My first experience of investment
One of my teachers at college in the UK gave me my first lesson in how to invest. He sold his house at the peak of the market and rented a while before buying a new house after the crash. I recall him telling me that his friends and bank manager laughed at him. They told him “house prices never go down”. Well in the early Nineties they went down 13% over 5 years. My teacher profited quite well from this.
This seemed like a clever thing to do but at the time, this kind of ballsy move was well beyond me. I was just a teenager. But I was impressed with this kind of investment action and never forgot it.
Discovering investment principles at school
I later moved to the Northern Virginia in the United States to study at George Mason University. I studied marketing at first but after talking with a friend I decided to change my major to finance. He told me that he was studying his professional exams so that he could invest in stocks for his clients. I found this incredibly exciting and so I made the change.
I completed my degree in finance with distinction but still didn’t feel like I fully understood how to invest. Finance is a broad topic and it can be hard to really understand the big picture. For example, when most people think of investment they probably just think of the stock market. Or real estate. But there is a lot more to it than that.
Finance is the process of getting money to pay for either a project or for a good. But when we talk of investment we are thinking of commercial projects only. Companies, governments and charitable organisations all need to finance themselves and they do it in a variety of different ways. They also need to invest their proceeds to get a worthwhile return. But I was always interested in how to invest for individuals.
Next, I studied my masters degree in finance at the London School of Economics. Strangely the classes on investment didn’t make much of an impression on me. They seemed highly theoretical. I learned the basic principles of investment including diversification, portfolio analysis and performance analysis. I also learned how to properly calculate returns both before and after the fact.
The boredom of government work…
After this I began working for PwC in Washington DC where I analysed mortgage-backed securities. Honestly this was dull. My main client was the US Federal Government. My enduring memory was trying to call my clients in the afternoon only to find they had gone home at 3:30 in the afternoon. It seemed like these guys didn’t do any work.
Even worse, when I visited their offices, half the time they seemed to be messing around.
That aside I seemed to be locked in a storeroom going through dusty old files looking for evidence of wrongdoing by companies who had been hired by the Government to manage loan portfolios. Not exciting work and not the reason why I had studied finance. I wanted to learn how to invest and what to invest my money in.
The problem with pensions
I studied finance because I wanted to be involved in investment but I didn’t seem to be getting anywhere near it. Not only that I made one of my first major investment mistakes. I had started early with a pension from PwC. They matched my contributions and I built up a considerable sum in my first year.
However, I was laid off shortly after my first year. So I cashed in my pension to pay my bills. I paid quite a significant penalty for this. Basically this was a fine levied against my pension proceeds. I say that this was a mistake but I was currently unemployed and I needed the money. Sometimes you have to make a tough decision like this. But the important thing, is that even though you may be saving for a long-term goal it is important to have access to your funds when you need them.
Discovering stock options
Soon after leaving PwC I joined an Internet company. Right at the peak of the dotcom boom! Here I had my first experience of stock options. Part of my compensation included options. In this case, I had call options. Call options allow you to buy stock for a fixed price. This is called the “exercise price”. If the price of the underlying asset (in this case, company stock) is higher than the exercise price you can buy the stock cheap and sell it at the higher market price and depending on how many options you have, make quite a significant profit.
The other kind of option is a “put option”. Put options allow you to sell the stock at a fixed exercise price. In this case, you profit when the price of the underlying asset is low. Your profit is the exercise price less the stock price.
For a while I was happy about this because the stock was doing really well. It was common during the early 00’s for a company to give employees stock options. This was to motivate them to work hard and boost the stock price. It certainly motivated me.
But unfortunately, when the dotcom industry crashed my company when bust. My stock options were worthless and I lost my job. I had no money and no job. And I had just bought an expensive BMW. I can’t tell you what a bitter pill this was to swallow.
Don’t buy your company’s stock!
Here I learned a serious lesson. Never buy stock in a company where you work. You could lose your wealth and job at the same time which is a terrible combination. Now in this specific case I had not bought the stock I was just given stock options. But it would have been better to have cashed them in immediately and bought a diversified portfolio.
After I left the Internet company I joined Sallie Mae. This was a lot better. Though I worked as an accountant I was involved in the calculation of interest for bonds and for various types of derivatives. I hated the job. Most of it was pure bookkeeping. Boring and never-ending repetitive work. But learning about how these investments worked was really useful knowledge.
Once again, I received stock options. Fortunately, though Sallie Mae was a significantly stronger company that the previous one. They had an implied guarantee from the US Federal Government. Additionally, they had a virtual monopoly on the US student loan market. They weren’t going anywhere.
Dealing with financial advisers
While there I received a call from a financial adviser. He wanted to sell me an investment in diversified portfolio of some description. It was a Roth IRA. Honestly, I had no idea of whether what he was telling me was true but he worked for a reputable company. UBS. In spite of my banking and finance experience I still had no framework of how to evaluate investments.
I put my trust in this guy. I have no idea if the investment was truly appropriate for me but I continued contributing to it and it accumulated over time. It made losses in the crash of 2008 but otherwise survived.
…there are trustworthy advisers out there but you do need to trust your gut…
The lesson I learned here was that there are trustworthy advisers out there but you do need to trust your gut. And while there was no independent review of this investment it didn’t disappear in the economic collapse.
Becoming an investment professional
I hated the job at Sallie Mae though. So I began studying the Chartered Financial Analyst® (CFA) program. The CFA credential is the most respected and recognised investment management designation in the world. I saw this as a way to change my profile and show employers and clients that I have “mastered a broad range of practical portfolio management and advanced investment analysis skills”.
The CFA program put everything together for me. I now had a framework by which I could understand the fundamental principles of investment. I could also apply them to my own life.
Accessible investments
However, I didn’t finish the program until 2010. In the meantime I left Sallie Mae and moved to London. At this time I did not fully understand investment concepts. So when I left Sallie Mae I cashed in my stock options and pension. But I kept the UBS IRA.
…accessibility to your funds is very important…
What was important to me at this time was access to my funds. I had a major change in my circumstances. I had debts to pay off and I had to finance myself while I looked for work in London. For some people, accessibility to your funds is very important. You never know when you may need your funds urgently. So it is important to have liquid investments alongside your more long-term ones. In later articles I will talk about some of the more liquid (i.e. accessible) investments.
Working with derivatives
I took a job with Deutsche Bank in London. There I worked on asset backed securities. There are essentially bonds that are backed by a cash flow producing asset. The most famous kind are mortgage-backed securities. In this case 100’s of mortgages might be pooled together. As people repay their mortgages the payments are used to repay the interest and principal on the bonds. The bonds would usually be held by large institutional investors, such as pension and insurance companies.
I worked with other assets such as company receivables, commercial real estate loans and student loans. I think that the most interest part of this was learning about the derivatives that investors use to manage the risk of losses. Mostly we used interest rate caps, interest rate swaps and currency swaps. Derivatives have a reputation for being complicated and risky. The fact is, investors primarily use derivatives to reduce the risk of losses. Few investors use them for risky speculative transactions.
Avoiding losses by hedging
The point is that professional investors are as concerned as ordinary people about making losses in their investments. The investment should not lose value should the market go down significantly. The difference is that professional investors are well aware of the various tools that are available to manage risk. The average person is not. And this is where I intend to help. I will talk more about this is in later articles.
I left Deutsche Bank and moved on to another bank where I focused on making real estate loans to professional investors. A key part of what I did here was protecting the bank from making losses. It may seem hard to believe given the large number of high-profile banking failures in 2008 but banks tend to be very sensitive to risk.
Bank collapses and bail-outs
So why did all these banks go bust? The issues are complex and I will get into it deeper with later articles. But the main reason is that as the economy continued to boom banks became overconfident. They believed overly optimistic valuations of investments. They then relaxed their credit standards. They made higher risk loans but charged lower levels of interest. Any conservative banks came under pressure to make riskier loans because if they didn’t their customers went elsewhere.
…one indicator that a recession is coming is when investors start buying riskier bonds…
Banks found themselves in the position of reaching for yield. Just the idea of having to find riskier investments to get worthwhile return. In fact, one indicator that a recession is coming is when investors start buying riskier bonds. So I joined this bank at the peak of the market.
I discovered very quickly the cost of making risky investments. While my bank did not go bust plenty of others in the same industry did. Fortunately, my bank was relatively conservative compared to others. But I spent the next several years managing loans that had gone bad in spite of our carefulness.
Saving tax payers from losses
I moved on to a German bank that had gone bust. The German Federal Government had bailed this bank out. However, there were a lot of bad debts on the books. It was my job to get this money back and repay the taxpayers who had generously bailed this bank out. I saw all kinds of messed up deals but fortunately, I was able to get all the money back for the debts I was responsible for.
…your future won’t exist either if you don’t invest in it.
What did I learn here? I learned how catastrophic can be if you make bad investments. I learned that there are ways of protecting yourself from the inevitable collapse. I learned that the economic collapse probably won’t be as bad as you think. And I learned that in spite of the risks that you must invest. Banks will not exist if they don’t make investments. And your future won’t exist either if you don’t invest in it.
Eventually I lost my job because of the crisis. But it wasn’t the first time I had lost a job because of a crisis. But when I got another job it was at a significantly lower salary. Also, I had to sell some of my investments in order to make ends meet. But the point is, before I truly learned where to invest and how to invest I was making perhaps some really bad investment decisions.
Key Lessons
I was not taking full advantage of the investments that in some cases were simply handed to me. I think of the stock options that I allowed to become worthless. And also, of the pension that I cashed in, paying a hefty fine. If I had kept it, its possible that it could have been worth a considerable amount today. But I was young. We are all allowed a few mistakes when we’re young. But things needed to change.
But what did I learn from my academic experience and work experience?
- I learned that it was possible for ordinary people to make profitable investment decisions
- I realized that everyone is involved in finance whether borrowing or investing.
- I learned that having ready access to your funds in an emergency is important
- I discovered that even professional investors can make catastrophic mistakes.
- I determined that conservative investors will survive economic collapses
- You can use derivatives to protect yourself from the risk of losses
- You can overcome the fear of loss by investing conservatively and by following basic investment principles
I’ll tell you more about how I mastered investment principles in my next article. If you missed my previous article, you can find it here. But in the meantime, if you have any questions or comments, please leave them below.
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