In Search of the Perfect Investment

I spent yesterday fiddling with semi-dead and dead investments. And the rule is: Don’t put significant (or any) money into startups, private funds, and other illiquid investments.

Best for the brain: When things go awry, hit the “sell” button, lose your money and move on.

Moving on is good.

One day I’ll do a big study. For now, my experience is illiquids s*ck. (That’s a technical term.) I left out the “u” because many of the companies my subscribers work for actively reject words like “s*ck.”

Ten Investment Rules to Contemplate: Continued from yesterday.

1. Life insurance. Most people (including me) don’t carry it. But it makes huge sense for people with illiquid assets — like buildings or rare art. One friend has policies for his children that grow at  7.5% a year. He says they can borrow against the policies at 94% tax-free. But he also bought the policies eons ago.

2. A friend suggests a panel of 4-5 smart friends rather than a paid advisor. Sounds like a good idea. Can you find that many smart friends?

3. Instead of buying individual stocks, and instead of buying a large mutual fund, buy more Berkshire (BRKA).

4. Matching borrowing with investments may make sense, my friend says. Borrow at 2.5%, Earn maybe seven or eight percent. That’s a nice margin. I went through this “logic” a few months ago. Borrowing from my bank was a total nightmare. Endless demands for endless paperwork. In the end I figured I’d rather be playing tennis than filing our more stupid paperwork.

5. A vacation home may make sense as an investment — so long as you’re careful not to overspend, i.e. make the house too pricey for the local community. My friend writes “DON’T BUY A REMOTE VACATION HOME FOR SUBSTANTIAL MONEY BECAUSE YOU FEEL GOOD SAYING YOU OWN 4 BEDROOMS IN CABO OR ANGUILLA. SO STUPID. FOR JUST THE COST OF THE MONEY, YOU COULD VACATION THREE WEEKS A YEAR AT THREE DIFFERENT MAGNIFICENT PLACES.”

For the full ten investment rules to contemplate from yesterday, click here.

 Why market volatility is here to stay. James Surowiecki writes brilliantly for the New Yorker on financial things. Here’s this week’s neat piece on the flash crash, et al.

New Ways to Crash the Market

Five years ago, on the afternoon of May 6, 2010, the Dow and the S. & P. fell more than six per cent in a matter of minutes, losing a trillion dollars in value. The “flash crash,” as it came to be known, terrified investors: it was huge, it was fast, and it made absolutely no sense. Nothing happening in the real world that day, a few market jitters aside, could explain the plunge, and the market recovered almost as quickly as it had fallen. Now prosecutors claim that they’ve found a culprit: a London-based trader, Navinder Sarao, who may be extradited to the U.S. to face charges of market manipulation.

Sarao is hardly your idea of a devious financial mastermind. He’s a thirty-six-year-old private investor who often made his trades from his bedroom, in his parents’ modest suburban house. His e-mails to regulators make him sound like a crank: “I trade very large but change my mind in a second”; “For the large part it is just my INTUITION.” Yet the S.E.C. and the Commodity Futures Trading Commission claim that he’s made millions of dollars trading S. & P. futures by cleverly scamming the market. Sarao denies all charges, and plenty of observers are skeptical that he had anything to do with the flash crash. Whether or not the authorities can make their charges stick, the case highlights a key truth about today’s market prices: on a day-to-day level, they are determined as much by computer algorithms as by human judgment.

In the popular imagination, investing is about economic fundamentals. Investors scrutinize companies, weighing factors like cash flow, product lineup, and merger plans. They keep in mind general stuff like interest-rate hikes and what’s happening to the dollar. But most trading these days has nothing to do with any of these things. Instead, it’s all about what the market is going to do in the very short term-often a matter of milliseconds. Most of this trading takes place too fast for humans to be involved, so the decisions are left to computers. Andrei Kirilenko, a professor at M.I.T. and a lead author of the S.E.C. and C.F.T.C. report on the flash crash, told me that the computers look at the market “through a magnifying glass, quickly changing, with every tick up and every tick down.” The robots base their trades partly on factors like price changes and partly on what’s in the market’s “order book”-a virtual log that contains all the market’s buy and sell orders.

A human trader would never be able to quickly synthesize all the information in the order book, but a bot can. Unfortunately, the bots’ focus on the order book creates an opportunity for a new kind of scam, known as “spoofing,” which is what Sarao is accused of. In its simplest form, spoofing involves putting in a lot of fake offers to buy or sell, in the hope of creating the impression of buying or selling pressure in the market. Sarao stands accused of flooding the market with sell orders at an above-market price. (On some days, the C.F.T.C. claims, he accounted for forty per cent of the sell orders in the market.) Allegedly, he never intended to fill those orders; it was a ploy to trick robots into anticipating a fall in price. Once the robots sold, prices would fall, at which point, presumably, Sarao would buy. Then he would do it all in reverse. The mechanics sound complicated, but spoofing is simple: you create conditions that let you buy low and sell high.

Market manipulation is nothing new. But when, back in the day, legendary speculators like Jesse Livermore drove down prices with “bear raids,” they typically did so by short selling actual assets, which scared others into selling. Spoofers have found that in today’s market you don’t even need to execute trades: you just need to convince some robots that trades might happen. Appearance begets reality.

For now, spoofing is a minority sport and rarely has a big effect on the market. But its success points to a basic problem of a market dominated by short-term robot traders: it’s exceptionally vulnerable to feedback loops. High-speed firms tend to mimic one another’s trading strategies, and in times of crisis this can amplify price swings. That seems to have been what happened during the flash crash: high-frequency trading didn’t start the snowball rolling, but it helped turn it into an avalanche.

The problem isn’t the robots per se but the uses we’ve put them to. As Kirilenko told me, “Automation should, in principle, make markets cheaper, faster, and more accessible.” Indeed, markets today incorporate new information faster than ever before. Yet they are also fundamentally less stable, and more prone to sudden and inexplicable breakdowns. A 2014 study of the impact of algorithmic trading across forty-two global stock markets found that it made the markets more liquid and more efficient but also more volatile. Even more striking, a 2013 study of commodity markets found that, over the years, these markets have become increasingly self-reflexive: sixty to seventy per cent of price changes are driven not by new information from the real world but by “self-generated activities.” Markets, in other words, are moving themselves much of the time. That may be how Navinder Sarao got rich. It’s also how we’ve arrived at a situation where a trillion dollars can vanish in a matter of minutes, even though the real world hasn’t changed at all. 

Stuff:

1. If your favorite web site no longer recognizes you — and you have to keep entering your name and password — try killing all your cookies.

2. Please hold the banister going up or down stairs.

3. Watch out for bathrooms in strange hotels. Falling is not good. Twisting and breaking is not good, especially as you get older.

4. Verizon’s traveling Internet service is worse than AT&T’s. and now Verizon is actively not improving its cell phone service. It’s wasting $4.4 billion to to buy AOL.

5. If you use Outlook, you need Lookeen. It searches Outlook much faster than Outlook does. Trust me on this one. I use Lookeen many times a day to find stuff in emails. Go to Lookeen.net.

6. Nikon has fallen behind Canon in most areas of photography. Canon’s cameras and lenses are better. Nikon’s camera software is too obtuse, too hard to understand.

7. Don’t give your best email address to any company.

8. This is the best WiFi router. It’s called NETGEAR Nighthawk AC1900 Dual Band Wi-Fi Gigabit Router (R7000). I’ve installed three of them. They’re great. Get it. You won’t notice a difference between wired and wireless Internet in your office or office.

Buy it here.

Only in Australia: Chocolate flavored with Vegemite:

Five thoughts for the day.

1. The nicest thing about the future is that it always starts tomorrow.

2. A good time to keep your mouth shut is when you’re in deep water.

3. No one has more driving ambition than the teenage boy who wants to buy a car.

4. There are no new sins; the old ones just get more publicity.

5. In about 40 years, we’ll have thousands of old ladies running around with tattoos. Wrinkled tatoos!

Harry Newton. The ONLY guaranteed way to make a small fortune is to start with a large one. When in doubt, stay out. Todd Kingsley, my venerated financial advisor,taught me that. I wish I had listened to Todd more often.