were going to have a very profitable year? That was legal inside information, and my small unfair advantage was that I was able to recognize the significance of what that barista had told me. Comments like this, and other sources of objective, unbiased, and timely information are threads that weave your unfair advantage as an investor. By the time a news story hits the media, it’s too late to profit from that information. The price of the stock has already moved, thanks to the action of other investors who may not be smarter than you, but they are much quicker to act. Here’s another example. A well-connected blogger who specializes in junior gold mining shares often has access to people inside that industry who are more likely to speak the unvarnished truth, instead of repeating the talking points that were prepared for them by the Investor Relations Department. There are other skills you can learn, that are part of your unfair advantage. Take problem solving, for example. If you take the time to write down your thoughts regarding an investment idea, and list the possible solutions, you’re more likely to choose the one that advances your goal in the most cost-effective and meaningful way. A single-minded, uncompromising commitment to following through on your strategic plan is an unfair advantage in and of itself. All institutional investors, and most wealthy individual investors, have a strategic plan in place. But following through on it is another matter. If your plan is well-written, it can save you from making costly mistakes that can ruin an otherwise great year. Your Dream Team is another source of unfair advantage. This is your “inner circle,” your private network of contacts and experts who make up your Brain Trust. Highly successful investors have a small group of advisers who are all specialists in their fields. They understand the value of paying for expert advice because they recognize that they will never have enough time and energy to learn more than an expert about that one particular thing. Critical Thinking is an unfair advantage, because so few people practice it. This is the process of detaching yourself from the emotions of the moment, and examining the facts about the decision at hand. It takes patience and discipline, but it’s not rocket science. It’s simply a clearly defined and well-executed procedure. When you put all these things together, you can see that the common thread is independent thinking. Don’t settle for the conventional wisdom when it comes to making investment choices. Look for unbiased expert opinion, even if that means paying someone to advise you about a specific issue. The essence of your small unfair advantage is that nobody can copy, steal, or buy your investment ideas if you think for yourself.

Expected Returns For The Next Ten Years

According to Jack Bogle and Michael Nolan, U.S. stocks are projected to gain about 6% per year over the next decade. Bonds are projected to earn about 3%. These return projections are significantly lower than the long-term averages of 9% and 4.5%, respectively. For the bond market, future returns are expressed as the current yield to maturity. The yield to maturity on 10-year Treasuries is 2.4%, which Bogle and Nolan round up to 3%. (This could be justified by the addition of higher-yielding bonds.) Since today’s 10-year Treasury yield is 2.3%, that estimate looks reasonable. Stock market returns have three components: the market’s current dividend yield the estimated annualized growth in corporate earnings the expected change in the market’s price/earnings ratio Stock Returns = dividend yield + earnings growth +/- (change in P/E ratio) With the stock market today yielding about 2% and historical earnings growth of 4.7%, Bogle/Nolan arrive at a preliminary estimate of about 7% per year, which they reduce to 6% by figuring that today’s P/E ratio will end up ten years from now at its long-term average of 17.8. Enterprise Returns and Speculative Returns Bogle took inspiration from John Maynard Keynes. Keynes believed that the best economic models are as simple as possible, with components and results that are clearly understood. For example, stock returns could be decomposed into two sources: enterprise returns, which are the returns that came from the growth (or shrinkage) of the intrinsic business, and speculative returns, which come from changes in investor psychology. Bogle uses Keynes’ framework to construct his model. Dividend yield plus earnings growth measures the stock market’s enterprise returns. The last Bogle term – the change in the P/E ratio – equates to Keynes’ concept of speculation. What’s An Investor To Do? First, expect lower than usual returns from both stocks and bonds. There’s no way for bonds to achieve high returns, given a starting yield of 2.4%. As usual, stocks offer less certainty. It’s possible that continued low inflation justifies a market P/E ratio of 25 or higher, leading to annualized stock-market gains that approach 10%. But it is also very easy to envision scenarios that fall short of Bogle’s estimate. The 6% estimate is not overly cautious. Second, inflation-adjusted returns look a little less onerous. Bogle’s models don’t take into account the effects of inflation, but today’s bond yields implicitly forecast low future inflation. If that proves true, bonds could eke out a modest real gain. Stocks would of course fare even better. A 6% nominal gain with 2% inflation means a 4% real return, which is respectable if not spectacular by historic standards and flat-out terrific compared with the paltry yields now paid by Treasury Inflation-Protected Securities. Third, the relationship between stocks and bonds looks normal. The historic return premium offered by stocks over bonds has been 4.6%. That would suggest a modest relative advantage for bonds. On the other hand, because bond yields are so depressed today, the ratio of stock-to-bond returns is not particularly low. Bogle and Nolan find no relationship between forecast equity premiums and future stock returns. Investors have to make some important decisions. If they keep their asset allocations as they are, they will probably end up with smaller account balances than they had hoped for in ten years. Bogle and Nolan do not interpret their findings as suggesting that investors should change their asset allocations. If lower account values are not acceptable, investors can either take more risk, or increase their savings rate to make up the expected shortfall. Neither of these is an ideal solution. Taking more risk will not guarantee a better outcome in ten years. And many investors simply can’t increase their savings rate due to already-stretched finances. But it’s important to face up to the fact that the expected returns over the next ten years are going to be lower than usual. Ignoring this warning and hoping for the best is an option, but not a very practical one.