1. “The problem is, as a retail broker, you don’t make commissions when you sit in cash. You put all your clients in cash, you are going to end up going to the soup kitchen.” Josh Brown is talking about one of the many “incentive” problems which exist in investing. In this specific case, the broker has incentives to convince you to trade stocks, since that is the basis on which he or she gets paid (i.e., brokers who are paid on how much you trade are in the moving business not the storage business). The broker’s incentive is to create reasons for you to trade since that generates a fee. The problem with this incentive is that nearly all of the time the best thing for the investor to do is nothing. Incentives are powerful and almost always underestimated.
Josh tells a great story about how Babe Ruth’s home run production dramatically rose when a bonus was put in his contract for each home run hit. What the investor wants is an incentive structure for the financial advisor that is aligned with the investor’s interests. You want your advisor to have “skin in the game,” but also not to have an incentive to “skin you” as part of their game. Charlie Munger makes this same point with a story too: “I know a guy who sold fishing tackle. I asked him, ‘My God, they’re purple and green. Do fish really take these lures?’ And he said, ‘Mister, I don’t sell to fish.’ Investment managers are often in the position of the fishing tackle salesman. They’re like the guy who was selling salt to the guy who already had too much salt. And as long as the guy will buy salt, why, they’ll sell salt! But that isn’t what ordinarily works for the buyer of investment advice.”
2. “I kind of got taken under the wing of the wrong people (retail brokers) and then got way too good at selling – it was like a ten year layover in a really horrible airport. But then I caught a plane out of there, dropped my Series 7 and converted my best clients to fee-based – which is a great deal for them obviously, compared to paying 2.5% on every buy and sell.” People can get really good at selling almost anything, especially if they get the right training. By using the scripts that Josh Brown details in his first book, stock brokers can become what Professor Robert Cialdini calls “compliance professionals” and do things like sell snow in the middle of winter in Alaska. Ideas can be sold just as easily as goods and services. I have a salesman friend who people have said could fire you and you would not realize it until you are home telling your spouse. There is nothing inherently wrong with sales. As I have said in other post in this series, sales is the lifeblood of any business. But as a consumer you want to make sure that the incentives of the salesperson are aligned with yours. It is also helpful to understand some of the basic sales techniques of compliance professional – on that subject, reading Cialdini’s book is a good start.
3. “People need to learn the difference between information that’s interesting and information that’s actionable.” The financial media’s incentives are very different than an investor’s incentives. Financial media wants to assemble viewers to sell to advertisers. Viewers consume media most often if: (1) there is a crisis (real or manufactured) or (2) if they think they can get rich quickly (better yet, both). Research done by Phil Tetlock has found that as the number of interviews an expert does with the press rises, the worse his or her predictions tend to be. John Bogle once said that he watches financial television only for entertainment value.
Josh Brown pulls off a neat trick in that when he is on television he substitutes actual insight and humor for predictions. He also has a nice way of dealing with the people who are better viewed as entertainers than investors. He is naturally funny. If CNBC actually wants to increase its ratings it should put Josh and people like him on the network more often. More Josh, less “analysts” whose credibility is less than zero. That assumes Josh would want to be on CNBC more. Maybe he should be on FX like Louis CK instead of financial television. The last time I was asked to be on financial television I declined since it would more than likely have increased the number of mistakes I make via hubris effects. But if I get asked to be on FX with Josh and Louis CK, I’m in.
4. “It’s not different this time, it’s different EVERY time.” History never repeats itself precisely. Trying to predict the future by extrapolating the past is folly. Despite this fact, humans are pattern seeking creatures and like to ascribe predictive value to patterns they feel they have discovered. People tend to seek meaning from events even if they are random. Humans love to tell stories to themselves and others about past successes being the result of skill rather than luck, which makes the “forecasting folly” problem worse.
5. “The next time you hear someone say we’re overdue for a correction, ask them for a copy of the schedule. Unfortunately, markets are biological rather than mechanical in nature and, as such, precision in timing is nowhere to be found.” A market is more like a cat than a machine. This is what Josh is referring to when he says markets are “biological.” In more technical terms, a market is a “complex adaptive system” and for that reason trying to make short term predictions about the future is folly. If you want to be an “active” investor I suggest a value investing approach: the occurrence of certain types of events over the long term (change in a stock price) within your circle of competence can occasionally be predicted in a way that gives you odds that are substantially better than even – but that happens rarely. When it does happen, bet big. The rest of the time, don’t bet. Accept this fact of life sooner rather than later, and you will be wealthier and happier.
6. “I’m waiting for someone to let me know when things are ‘certain.’” The reality is that very few things in real life involve risk, defined as “future states of the world known, probabilities of those states known.” Risk is actually far less common than people imagine. Almost everything in life involves (1) “unknown probabilities about known potential future states of the world” (uncertainty) or (2) “ignorance of potential future states of the world, probability not calculable.” Uncertainty is everywhere and is actually the friend of the investor since it can result in mispriced assets within his or her circle of competence. The best time to invest is when uncertainty is high. If uncertainty is high and you know what you are doing you can have an edge over other investors. Avoid situations in which you do not know what you are doing. What could be more simple?
7. “Panic buying is what happens when you run money for a living and you feel like you’re missing a huge upside move. To make up for lost performance, your purchases get more aggressive than usual.” Panic buying was never more in evidence in my lifetime than it was during the Internet bubble. Panic buying happens because, as Warren Buffett points out, it is envy and not fear or greed that makes the world go around. The drive for evolutionary fitness makes people want what others have and that drive is very strong. Envy is much more adaptive in an environment of extreme scarcity. In a modern world, envy has become counterproductive. Charlie Munger believes that envy is the most useless emotion, since it produces nothing but unhappiness. The more you suppress envy, the better your investing result will be and the happier you will be.
8. “The way to defeat high frequency traders is to be a low frequency trader, plain and simple.” The people who run markets and/or are close to markets as professionals are always going to have the ability to game the game (the only question is how much). The situation is worse when markets are non-transparent (for example, Dark pools? What could possibly go wrong?). For the ordinary investor, the less you trade the less likely you are to be the sucker at the poker table. All of this obviously increases the attractiveness of an investing style like value investing where you need to engage in very few transactions.
9. “Controlling emotions is the thing that advisors can help the most with when they’re at their best.” “A fantastic portfolio that our clients can’t stick to is worthless, we may as well be throwing darts at ETFs.” “The real challenge is keeping our clients from acting on their worst instincts. It’s keeping the Recency Bias in check, the performance-chasing impulse restrained and the grass-is-greener wolf away from the door. Easy in theory, hard in the real world.” The “behavior gap” caused by investors “chasing performance” is a huge problem. The more you chase performance the more you may benefit from an advisor. If an advisor can help you with controlling emotions at a reasonable price relative to your actual performance gap, you are ahead of the game. The best advisors add other value in areas like tax planning, estate/retirement planning and saving for college tuitions.
10. “Sometimes it’s a lot more about not screwing up than doing something wonderful.” The best way to be smart is to not be stupid. This is straight up consistent with the ideas of Charlie Munger (e.g., when faced with a problem: Invert!). Avoid situations in which you don’t know what you are doing. What could be more simple? To improve on that result, if someone is going to pee on an electric fence, it is best if it is not you. That seem obvious, but people don’t follow that advice all the time. If someone does pee on that electric fence it is best to pay attention since that is a highly teachable moment, even if we are teaching ourselves.
11. “The model of making 500 phone calls a day and getting 50 people to pick up the phone and getting five of them to be maybes and one to say yes is almost impossible in the age of cell phones and e-mail. People just don’t pick up the phone anymore.”… [It is] hard to con someone over the phone you can’t get in touch with.” The boiler rooms of the world have morphed in form and mostly found their way to the Internet as a result of the death of the land line telephone system and the telephone book. Unfortunately, the sorts of people who are attracted to get rich quick scams will always find new outlets.
12. “The type of investor who is easily impressed by short-term performance is also really easily disappointed when a strategy struggles. It’s a personality thing. It’s what drives the behavior gap that Carl Richards talks about – getting into the next hot thing at a top and then getting out at a bottom for the hot thing after that, ‘repeat until broke.’” Most people will panic when trouble arises, even if they think they have prepared themselves for the sort of events that cause panic. You can be a better investor:
[If you] can keep your head when all about you
Are losing theirs and blaming it on you,
[If you] can trust yourself when all men doubt you,
But make allowance for their doubting too;
[If you can] wait and not be tired by waiting,
Or being lied about, don’t deal in lies,
Or being hated, don’t give way to hating,
And yet don’t look too good, nor talk too wise.
Yahoo Finance – Avoid Small Caps Entirely
Learn Bonds – Interview with The Reformed Broker
HZ Capital – 8 Questions for the Reformed Broker
The Reformed Broker – Good luck with that
The Reformed Broker – You are here
Fool – 5 Questions for the Reformed Broker
The Reformed Broker – Nonsense Forecasts
The Reformed Broker – What have you done for me lately
The Reformed Broker – Wolf of Wall Street Review
BusinessWeek – Confessions of a reformed stockbroker
TalkingBizNews – The financial media and investment advice
Benzinga – Josh Brown On ‘The Reformed Broker,’ His New Book and High Frequency Trading
Stocks.com – Must-Read Books: Josh Brown, The Reformed Broker
WBUR – In ‘Clash Of The Financial Pundits,’ Clarity For The Investor?
The Reformed Broker – The Challenge