“Pain + Reflection
— Ray Dalio, founder of Bridgewater Associates
2014 is behind us, and before the first quarter sneaks by, I am obligated to offer my annual admissions of error.
One of my biggest peeves about finance is that there is little or no accountability on Wall Street, and even less in the media. My response has been to call out people who make terrible, money-losing market predictions and other financially dangerous mistakes. You might remember my column earlier this year where we noted that “Forecasting is marketing.”
To be fair, I apply the same standards to myself, reviewing my errors each year and publishing them for the world to see. I have been performing this public rite of contrition since 2009 for the following reasons:
1. Owning up to your own mistakes is how to you become better: When it comes to investing, there is always room to refine your approach and improve the decision-making process.
2. It is important to recognize that failure is part of the process. In the world of investing, you must expect to be wrong .
3. Anyone who does a mea culpa is forced to stop lying to himself about how great he is. You are not a genius stockpicker, market timer, macro-pundit, whatever. You are not infallible (and neither am I). Admitting your own errors keeps you humble and grounded.
With that introduction behind us, let’s get right to this year’s errata.
Taxing traders. Last summer, I pointed out the enormous burden short-term traders face: They have to overcome a 30 percent capital gains tax waiting for them each year. If markets average about 10 percent gains per year, traders need to consistently generate 13 percent gains in order to generate on an after-tax basis what long-term indexers get.
That key point still is valid, but I overlooked one tax issue and miscalculated another.
Yes, the indexer beats the active trader — but he does not escape his eventual meeting with the taxman. As I noted in a subsequent column, the passive index investor is likely to owe a 20 percent capital gains tax when cashing out. Although that is better than 30 percent, it’s not nothing. Remember, though, that long-term investors typically draw down 4.5 percent per year in retirement, so their tax bite is going to be lower, and they can expect to benefit from continuing appreciation of their passive portfolios. Nevertheless, omitting the 20 percent tax was an error.
I also made a minor miscalculation regarding capital losses tax carry forward — and also corrected it later — but that error did not materially affect the outcome. It would have mattered more following years such as 2008, where active traders had enormous losses.
Kickstarting Oculus. In 2012, Virtual reality headset maker Oculus Rift raised $2.4 million on Kickstarter. Then last year, Facebook purchased it for $2 billion. I thought that was a pretty raw deal for the early “backers” (as Kickstarter calls them) of Oculus, and I said as much under the headline “Attention Suckers: Please Send Us Your Money.” There was a minor flare-up in comments, but that was pretty much it.
Until earlier this year, when Oculus founder Palmer Luckey called me out on Twitter, and we debated whether the billion-dollar sale was fair to the original backers. Luckey argued the backers understood they were not getting any equity (it’s in Kickstarter’s terms of service); they are really donors and know this ahead of time. Some folks call this “altruistic lending.”
To my Wall Street eyes, Kickstarter still looks like thinly disguised angel financing — the earliest stage, or “friends and family,” capital raise — regardless of what the fine print says.
However, with Oculus, it was clear that game developers were pre-ordering a developers kit, and not making an investment. Luckey tweeted “People kicked in cash explicitly to get VR development hardware. Nobody was looking at it as an angel round.” (He noted that the kickstarter money was used to build an already developed hardware product, not fund a new company.)
I went back and reread the history — from the original Kickstarter posting, to the subsequent developments, to the Facebook acquisition. And you know what? He was right, and I was wrong.
The Robbins alternative portfolio. Last year, I had issues with Tony Robbins’s new book, “Money: Master the Game.” His core “All-Weather” portfolio was very heavy on bonds and commodities, both of which just had legendary run-ups. Robbins made a rookie mistake: He was “form-fitting” his portfolio to what had already occurred rather than look forward. And I said as much.
Then I countered by creating a classic 60/40 portfolio, using inexpensive exchange-traded funds. Somehow, I overlooked emerging markets in my portfolio construction. This was not a purposeful decision but simply a deadline-driven mistake. Indeed, we own EM equities for our clients — they are much cheaper than stocks in the U.S. or other developed nations. They have been lagging underperformers over the past few years, but we understand that mean reversion will eventually correct that lag.
The portfolio should have looked like this:
20 percent total U.S stock market
5 percent U.S. small cap value
10 percent Pacific equities
10 percent European equities
10 percent Emerging Market equities
5 percent U.S. REITs
10 percent U.S. TIPs
10 percent U.S. high yield corp bonds
20 percent U.S. total bond
Barron’s on housing. It seems that every other year or so Barron’s prints a big cover story about a bottom in housing. And every time, I mock its track record and take the opposite side of the trade. It has been easy money!
Last year, I got cocky: I challenged Barron’s writer Jonathan Laing to a friendly wager: A NYC lunch for four, restaurant chosen by the winner, tab picked up by the loser, on that 5 percent per annum housing increase.
Housing surprised me: S&P Case Shiller reported that for 2014, housing gained 4.46 percent for the year . . . and although 4.46 percent is not 5 percent, it’s so damned close that my technical victory was really a spiritual win for Laing.
Wrong on gold. Just kidding! Every negative thing I wrote about gold last year was totally right. Every. Single. Word.
Errors are an opportunity to learn something new — about yourself, your process and sometimes even about the markets. And as I learned many years ago when I began on a trading desk: Although it is okay to be wrong, it is not okay to stay wrong.
My motto is “Fresh mistakes, every year.” Come back next year for a whole new list.