The Game of Life


I have come to look at life as a game. Not that game. More like Settlers of Catan. In life, as in Catan, everyone starts in a certain position. That position is partly determined by chance. As a result, initially everyone has access to different resources.* Strong players do not use their starting position as a crutch. They find creative ways of gaining access to resources over time. Trade and relationship building are key.

In my experience, the majority of players in life are weak ones. That’s not to say they are weak people. Just weak players. There are lots of ways to explore this distinction but because of this blog’s theme, let’s start with money.

I have met many individuals who are slaves to their money. For these people money is always a limiting factor. There is never “enough” money for X, Y, or Z. Note that this is independent of income. You would be surprised how many hedge fund managers are slaves to their money, even with net worth figures in the hundreds of millions of dollars. Weak players do not realize that income and spending are not external forces acting on otherwise hapless human beings. Money is a resource. It is a raw material you use to design and build a meaningful life.

The use of the indefinite article “a” versus the definite article “the” is quite intentional here. Money is hardly the only raw material required to build a meaningful life. Other materials include empathy, creativity, compassion–the amount of each required to build out a meaningful life will vary with the individual.

The key to becoming a strong player in The Game of Life is to locate control within yourself. You are the architect and head contractor on the project of living. Yes, external forces can have a dramatic impact. But a surprising amount of the game lies within your locus of control.

Thus, strong players tend to do the following:

  • Make investments with convex return profiles. I am not just talking about money here. This can be any decision to improve your education, skills, or health. When you invest in yourself, the benefits tend to compound over time. If you are interested in a deeper discussion of this, listen to this interview with Chris Cole:
  • Selflessly invest in others. Again, I am not talking about financial investments. Doing simple things like taking a few minutes to do an informational interview with a job seeker, or helping a co-worker with a project in an area of your expertise, also has a convex return profile. Not only does it feel good to help other people, but it also helps build a stronger relationships and a solid reputation. You never know who someone else might know, and it is relationships that make the world go round. And for the umpteenth time, I am not just talking business! John Wathen is a powerful example.
  • Practice optimism. It is difficult to build anything, let alone a worthwhile life, if you only ever see the worst in everything. A moderate dose of cynicism will not put you down. However, chronic pessimism is an incredibly destructive thought pattern. Pessimists tend to focus on external forces they can’t control, versus aspects of their daily lives they control completely. You have definitely met chronic pessimists. These are the people who spend their lives hurtling from one crisis to the next. They are chronically ill. They are constantly distracted by relationship problems. There is never enough money and it is always someone else’s fault.
  • Minimize/eliminate the role of chronic pessimists in life. As a natural consequence of their unpleasant disposition, chronic pessimists are not enjoyable people to spend time around. They drain your energy. If you have the misfortune to work on a team with one you will quickly realize they are shirkers, ever-reluctant to pull their weight. Unless you have a special gift for coaching and leadership, the most efficient way to deal with chronic pessimists is to cut them out of your personal life and workplace.

Above all else, however, strong players in the game of life act with intention. They think through the consequences of their actions ahead of time. They think strategically about how they should deploy their time and financial resources in pursuit of their goals. They are mindful of their thoughts and emotions and how those may influence perception and behavior. They understand that to a great extent, people create their own realities. There is probably plenty more to be added to this list, but the way I see it these are the essentials.

* If you are curious, I believe the role of government in society is to promote equality of access to opportunities.

On Risk And Very Low Savings Rates


We can officially add the US personal savings rate to my list of late cycle indicators. For those of you keeping score at home, others include really rich high yield valuations and really, really silly bond issues. Oh, and don’t forget the worst leveraged loan covenant quality on record. There is a lot of commentary out there about what the equity market might do over the next few years but considerably less on the credit cycle. Apparently the steady erosion of covenant quality in the leveraged loan market does not make for riveting CNBC programming.

Readers may recall that I believe the credit cycle, and its attendant indicators, are the best signposts for where we stand in the economic cycle. Credit has a habit of leading the equity market. In the financial crisis era, credit began showing cracks in 2007, while the equity market didn’t wake up to the severity of the issues until later in 2008.

The yield spread between the lowest quality debt and Treasuries (blue line) tends to widen before recessions (gray bars) and market downturns (red line).

So whenever I am trying to understand where we are in the cycle, I am looking at credit markets first and then everything else.

A couple more reasons for that:

  • It is easy and intuitive intuitive to compare the yield to maturity on risky debt to one’s hurdle rate for risky investments.
  • Spreads of risky debt over Treasuries of equal maturity are a great indicator of how investors are pricing more equity-like risk.
  • Covenant quality is a “squishy” qualitative measure of trust in the financial markets. As an investor, you want to put capital at risk when trust is low and protect capital when trust is high. When investor trust levels are high and capital is plentiful, companies are able to do things like issue PIK bonds subordinated to other PIK bonds so they can pay insiders a dividend. (See “really, really silly bond issues” above)

I am not a fan of “all in” or “all out” market calls. Timing calls are really tough to get right and can be extremely destructive to a portfolio if they result in repeated whipsaws (selling out of the market at low prices and having to buy back in at successively higher prices). I am, however, a big fan of thoughtfully paring risk when the market is not rewarding you for bearing it.

So what does any of this have to do with the personal savings rate?

The Wealth Effect & Its Deleterious Impact On Investors’ Risk Preferences

The Wealth Effect is super easy to understand. As risk assets perform well, people feel wealthier. After all, their net worth is growing along with the value of their portfolios, their homes and, in all likelihood, their paychecks. They therefore begin to spend more of their disposable income, and take on more debt. Because they feel wealthier, they take more risk.

The problem with the Wealth Effect is that it is about the most pro-cyclical behavioral bias you can imagine. The Wealth Effect literally drives people to lever up their personal balance sheets and fritter away their free cash flow at the worst possible time–that is to say, when the market is offering very little compensation for taking on incremental risk. You aren’t just overextended. You are highly levered and overextended. Such a posture transforms even modest financial shocks into cataclysms.

This is what Buffett is driving at when he says: “be greedy when others are fearful and fearful when others are greedy.”

The advantage of approaching asset allocation through the lens of whether the market is offering a premium or demanding a discount for risk is that it obviates the need for price or return-based timing calls. Frankly I can’t believe more people don’t think along these lines.

I suspect there are two main reasons:

  1. If you are managing Other People’s Money it can be very difficult to act counter-cyclically for a whole host of business reasons.
  2. Greed.