How To Act
Strategy is a complex subject, to say the least.
In finance and money management, just like in any other important aspect in life, making beneficial decisions at the right time is essential for success. However, there is no “one-size-fits-all” approach when your personal finances are at stake, on the contrary, it is up to you to learn as much as you possibly can about different strategy examples, philosophies, and approaches, in order to form your own foundation for sound financial decision making. The FPF framework should serve as your foundation. Your strategy will depend on your specific circumstance and financial profile.
Strategy is formed as part of specific micro-level decisions, which are set in context by the larger position relating to the macro forces and systemic rules. In other words, when you are deciding whether or not to buy an asset, you are not operating in a vacuum, you are not simply judging the asset “as is”, you are weighing its value in context, as part of the sector it belongs to (i.e. real estate), in terms of the market it belongs to - locally, regionally, nationally. You are also looking at the overarching macro events on the national and global economic scale in order to fully assess your micro strategy in the context of the macro (i.e. short/long-term debt cycles). In other-words, when purchasing an asset you are not simply asking yourself “is this a good buy for today?”, you are judging the situation in terms of economic performance as a whole, interest rates, price performance history, relevance to the future, etc.
When it comes to personal finance; strategy, risk management, and decision making become very specific, and the micro tends to outweigh the macro. As the micro becomes dominant in details and complexity, the macro cannot be forgotten, it has to be taken into consideration as the context of the playing field. In other words, financial strategy is specific to you. Your needs, your goals, and your positions. However, the specificities of your circumstance are set on a playing field with many other players you must be aware of. As another example, if you are older and more established, say in your 50’s-60’s, you are probably (but not necessarily) looking for more secure investment options, ones that will first and foremost protect your wealth as you age, and more specifically, dependent on your retirement plan and the amount of assets you own. If you are young, say in your 20’s and single, you are just getting started, then getting into high-risk/ high-reward situations is probably more fitting, this means you have more risk, and therefore, more to lose, but also more to gain. Since you are young you can rebound more easily, since you have time on your side. This doesn’t mean that young people don’t need security though…
When formulating your strategy, stay flexible, adjust constantly, and don’t ever stop learning, here are some of the basics we’ll be covering:
The Long Game
Determinate Vs. Indeterminate
Optimistic Vs. Pessimistic
Risk Management Principles
The Long Game
Financial strategy is a wide-ranging topic, which is incredibly specific to the individual. It is difficult to even write about this topic in generalities, because it is so specific. However, any “Replicable Success - Strategy” we know-of/ever-heard-of has one thing in common: Longevity View.
Longevity view or playing The Long Game is rooted in fundamentals. When the foundations of an investment in an asset are sound then the risk is reduced, and the longevity of said asset is “guaranteed”. There is no hype involved. There are no trends. The investments are fundamentally sound, and so are the returns. Some of the most extreme examples of such an investment are government bonds, which are guaranteed by that government. Others more “risky” but still secure examples are corporations with a long history and track-record of sound fundamental returns, management, and business operations. The list of fundamentals goes on and extends all the way to your own business and your own decisions. If the first principles are sound, if the foundations are sound, if you are thinking about the long term (i.e. not trying to make a quick-buck), then you are playing the long game, and with time you will win.
Playing The Long Game: how can I maximize desirable outcomes over an extended/ longer period of time? Are my actions aligned with my strategy, with my beliefs, with my interests? If I look back, 50 years from now, will I regret not making this decision (Jeff Bezos style)? If you are playing the long game then the likelihood of your success increases tremendously. You can make mistakes and course correct over time, thereby increasing your fundamentals and strengthening your position. So, instead of thinking about strategy in terms of months, start thinking in terms of building wealth in years. Where will you be in 10years? 20years? 30-40years?
Whenever businesses, individuals, families, trusts, funds, etc., invest time, money, effort; they do so expecting a beneficial outcome. They do so now, so the beneficial outcome guarantees/increases the odds of a positive future. This is a no-brainer for most people. It is intuitive to us all. As humans, one of our innate abilities distinguishing us from the remainder of the animal kingdom is our ability to project our thoughts into the future, and predict.
However, no one person or group can predict the future in certainty, but we can all speculate and simulate various scenarios. These simulations can and should have various inputs and considerations based on accurate and reliable information. These inputs should give one an assessment, or at the very least a hypothesis, of the future. Since investments are all about the future, one must be able to project and simulate various scenarios given their current position, as well as past performance.
The only certain thing about the future is that it is uncertain. When simulating and predicting various outcomes it helps to have a philosophical framework for your decision-making, and a sound justification for your investments based on your various possible predictions of the future. Enter, determinate and indeterminate outlooks, and optimistic (bull) vs. pessimistic (bear) attitudes:
Determinate Vs. Indeterminate Outlooks
When making any decision regarding your finances, one of the very first things you must ask yourself is: how sure are you?
Enter, Determinate Vs. Indeterminate Futures, your starting points when establishing the fundamentals of any investment thesis you come up with, therefore it is important to fully address and understand the guiding outlooks on the future.
Determinism and Indeterminism encapsulate your conviction, your degree of certainty, and your beliefs about the future.
To briefly illustrate these attitudes, the following chart showcases the comparisons of the two opposing outlooks:
* Much more on this topic as it relates to investing in the video link below.
To sum it up quickly, are you sure or unsure about the future = determinate or indeterminate. We should all strive to be as determinate as we possibly can given the circumstances we are faced with. However, often times indeterminate futures do take place and we must act accordingly to protect ourselves and our financial well-being. Simulating these scenarios in detail will allow you to remove much of your risk from your investments.
Optimistic Vs. Pessimistic Outlooks
Optimism and pessimism are familiar concepts to most of us.
Optimism = feeling good/ positive about the future.
Pessimism = feeling bad/ negative about the future.
When it comes to your personal finances and wealth management, your outlooks on the future are critical in aligning your investment decisions, liabilities, income and expenses; with your over all philosophy and outlook. Most of us completely neglect this work, and one of the many consequences of this misalignment is the mismanagement of your personal finances both in the short and long term.
Generally speaking, your positive or negative outlook of the future will dictate the way in which you allocate your wealth i.e. concentration vs. diversification. If one is optimistic about the future in general or the future of a specific company, for example, then one will choose to concentrate their efforts and investment in said future in order to maximize the ROI. However, if one is pessimistic about the future in general or the future of a specific company, for example, then one will choose to diversify their efforts and investments in said future in order to protect their wealth from the risk of uncertainty (more on this in the following segment on Managing Risk).
One can be optimistic in general and pessimistic in detail, one can also feel optimistic in the long run and pessimistic in the short run, or vice versa. These outlooks are dynamic and can be applied to any and all scenarios. The questions you should be asking yourself now is: which outlook do I choose in what scenario, and why?
Some of the techniques of risk management are a fantastic tool for managing your risk exposure, wether you are optimistic or pessimistic, determinate or indeterminate - make sure to apply them to your specific scenarios:
Risk Tolerance Stress Level - Test
Risk Architecture - Design
Risk Trigger Options - Identify
SWOT Analysis - List
80/20 Pareto’s Law - List
Secondary & Residual Risk Assessments - Analysis
Contingency Reserves Assessments - Calculation
Illustrating “The Holy Grail” of risk management through uncorrelated diversification, is Ray Dalio:
Risk management can become extremely complex, there are entire teams and organization dedicated to this topic alone. However, when it comes to managing your own wealth, what you need, and must consider, are your philosophical and future outlooks first, from there your thesis will solidify, and your strategy options will become clear. Once this point is reached, then whatever risk is associated with your selected position must be minimized to the best of your ability, and for this you can use the risk management principles listed above.
Lastly, Tail Hedge Protection:
Tail Risk: “Tail risk is a form of portfolio risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution. Tail risks include events that have a small probability of occurring, and occur at both ends of a normal distribution curve.”
Hedging: “A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. In simple language, a hedge is a risk management technique used to reduce any substantial losses or gains suffered by an individual or an organization.”
There are extremely sophisticated financial instruments and strategies designed specifically for addressing tail hedge protection. As it relates to the individual tail hedge protection can (and should be) a simple act of investment in an uncorrelated position. For example, Gold. Some say Bitcoin. This can also be RealEstate. Or a Commodity. Since most people are invested through their “retirement accounts” (401Ks and IRAs) they are typically exposed to 60% Equities and 40% Bonds, or some other similar distribution of capital. In order to create some tail hedge protection against an unlikely (but probable) even of these assets collapsing in value, one must allocate a certain % of their wealth to a completely uncorrelated asset which will gain from the disorder which lead to the collapse in equities/bonds. Thus, creating what Ray Dalio calls an “All Wether Fund” or Nassim Nicholas Taleb refers to this as being “Anti fragile”. In simplified terms, one should always consider the worst case scenario for their investments, and position themselves accordingly in order to reduce their risk and exposure in case such an event does in fact end up taking place.
Strategy has a purpose. The sole purpose of strategy is achieving victory. Victory is not a vague concept, it is extremely specific. Therefore, victory must be clearly defined in order to establish a clear strategy.
Clear strategy takes time, energy, contemplation, and introspection in order to develop and establish. It cannot be sound with out alignment, without purpose. Sound strategy is the extension of the individual’s truth.
Once formulated, the application of strategy encompass tactics, actions, pivoting, flexibility, and re-calculations. As it relates to personal finance, there is no better risk-free simulation of capital/asset allocation and application then the game of Monopoly. The word Monopoly itself describes the definition of this specific form of victory. When assessing the game in abstraction, there is so much to learn about strategy as well as context.
The game is comprised of 12 distinct phases, and is quite honest and accurate model for success in real-estate strategy -
Consider the 12 Steps of Monopoly:
Open Box - Intention to engage
Set Up Board - Prepare engagement
Distribute Cash - Secure liquidity
Purchase 1 whole asset: 1 Green House - Baseline/Foundation
X amount of Green Houses - Growth/Accumulation phase
1 Red House = Asset Class Upgrades - Excess phase begins
X amount of Red Houses - Excess phase expands
Deals = Negotiations = Credit Cycles Level - Influence others
Consolidations = Concentration of Wealth - End “Competition”
10. Final = Dominate - Victory
11. End Game - Conclusion
12. Pack-up / Back in the Box / Time Scale
This is the outline of the game of Monopoly, it is the blueprint for successfully completing the specific set of rules and parameters the game clearly outlines. In any asset class you are investing in, you should first understand the rules and parameters and then reverse engineer the process in order to reach that understanding. The ultimate rules of the game we are playing for is retirement (i.e. the ability to decouple time from money), which in order to reach (and/or to reach early) one must start with a clear understanding of the and game and reverse engineer their way to their current position.
Moreover, accumulation of assets and non-competition are what drive one to Monopoly, which is what we should all be striving to do in the game of equity we are playing. This game can teach us so much about how we should be operating our personal finances in order to reach personal financial victory. Risks and negotiations are part of the path to reaching that point, and we should learn to master these threats along the way. Ultimately, an individuals doesn’t need to completely dominate others in order to win in personal finance, but one does need to dominate and control their own personal finances in order to win, and control their time and destiny.
*Note on Step 12: The post important step of the game, and perhaps the most over looked one as well. Pack-up / Back in the Box / Time Scale. Everything goes back in the box. You don’t get to keep it. Not to get too grim here, but we are all going to die at some point in the near future. We don’t get to take with us what we’ve accumulated. Maybe we get to pass it on. But, all of the assets, liabilities, income and expenses, they all go back in the box. They are fleeting. They are all impermanent. Our general guidance to most is: accumulate enough, just what you need, and spend the rest of your time pursuing what you are interested in, along with the ones you love. More on this in the following section on Time.
Strategy is dynamic, it is evolving, and always iterating. Moreover, you need to customize your own personalized approach to formulating your strategies, ignore the heard and make up your own mind about any given situation based on the evidence at hand. However, and contradictory at time to the above mentioned, you also need to constantly challenge your assumptions by considering others' understanding and findings on these topics. Strategy is what should align with your truth. All of your micro decisions should align with your macro strategy and philosophy.
Next Phase ->Time
Food for thought:
Legendary Peter Thiel on Determinism & Outlook.