Munger on Human Misjudgements

Charlie Munger, Vice Chairman of Berkshire Hathaway, often does not get the recognition that his investing partner, Warren Buffett, receives. However, Munger is an investing legend in his own way. I have always admired Munger for his critical and rational thinking and it was a privilege to hear him speak at the 2006 Berkshire shareholder meeting.

Recently, I came across an article on the Reflections on Value Investing blog (I highly recommend this blog to all value investors) which talks about the Man-with-the-hammer syndrome.

The article has a link to Munger's speech titled PSYCHOLOGY OF HUMAN MISJUDGMENT. In the undated speech at Harvard Law School, Munger talks about the extreme irrationality and biases that are prevalent in the world. Click here for a link to the article.

Munger also makes several references to Robert Cialdini and his work on influence and compliance. I recently re-read Cialdini's book Influence - a must read for anybody trying to understand the different techniques compliance professionals use to manipulate our minds!

I found Munger's talk very enlightening and it reinforced my belief that Munger is one of top thinkers of our time.

The Intelligent Investor

Charlie Munger oftens says that all inteligent investing is value investing.

Sham Gad, Managing Partner, Gad Partners Funds, will be talking about value investing in a talk titled "THE INTELLIGENT INVESTOR: THE PRACTICAL APPROACH TO INVESTING".

Click here for Sham's blog.

Venue: Chelmsford Public Library, MA (click here for the library's web site)
When: December 13, 2007 at 7 PM

Agenda
–Understand why a value oriented investment operation offers the most sensible and practical approach to managing money.
–The ideas and philosophies developed by Ben Graham in the 1930’s and extended by Warren Buffett today.
–Six characteristics that define an intelligent investment approach.
–A simple value based investment case study.

Please note that this a free seminar and open to the public.

The Billionaire Next Door

"Warren Buffett: The Billionaire Next Door Going Global" premieres on Friday, November 30th on CNBC.

I think this will provide a valuable insight into the mind of the uber-investor. In particular, I'm interested to hear about his latest trips to China and Korea and if offers any investing ideas.

Click here for details on this program.

Trust & Estate Planning Seminar at the Chelmsford Library

We had a great turnout last night with over 100 people attending the seminar!
Dan Caplinger (see his bio) did an excellent job in explaining the intricacies of estate planning.

There were a lot of interesting questions from the audience. Since this is a very complex subject, we are thinking of organizing a follow up session in February or March of next year. Please let me know if you are interested.

If you missed the seminars or if you want to review the topics again, you can check out his presentation here:
http://www.chelmsfordlibrary.org/programs/programs/pdf/dan_caplinger_presentation.pdf

Note that the next seminar will be December, 13 by Sham Gad, "The Intelligent Investor: A Practical Approach to Investing".

I look forward to seeing you then.

Circle of Competence

"Its not competence if you don't know its edge" - Charlie Munger

One of the least talked about subjects in investing is an investor's circle of competence. I believe every investor should have a thorough understanding of his/her area of competence if there is any hope of besting the market.

I can speak from personal experience: when I started investing in 2000, I was bitten by the telecon industry. Looking back, I realize I had no business investing in companies like JDSU, Nortel Network and other dotcom darlings of the day. I had no idea of what these companies did, how did they make money and what their future prospects looked like. I was lucky that I did not invest (read "bet") a lot of money. Nevertheless, it was a lesson worth learning in spite of the hefty tuition bill :)

In one sense, "circle of competence" forces you to "buy what you know" - a concept put forth by investing legend, Peter Lynch. Although it is commonly misunderstood as buying what you are "familiar" with, it goes beyond just familiarity. What Lynch meant was that if you work in the health care industry and see a particular drug or device being prescribed more than the others, you have an advantage over others and could use this to investigate the company behind that product. And after your analysis, if you find an opportunity, go ahead and buy it. This is different from going to the local mall and seeing a line at the GAP store and buying the GAP stock based on this visit. The line could be due to several reasons - a slow cashier, cash register down or something else that has nothing to do with the latest design of khakis at GAP.

With that said, one can and should increase his or her circle of competence. It is amazing to see that Warren Buffett and Charlie Munger are still learning and increasing their circle after decades of experience. Not to mention, both of them are over 70 years old!

Berkshire Hathaway's recent purchases in the railroad industry gives us an insight into the minds of these uber-investors. Here is an excerpt from Charlie Munger's talk at the 2007 Wesco shareholder's meeting...

Railroads – now that’s an example of changing our minds. Warren and I have hated railroads our entire life. They’re capital-intensive, heavily unionized, with some make-work rules, heavily regulated, and long competed with a comparative disadvantage vs. the trucking industry, which has a very efficient method of propulsion (diesel engines) and uses free public roads. Railroads have long been a terrible business and have been lousy for investors.

We did finally change our minds and invested. We threw out our paradigms, but did it too late. We should have done it two years ago, but we were too stupid to do it at the most ideal time.

There’s a German saying: Man is too soon old and too late smart. We were too late smart. We finally realized that railroads now have a huge competitive advantage, with double stacked railcars, guided by computers, moving more and more production from China, etc. They have a big advantage over truckers in huge classes of business.

Bill Gates figured this out years before us – he invested in a Canadian railroad and made eight hundred percent. Maybe Gates should manage Berkshire’s money. [Laughter] This is a good example of how hard it is to change one’s mind and change entrenched thinking, but at last we did change.

The world changed and, way too slowly, we recognized this.

Source: Whitney Tilson's Wesco meeting notes

Trusts and Estate Planning

Listen Dan Caplinger (Motley Fool writer and an attorney) talk about Trusts and Estates. I think this is one of most important aspects of financial planning, which most people ignore.

Click here for a short bio of the speaker.

Venue: Chelmsford, MA Public Library
When: November 8, 2007 at 7 PM

Agenda

• Overview: Why Estate Planning Is Important (orderly transfer of assets, addresses family obligations, taxation)
• Common EP Documents (will, trust, power of attorney, living will)
• Description of estate process (probate for wills v. administration of trusts)
• Brief discussion of tax issues for rich estates

See below for more details on this and other educational seminars

http://www.chelmsfordlibrary.org/programs/programs/financial_fitness.html

Note that these presentations are free and open to public. You can get also get directions to the library from the above page.

Please let me know if there are any questions.

Financial Fitness - Intro

Please see the below link for my presentation at the Chelmsford Public Library on personal finance and investing topics. This was recorded by the local TV network for broadcasting to the community. A copy of the presentation is also available at the library.

http://rishisondhi.googlepages.com/Financial_Fitness_Intro_ppt.pdf

20 Common Investing Mistakes

Listen Selena Maranjian (The Motley Fool writer) talk about 20 common investing mistakes people make.

Venue: Chelmsford, MA Public Library
When: October 11, 2007 at 7 PM
Agenda

• Not tracking your returns.
• Holding on too long.
• Paying too much in commissions.
• Letting emotions rule your investing.
• Having unrealistic expectations.
  

See below for more details on this and other educational seminars

http://www.chelmsfordlibrary.org/programs/programs/financial_fitness.html

Note that these presentations are free and open to public. You can get also get directions to the library from the above page.

Please let me know if there are any questions.

The Lowell Sun article

Here is a new link to my interview in The lowell Sun newspaper (9/2/07)

http://rishisondhi.googlepages.com/LowellSunarticle.pdf

Margin of Safety

According to Warren Buffett, the two rules of investing are:

• Rule No. 1: Never lose money
• Rule No. 2: Never forget Rule No. 1

As an individual investor who started investing just before the dot com bust, I have learned this the hard way but now these tenets are instilled in me.

Warren Buffett’s teacher and father of value investing, Ben Graham, first coined the "margin of safety" expression in his classic text, The Intelligent Investor. In investing, trends come and go all the time. However, these words have stood the test of time. Even today, Warren Buffett calls them "the three most important words in all of investing."

The beauty of value investing is in its simplicity. All one has to do is:

1. Calculate the intrinsic value of a company.
2. Buy the stock if it can purchased at a suitable margin of safety compared to its intrinsic value.
3. Wait for the market to correct the stock price.
   

[The intrinsic value of an investment is determined by discounting the future cash flows of an investment by an appropriate interest rate. I personally use DCF analysis.]

While this approach is painfully simple, it is difficult to follow. The main reason is that since every investor has to make assumptions to calculate this value, the estimates can vary widely. This is where margin of safety comes in. Ben Graham used a 33% (one-third) margin of safety compared to the book value when looking for potential investments. Other value investors have a different hurdle rate. The bottom line is: the wider the margin of safety, the better it is. To paraphrase Buffett, “You build a bridge that can withstand 30,000 ton trucks but insist that only 10,000 ton trucks drive on it”.

The more I thought about this, the more it made sense. As an engineer designing complex technical solutions, I was using margin of safety everyday. When working on industrial applications, I would scale up the pilot test data to design production scale systems incorporating a safety factor or scale-up factor: this is exactly the concept of margin of safety!

Margin of safety protects us from the whims of the market and minimizes the risk of permanent loss of capital. There are two main benefits:

1. Lets say you made an investment in a company that was selling at a 40% margin of safety. Suppose there is a change in the company’s business or if your assumptions were not as accurate, and the new margin of safety is 20%. You are still protected and can wait for your thesis to play out.
2. The other advantage is the higher upside potential. Suppose your original thesis was sound and you were able to purchase the company at a 40% discount. Just because the market restores the company price to match its intrinsic value, your investment will have a 66% return!

Of course, having a disciplined strategy is easier said than done. Even if you apply a margin of safety in your purchase decision, any subsequent decrease in price may be difficult on your system. This is where your temperament comes in. Ideally, any change in price should be considered as an opportunity to buy, sell or hold that investment. In other words, look at it as if you were approaching it for the first time.

In the end, it takes discipline to apply the margin of safety and courage to stick with your investments when the gusts are blowing in your face.

Lowell Sun newspaper article

Please checkout my interview in the Lowell Sun newspaper about my interest in investing and the investing seminars that I am organizing with the help of Chelmsford Public Library.

http://www.lowellsun.com/business/ci_6786395

Stocks: The Best Investment Vehicle?

One of the ongoing debates in the world of personal finance is what is the best investment option: stocks, bonds, treasuries or commodities? The answer, I believe, depends on personal risk-tolerance and circumstances. For money that is needed for at least five years, the best option may be an intelligent investment in the stock market.

Perhaps the most comprehensive evidence I have seen is the research by Wharton Professor, Dr. Jeremy Siegel. In his book, Stock for the long run, Prof. Siegel compares the returns of different assets over the last two centuries (yes, you read that correct). See below Table.

Time: 1802 - 2001
Not adjusted for inflation
Stocks: $8.8 million
Bonds: $13,975
Bills: $4,455
Gold: $14

Adjusted for inflation
Stocks: $599,605
Bonds: $952
Bills: $304
Gold: $1


Stocks beat the pants off all other investments over the same time. Its not even close!

Critics will say that average investor does not invest for 200 years. Fair enough.
But research has shown that even for shorter periods like 5 to 10 years, stocks still outpace the other investments on average even though there may be periods of under performance.

Additionally, people correctly point out that real estate was not included in the above comparison. Investment in real estate is easier than ever with REITs (Real Estate Investment Trusts), which can be bought and sold like stocks. Another advantage of real estate is the extended returns one can achieve with leverage.

Jack Clark Francis at Baruch College, New York City, and Roger G. Ibbotson at Yale University compared real estate with 15 different "paper" investments – stocks, bonds, commodities and real estate investment trusts (REITs) from 1978 to 2004. They reported the following returns:

• Housing – 8.6%.
• Commercial property – 9.5%.
• The S&P 500 (proxy for stocks) – 13.4%.

In spite of the strong housing market of the last 2 decades, stocks still came out ahead. Additionally, stocks have several advantages – better performance, low costs, diversification and amount of effort needed by the investor - compared to real estate. The recent downturn in the housing market has shown us how difficult it is for some homeowners to sell their house in a down market.

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Time to take charge

Wake up Call

One would think that in today's society, which encourages putting self before others, everybody would make their finances the top priority. The truth, however, is that we are not financially prepared. In my earlier post, I had listed some of the reasons why the individual investor is not financially savvy.

In this post, I would like to talk about the reasons why we need to take charge of our finances:

Retirement

• According to the Employee Benefits Research Institute (EBRI) 2007 Retirement Confidence Survey, nearly 50% people have less than $25,000 saved!
• Many companies are discontinuing defined benefit plans (pension plans) and moving to defined contribution (401k plans).
• Individuals are responsible for their retirement accounts. Individuals need to be aware of different fund types (equities, income and sector funds), asset allocation and expenses among other things.
• Social security system may not be solvent when we retire.

Health care

• Health care and medical insurance costs , which have been steadily increasing, are expected to be majority of the retirement spending.
  

Negative savings

• We spend more than we earn. According to latest savings survey, national saving rate is -1% ! You do the math - I do not need to add anything here except that we should not forget the "Live Below Your Means" mantra.
  

Education costs

• College costs are increasing faster than inflation rate. For some of the top schools in the country, annual tuition and boarding costs are ~$40,000. Do you have enough money saved for junior's Ivy League education?

Estate Planning

• If you are lucky to leave a legacy behind, you need to establish the right trusts and estates to provide for your family and take care of other goals like charitable donations. According to some estimates, probate and estate settlement costs (a.k.a death taxes) can be up to 10% of your estate.
  

Fun money

• This is how we pay for the fun stuff - vacations, second home, cars, big screen TV, etc. While we like to splurge on vacations and toys, it makes sense to plan for such purchases so our saving plan doesn't derail.
  
  
  

Book Review: The Little Book of Common Sense Investing

The Little Book of Common Sense Investing
By John Bogle



This is the latest book in the Little Book Big Profits series.
As much as I'm a big fan of value investing and enjoyed the earlier books in this series (The Little Book That Beats the Market by Joel Greenblatt and The Little Book of Value Investing by Christopher Browne), John Bogle makes a very compelling argument in favor of passive investing. I have to agree with Mr. Bogle and I personally follow an "index funds plus a few stocks" philosophy. As I hone my investing skills, individual stocks will be a greater percentage of my portfolio but foe now, I'm a firm believer in index funds and ETFs.



Anyway, onwards we go...



Main point of the book:

• Beating the market before costs and expenses is a zero sum game, while


• Beating the market after costs and expenses is a loser's game

Tyranny of Costs

• On average, the typical cost of fund ownership is 3% to 3.5%.


• Assuming a 8% average return of stock market and 5.5% return on typical fund, a $10,000 investment in a index fund will grow to $469,000 while the same investment in the typical managed fund will grow to $145,000- resulting in a shortfall of $323,600!


• The real return of a typical managed fund is even worse because of higher turnover (portfolio churning) which means higher capital gains taxes for fundholders.

Are fund managers and investment advisers smarter than the average investor?

• Out of the 355 mutual funds started in 1970, only three funds, or 8/10 of 1%, have beaten the market!


• A recent study found that average return of funds recommended by advisor was 2.9%. Average return of funds selected directly by investors - 6.6%

A good rule of thumb

• Transaction costs of a fund average about 1% of the fund turnover rate. For example, a fund with 100% turnover would carry a cost of 1% of assets. This is important fact generally overlooked by fundholders since it is not disclosed by the fund companies and difficult to find.

An interesting thing about the book is that Bogle brings up Buffett and Graham as proponents of index funds while these two individuals have been called the founders of value investing! While it is true that Buffett has endorsed index funds for the "know nothing" investor, he has also said that for a "know something" investor, it makes sense to buy fractional ownership stakes (a.k.a shares) of wide-moat companies selling at reasonable prices compared to their intrinsic values.

The above issue notwithstanding, this is a great book and I recommend it to everybody.

For another excellent take on the book, check out...

http://www.fool.com/investing/value/2007/07/02/the-little-book-of-common-sense-investing.aspx?vstest=search_042607_linkdefault

Our own worst enemy?

When it comes to personal finance, why are we our own worst enemy?

There has been a lot written about the financial skills, or the lack thereof, of joe investor. I have to agree that the average investor lacks the basic financial planning skills but that's because the system is rigged against us! Here are the main reasons of financial illiteracy that is so prevalent today:

1. Our schools and colleges do not teach basic personal finance skills. Since I did my schooling in India, I thought I was at a disadvantage when it came to investing and retirement planning. To my surprise, the average investor is no better. At least, I was starting with a level playing field!
2. We don’t like discussing it with friends & family. According to a recent Fidelity survey, 30% of couples have different opinions about retirement dates and lifestyle choices.
3. We just don't have the time or desire to plan our finances. Lets face it - life happens! We all have lives and something or the other gets between us and financial planning.
4. Experts wants us to think it is "rocket science". In fact, I think the main premise for the financial industry existence is that we would ne lost without these "helpers"!
5. Lastly but most importantly, it's us! In spite of our best intentions, we sabotage our plans because of our biases. This is a separate post (perhaps several posts!) in itself but suffice it to say that overconfidence, anchoring, loss-aversion, stubbornness and other factors result in mediocre or poor investor performance. More on this later...

Introduction to Financial Fitness

Welcome to my blog!

My is Rishi and I am student of value investing. Here, I'll talk about all things financial with a focus on investing. Which raises the question - who am I and why am I writing this? :)

My journey into the world of personal finance started several years ago when I entered the workforce. On my first day at the job, I was handed a binder of mutual fund prospectuses to select my 401(k) contributions. I realized that even though I had been to graduate school, I was ill-equipped to make financial decisions. I soon learned that my colleagues – some of them 10 to 20 years my senior – were in the same boat. So I took it upon myself to learn the basics. During my research, I came across The Warren Buffett Way by Robert Hagstrom and started learning about Buffett, businesses and investing.

What started as a curiosity became a passion - during the last seven years, I have read several books and countless articles and attended a Berkshire Hathaway annual meeting. I have been managing my family’s portfolio with good results and feel that I am now in a position to share the knowledge with others. The idea is to present information about topics such as retirement planning, stocks, mutual funds and estate planning among other things in an educational format so people can use that information to make their own decisions.

I have a selfish motive as well – to learn from the collective wisdom and improve my investing skills!