Manage Your Portfolio Like a Professional Investor

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What does a professional portfolio manager have in common with an every day do-it-yourself investor? They should have a lot in common according to David Stein.

Money For the Rest Of Us Book

Stein was a professional portfolio manager who managed billions of dollars for individual and institutional investors. In his mid-forties, he realized that wasn’t what he wanted to do with the rest of his life. So he quit.

David and I had a chance lunch meeting a little over a year ago after we got split up from a larger group at a conference.

We hit it off discussing our shared experiences of retiring early from our original careers, moving from rust belt cities to the mountain west and struggling with our transitions.

It was ironic that we met at FinCon, a conference where financial content producers go to promote their work. Yet we spent an hour talking about everything but money or our projects.

After meeting David, I started listening to his podcast and learned he was writing a book about investing, which will be released later this week. I asked David for an advance copy with the offer to share it if I felt it would add value for our audience.

The book provides ten questions you should be able to answer to effectively manage your own investment portfolio. It challenged me to think about investing at a deeper level and it left me with a few more questions which David graciously answered to help us all become better investors.

Read to the end for a chance to win a copy of the book.

Before getting into the book, tell readers about yourself. Briefly describe your career as a professional portfolio advisor and manager?

What was the first year or two after leaving your career like, and how did it compare to your expectations? How did that lead you to the Money for the Rest of Us podcast, blog and now book?

I spent seventeen years as an institutional investment advisor and money manager where I was Chief Investment Strategist and Chief Portfolio Strategist at a $70 billion investment advisory firm.

I developed the investment process and was the lead portfolio manager on a $2 billion portfolio that incorporated many of the principles shared in my book.

I left my investment firm seven years ago and declared myself early retired. Then over a period of two years, I proceeded to launch and shut down five different investment-related sites and services as I tried to figure out what I wanted to do with the rest of my life.

Finally, after being a guest on a podcast and finding I loved the format, I launched my show Money For the Rest of Us in May 2014. 

Having worked with many individual and institutional investors, which is more common: investors who overestimate risk tolerance or fearful investors unwilling to take adequate risk with investments?

Have you observed behavioral patterns based on age, sex, investing experience, portfolio size, stage in a market cycle or other factors? 

I believe it is more common for investors to overestimate their risk tolerance, but the whole concept of risk tolerance is flawed because our tolerance for risk changes based on our experiences, current circumstances and even the pool of money we are considering. 

Rather than focus on risk tolerance, individuals should focus on the personal financial harm a bad outcome, such as a major stock market loss, can cause. In other words, how would your lifestyle be changed if stocks fell 60%.

For younger investors, the answer is not much since their account balances tend to be smaller and they have many years to invest and save for retirement. For those in or near retirement, such a loss could be devastating if most of their portfolio was allocated to stocks.

You differentiate speculation from investment by the fact that there is usually no income generated with speculation.

Do you view this as a continuum? For example, do you feel with current low interest rates and dividend yields, stocks and bonds are becoming more speculative?

Do bonds shift from investment to speculation when interest rates are negative? Similarly, is a stock that doesn’t pay dividends a speculation?

How does this impact the way you allocate money to these asset classes?

Investments have a positive expected return, usually because there is cash flow, often in the form of dividends, interest, or rent. For speculations, there is disagreement about whether the return will be positive or negative, usually because there is no cash flow.

Many stocks don’t pay dividends, but they still generate cash flow as an operating business so they are investments. Gold, antiques, and cryptocurrencies don’t generate cash flow and are speculations.

There are exceptions, though. Most bonds are investments because of the interest payments received, but a negative-yielding bond is a speculation because it is priced to lose money. To make money on a negative-yielding bond, interest rates need to fall further.  

Another way to determine if a financial opportunity is a speculation or an investment is speculations are binary in that you have to be precisely right to earn a profit. With negative-yielding bonds, you have to be precisely right about interest rates falling in order to earn a profit. 

In Chapter 3, you address the concept of forecasting bond and stock returns versus using historical averages when setting expectations? While forecasting bonds is relatively straightforward, stocks require estimating earnings growth and inflation?

Given your experience and knowledge, what degree of confidence do you place on your forecasts? How accurate do you think average investors’ forecasts are compared to simply using historical averages adjusted up or down based on current PE or PE 10 ratios compared to historical averages?

Using historical averages and adjusting them up or down based on the price to earnings ratio is a viable approach to estimating returns. Investors could also take the current dividend yield for U.S. stocks and use the average historical earnings growth of 5.4% to develop a return assumption.

The point is that it is naive to assume historical returns will be repeated in the future if starting conditions aren’t the same. Dividend yields for U.S. stocks are much lower than historical averages while price-to-earnings ratios are higher.

The rationale for estimating returns or using reasonable return estimates provided by others, such as Research Affiliates or GMO, is to recognize the high degree of uncertainty with financial markets and what drives that uncertainty. That keeps us from becoming overconfident that history will repeat.

You emphasize risk management throughout the book. I thought this quote was particularly insightful: “… by definition every worst thing that ever happened always exceeded the previous worst case.”

Do you have any hard and fast rules regarding the risk/reward relationship that would make you completely exit an asset class because that relationship is unacceptable? How do you approach the current environment, where few asset classes are particularly attractive?

Unfortunately, there are no hard and fast rules when it comes to exiting an investment. I evaluate how much cash flow a particular investment generates, how much investors are paying for that cash flow stream and how those metrics compare to their historical patterns. Then I decide if the cash flow is sufficient in light of the historical worst case loss the asset category has experienced.

In the current environment, while there may not be asset classes that are extremely attractive there are still plenty of asset categories where the expected 10-year return more than mitigates for the potential risk.

As a buy and hold investor, I’ve traditionally used index funds and only recently added ETFs in my HSA account. I found the idea of protecting myself when doing ETF transactions by using limit orders extremely useful.

Can you explain how this protects investors against flash crashes and why this is important, particularly on larger trades?

A limit order allows an investor to specify the price at which they are willing to buy or sell a security. This compares with a market order where the investor buys or sells at the prevailing market price.

Sudden drops in price, such as ETF flash crashes, are rare, but by using a limit order an investor eliminates the risk that their order gets filled at a price they weren’t expecting. 

Another question about ETFs. In Chapter 8, you wrote that the most effective way to optimize taxes in a taxable account is to hold investments in tax efficient ETFs rather than actively managed mutual funds.

I’ve traditionally used broad based Vanguard index mutual funds in my taxable accounts and found them to be very tax friendly.

Are there characteristics of ETFs that make them fundamentally better than index funds holding the same assets? Is it worth the effort to switch from index funds to ETFs, particularly if it is possible to do so without creating a taxable event?

ETFs are more tax efficient than index mutual funds but the tax efficiency isn’t that much greater that it would warrant selling one’s index mutual funds and shifting to ETFs.

The incremental tax efficiency of ETFs is due to the ability of ETF sponsors to transfer low cost basis holdings to authorized participants as part of the ETF share creation and redemption process instead of selling holdings in the open market, potentially generating taxable gains. Index mutual funds don’t have this option of transferring securities and could be forced to sell holdings and recognize taxable capital gains if there are large redemptions from the fund.

Having said that, both ETFs and index mutual funds are much more tax efficient than actively managed funds because ETFs and index mutual funds have such a low turnover in their underlying holdings.

In Chapter 7 you list value investing as a factor that is a “dependable return driver.” I happen to agree, but this is an opinion that many experts currently debate.

How long should buy and hold investors expect to wait to be rewarded for allocating a portion of their portfolio to any particular factor?

Given value investing has underperformed both growth stocks and the overall market for 12 years, investors are going to have to wait at least that long.

This reinforces the point that starting conditions matter. This long stretch of value underperformance began at a time when value stocks were much more expensive than they had been historically compared with growth stocks. 

In the book you write, “In my portfolio, I add investments when they have an attractive expected return and reduce their exposure when I feel like I am no longer being adequately compensated for the risk.”

This makes total sense in theory. I’ve wrestled with how to do this since reading William Bernstein’s The Intelligent Asset Allocator, but I’ve struggled with developing systems to put it into practice. 

Instead, my wife and I continue to be buy and hold investors with periodic rebalancing. We manage portfolio risk with decisions external to the portfolio (building flexibility into our spending, my wife’s part-time work income, developing my blogging into an income producing hobby/business, creating an income producing asset by writing a book). 

Is this a false dichotomy? Should we also be doing more to manage risk internally?

Is the average buy and hold investor like myself more likely to do more good than harm by doing more than periodically rebalancing?

How much time should we expect to spend on our portfolio to improve our risk adjusted performance? If someone wants to use a more dynamic asset allocation approach, what are the most important first steps to take and things to know?

I think spending time developing other sources of income apart from financial markets is a much better use of time than pursuing a dynamic asset allocation approach.

Having a strategic asset allocation target and periodically rebalancing back to that target is a valid investment approach. Most investors are not going to be dynamic allocators.

More than anything, investors shouldn’t invest and rebalance on autopilot. At least be aware of how different asset categories are valued so you are not over allocating to areas that are extremely expensive and more than likely will have lower returns in the future.

My $.02

David states in the introduction of Money For the Rest of Us that he set out to write a different type of investing book. His goal is to “take a step back and show you how to evaluate investment opportunities.”

He organizes the book into ten questions for analyzing any potential investment “so you can avoid big mistakes and increase your odds at profiting from successful investments no matter what they are.”

After reading countless investing and personal finance books, I’ve found they get repetitive. This book is different. David’s knowledge and experience came through and I learned something in every chapter.

This is not to say that the book is perfect, and it definitely is not an easy read. I found Chapter 3, about forecasting a potential investment’s returns, to be particularly challenging.

Long-time readers of the blog who tend to be experienced and knowledgeable DIY investors are likely to find new ideas, information and insights to help better manage their portfolios. Newer investors who struggle with the perceived complexity of investing may find parts of this book overwhelming.

For both groups, the book is worth the effort, even if some of the concepts are challenging. The ten question framework provided will help those that apply it evaluate investment opportunities, set reasonable expectations for investments and avoid making costly errors.

Thanks to David for the opportunity to read an advance copy of Money For the Rest of Us: 10 Questions to Master Successful Investing and for taking the time to answer my questions.

Win a Book!

I requested a print version of the book to review this summer. They weren’t ready yet so I reviewed an e-version that David sent me. I just got the hard cover copy from his publisher last week.

Since, I’ve already read the book, I’m going to give away my print version to a reader. If you’d like a chance to win, leave a comment below letting me know by Midnight EST, Tuesday, October 22, 2019. I’ll randomly select one winner.

First time commenters will not see your comment until I manually approve it. Please do not leave more than one comment.

You don’t have to use your full name publicly to enter, but you do need to include a valid email (which will remain private) so I can contact you if you win. Good luck!

*Update: Congratulations to Susan Secord for winning the free book!

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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to Financial planning inquiries can be sent to]

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