There are two things I’ve not done in a while.

The first of them is to answer some of the questions that come pouring in. My apologies to all those unanswered – lack of response due to volume, not bad manners.

McDonald's

McDonald’s

Hey Chris,

would you mind if I too throw a question at you?

I’m thinking about this for a while now, but never went ahead and actually asked anyone, so here we go: how do you learn all this stuff?

I mean, I don’t have a finance background. I studied philosophy and political science at university, so I’m used to thinking about stuff (from the former, PolSci was mostly BS).

Later this month I’ll turn 28. I work for myself as basically a web developer in the insurance sector and have put away money for a while now. I took notes whenever I saw stuff in the markets for the last two or three years and would’ve been right often enough, but never trusted my judgement and only really invested twice (once in a friend’s company, once in some Mongolian companies just before they went down 90% around 2014).

When a friend introduced me to some people in Mongolia a few years ago and I started consulting in the financial services sector there I asked him if there’s anything I should read to fix my lack knowledge of in finance, but he replied that it was mostly just common sense. I’ve also talked to your friend Kuppy a few times when I was in UB and got a similar impression: that it was just about thinking stuff through.

On the other hand, there’s shitloads of numbers and terms and metrics I don’t know. Most of them are probably irrelevant, but I guess some of them are important I don’t yet know which is which. And you guys do have analysts, right?

When this year I told my aforementioned friend that I wanted to get a CFA to understand the lingo, he told me that all stuff didn’t matter anymore and I think I remember reading something similar in one of your emails a few months ago.

So I’m wondering, how would you go about learning this stuff?

For me, the obvious thing is thinking stuff through, reading financial history, keep earning money from work, slowly migrate it into making money from money through small trial and error steps. I’m wondering though whether I’m missing the quant part. And at the same time I’m worried of getting myself into the sway of dumb non-functioning economic theories and missing the stuff that’s of real importance if I were to focus on the quant part.

I’m curious to hear your thoughts.

– D

Answer:

Let’s start with what a friend and business partner loves to say: What equation are you trying to solve?

I’m going to suggest it’s the following: You’re wanting to know how to evaluate things in order to be comfortable with your investment decisions. Sound fair?

It’s one problem with our education system. It doesn’t teach us how to think, how to critically examine and question, test and retest in order to find the truth.

Kuppy is right when he says just think stuff through. So let’s take two real world examples which come to mind.

Example 1:

I was just having a discussion with an associate about my belief that we’ve seen the top of the bond market and I think rates are going higher (something I’ve written a lot about). My friend’s in private equity and we had the discussion which he’d not thought about.

Let’s say you’re an asset manager with a few billion to allocate. What happens to your base case assumptions on asset allocation in a rising rate environment? Well, private equity, which is nuts at the moment anyway, has been competing against fixed income. Easy! How hard is it to beat zero?

So take away some of the zero and on a relative basis you get capital shifting. This doesn’t require you to understand Black-Scholes pricing, risk parity, foreign exchange flows, or any other “financial” knowledge. Think stuff through and take it beyond first level thinking. Do it lots, do it regularly, and you start training your brain. It’s just a muscle, after all.

Example 2:

I’m trying to make sure my kids aren’t completely ignorant. The other day we were at a mall, and I bought them an ice cream in a food hall. Their purpose was to eat an ice cream and mine to get them to think. So there were a dozen food outlets. I asked them to tell me which one they’d buy and why.

The responses were typical from a 10 and 11-year old. They picked their favourite foods. I told them to pick the one that will make them the most money. So how do you figure that out?

Basic math and metrics. Shop size (some are bigger than others). Those with larger footprint have higher lease costs but potentially more traffic. So I told them to spend a few minutes and tell me which one is getting the most traffic. Easy: It was McDonald’s.

Next question. Who’s second? Easy. Sushi place.

Then a trickier question. I told them to tell me which one is getting the most traffic relative to size. Done. Sushi place. After doing some napkin math with them and making it easy at 50% size difference (it wasn’t but this was teaching them how to evaluate the world and think).

Next: What’s the average dollar spend at the sushi shop and what’s the average dollar spend at McDonald’s? So they had to do some math, a bunch of guessing, and so on. They guessed the average dollar spend at McDonald’s was about $12 and about $18 at Sushi.

Back to size of shop. Sushi shop is about half the footprint so probably half the lease costs.

Staffing was only 2 at Sushi shop and about 8 at McDonald’s (as far as we could tell). That’s the biggest cost (labour). So McDonald’s has about a double on lease costs and a 4x on labour costs, and the average dollar spend is $12 compared to Sushi place at $18.

Our guesstimates where that McDonald’s runs about 30% more traffic so we can level the playing field by saying that Sushi place gross dollar spend isn’t $18 but 30% less (due to 30% less traffic) so this is $12.60. Easy. Now factoring in half the lease costs and a quarter labour costs my kids quickly figured out that they’d buy Sushi place.

Sitting there doing my own math on it, if you put a gun at my head and told me to buy one I’d buy Sushi place and I reckon I’d be correct, and that’s without ever touching their financial statements.

Now, obviously you wouldn’t go out and buy Sushi place based on these variables and based on sitting and eating an ice cream for 10 minutes at a food hall. That would be sillier than blindly buying a low volatility ETF right now but when you do this regularly, fast, and repeatedly (I have trouble not doing it – just a defect, I guess), then you’ll find you’re pretty good at

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