Risk Versus Reward Round 5 - 2m 59s

Posted on the 25 September 2012 by The Contender @The__Contender
Is MUFF risking a knockout blow?
MUFF thought he would write a post on perceived Risk versus Reward when investing. MUFF compared the MUFF strategy against a couple of very successful savvy bloggers. MUFF's investment plan can be summarised in one simple statement "save as much as possible, in stocks that have a high risk \ reward profile early in life then choose lower risk stocks later". That was the easy part. The next part was devising a strategy to max out the strategy for early financial freedom. The MUFF approach is covered in more detail in "MUFF Investment Challenges". Here are links to a few articles from the bloggers MUFF was talking about earlier:
 jlcollinsnh 
  1. Stocks part vi portfolio ideas to build and keep your wealth
  2. How I failed my daughter and a simple path to wealth
Mr Money Mustache
  1. How to make money in the stock market 
  2. Where should I invest my short term stash?
  3. A Brief History of the ‘Stash: How we Saved from Zero to Retirement in Nine Year
(Other early financial freedom bloggers: A Good Day to Live, Brave New Life and Early Retirement Extreme)
First, both of these guys have made it, are financially free and are still able to save and invest each month. Both guys built significant savings through very hard work and dedication in their employment and investing decisions. Hats off to both of them. This blog highly recommends working through their sites for insights on finance and life.
Next, let's start a comparison of the different strategies:

Jlcollinsnh and MMM long term fund tracker strategy


From what MUFF has read, their current strategy is biased towards investing through Vanguard (very low cost) share trackers. MMM complements this approach with his skills to buy, renovate and rent out properties. The reasons are highlighted in their excellent blogs. Both keep some cash for emergencies and opportunities.

MUFF active investment strategy


MUFF is not far off early retirement but with a slightly different longer term strategy. MUFF wanted to re-consider his approach in light of the information provided by these esteemed bloggers. Is MUFF about to be caught out by a left hook?
MUFF is more of an active portfolio management guy. MUFF likes the idea of investment themes over total diversification (all share trackers). As per the financial toolkit and article "MUFF Investment challenges" MUFF invests in individual companies and assets that fall into three categories:
  1. Growth
  2. Income
  3. Protection
The themes followed are:
  1. Increasing resource consumption due to population growth (Energy and Agriculture)
  2. Steady income stocks in companies that have a deep moat around them (hard to enter their market). Utilities and Pharmaceuticals fall into this category.
  3. Protection from some sort of collapse in the economy (diversified cash and precious mining stocks)
Here is a basic comparison of  a portfolio of primarily trackers fund to the MUFF active portfolio only:
To score each area I have considered a risk analysis grid:  So scoring each area gives the following result:File is located here
The analysis demonstrates the benefits of the sound strategy jlcollinsnh and MMM are taking (lower risk score of tracker approach). At this point then you may ask why am I not following their strategy?

MUFF likes active investing and learning about the wider world


MUFF has been following a few topics over the last few years. MUFF is a realist and does not believe in catastrophic events occurring. Big events may occur but mankind has a formidable ability to adapt to change. Here are some of the topics that could trigger that change:
  1. Peak oil theory (ASPO USA)
  2. Peak debt in western societies (See KWN)
  3. Peak population and resource consumption (Club of Rome - Limits to Growth)
  4. War in the Arabian Gulf
  5. Climate Change
A good overview of some of these issues is covered by Chris Martenson's crash course. Chris is another realist in my opinion and not "doomer". His work is dedicated to moving society forward by encouraging greater resiliency. Chris reviews the inter-dependencies of what he has called the three E's (Economy, Energy and Environment). He has a wonderful ability to join these three areas together in a very simple and understandable manner (MUFF likes simple). Here is the condensed version of his Crash Course (38 mins).

Chris has a free e-letter containing articles posted over the week on the three E's you can sign up on his website Peak Prosperity.
From the video above and the book Limits to Growth I can see greater risks going forward than the past 50 years. This is the reason I am reluctant to follow a diversified investing approach, that has worked very well in the past, now and in the immediate future.
Any of the "black swan" events listed above may be unlikely and the Crash Course or the book "Limits to growth" may be a few decades out. If so, should MUFF ignore the risks? If one "black swan" event does happen, a balanced portfolio could get badly stung and might never recover. Also, would MUFF miss out on investment opportunities?
What could happen to a few sectors MUFF can think of:
  1. Highly leveraged financial institutions would again be hit and may not survive this time around.
  2. Chemical firms would be heavily impacted as their raw material prices would dramatically increase.
  3. Consumer goods margins would be quickly squeezed by rising transport and energy costs.
  4. Discretionary spending would drop as the consumer retracts spending to save for a rainy day (for ex new cars, electronic gadgets, designer clothes and beauty products)
If any "black swan" event occurred a mortal wound could be made to large parts of the economy. Some of these which have relied on ever greater bailouts down the years to survive may be wiped out completely. In this circumstance MUFF believes he would be happier as an active rather than a passive investor with the ability to use his hard learnt financial intelligence to protect and possibly grow his capital.
An investment in knowledge pays the best interest - Benjamin Franklin

Closing Comments


jlcollinsnh and MMM have, in my opinion, a very strong argument for passive investing a large part of an investment portfolio in tracker finds. MMM also has a very effective side business in rental accommodation which provides good income diversification as well as useful practical skills. MUFF's opinion is if you do not want to spend a significant amount of time learning about investing and taking some losses along the way, tracker funds may be a good approach.
If like MUFF you have a desire to learn about investing, start with a small percentage of your savings in a brokerage account, research and buy some individual shares as a starting point. Like all people MUFF continues to make mistakes, whatever asset class MUFF invests in has its risks and he takes full responsibility for it.
I am not so much concerned with the return on capital as I am with the return of capital. - Will Rodgers

Good Luck!
MUFF
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