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A Few Notes on The Missing Billionaires

| | Posted in: Animal Spirits, Individual Investing, Strategic Allocation

In their 2023 book, The Missing Billionaires: A Guide to Better Financial Decisions, authors Victor Haghani and James White seek “to give you a practical framework, consistent with the consensus of university finance textbooks, for making good financial decisions that are right for you. Good decisions will take account of your personal circumstances, financial preferences, and your considered views on the risks and expected returns of available investments. …You will likely get the most out of this book if you have already accumulated a decent amount of financial capital or if you are young with a healthy measure of human capital. …The book is written from the perspective of a US individual or family…” Based on their many years of wealth management experience and portfolio systems development, they conclude that:

Page 36: “The optimal bet size [such as allocation to stocks], expressed as a fraction of wealth, is directly proportional to the gamble’s expected return, and inversely proportional to its variance [square of the standard deviation] and to your personal degree of risk-aversion.”

Pages 52, 54, 60: “If we want to use earnings yield and expected real returns to decide how much to invest in the stock market, to be consistent we also need to evaluate alternatives to stocks in terms of their long-term real return. It seems natural to turn to US Treasury inflation-protected securities (TIPS) as the relevant low-risk alternative to stocks, since the yield on TIPS is a measure of their expected real return… [During 1900-2022,] the excess earnings yield dynamic strategy did a lot better than a static strategy… Momentum can be effectively used in combination with earnings yield by increasing the equity allocation when momentum is positive and reducing it when momentum is negative.” 

Pages 76-77, 79, 82, 83: “The empirical finding that we see similar levels of risk-aversion for people at quite different wealth supports use of CRRA [Constant Relative Risk-aversion] utility as a reasonable fit for most people… Each curve with positive risk-aversion goes up more slowly as wealth increases, and this effect is more dramatic for higher levels of risk-aversion. …our Base Case individual has CRRA utility with risk-aversion 2,…within the range of risk-aversion expressed by respondents to our survey… The Certainty-equivalent Return (CER) of a risky investment is the return of a risk-free, certain investment that generates utility identical to the Expected Utility of the risky investment… CER takes in all the information known about the investment’s return distribution, and in combination with the investor’s utility function, transforms it into one number that can be used to compare across very different investments.”

Pages 132, 138, 144: “Using Expected Lifetime Utility [sum of the utility from each period’s spending, all discounted back to the present] to guide family investment and spending decisions…involves three main steps:

    1. Simulate asset prices, wealth, and spending based on a given investment and spending policy over time.
    2. Calculate the Expected Lifetime Utility of the spending that arises from each policy choice, including that from the wealth left over for legacy bequests.
    3. Search over many investing and spending rules to find that which gives the best result.”

…it is important to realize that as circumstances evolve with the passage of time, a new plan should be created to reflect updated conditions.”

Page 191: “The Expected Utility framework won’t tell you how to balance personal consumption, intergenerational giving, and philanthropy because your relative preferences are an input to the framework. What it will do is provide a good rule for how to spend and invest in light of these preferences and all the different sources of complexity and uncertainty we throw into the mix–taxes, inflation, volatile asset returns, uncertain longevity, uncertain family dynamics…”

Pages 194-195: “The Expected Utility concept is valuable in weighing the pros and cons of different career paths, by focusing attention on the risk-adjusted value of human capital. Different vocations will vary dramatically in terms of the uncertainty of outcomes, from those with high expected values but with payoffs similar to those of a lottery ticket to others that resemble the payouts of an inflation-indexed government bond… If your human capital is equity-like, you may want your investment portfolio to have less equity risk.”

Page 203: “To cut through all the complexity, we find ourselves always coming back to these three related hypotheses:

    • The efficient markets hypothesis: The markets, especially large and liquid ones, are fairly efficient.
    • The cost matter hypothesis: Costs matter.
    • The average investor hypothesis: The market portfolio is the only investment that everybody can own at the same time.

…Given these beliefs, the headline message is that individual investors should avail themselves of the low hanging fruit of high diversification, low fees, and tax efficiency. Such an approach will generally preclude concentrated, high-fee, tax-inefficient investments in hedge funds, structured products, and other complex alternative investments.”

Page 264: “…under the right conditions and with due care, options can modestly increase investor welfare as a substitute for portfolio rebalancing, as portfolio protection, or as a source of limited liability leverage. The benefits tend to be greatest for investors who are some combination of risk tolerant, optimistic, or young. But we have also seen that a number of popular option strategies, such as buying out-of-the-money options to speculate on individual stocks , or shorting equity market volatility, are more likely to harm an investor’s welfare.”

Page 273: “When we bring taxes into the mix, the optimal asset allocation depends on many other variables, and the investment horizon in particular becomes a critical input.”

In summary, individual investors will likely The Missing Billionaires an interesting life cycle investing and spending model, but perhaps will view the uncertainties of life as demotivating a detailed model implementation.

Cautions regarding conclusions include:

  • Implementation of the model requires, in addition to estimation of asset returns and variabilities, quantification of arguably squishy individual risk- aversion.
  • The track record of economic theories suggests that hand waving is insufficient justification for implementation. How have individuals who have followed the model fared versus control groups?
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