Ep714: Richard Smith – Anything Valuable Is Hard

Andrew Stotz 00:02
Hello fellow risk takers and welcome to my worst investment ever stories of loss to keep you winning in our community. We know that to win an investing, you must take risks but to win big, you've got to reduce it. Ladies and gentlemen, I'm on a mission to help 1 million people reduce risk in their lives. To join me go to my worst investment ever.com and sign up for my free weekly become a better investor newsletter where I share how to reduce risk and create grow and protect your wealth. Fellow risk takers this is your worst podcast hosts Andrew Stotz, from a Stotz Academy, and I'm here with featured guest, Richard Smith. Richard, are you ready to join the mission?

Richard Smith 00:39
I've been on this mission with you for 20 years now, Andrew, happy to be here.

Andrew Stotz 00:44
I am excited to go into that. And I think you're going to bring a lot of value to all of my fellow risk takers. So let me introduce you to the audience. Dr. Richard Smith, Berkeley mathematician and PhD in system science is a FinTech entrepreneur, the CEO of the foundation for the study of cycles, and co founder of the investment tool of finance. Richard has built a reputation as the doctor of uncertainty amongst his academic peers, and has helped government agencies and fortune 500 companies alike make sense of complex datasets or sets of data. With his background in mathematical theories of uncertainty combined with his investing and trading experience. He is a regular speaker and lecturer and particularly enjoys opportunities to share his knowledge and help others gain an edge in the market. Richard, take a minute and tell us about the unique value you are bringing to this wonderful world.

Richard Smith 01:42
Well, thanks again, Andrew, for having me. And, you know, my PhD was in systems science. But it was really in how do we be honest about the uncertainties that are in our models? Because we're always modeling things, right? If we're dealing with data, it's a model. It's not the thing itself, right. So we're always modeling. And we're always dealing with uncertainty, anything in the real world that is going to have you know, consequences, from our decisions, and our actions is fundamentally uncertain. And so how do we use computers? How do we use data? How do we combine those powerful tools with human intuition to improve our decision making under uncertainty? And so after I finished my PhD on my cake, it said, Doctor of uncertainty, and, you know, that became a really a mission of mine, to to really help people to embrace uncertainty. Yes, everybody wants to reduce risk. But Andrew, we also have to take risks, because investing speculating, is fundamentally the conversion of risk to reward. Hmm, okay, we are actually spending risk in the markets. And we're looking to convert that risk into reward. So we have the highest reward to risk ratio. And so you can't get reward if you don't take risk. So yes, we want to minimize risk. But that doesn't always mean reducing risk, right? So how do I help people to not only use the tools that professionals use for risk management? You know, I know you had Jack Swagger on your show recently, and I interviewed him myself, a few years ago, you know, and I said, What's the one thing that the Market Wizards have in common? And he's like, Well, pretty much nothing, except they're all pretty religious about risk management, right. And so risk management really, is the name of the game if you're going to stay alive if you're going to succeed. And you know, I've always been somebody who was pretty good at taking complex ideas and communicating them to the public, and a little bit more accessible way than then maybe other academics. And so part of that actually may date back to some child acting that I did growing up in Los Angeles, I don't know. But one way or another, I've been pretty good at, you know, being able to explore these complex doctoral level topics, and then making them accessible to the public and also building software around them. Okay, so, you know, I really got involved in markets while back in 99 2000, investing myself and then the first big project I did was to bring trailing stop loss alerts to the public via a website I built called trade stops.com. And I built that I launched that in 2005. You know, before brokers had trade willing stops. And so I really, you know, I got hundreds of 1000s of people using trailing stops. And I really learned a tremendous amount from that experience. And I learned some lessons that that really aren't that I'm still pursuing today.

Andrew Stotz 05:22
Mm hmm. Interesting. I mean, I was started out as a fundamental analyst looking at a company and, you know, also not really taking into consideration the flow of funds. And here I was in Thailand. And if you know, if American investors turn the on switch on investing in emerging markets, or Thailand, you know, it doesn't matter what the valuation of a particular company is, in fact, the companies that are the like, most speculative ended up going up the most. And so I started to learn that it was more than just fundamentals. And then I created a framework I call fVm, or fundamentals, valuation, momentum and risk. And I figured those that kind of encapsulates, you know, the main factors that I look at, but what I did, I had a when I was working on my PhD, which I did in China, and I was flying back and forth. I was, I had the problem where I had I gave a speech about a book I wrote called How to start building your wealth, investing in the stock market, very basic, you know, simple stuff, buy an index fund, if you don't know how to, you know, and all of that type of stuff. And I was in the Philippines, and I had 2000 college students in a room. And I had a three hour time and I realized, like, as I was getting through this, like, this don't work. This doesn't work for them, because they don't have index funds. And they don't have access to, you know, invest outside. So I'm like, Oh, my God, this is so impractical. And then I thought, Okay, well, they can invest in funds. But you know, in Asia, particularly countries like Philippines, the fees for investing in funds can be massive. So what they could pretend and they can only invest at that time in the Philippines, so funds that are picking stocks in the Philippines. And then I thought, Well, okay, the one place it's been, that's been liberalized is broking stock broking, the fees are down really low. So I could tell them, hey, you should buy a portfolio of 10 stocks. But then I realized that's terrible advice, too, because 99% of them are never going to be able to do the research. So I thought, what if I have a create a way of just saying randomly select 10 stocks? Well, the problem you faced there is that, you know, what happens when one of them's collapses? What do you do? Yeah, so I created a, you know, a model, and I went through and I created, I, you know, did like 1000 iterations of portfolios, and I found like, a fan diagram of where the terminal values ended. And then I asked the question, what if, okay, what if I put a stop loss on an annual basis and have them re-position the portfolio randomly every year, and put a stop loss at, let's say, 1020 30? When I tested all the different ones, and I, I think I came up with about 25%. that would be and basically, it caused the fan diagram and truncated the downside. Yep. and it in fact, shifted the demand diagram up because the upper bound of the terminal value actually was massive, because it forced you to get out of some things. And I thought, okay, that's the advice that I would give in the Philippines. I didn't formalize.

Richard Smith 08:27
When I did trade stops, I had access to all of these portfolios of real people. And I was working with a lot of newsletter publishers who had their track records. And so I was able to take a trailing stop strategy. And just, you know, say add it as a mechanical exit strategy to all these literally hundreds and 1000s of portfolios. And I would always see improvement of the outcomes when it was a real human decision maker. Okay, if it was a totally mechanical strategy, a trailing stop may or may not add value to it. But when it was a real human decision maker, it almost always added value to it. And one of the most like shocking things was the person that I learned about trailing stops from it was a man named Dr. Steve sugar, rude, fantastic investor and newsletter writer. And he had taught me about trailing stops, and I back tested his portfolio using a mechanical trailing stop strategy and it did better. And it was like, Well, why did wait a minute you're using trailing stops. You taught me about trailing stops when I apply a mechanical trailing stop strategy, exit strategy to your portfolio. The performance goes up what's wrong, and that was one of the first big aha was that I learned was what was going wrong was he was using trailing stops to exit his losers. But he wasn't you Using trailing stops to exit his winners. Okay. So he was getting out of his winners early, right taking rational profits. And, you know, but not letting having some crazy winners letting some winners just get away from you. And you know, the markets can remain irrational longer than we can remain solvent. You've probably heard that saying, but it's the same to the downside and the upside. Right. So my whole fascination and it dated back to my PhD work where I was studying Kahneman and Tversky. Right and Prospect Theory, this source of Moneyball right, the Michael Lewis movie about Billy Beane, and the Oakland A's kind of made that popularized, right. And then he wrote another follow up book, I think it was called the undoing project. It was specifically about Kahneman and Tversky. Well, what they, their fundamental insight, you know, that that Kahneman ultimately was awarded the Nobel Prize for is what's called loss aversion. And the technical way of saying is that we are risk seeking when we are losing. And we are risk averse, when we are winning. Okay, so both of these have to do with our feelings about loss and our ideas about loss. So when we are losing, okay, the way to avoid loss, right? To have to be loss averse is not to sell. Because selling means you take the loss, you have to swallow hard you got to sell, you got to take the loss. So instead of taking loss because we're averse to losing, we double down, we hold on we turn a short term trade into a long term investment. And I've got all kinds of stories, you know, of clients of mine, you know, telling me their stories about I mean, literally, like this one guy is a safety engineer for NASA, right? I mean, this guy knows about risk, managing risk, but when it comes through his portfolio, he's an utter basket case. You know, everything's emotional. And so look, we are risk seeking, when we are losing, we want to do anything, but take the loss. Okay. So then when we are winning, what our loss aversion attaches itself to is our gains. So we actually become risk averse, when we're winning. So we have this mechanism for downside disaster. But we have no corresponding mechanism for upside, explosions, okay, Roy's limiting, you know, our winds and unlimited our losses. So that's what interests me, you know, how do we reverse that and, and that really is very psychological, right? And what's fascinated me the most is the way that our, our hearts and minds interact with markets. Right? And so much, especially for novice amateur investors, you know, almost all of the underperformance and this is documented to is attributable to just behavioral biases, that are essentially being monetized by, you know, more mature market participants. And all of the businesses that serve retail investors, the broker dealers, you know, who don't really give you the tools that you need to succeed, because really, what they, how they make money is on churn around today with payment for order flow. Right. So I was a big critic of Robin Hood, for years now, you know, all the way back in the pandemic, before the pandemic, about them, essentially selling, you know, customer data to very sophisticated market participants, you know, particularly Citadel securities, and Ken Griffin, you know, who they make billions in up and down markets every year. Right? And so, you know, it's really how do we position ourselves that we can be in the markets in a way that we can be comfortable, and that we can limit our downside and unlimited our upside? Right? So almost all my work is essentially around that simple idea of, you know, how do we stop having irrational losses and rational gains? And how do we begin having rational losses and irrational gains? And I think that's the key. You know, if you can do that, one way or another, you're going to be successful. And most of that, it, you know, and I think more and more today, Andrew? It's really more of a myth. It'll edge. Like finding a performance edge isn't that hard? You know, there's lots of different ways out there. But it's kind of like what Cliff Asness said, which was one of my favorite quotes, clip assets for make you are, you know, I used to think that successful investing was about genius. And I'm paraphrasing now, but more and more, it's about finding something that works, you know, and doing it religiously. It's really the discipline of acting, you know, and you can't be a machine about it, either, you can't just turn it over to a machine, there's something about the human element of, you know, being in that crucible? Well, it's part of lamda, and having to behave, you know, consistently. And on principle, that ultimately is the biggest key to success.

Andrew Stotz 15:53
Yeah, and part of that, that goes back to what Jack said in the interview I did, which is like, find the style that works for you. And then, you know, go in deep, and, you know, learn it and study it and think about it, there's, there's, there's probably going to be a time where that particular strategy is going to do well, and timing that's going to do poorly. Understanding on

Richard Smith 16:16
and within a strategy. There are other level, like, one of the big things for me has been what's the right time frequency for me to be looking at in my data? You know, so if I'm looking at, like, you know, weekly data, forget about it, you know, it's just, it's too long for my short term, with my short attention span, right. But then if I go down and look at like, 15 minute data, or 30 minute data, I'm not in front of my desk enough to be able to really be hovering over the markets all day long. You know, I got businesses, I got kids, I got family. And so I've had to really go through a bunch of iterations of finding, you know, what the time frequency that works best for me, is about two to four hours. So I like to look at my data in two to four hour bars, right? Because then that gives me, you know, trades that might be two weeks to four weeks long.

Andrew Stotz 17:18
And that's a great lesson right there for everybody is like, find what works for you. Because

Richard Smith 17:25
I wasn't it's even more important than like, what system I'm using like that is or it's at least equally as important. But it's not something that people think about that much. You think, Oh, I gotta go get this tool. I gotta go to that school. No, you got to figure out, you know, how much do you want to sit at your desk? You know, how much do you want to stare at a screen? Or do you want to just like, set it and forget it? You know, for decades, right? That's one of the biggest things that you got to figure out.

Andrew Stotz 17:53
It's funny listening to you talk about that, because I was just wondering what number you were going to come up with. And I was thinking about mine, and mine is three months,

Richard Smith 18:03
every three months your trade, or that's how often you look at the markets.

Andrew Stotz 18:07
That's how often I look at the markets. Okay, great. And what I've done is, and maybe I'll explain what I do is, let's forget about my methodology for a moment as far as like, and my fundamental and my technical, but let's just imagine, at at some point in time, and I'm looking across many markets, not just let's say us, but all across Asia, in particular, different markets, different companies produce results at different times. And there's different deadlines. And so it gets a little bit more complicated. But let's just pick an optimum date, where new information comes into the market, I would like to act on that right away, but I have a process that takes some time. So new information comes into the market at times zero, every quarter. And so times zero, what I then do is I survey all the stocks in my universe, that are investable for me and what my clients want. And then I rank them based upon a level of attractiveness based upon my methodology. And then I start at the top of that list, and then I started to look at it and I do some, you know, was there error in the data? Was it just a one off? You know, there's many different things I made look to try to make sure that that's reasonable. But because of the work that I've done for many years, I know that those stocks at the top generally are going to have a slightly higher chance of outperforming in the coming three month period. It also depends on how quickly you get into them. It also is a question of you know, is one of them, or the top ones more valuable. I've found that equal weighting is probably the best way because it's really hard to tell. So then I do some research on each company. And then after that, I come up with an equal weighted portfolio. And then and then I go into that portfolio, and then I have stop losses at let's say two 20 to 25% It depends on different markets in Asia, different markets, I've tested stop losses across markets, but let's just say 25%. And therefore, I'm not going to think about it, I'm gonna let that strategy work until three months from now. And if anything happens in between I exit, and that is my trailing stop loss in a sense, too, because imagine that my portfolio is zero every quarter at times zero. And then I can, I can completely pick completely new stocks or keep if the other ones score on my attractiveness as still attractive, I keep it in the portfolio, but I reset the stop loss for the new price every quarter. So I don't have an explicit gain, you know, stop on the game, because I realized that just that's just going to lower the performance, but I do have a trailing stop loss in a sense, what do you think about that strategy?

Richard Smith 20:58
I think I see a lot of great things in it in particular, you know, and I know you'll recognize this, where we really get in trouble is when our minds get fixated on, like, a single thing in the portfolio. Right. And, and so, you know, what you're talking about equal weighting things, having a stop loss. So, you know, again, Jack Swagger, quoting Bruce Koebner, right, 90% of risk management is knowing when you'll sell before you buy. So it's just we have to avoid getting, you know, tar babies in our portfolio. Right. And, and by the way, those can be things that get too big, you know, as well as things that get to they that the losses get too brutal, you know, but yeah, Cliff Asness again, he was talking to David Rubenstein over at Bloomberg. And he's, you know, David Rubenstein said, what's the biggest mistake most people make? And you said, obsessing over every line versus the total portfolio? Right? Right. So that's something I've really been focused on. That's what talking a little bit about finance. That's what really Fini AK is about, how do you really focus on the portfolio level, and build what Ray Dalio called Holy Grail portfolios of 15 to 20, good uncorrelated return streams, okay, I like to get a little more nuanced than the equal weight, you know, I like to, I like to have uncorrelated, I like to look at correlation, so so that I have uncorrelated bets. And I like to allocate based on volatility. So that's called the risk parity strategy, right? So you're getting less money into your more volatile positions and more money into your less volatile positions. So I mostly trade futures markets myself, I use mostly cycles analysis, the first website I ever built with seasonal trader.com, for Jake Bernstein, if you know, Jake, but I got into seasonals and cycles, they're the thing that have really stayed with me through thick and thin, over 25 years now in the market. So So anyway, I like I use cycles, supported by a few technical indicators, and then I construct a, you know, uncorrelated collection of bets, and I allocate position sizes based on volatility, right, so I'm not going to have the same amount of capital in a natural gas that as I'm going to have in a, you know, 10 year treasury note. Right? So I can hold a lot more 10 year treasuries, you know, then I can natural gas, but they'll end up being about the same level of volatility. So I like to take equal risk on my bets. And then I like to make sure they're uncorrelated. But all of this really has to do with, you know, getting your head out of the weeds and up to the portfolio level. Right. And I think that's, I just think, you know, I'm so disgusted by the retail investing space. And I'm so disgusted by the dopamine drip, culture, media, social media, etc. You know, it's really an addiction model. And they're just trying, they're pushers that are trying to get us hooked. Yeah, you know, and we do it to ourselves, you know, as more than anything, right? Where ultimately the responsibility lies within each of us to accept getting hooked or not. But once you understand that that's the model that most of the media If we're consuming is really an addiction based model. And that other market participants, mature market participants, institutional market participants are actually monetizing, you know, our addiction in addition to all the media that's getting, you know, our eyeballs and our attention because we live in the attention economy. So that's what people have to get past. You know, when you tell me about the way you were doing it, and obviously, you've got a system, and it's a system that works for you. It's something that's been honed over decades. And you know, your head's not in the weeds. And so,

Andrew Stotz 25:36
I'm gonna have a link to the Finance website, and there's a couple of points on it. For the listeners out there. You know, it's great advice about the stop loss. It's, but let me just read a couple of things off the Feeny X site. Fini act lets you research investments with clear data meant for real people, build your portfolio, minimize your risk, and then get back to living your life. And there's another one at the bottom that I like, I like this one, it says, you can put the phone down, we'll watch the market for you. So just go to

Richard Smith 26:06
Vinnie hecto and our early stages, and we're building it out. But it is my passion project. Frankly, it's hard. You know, I mean, I'm interested, you know, your podcast interest me, Andrew, because you've actually gotten people interested in risk management by framing it as my worst investment ever, as a storytelling, right, which is great. When we actually talk to, you know, especially younger investors about risk, they literally say like, I never thought risk was part of investing. Like, I don't think of risk as part of investing what I don't want to talk about risk, you know, or my mom named the company, risk Smith. And she's like, risk RAS Kay. I said, Yeah, risk, and she's like, why would you name it, that risk isn't a good thing, you know, and I'm like, Mom, we're all dealing with risk all the time. Like, we got to get our heads out of the sand. But it's a tough sell. You know, it's kind of like selling you know, a salad bar. Reminds me at McDonald's,

Andrew Stotz 27:11
I gave a speech to a lot of it was about 1000 students about ethics. In fact, I was asked for another event, the Philippine CFA society invited me to come and speak. So I flew from Thailand, to the Philippines. And my speech was about my what I learned from my podcasts, I call it six, six ways to lose your money and six strategies to win the six lessons I learned from interviewing 600 people about their worst investment ever. Now, it's 700. So I got to think about that. But the thing is, I was going to give a speech about that which I had prepared. And I arrived the night before. And then I thought my speech was in the afternoon, but the event was all day. And it was 1000s. Like the keynote speaker was speaking to about 2000 young people. And then mine will be I don't know, probably 500 In a breakout session. So I arrived, but I thought, yeah, I'll just go there for the whole event, just get the vibe of everything before I spoke. And basically, I arrived and the keynote speaker, the first speaker that like the Ministry of Finance and stuff spoke, and then eventually, the organizers came to see me who they're friends of mine. And they, I said, How's things going, they say we're in a panic. And I was like, why? And they said, because the speaker that we're supposed to give our big keynote at 1030, or 10, or whatever it was, he's got to take his mom to the hospital. So we're gonna have to go out there and talk about case studies. And I was like, what, what is the topic? And they said, ethics, I said, Well, would you like me to give a lecture on ethics? And they said, Yes. And I said, just give me a computer in a room for one hour, and I will be ready to go on stage in an hour. And I have a lecture I call 10 ways ethics adds value to you. And I do it by getting people in the audience like your pinky finger, and then go through all of the different 10 words that are words in the CFA ethics code. But the idea is that I'm trying to tell people that see ethics, not in a negative light, but in a positive light. If I could add these ethical behaviors, I will become more valuable and ethical behaviors are not that common. I mean, most people are not criminals, but they're not thinking about the interest of the client the way they should. So what I was telling them is, you know, and so I went out, and just gave the smashing presentation. And, and then one of the students came up to me and said something that I always remembered. She said, You know, I never thought that and the reason I'm telling this whole story because you said the person said I never thought about risk. They said I never thought that you could be ethical in finance. And I thought I just planted amazing that kid's head that finance is not about ripping people off or you know,

Richard Smith 29:56
it's so sad isn't very so talk

Andrew Stotz 29:59
about being discussed. Sitting frustrating. So I have a whole course I do called ethics and finance. And it's based upon CFA ethics because CFA did so much for me. And I just loved the topic, and I'm an expert in it. But it's all about how do I try to make ethics a positive experience? Not, you know, here's someone that did this and don't do that. So I have one question I want to ask, before we get to the big question. And that is, the problem I faced with stop losses is that when I go, so for some of my portfolios, its asset allocation, its funds, or ETFs, let's say. And the problem that you face is with a stoploss, it can make perfect sense when you have a portfolio of individual stocks, because a stock could continue to go to zero or just could go down 50%, or 75%. But most of the bigger indices that I'm using, they're not going to disappear. Number one, they could fall, but generally, they're going to rise again. And so a stoploss doesn't work as well, with a broad based index, or ETF. And I'm curious if you've got any knowledge or experience about how can I try to minimize the downside with such an instrument? And keep in mind, I don't have access to sophisticated tools, like all kinds of futures and other things, because I'm operating in markets in Asia that just don't necessarily have those things.

Richard Smith 31:30
Yeah, no, I'm here. Yeah. And again, it's one of the reasons that I like allocating by volatility or taking equal risk on my positions, right, because I do think that stop losses are not as effective today, as they were even 10 years ago, you know, going back to the payment for order flow situation, the most valuable order that the market makers will pay for is what's called a non marketable limit order. Okay, so you know, what a market order is, right? You send it to the market, you say, give me a market order, I'll take whatever the price is, and, you know, that goes straight to the exchange. And then there are marketable limit orders, which can go to the exchange. But something like a trailing stop is actually kind of a complicated order, right. And that's actually why I was able to build a service that offered trailing stops, uniquely, because you have to recalculate what the price is, at which you're going to exit, right, because if you buy it at $100, and your stops 25%. And you're initially at $75. But if the stock goes up to $200. Now, you know, your stock, your 25%, stop is at $150. So that price is always changing. And somebody's got to calculate that. So it's a non marketable limit order. And that's what the institutions pay the most money for, to the Robin Hood's of the world. Right, because that's gives them the most market intelligence, about the structure of the markets. So that, you know, these new AI tools have large language models, so called, right well, people, you know, these institutions have had these large variable, machine learning models, that they put all kinds of data into, that they buy from Robin Hood, and, and you know, all other places to make massive, essentially AI models of the markets. And so, you know, trailing stops, I think, have become more compromised more, there's more visibility into where those stops are. So I, you know, I mostly do market orders at this point, that doesn't really address exactly what your question is, it's basically should I be using a trailing stop on these, you know, highly like, well,

Andrew Stotz 33:56
let, let's try to break that down for a second. Let's say that I have a core allocation to world equity. And let's say 50% of my portfolio is that and then I'm tilting the portfolio. Let's just say that a country, like, let's say, Poland, is interesting right now. So Poland is in the All Country World Index at 1%. But I'm going to double that to 2%, let's say two or 3%. Yeah. And let's say that tech is doing really well. So I've allocated your country a little bit increased the weighting of that country. And let's say tech is doing well. So let's just say that I allocated on momentum based and I increase the weighting in tech. Now let's just look at those two, two allocations. There's a different level of volatility let's just say for right for this argument's sake, that the polling index ETF is much more volatile than the tech ETF. Originally, I was planning on putting, let's say, you know, 5% in each as an exit ample to simplify things, let's make a model. So the simple things that say I was gonna put 5% in each, what would the volatility in the Poland index tell me relative to the tech index about how should I consider my weighting or something like that? Is that what you're talking about?

Richard Smith 35:20
Yeah, so you might put 7% in tech and 3%, in Poland, you know, and to still allocate the 10% to those two combined things. But you're putting less into the more volatile position, because really, what bothers people, you know, is when, when a loss in an individual position, it's a certain dollar level, right? It's like, oh, I'm really uncomfortable with that, you know, so if you have less, you know, of your position, if you have a smaller position size in a more volatile position, and a larger position, size, and a less volatile position, you know, the daily dollar changes in those positions are going to be, you know, more similar, right. So, that's a very helpful strategy for, you know, essentially accomplishing some of the similar things that a trailing stop accomplishes, which is risk management, basically.

Andrew Stotz 36:14
So I like to say this is the number one risk management podcast, but I don't really teach risk management. And I don't have a case, I don't have all of these lessons on risk management. But these types of discussions give us a lot of value. So for listeners out there, this has been a long, you know, pre amble discussion, because I think there's a lot that we can gain from what you understand, Richard, and so let's just summarize, I'm going to summarize just for the ending up this session. And that is, the first thing is that if you've got a portfolio of stocks, consider some torts type type of trailing or otherwise stop loss that can protect you from the risk of the downside, if you

Richard Smith 36:58
are, especially if you're in really novice investor. Okay, it's simple. Keep it simple.

Andrew Stotz 37:03
Yep. And then the second one is, look at the end, the volatility aspect, you've also talked about the correlation, if you've got a portfolio of 10, or 20, stocks, look at the correlations at them, you may actually realize that, oh, wait a minute, I'm kind of triple these three stocks are highly correlated, meaning I'm really increasing my exposure to something that they're all reacting to. And therefore, I should think about reducing either a little bit of exposure to all of them, or eliminating one or two from the portfolio.

Richard Smith 37:38
Think about it in terms of golf, right? Most golfers, you're, you know, your hooking way out to the right or your, you know, sorry, hooking way out to the left or slicing way out to the right, you know, and that's kind of like what happens with the stocks in our portfolio. But if you take the average of those, you know, you'll end up down the middle of the fairway. So how do you kind of or think about, you know, like, the another image I like to use are the hurricane forecast models, if you've seen those, right. So you have this kind of spaghetti, you know, type models are actually called spaghetti models, where you have all these different lines that the hurricane might follow, you know, and mostly it ends up going down the middle there. But how do you tighten up those lines, and still, like, keep that overall portfolio within a tighter set of lines, then the individual positions? So that's, that's really, you know, at the end of the day, most people are like, I just want to look at one number, how much did I lose? You know, or how much did I gain? And it's, it's really that when the losses get too out of our comfort zone that our head starts play games with us, right? So that's really like where having uncorrelated bets comes in uncorrelated investments. And again, this is Ray Dalio, you know, the biggest hedge fund, most successful hedge fund manager in the world, said the Holy Grail of investing is 15 to 20, good, uncorrelated return streams. And that's some sage advice right there. That's really what I've tried to make accessible through Fini, AK is give people a chance to see how to build holy grail portfolios. Yeah. And to say, like, Look, if you've got this collection, you've got some money to put to work you want to a new position, you've got this collection of candidate positions. And, you know, more or less they're there. They're equal in terms of your their goodness, you know, the likelihood that they're going to go up. Then you want to take the one And that is least correlated to your existing portfolio, because it gives you an overall smoother ride for your portfolio. And like Cliff Asness said, you know, like, the biggest mistake people make is focusing on the individual positions instead of on the portfolio as a whole.

Andrew Stotz 40:18
Yeah, and I think for the beginners out there, it's all about staying in the game. It reminds me of a story of my best friend who runs our coffee factory. And we've been having a coffee factory in Thailand for about 28 years. And Dale, basically one night I called him and I was like, how's it going? He said, It was awful. You know, it's just awful today, you know, it's just, it's like, it's like, business is like a prize fight, you know, but in the old days, the prize fights, the boxing matches, were like 70 rounds. Right now, we have three rounds in the Olympics, and you know, 12 rounds, but they were like, 70 rounds. And so he, he, we had watched the fight of Jack Johnson on video, and he, he came back and he said, Yeah, I'm in round, you know, 47, you're, like, I'm tired. And he said, what the objective in round 47 is just not getting knocked out. That you can't attack in every round. And so I think what you're saying for young person and a new investor is protect your capital first, and that allows you to stay in the game and keep learning and then you know, overtime, winning

Richard Smith 41:31
and make sure that you don't get stuck on, you know, one thing that that has, that becomes kind of disproportionately, you know, important in your mind. So I just wrote an article called to Nvidia or not to Nvidia. Right, it's kind of a play on Shakespeare to be or not to be right. But, you know, we're constantly hammered in the media with these hot button issues. Right, you know, Musk or Zuck, who's gonna win in the cage fight. You know, like, when Nvidia came out, and they had an incredible quarter, right, and they raised the, their guidance for the next quarter, we basically doubled their revenues in like a six month period. You know, it was crazy, it was wildly successful, great. But for the next two weeks, it was like, the only question was, are you in video? Are you in a video? Or aren't you like, were you smart? Or are you dumb? And you know, that there's, there's 10 or 20,000 different things you could put your money in, right in video wasn't the only stock in the world. But that's the media level example of what happens to us individually to not only like what the media is feeding us, but the stories that we're telling ourselves, right? So for me recently, I got stuck in a position in the Nasdaq futures. I was short, the Nasdaq futures and the Nasdaq kept going up and up and up. And I'm like going, Ah, you damn NASDAQ, you know, you, you're gonna go down, I just know it. You're this is ridiculous, whatever, right. And so that position became this kind of something that I was constantly talking to myself about constantly rationalizing, right? And when you see that happening, you know, it's out of balance. And you have to figure out how to get out of that. Right. So focusing on the portfolio level as a whole immediately, like, I went back to it before that I'm like, wait a minute, the NASDAQ isn't the only fish in the sea. You know, there's, there's at least a dozen other highly liquid futures markets that I can participate in. Let me get a balanced portfolio going again. Get back to my own rules. And stop this, you know, insanity?

Andrew Stotz 43:51
Well, on that note, now, it's time to show you a worst investment ever. And since no one goes into their worst investment thinking it will be tell us a bit about the circumstances leading up to it, then tell us your story.

Richard Smith 44:01
Well, I'm going to go back to the beginning. And I've had worst investments than this in terms of dollar amounts, but this is still the one that left the most searing mark on my investor psyche, right? And it was 9899, right during the.com Boom, and I just started investing and I was in graduate school at the time working on my PhD. And, you know, over about 18 months, I get my account up from you know, like 300%, okay, from $10,000, which was my life savings at the time, up to $40,000. Right, and I'm going foof What a smart guy. This PhD is really paying off and I'm actually getting married in June of 2000. And I'm about to let the inlaws know you know, I'm a real man. I don't need as much help with the wedding. I got a lot of this covered. And then March of 2000 hits You know, and it's like, all of a sudden my $40,000 is like $30,000, practically overnight. And, you know, that's, that's a big loss for me. moment, right? But, but what was really shocking about the whole thing is the lies that I told myself through the whole process, right? So he gets down to $30,000. And then I'm like, Well, look, let's not get greedy here. We'll get out when it gets back to $35,000. Okay, so then it gets back to $35,000. And you say, Well, you know, it's back to $35,000. Why couldn't it get back to $40,000? Heck, maybe it could go to 50,000. You know, there is just this, I'm working on my PhD is the doctor of uncertainty, and I'm having these insane rationalizations, you know, that are very embarrassing. So, you know, doesn't get back to $35,000, it gets down to $20,000, I'll get out when it gets back to $25,000. Now, you know, finally it gets back to $10,000. And at that point, I panic, and I just, like, get all my money out of the market, like, let me get married. Let's, let's just put this investing thing to the side for a little bit, you know, and then it was like, five years later that I started trade stops.com And I started integrating trailing stops, and, and then it started to really turn into a lifelong passion for me. So then how would you? You know, the most? Yeah, the most searing lesson. There have been bigger dollar losses. And I mean, I still make bad trades today. You know, knowing all that I know. And all that I preach, even this is hard stuff, it's hard to do the right thing in the markets. I mean, they wouldn't, you know, the markets wouldn't be as interesting or as potentially valuable if it wasn't hard, you know, anything valuable is hard.

Andrew Stotz 47:03
And so let's, let's think about a young person right now, who's overwhelmed with all of the media out there about all the different information that that you weren't exposed to, to the same degree, and the ease of the platforms and all of that, and they're starting out, they get into a portfolio and it starts to rise. Based upon what you learned from this story, and what you've continued to learn all of your life, what's one action you'd recommend that they take to avoid suffering the same fate?

Richard Smith 47:31
I'd say get your head out of your mass media.

Andrew Stotz 47:37
So that's a good one, get your head out of your mind, out of

Richard Smith 47:41
your head out of your mass media. You know, it's just if everybody's looking in the same place the opportunities in their AI right now. Right, Nvidia, you know, Apple, I mean, Microsoft, all of the you know, there's seven or eight tech companies that have basically dominated the NASDAQ this year dominated the stock market, the s&p 500, I think something like 26% of the s&p 500. The seven companies make up 26% out of 500 companies, there's seven, there's over 26% of the market cap of the s&p 500 is in the seven companies. So that's not the place you want to be looking right now. You know, so you have to be willing to look off the beaten path. And that's why I love this. You know what I've done it for ENIAC, because there you can go, you know, one of the things I like to do Andrew is I use the 13 F filings of what great investors are buying and holding in their portfolios. Right. And, and that gives me like, maybe 100 ideas I can work with, if I have, you know, Rajiv Jain at GQ. GE partners is one that I've been following. He's got 100, you know, good investments in his portfolio, if I just take those 100 investments, say, which of these is uncorrelated to my existing portfolio? Lo and behold, you know, I get 10 ideas that I've never heard about in the media before. So do I want to listen to CNBC or Yahoo Finance or Fox Business, you know, where they're always just seeing the same thing over and over again, or I want to go look at what's in the portfolios of wildly successful investors. You know, just add one or two things at a time to my portfolio when I have a little bit more capital to allocate and and find the ones that are uncorrelated to my existing portfolio and build my portfolio the way geniuses like Ray Dalio do. So that's where I've gotten to and anybody can do it. You know, you just have to be willing to, you know, take the road less traveled.

Andrew Stotz 49:48
So I'm going to do what terrible podcast hosts do, and that is answer the question for the guests. The next question is, what's a resource? And I would just say, you know, Feeny AG is a place that you can start and as it says, Start now for free, you know, and start learning. So let me ask you. Last question, what is your number one goal for the next 12 months?

Richard Smith 50:14
My number one goal for the next 12 months. I mean, personally, financially is to get my business cashflow positive.

Andrew Stotz 50:22
That's the key. Yeah, that's the key.

Richard Smith 50:26
Well, we're definitely not in the growth at all costs world anymore. Yeah, and that's a good lesson for everybody. I'm a FinTech entrepreneur. And, you know, I mean, you were really valued for growth at any cost, even just two years ago. And it's not about that anymore. And I think that's a good change, actually, even though it's cost me a bit. Yeah, but I think ultimately, it's the right thing. It's a better way to, you know, build an economy and, and build a society. So I think it's, anyway, that that's my goal for the next 12 months is get my businesses cashflow positive.

Andrew Stotz 51:13
There's something to be said for bootstrapping and not, you know, getting out there and necessarily, yeah, raising capital and forcing yourself to develop the cash flow from it. And for the listeners out there, you can listen to episode 235, which was Rand Fishkin, and his, you know, experience in the startup world, particularly, he said, the title of his don't be afraid to stand up against the growth at all costs, venture capital model. And I think he gave a really good discussion about that. So for the listeners out there, you know, make sure to check that out, because that gives you know, exactly what can go wrong, if all you're doing is focusing on that. So I think I'll go listen to that one. It's great. Grant rands amazing, well, listeners, there you have it another story of loss to keep you winning. Remember, I'm on a mission to help 1 million people reduce risk in their lives. As we conclude, Richard, I want to thank you again for joining our mission and on behalf of a Stotz Academy, I hereby award you alumni status for turning your worst investment ever into your best teaching moment. Do you have any parting words for the audience?

Richard Smith 52:21
Stay the course. Remember that it's time in the markets not just timing the markets although you can still time the markets but you got to make sure you're still in exposure matters. Yep. And targeting the right level of exposure for you is very important.

Andrew Stotz 52:41
And that's a wrap on another great story to help with Craig growing protect our wealth fellow risk takers. Let's celebrate that today. We added one more person to our mission to help 1 million people reduce risk in their lives. This is your worst podcast host Andrew Stotz saying I'll see you on the upside.