Value Investing

Stoic Training For Private Investors

Philosophy seems to be trending these days. In 2013, Burgundy sought investing inspiration from ancient Greece, publishing a View on Stoicism and the Art of Portfolio Intervention. Several tech entrepreneurs, such as Peter Thiel (co-founder of PayPal) and Reid Hoffman (co-founder of LinkedIn), proudly hold philosophy degrees. Charlie Munger, partner of Warren Buffett, has also been known to dabble in these matters of existence, often quoting stoic philosophers. Of course, this curiosity is not limited to moguls and financial aficionados. The general public is also drawn to the philosophical realm, as seen in the success of books like The Daily Stoic: 366 Meditations on Wisdom, Perseverance and the Art of Living, which made it to the Wall Street Journal’s bestsellers list in late 2016.

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Inspired by this book’s observance of daily stoic meditations, we wanted to offer our own version of these exercises. Here they are as applied through the lens of personal finance:

Practice Misfortune

“The premeditatio malorum (‘the premeditation of evils’) is a Stoic exercise of imagining things that could go wrong or be taken away from us. (…) Seneca, who enjoyed great wealth as the adviser of Nero, suggested that we ought to set aside a certain number of days each month to practice poverty. Take a little food, wear your worst clothes, get away from the comfort of your home and bed. Put yourself face to face with want, he said, you’ll ask yourself ‘Is this what I used to dread?’”¹

Investment misfortune is inevitable. Markets can be volatile, subject to changes in economic and political conditions. Companies face competitive forces and disruptive innovations. Both of which can be influenced by the vagaries of the collective mood of investors.

Do you fear volatility? Why not submit your portfolio to the premeditatio malorum. If your portfolio loses 15% or even 25% of its value, will your monthly budget be affected? If so, are these concessions uncomfortable or disastrous? Will you need to give up important life goals or just your dream of a third sports car? If the impact of a significant decline is unbearable or you do not know the answer to these questions, talk to your counsellor.

Although volatility is often temporary, one of the prescriptions for investor anxiety is to isolate a portion of your withdrawal needs in order to protect yourself against the mood swings of “Mr. Market”.

If a decline has no material impact, you should not be overly concerned (let alone be trying to time market movements).

Turn the Obstacle Upside Down

“The Stoics had an exercise called Turning the Obstacle Upside Down. What they meant to do was make it impossible to not practice the art of philosophy. Because if you can properly turn a problem upside down, every ‘bad’ becomes a new source of good.”²

What might be perceived as negative, a bearish stock market or an economic recession, may actually be a great opportunity. For a strong business, a recession can be a good time to acquire strategic assets and hire employees, attacking a new market while others are on the defensive. Think of the Canadian TD Bank, which is now the 8th largest retail bank in the United States. From 2005 to 2010 (which included the 2007-2009 financial crisis), the bank spent more than $17 billion on acquisitions, gaining a foothold in the market as competitors were weakened.

Baron Rothschild said: “The time to buy is when there is blood in the streets”. For the long-term investor, volatility provides an opportunity to increase potential for future returns by buying shares in quality companies at a low cost.

Follow your own Path

“In Seneca’s essay on tranquility, he uses the Greek word euthymia, which he defines as ‘believing in yourself and trusting that you are on the right path, and not being in doubt by following the myriad footpaths of those wandering in every direction.’”³

The fear of regret can be controlling when investing. As historian Charles Kindleberger, author of The Global History of Financial Speculation, puts it, “There is nothing more disturbing to one’s well-being and judgment than to see a friend become rich.”

The popularity of a stock can be as ephemeral as fashion trends. Many investors forego extensive research when they buy a business or a fund. They follow the pack without fully understanding why. This phenomenon can be rationalized by the greater fool’s theory. According to this theory, the price of an asset (real estate, art, wine, shares) can always be justified if one believes that there is a fool ready to pay more. However, as in musical chairs, the music stops at any given moment and the last player loses. Don’t be a fool. Follow your own path.

Pay your Taxes

“Nothing will ever befall me that I will receive with gloom or a bad disposition. I will pay my taxes gladly. Now, all the things which cause complaint or dread are like the taxes of life – things from which, my dear Lucilius, you should never hope from exemption or seek escape.”4

Several provisions in our tax system allow investors to legitimately deduct or defer taxes and thus improve after-tax returns. In taxable accounts, for example, it is often best to avoid investment strategies with a high turnover rate which trigger capital gains. It may also be beneficial to tweak the asset mix in your portfolio depending on the type of account (taxable personal account, holding company, RRSP, TFSA).

However, taxes are only one of the considerations to determine whether an investment is appropriate for your portfolio. Do not lose sight of the forest for the trees. Remember that the tax bill is the result, as unpleasant as it is, of a gain or income stream.

Here are some risks that arise from putting too much weight into tax planning when making investment decisions:

  • Postponing the sale of an investment that has become too large in your portfolio, or that has become largely overvalued, in order to defer capital gains tax.
  • Overweighting high-dividend Canadian stocks in your portfolio because they receive a favorable tax treatment. By doing this, you might miss out on investment opportunities in global companies that reinvest their profits to grow intrinsic value. Instead, you risk owning many local businesses with restricted investment opportunities, financial difficulties, or that can be very sensitive to economic cycles.
  • Investing in vehicles associated with tax credits (flow-through shares, labour-sponsored funds) without considering their return potential and the risk associated with them.

As investors, you likely have multiple goals: to protect and grow your capital in the long term and to generate income. These objectives must not be forgotten in an attempt to escape the taxman.

Keep it simple

“Do nothing but what is necessary. (…) By this rule a man has the double pleasure of making his actions good and few into the bargain. For the greater part of what we say and do, being unnecessary, if this were but taken away, we should have both more leisure and less disturbance. And therefore before a man sets forward, he should ask himself this question, ‘Am I not upon the verge of something unnecessary?’”5

Fortunately, the investment world attracts a lot of smart people. Unfortunately, smart people have the tendency to over-complicate things. For finance novices, complexity is impressive even if it adds no value. For fund managers, complexity is also attractive since it justifies higher fees. A recent study on financial products shows that their complexity is positively correlated to their profitability for their issuer and inversely correlated to their returns for the investor.6

Imagine that you hold a highly diversified portfolio following the example of major American universities. Not only do you hold multiple stock and bond funds, you also have complex financial instruments that you do not understand very well but that have been recommended to you by someone you trust (this could be a bitcoin or an exotic exchange-traded fund). You feel reassured believing you have a diversified portfolio without understanding the nature and risk of the products you own.

Then, unexpectedly, one of these opaque instruments loses 30% of its value. Is this a buy opportunity or do you own a lemon? If you do not fully understand what you hold in your portfolio, your decision will probably be driven by emotion rather than reasoned judgment. The advantage of diversification, which justified the complexity of your portfolio, will thus be invalid.

Simplicity facilitates decision making, which is important in times of turbulence. As Philip Fisher said: “Buying a business without having enough knowledge can be even more dangerous than having insufficient diversification.”

  1. Holiday, Ryan, “What is Stoicism? A definition & 9 Stoic Exercises to Get You Started,” Daily Stoic Blog
  2. Holiday, Ryan, “What is Stoicism? A definition & 9 Stoic Exercises to Get You Started,” Daily Stoic Blog
  3. Holiday, Ryan and Stephen Hanselman, The Daily Stoic: 366 Meditations on Wisdom, Perseverance, and the Art of Living (New York, NY: Penguin Random House, 2016), 23
  4. Holiday, Ryan and Stephen Hanselman, The Daily Stoic: 366 Meditations on Wisdom, Perseverance, and the Art of Living (New York, NY: Penguin Random House, 2016), 117
  5. Marcus Aurelius Antonius, Meditations, Translation by Collier, Jeremy and Zimmern, Alice (Pierides Press, made available through hoopla, 2013), 706
  6. Célérier, Claire and Boris Vallée, “Catering to Investors Through Security Design: Headline Rate and Complexity,” The Quarterly Journal of Economics (August 2017): Vol. 132, Issue 3, 1469–1508

This post is presented for illustrative and discussion purposes only. It is not intended to provide investment advice and does not consider unique objectives, constraints, or financial needs. Under no circumstances does this post suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. The information contained in this post is the opinion of Burgundy Asset Management and/or its employees as of the date of the post and is subject to change without notice.

Article by Caroline Montminy, Burgundy Blog