Tesla Stock – RIA Reads: The humble billionaire and the Monte Carlo mistake
Call it in the air
Client: Am I on track to meet my retirement goals?
Advisor: I dunno, flip a coin.
That might not sound like a conversation an advisor should be excited to have. But in a post recently published on Kitces.com, Derek Tharp argues that a Monte Carlo analysis showing a 50% probability of success for a retirement plan isn’t nearly as bad as it might sound.
And it does sound bad. There’s a 50% chance I’ll outlive my assets?! Indeed, Tharp reports that the vast majority of advisors say it’s imprudent to endorse a plan that has a probability of success below 70%.
Here’s what those advisors might be missing:
[T]he reality is that often all it takes are minor adjustments to save a ‘failing’ plan…If you had to select one spending level at the beginning of retirement, and you were bound to stick with it no matter what happened in the future, then perhaps you would want to err significantly on the side of caution and select a conservative spending level that provides a relatively high probability of success… However, this does not reflect how most planners actually go about financial planning for their clients…[A] 50% probability of success is really nothing more than a 50% probability that there will be something to do – i.e., to make some adjustment – when the client comes in for a future planning review meeting.
After all, an ongoing advisory relationship is premised on the idea that things will change, both in the clients’ lives and in the markets. Tharp asks: ‘Is it necessarily imprudent for there to be a 50% probability that “something” will simply happen at one of those future meetings?’
The real takeaway is the impact that framing can have in these advisor-client conversations. Tharp compares the language of failure (‘There is a 50% chance that your retirement will fail’) to the language of adjustment (‘there is a decent chance you may need to make some spending cuts in the future’). Different deliveries of the same message can provoke very different emotional responses.
At the end of each of his podcast interviews, Michael Kitces points out that ‘the word “success” means different things to different people.’ It’s interesting that in this case, we are asked to consider the parallel statement that the word ‘failure’ means different things to different people. The advisor’s job in this case is to level-set, by reminding clients that failure here means ‘relatively minor spending cuts’ and not, say, ‘cat food for dinner.’
Not your father’s market
In many fields, confidence (real or feigned) can be an important attribute. No one wants to hire an anxious airplane pilot or a self-doubting trial lawyer. But investing is one of those domains in which humility proffers a profound advantage.
Few make that as evident as Howard Marks of Oaktree Capital. In a note released Monday, he utilizes a slightly sitcomish life experience – a growth-stock-and-bitcoin-loving son rides out a pandemic with his slightly stodgy contrarian-investor father – to draw lessons about what he, the elder Marks, has been missing about buying and holding shares of high-growth companies.
Here is one of the revelations at which he arrives:
Skepticism is important for any investor; it’s always essential to challenge assumptions, avoid herd mentality and think independently. Skepticism keeps investors safe and helps them avoid things that are “too good to be true.”But I also think skepticism can lead to knee-jerk dismissiveness. While it’s important not to lose your skepticism, it’s also very important in this new world to be curious, look deeply into things and seek to truly understand them from the bottom up, rather than dismissing them out of hand.
This out-of-hand dismissal is a common reaction; it might even be your own. If a young relative asks you if they should buy Tesla shares, do you start by rolling your eyes? If so, is this eye-rolling based on an in-depth analysis, or a general perception having to do with a stratospheric price-earnings ratio and the fact that Elon Musk named his most recent child X Æ A-12?
Perhaps Tesla shares indeed present an absurdly poor value. But as Marks points out:
[D]etermining the appropriateness of the market price of companies today requires deep micro-understanding, and that makes it virtually impossible to opine on the valuation of a rapidly growing company from 30,000 feet or by applying traditional value parameters to superficial projections. Some of today’s lofty valuations are probably more than justified by future prospects, while others are laughable – just as certain companies that carry low valuations can be facing imminent demise, while others are just momentarily impaired. The key, as always, is to understand how today’s market price relates to the company’s broadly defined intrinsic value, including its prospects.
This is not easy, which is kind of the whole point (since if it was easy, someone else would have done it, and the fair price would have been reached already). Indeed, Marks spends a lot of time castigating so-called ‘value’ investors for potentially ignoring compelling opportunities because they are difficult to evaluate numerically.
Which brings us to cryptocurrencies. Marks writes:
When innovations work, it’s only later that what first seemed crazy becomes consensus. Without attaining real knowledge of what’s going on and attempting to fully understand the positive case, it’s impossible to have a sufficiently informed view to warrant the dismissiveness that many of us exhibit in the face of innovation.In the case of cryptocurrencies, I probably allowed my pattern recognition around financial innovation and speculative market behavior – along with my natural conservatism – to produce my skeptical position. These things have kept Oaktree and me out of trouble many times, but they probably don’t help me think through innovation. Thus, I’ve concluded that I’m not yet informed enough to form a firm view on cryptocurrencies. In the spirit of open-mindedness, I’m striving to learn.
My own view about bitcoin, which I also believe to be the consensus view, can be summarized in five words: ‘I just don’t get it.’ In other words, I don’t get why something has value just because it’s scarce, or how it can be considered an alternative to the US dollar when it cannot be used to buy good or services (with the occasional exception of illegal drugs, if you’re dealing in large enough quantities).
This is not the ‘I don’t get it’ of sheer ignorance; I’ve actually had a lot of exposure to crypto, spent a good deal of time thinking about the economic and social implications of a crypto-centric world, and have had long conversations on the topic which have ranged from the fascinating to the interminable. But I still don’t see why it should have value. Within the realm of ‘investing,’ I see bitcoin, ethereum and other coins as collectibles at best; expensive art you cannot admire, ancient coins you cannot hold.
But Marks advocates using that same phrase – ‘I don’t get it’ – as prelude rather than as conclusion. The fact that bitcoin has long held significant value despite all of the obvious detractions suggests that something significant is missing from my analysis. If you have similar views to me, the next time you speak to a cultish crypto investor, don’t say ‘I don’t get it’; say, ‘what don’t I get?’ You probably stand to learn a great deal more that way.
After all – if the legendary Howard Marks has more to learn, then so do you and I.