Ashvin Chhabra (Wealth Of Wisdom)

Very insightful interview with Ashvin Chhabra on the Wealth of Wisdom podcast, in which he discusses some of the ideas and lessons from his excellent book “The Aspirational Investor.” Some brief notes below (these are for personal reference only, any mistakes in transcription are my own):

On the most important thing he has learnt over the course of his career – investing is not about the market, it’s about you. The person investing the money has to figure out what is the purpose of that money, the role that it plays in his or her life and proceed from there. It is not about looking at the markets and figuring out what’s cheap, hot etc. Pretty subtle, even though it sounds obvious when you state it. The entire industry is focused on markets. Took him many years to figure out that most of that is all wrong and one needs to take a step back from the market.

Why is it like that? The blame lies with everybody. It starts with individuals and goes all the way to advisors, as well as the broader industry. Part of the problem is that nobody gives us any training about finances and how to invest, unlike in everything else we do (e.g. our parents teach us how to speak properly, we learn manners at the dining table, we go to school etc.). We don’t know what to ask for, so we gravitate towards things that make money and think that’s the right answer. The industry is also to blame, but it’s not just the finance industry. Human nature is such that interactions between people, industry and the government gravitates towards a state where somethings are good, somethings are not good, and somethings are reasonable but need to be adapted.

How can you make sure your portfolio lines up with your actual goals?

One helpful framework is Maslow’s Hierarchy of Needs. What do successful people want to do in life? First, to fulfil their basic needs (shelter, food, water). Once you’ve done that and taken care of yourself, then you take care of your family. Then your community – you want to get known, contribute to your community. Symbiotic in that when you invest in the community, the community recognizes you and helps you rise in society. Then once you achieve a certain amount of success, you want to do something that really distinguishes you. This is idiosyncratic – will be different for different people, what you might call your legacy. This hierarchy of needs is universal in some sense for human beings, and is equally applicable to money and investing (genesis is similar).

Everybody has goals – you need to define what are your essential goals, what are your important goals and what are your aspirational goals. Essential goals can include paying the rent, having enough money to buy food, sending your kids to college, taking care of your parents etc. These are not so much goals as needs, as they are non-negotiable. Question then is how do you take the resources you have and map them to your essential needs? It is ridiculous to say you were planning to send your kid to college but then the S&P 500 dropped; disconnect between the strategy of things you must do for your family and having them be dependent on markets that you can’t control. Your resources have to be positioned in a way such that they are independent of the market. So traditionally this might be the amount you have in cash and bonds, having a safety net etc.

Once you prioritize your needs (e.g. money for retirement – my first $1000 is essential, after that is important and then there is an aspirational piece), that gives you a bunch of cash flows, in terms of how much money you need to generate. Then on the other side you have your resources.  You can then begin to map the goals to your portfolio. If you put money in cash and bonds, there is a high probability that you achieve those goals but over time you are going to lose a lot of return. You are not looking for risk, you are looking for return, but with return comes a certain amount of risk and you have to mitigate that risk. Important to ask why are you risking your wealth. Some people are very risk averse by nature and have to be persuaded to put money into the markets, they want everything in bonds. In some sense, if you have a lot of wealth and it’s a much larger amount than you need, that strategy will work. It may not be optimal, but it will work. Lot of people don’t ever ask that question, however, because they just assume if you are investing you should be in the markets. It has become the default option and the entire industry is based around that – what products can you buy, rebalancing, finding new managers etc. Before you get sucked into that, go back and ask yourself what does each piece of capital do in the portfolio, what is the purpose and then begin to allocate appropriately. Do a similar exercise with your entire balance sheet. Liabilities are not just debts that you owe, but also the outgoing cash flows based on your goals.

Can think about allocation into 3 buckets. Left hand bucket is the safety bucket (think short-term bonds, cash, insurance, your home). You should get zero return after inflation because you are buying insurance/safety. Middle bucket is the market bucket (think equity or equity like instruments). Markets are inherently uncertain, so you need to truly understand the risk that you take in the short-term when you’re in the markets. If you look at the history of markets over ~100 years (human lifetime), markets go out of existence when countries go to war, markets stop functioning, you have 10-15 year periods where the total return is zero or negative. There has to be a balance between the money you keep for safety and lose market return on, and the money you put in the market and get a healthy market return on, but when the market wants to give it to you.

Right hand bucket is the aspirational bucket. This is where all the money gets made. What you really want to do and what you’re good at. Concentrate on that throughout your life. Build something, often need to take on non-recourse leverage (borrow money against that asset). The clearest example is building a business. Need capital from the bank, collateralize against the assets you have. Also need human capital – your own and you need to find other people who you think are very good who can come and work for you. You don’t want to diversify – keep compounding the alpha that you have, eventually becomes 95% of your wealth and it becomes what defines you. Key to the aspirational bucket and wealth creation in general is finding a skill, finding your passion, finding a way to leverage it and then compounding this alpha.

The whole idea of the framework is that you understand your goals, your need for safety and your aspirations. Make sure you have a good safety net, but understand that while it provides safety in the short-term it also costs a lot. Put some money in the market, gives you safety in the long-term, but keeps you ahead of inflation, keeps you in same wealth quadrant etc. The first two buckets are about buying short-term + long-term safety. The aspirational bucket is about the legacy you are going to leave and where all the wealth gets created. When thinking about the allocation between the 3 buckets, helps to do a simple scenario analysis. What if markets were down 50% tomorrow, what if your business runs into trouble and needs more cash, what if one of your family members need more money? You can do it on one page and see if there are devastating consequences or whether you can handle it, gives you some insight into whether need to rebalance. This is more important than asset allocation, manager selection etc. When you utilize this framework, there is no way risk can be defined as volatility – you think about what’s the risk that I don’t achieve my essential goals? But you also don’t want aspirational regret where you get to the end of your life and say I would have really liked to do this, but the S&P didn’t cooperate or I didn’t manage my money very well. 

Can you make aspiration-type returns in market-type buckets? Can link this to the broader active vs. passive debate. Everyone thinks they are smarter than they are. More confident you are about being a great investor, the more likely that it hurts you. Investing is a skill set – you have to be passionate about it, learn the ecosystem, how it works, have to do it full-time. Somebody who is good in one field is probably a very bad investor, but they won’t acknowledge that because most people don’t look at returns portfolio carefully over long period of time. We need both active and passive investors but the fundamental point is that it is very hard to beat the market and very hard to identify a person who will beat the market. Two levels of difficulty you have to jump over. The good news is that because a lot of people want to beat the market and won’t, you have an opportunity to get to the 80-90th percentile after transaction costs and taxes via passive investing.

Many people who do beat the market don’t beat the market by very much. Getting the cash flows right, adopting the right risk profile with regard to your goals, concentrating on your job to get promoted, building a successful business, stable family etc. are all so much more important than trying to beat the market by 1-2 percentage points. Even if you do this, it actually doesn’t matter in terms of your peer group because wealth is lognormally distributed, which means to move up in society you have to find ways to double your wealth and then double it again. Many people find it hard to understand that if you just change your wealth level by 10-20% it makes no difference to your place in society and where you are on the wealth spectrum.

Other problem is you have to stay the course. Even if you find a good active manager, they have to perform well, beat the market after fees and taxes, you have to stay with them. But many investors are expecting them to outperform the market all the time. Good active managers will outperform over time, but will also almost surely underperform for long periods of time. If you want to do active management, don’t look at returns and statistics, look at people, invest with good high quality people who love investing and give you good terms. There is nothing wrong with saying you have an investment goal of beating the market, but then you have to take a series of steps and have the discipline to do that.

What keeps private investors from operating this way (goals-based investing)? What is the catalyst for bigger buy in to the approach? It will happen when people realize that money management is really important and there are long-term consequences to not getting it right. Whatever goals you have will either be aided by or sabotaged by your approach to managing money, however little or much you have. The barriers are that it is a complex task. Ask a simple question – how much money do I need for a particular goal? There are no clear answers. You have to think about the time value of money, project it in the future and then discount it back. You need to understand the basics, have discipline in your process, revisit periodically, and you can’t get distracted and go off on tangents.