Tag: Money

How to choose a money manager?

(Image by teegardin)

You’ve inherited some money, or sold a business. What now?

Most people don’t have the skill, time, or willingness to manage their own investments.

One option is to entrust your funds to a professional money manager. But how to choose one?

I would recommend the following checklist:

1. Skin in the game
The first question I would ask: “What percentage of your net worth have you invested in the way you are recommending?” If it’s not a significant portion, I would quit the meeting right here and walk out.

Some years ago, I helped a friend get his finances in order. He owned some products that the private banker had recommended. “A great opportunity”, the banker said. I asked him: “Do you own any of these funds and certificates?” He smiled and said: “No, I’m saving to buy a rental property.” A prime example of “Don’t listen to what people say. Watch what they do.“

2. Aligned incentives
Make sure that the incentives between the manager and yourself are aligned. How does the manager get paid? Does he charge a high management fee? Does he get paid when the performance is negative?

Personally, I prefer and recommend the old Warren Buffett Partnership model: 0% management fee, an annual hurdle, and then a 25% performance fee. A high water mark ensures that a negative performance needs to be made up before the manager is paid. Simply said: the manager should only make money when you make money. Here’s a clip of Charlie Munger commenting on this topic.

3. Aligned investing philosophy
How does the manager choose investments? Which criteria are applied? What is the minimum time horizon? The approach needs to make sense to you, and you need to understand the basic concept. The manager should also be able to show a track record of the applied approach. Ideally his own, or at least of the people/organizations that inspired him to use this approach.

Applying this checklist does not guarantee investment success. But it might help you prevent painful mistakes, and stacking the odds in your favor for finding a good manager.


The Key Principles of Value Investing

The style of investing that speaks most to me is value investing, as practiced by Warren Buffett and Benjamin Graham. I’m often asked: “What is value investing exactly?”

Here is my understanding of the core principles:

Have more purchasing power in the future
The goal of all investing is laying out money today, so that you can enjoy more purchasing power in the future. The principle is: Instead of eating the seeds, plant them, so one day, you will have plenty more to enjoy.

Investing vs. Speculation
The goal is to be an “investor” and not a “speculator”. Here is the definition by Benjamin Graham: “An investment operation is one which, upon thorough analysis promises safety of principle and an adequate return. Operations not meeting these requirements are speculative.” (The Intelligent Investor)

A stock is a partial ownership of a business
A stock is not just an abstract ticker symbol with a constantly moving price. It is a partial ownership of a business. So no matter whether you are buying 0.000001%, 10% or 100% of a business, the decision process should be quite similar. You have to know what the whole business is worth, so that you can determine what each share of the business is worth.

Mr. Market is here to serve you, not to guide you
Treat the market as your manic-depressive business partner called “Mr. Market“. He is emotional, euphoric, moody, and often irrational. Every day, he quotes you a new price for his shares. You can reject him every day, and the next day he always comes back with a new price. You can never know what price he will offer next and you don’t know why he offers you the price that he does. Your job is to simply listen to him every day, and only buy if when he offers you a low price. As opposed to “market timing”, this is “market pricing”. You simply recognize a good deal when you hear one, but can never know when it happens.

A great song about Mr. Market

Margin of safety
Always have a margin of safety, as a buffer for errors and unforeseen situations. The principle is simple: If you are building a bridge that is supposed to support 20 tons of weight, you don’t build it for 21 tons. You build it for 40 tons, to have plenty of margin. The same is true for value investors: they try to be very conservative in their calculations. They don’t buy a stock because they think it’s 6% undervalued. They demand 50%.

Buy one dollar for 50 cents
To summarize, and to quote Warren Buffett: “All investing is value investing.” In fact, Warren Buffett or Charlie Munger don’t even call themselves value investors. They simply master these principles. The goal is to find something worth one dollar and buy it for 50 cents. And even if your assessment was wrong and it turns out to be worth only 50 cents, you at least didn’t lose any money, thanks to your wide margin of safety.

Results
By applying these principles, Warren Buffett has grown his net worth from $10,000 when he was 19 years old to more than $80 billion today, compounding at an average rate of more than 20 percent per year for more than 60 years straight.

If you’ve invested $1,000 into Warren Buffett’s publicly traded holding company Berkshire Hathaway in 1965, you would currently have $4.3 million.

So these principles are not just theory, they are achieving wonderful results.


The Cost per Use Principle

Do you want to spend less money than you earn, so you can save more, invest more, and ultimately achieve financial freedom?

Then I suggest you pay attention to the Cost per Use Principle:

For each material possession (especially the most expensive ones), calculate and minimize your cost per use.

Crave a swimming pool? Then interview someone who owns a pool and calculate his cost per use. It could be twenty dollars per swim.

Want to go on vacation with an RV? Then calculate the cost per night and compare it with a regular rental car in combination with hotels/motels/bungalows. The RV rental alone can easily be 100-150 EUR per day. Gas, campsite fees, parking, and additional public transportation not included. A regular rental car costs 20-25 EUR per day, with much less gas expenses. That leaves 75-130 EUR per night for the accommodation and parking. I love renting RVs myself, but you just have to be aware that more often than not, it’s the more expensive option.

Want to buy a Tesla with the largest battery pack and performance package? Compare the cost per kilometer with a smaller battery and regular performance. And then compare it with a pre-owned one. I talked to people who ended up paying more than $2 per kilometer ($3.22 per mile). So if I ever would buy a Tesla (I almost did), I’d do a careful calculation and try to bring my cost per kilometer down as much as possible.

Do your parents own a vacation home? You’d be surprised how much they pay per night if they don’t use it often. For the same money, they could often stay at 4 or 5 star hotels, and not always go to the same place.

I am aware that this is a purely financial perspective. You might want to consider convenience, quality of life, potential appreciation of assets, potential rental income, and other factors that are important to you.

Even more important than that is to make sure to consider the total and true cost of ownership of anything you own. Including maintenance, insurance, storage, opportunity cost of invested capital, your own time, people you need to hire, hassles/headaches, and all other directly and indirectly related expenses.

Of course, the most efficient cost per use is zero. This is achieved by either getting your things for free, or not buying them at all. Here are some hacks:

Hack #1: Instead of buying something, put it on your wishlist and wait for 48 hours. Often, your purchase impulse fades away. Example: Last year, I considered buying an electric moped. I ended up not buying it, and am using my bicycle (in combination with mobility-as-a-service options) ever since.

Hack #2: Force yourself to sell or give away one item before you are allowed to purchase another. Advanced: Give away two or more for each new one.

Hack #3: Make it a habit to buy things used. Example: I recently needed more teaspoons, so I went to a thrift store and bought some for a fraction of the price at IKEA.

Last year, I increased my iPhone cycle from 2 to 3 years, bringing my cost per day down by 33%. If I increase it to 3.5 years, 6 months after the introduction of a new model, I’d be able to buy it second-hand, decreasing my cost per use even further.

This is a powerful principle, and I hope that it will serve you as well as it did me.

[Hat tip to Mr. Money Mustache]