In hind sight I could have put more thought into my post and at least acknowledged that this is not the best place to ask for advice on this sort of thing. I apologize for that.
My main purpose was to reach out in group therapy format and hopefully find others who have pursued an entrepreneurial endeavor and struggled along the way, maybe even made mistakes due to emotional decisions. I was just looking for some help or encouragement to either continue along or perhaps get a reality check and move onto another endeavor. I have approached trading from a business perspective as much as I can within my current mental framework, but my own emotional disconnect has caused me to deviate from my strategy significantly.
As a few of you have mentioned, I really just need to revert back to:
1. Stop using real money immediately
2. Backtesting my system from scratch again and refining it
3. Forward testing through paper trading
4. Re-writing the business plan and strategy
5. Continue to work on developing the skill set needed to implement the strategy flawlessly via paper trading.
Looking back on my performance in my very active trading accounts, what has happened is my aspirational "FIRE" craving self has been consistently misaligned with the reality of my current skill set, which causes me to use position sizes way outside my emotional tolerance. Trying to “get rich quick” as many of you pointed out.
The $80k in losses was really weighted much more towards the earlier years of this 10-year endeavor. The past 2 years have totaled more towards $2500 of that larger amount.
I returned 32% in my retirement accounts in 2017, but that was a very different strategy than my more active trading accounts strategy and I naturally kept the size down which allowed me to take emotions out of it. One year of performance is good for about nothing, but I do know the smaller size made a big difference in the outcome.
I became debt free as of early last year, have annual expenditures of $16k, and a savings rate close to 75% ex 401k contributions, all thanks to reading MMM’s blog, so that is also why I thought this forum may be of some help in this area. However, I can see now how active trading will always be a highly controversial topic.
The reason I am pursuing trading is the same reason we all read MMM, FIRE and/or the life benefits associated with simplicity/rationality/minimalism. Trading has always seemed like one of the most flexible business options out there, but as I am finding out very painfully, it is also one of the hardest to succeed at.
I posted in this forum because I made the assumption that many of you have an entrepreneurial spirit and have probably delved deeply into real estate, consulting, brick and mortar businesses, and perhaps even trading. Emotions can wreak havoc on those endeavors just as they can trading, although they are probably a lot less amplified outside of trading.
I appreciate your candid responses and I have a lot to think about moving forward. Trading may not be an option for my personality, but I do know now that at least the first move I can rationally make is to stop using real money for an extended period of time until my psychological situation changes drastically. If I can’t stay diligent with the steps outlined above, I will know that my psychological situation has still not changed, and I will ultimately get the same results I always have.
At this point, my time would might even be better spent focusing on real estate or another venture.
I know Warren Buffet is a proponent of index investing, but the more I read about his story and the way he thinks, I start to feel like index investing has been misrepresented and I am not completely sold on this method, at least in the way it has been traditionally implemented by wall street.
The premise to index investing is that you should not attempt to time the market, because it is impossible, and your next best option is to take a basket of stocks and dollar cost average over time.
However, I wonder if this traditional index investing strategy is just a more laid-back approach to market timing. Is the index investor just assuming that the market will be higher in 15, 30, 60 years from now, and thus is currently in a price range that merits entry? “Buy low, sell high?”
This can look like it works in many cases historically, but again, I think it depends on the time frame I choose to look at.
If I poured the portion of my portfolio allocated for stocks/equities into a market index in late January 2018, I would be down currently.
If I poured my money into an index fund in 2000, my portfolio would not have broken even until 2007, only to again fall, and not reach that same entry point again until 2013. 13 years where my stock investments did nothing.
If I poured my money into an index fund in 1966, my portfolio would have been in the same spot in 1982.
Between 1906 and 1924? It ends at the same spot I entered. My portfolio did nothing.
Between 1924 and 1942? Nothing.
Between 1936 and 1950? Nothing.
Dollar cost averaging every month over a long enough time frame certainly helps the strategy be more comfortable since I will go through multiple market cycles and buy all the way down, but it is still timing the way I see it, buy low, sell high later on.
Also, my risk tolerance lowers each year I age. Thus, the portion of my portfolio that I am willing to allocate to stock investments lessens each year/decade I grow older. This shortens the time frame I can hold stocks for.
The hope is that I can dollar cost average over a period of time during my younger stock tolerant years in such a way that my average cost of stocks is lower than the stock market prices when my stock tolerant years are up, so I am timing the exit point based on my age and risk tolerance at that age.
It makes sense on paper, but I also try to ask the question of how much of the stock market price increases are simply due to traditional inflation (CPI) and Ponzi-like inflation versus real returns based on company earnings? I think it could be quite a lot.
The total money supply (pretend it is all cash assets and no debt for this example and has remained steady via modest inflation over the past 150 years) would be the total amount of money that could be invested in stocks. Of course, not all money is invested in stocks at any given period of time, but the portion of the total money supply that is invested in stocks during any period of time would fluctuate based on human behavior, which is driven by sociological and psychological factors.
Those behavior patterns are very apparently driven by what wall street (Warren Buffet, Financial Advisors, Business Schools, etc.) communicates to the general public regarding investments and what investors generally agree upon in totality.
If more and more investors start to agree that stocks are good investments, then more and more of those dollars will chase stocks and prices will rise for the same basket of stocks. If less and less investors start to agree that stocks are good investments, then less and less of these dollars will chase stocks and prices will fall for the same basket of stocks. This inflates asset prices in a similar way to how a Ponzi scheme inflates its own investment returns, via more and more money coming in.
The pre-Great Depression stock market boom was a period of time when Wall Street successfully convinced the general public that stocks were good investments for everyone, whereas before this period of time, the common many did not necessarily have access to the stock market.
When there are more and more people interested in stocks, a larger portion of the money supply will be allocated to stock investments and historically this happens in a bubble-like fashion where prices rise to levels well above their underlying asset value.
The big question for me then becomes, how do I determine what a good underlying asset value is?
I have to remind myself of what the stock market actually is. The stock market is made up of businesses that can be bought in proportion to the number of shares purchased out of the total number of shares available for each business.
The way I value a stock investment should closely resemble how I value any traditional business, by how much future cash flow/earnings I can reasonably expect to get back in comparison to my original investment.
Now I would ideally like a business that I can pay $1 dollar for and have it return to me over $10,000,000 per year, but I run into the problem of competition, because quite frankly, you want a business like that to, and you will pay more than my $1 dollar.
You are willing to pay $2 for that same business. The neighbor down the street is willing to pay $5. ABC Hedge Fund LLC is willing to pay $1,000. XYZ Charitable Trust Fund is willing to pay $500,000. Warren Buffet would be willing to buy this business for $100,000,000, etc.
The point is that a very good deal will attract more and more investors usually until the underlying asset value no longer reflects the current cost of buying that business. But this Ponzi like inflation can carry on for a very long period of time due to sociological and psychological factors I mentioned earlier, aka investors get out of touch with reality, just like I do with my active trading accounts.
If I am going to invest in a business, two factors I would very much like to consider are the investment yield and the payback time I require to get back my initial investment, and the two are directly related. Again, my first preference would be to invest in a business for $1 dollar and have it return to me 1,000,000,000% Return/Year and get back my money within seconds and then have everything beyond that be pure profit.
You have this same preference, but you are more flexible than me, so you are willing to pay $2 dollars for this same investment. Let’s compare the deals we are getting with some metrics.
PE Ratio = Price divided by Annual Earnings (This number also represents the # of years to payback your original investment)
Earnings Yield = 1/PE = This is the classic % return of investment.
Examples:
$1 / $10,000,000 = 0.0000001x & .0000001 Years to get back original investment (1,000,000,000% Return/Year)
$2 / $10,000,000 = 0.0000002x & 0.0000002x Years to get back original investment (500,000,000% Return/Year)
$5 / $10,000,000 = 0.0000005x & 0.0000005x Years to get back original investment (200,000,000% Return/Year)
$1,000 / $10,000,000 = 0.0001x & 0.0001 Years (100,000% Return/Year)
$500,000 / $10,000,000 = .05x & 0.05 Years (2000% Return/Year)
$100,000,000 / $10,000,000 = 10x & 10 Years to Payback (10% Return/Year)
$1,000,000,000.00 / $10,000,000 = No Limit Index Investors = 100x & 100 Years to Payback (1% Return/Year)
So clearly the less you pay, the greater the deal due to the higher yield on your money and thus shorter number of years before you get your original investment back.
As the total amount someone is willing to pay for a business increases, we get prices that reflect Ponzi-like inflation more and more. Like someone willing to pay $100,000,000,000,000.00 for the same business that Warren Buffett would prefer to pay only $100,000,000.00 for.
We can look at the stock market with this method using the Schiller PE which is one of MMM’s favorite indicators. This was originally advised by Benjamin Graham (Warren Buffett’s Mentor/Professor) but Robert Schiller expanded on the concept using a statistical approach.
Schiller PE Ratio = Take the average earnings over the past 10 years and adjust those earnings for traditional inflation (CPI). It is more reasonable to take the average versus assuming that earnings will remain the same each year.
Currently the Schiller PE Ratio for the SP&500 is 32. Roughly this comes out to be SP-500 Index at 2760 divided by $85/Year Schiller Earnings).
Using the example from above, this implies that index investors looking to get into the market right now are willing to pay $322,600,000.00 for the business that returns $10,000,000.00 per year.
This will pay back our original investment in 32 years and thus give us about a 3% return per year on our money.
I am not convinced that a 3% return on investment is worth my time. I would be getting a much better deal investing in tax free municipal bonds and perhaps even 10-Year Treasuries or even TIPS if I just wanted to stay conservative until I find good investment opportunities.
What would make stocks more attractive to me against other investments?
A higher earnings yield and shorter payback period. If I am a market timer no matter what my investing strategy, I would prefer to do the bulk of my index investing when the businesses I am buying are at more attractive levels.
This can only occur if earnings continue to increase and prices stay the same (unlikely from what I can tell) or prices come down to a level where compared to their earnings, they provide a yield that is above any other investment vehicle I can choose from and I can get my original investment back in a reasonable amount of time that I am comfortable with.
If I want to retire at age 60, then I am hoping that the stock market is higher when I am 60 then when I was investing in it when I started in my 20’s. Although I may be right about this, I are still timing the market. It kind of has a bull market bias built into the exit strategy which I would call timing.
And this also assumes that I am comfortable investing in stocks as a large portion of my portfolio from age 20 to 60, which I am not. I essentially have an even shorter time period to invest in stocks than those 40 years due to the fact that I will gradually move into more conservative investments as I age.
This is why I would personally prefer to look at trading or other types of traditional business opportunities that have a higher yield and shorter payback period or wait for a better deal on stocks before I buy index funds.
Warren Buffett’s actual behavior would reflect something similar, considering Berkshire Hathaway is sitting on near-record levels of cash currently, waiting for more opportune times to deploy.