The Virtuous Investor: Rule 20

Virtue has its own rewards – Only the virtuous investor will get to know these rewards

This post is part of a series on The Virtuous Investor. For an overview of the series and links to the other parts, click here.

“Virtue and wickedness hath in the mean season even in this life their fruits very much unlike, for of the one is assured tranquillity and quietness of mind, […] contrariwise there followeth the other […] a thousand other evils.”

Erasmus of Rotterdam

Throughout this series, I have touted the virtues of having a financial plan and following it. And I have warned of short-term thinking and transactional behaviour. And when I meet an investor, I can always tell if this person has a plan in place that she understands and has bought into, or whether she doesn’t. There is a certain peace of mind to people who have a plan in place, understand it and follow it. 

On the other hand, there are extreme cases of investors who are driven to make more money and chase the next best idea. To understand what that does to your life let’s have a look at a client I advised some years ago. 

Let’s call this client Mr. X.

Mr. X is from one of the former Soviet Republics and made his money in the aftermath of the fall of communism. With a Western partner, he built a successful pharmaceutical business that he eventually sold for a lot of money. My job was to help him develop an investment strategy and a financial plan that would ensure he would always have enough money to finance his lavish lifestyle. 

We developed a plan for Mr. X and explained it to him. He seemed to be pleased and accepted the plan, so we put everything in motion and implemented the proposed investment strategy and built a diversified portfolio for him. But while I explained the plan to Mr. X, I either did not manage to educate him enough about risks of the plan or he simply wasn’t able to get it. 

Whatever the reason, he didn’t fully buy into the plan and didn’t trust the process because he insisted on monthly meetings where we would go through every line of his investment statement and looked at the gains and losses. If there was a profit it was ok, if there was a loss, he demanded an explanation of what went wrong and what we intended to do with that position.

The situation quickly escalated in 2013 about half a year after his strategy was put in place. In February, his portfolio was down 0.3% for the month, which in his case meant he had just lost one million US Dollars. When we met, he was visibly annoyed and when his wife joined the meeting a little bit later, he greeted her with the words: “They are trying to explain to me why they have lost a million dollars of my money”. It wasn’t a great meeting, to say the least, but in the spring of 2013, we recovered the February loss and reduced risks in Mr. X's portfolio significantly with the help of a couple of options-based strategies. This proved to be fortunate because, in May 2013, Ben Bernanke indicated the Fed would reduce quantitative easing. The result was the so-called Taper Tantrum that caused a significant spike in bond yields and a simultaneous correction in stock markets. In May and June 2013 every asset class was down significantly. Treasuries were down about 2% or more while stocks were down 5% or more. And Mr. X's portfolio? Down 0.5%.

As an investor, I was quite proud of that achievement and I still don’t quite know how we managed to get through that episode with so little damage. Yet, in June 2013, I got a call from Mr. X’s assistant, telling me and his client adviser to book a flight to his hometown in the former Soviet Union. His assistant already warned us that Mr. X wasn’t happy at all, so I fully expected to be picked up by two hulky men in dark suits wearing sunglasses. Luckily, that wasn’t the case – or not quite. After letting us wait in our hotel rooms for two days, he finally sent a car to pick us up and drive us to his factory way outside town. When we arrived there, we were put into the waiting room on the top floor of an unairconditioned building without water. It was 35˚C (95˚F). We were left there for another hour or so before we were called into his office. In the meeting, I tried to explain to Mr. X what the market had done and what his portfolio had done, but after maybe five minutes, Mr. X started to shout at us. And shout. And shout. He wouldn’t stop shouting at us for two hours. Then we were sent back home.

There was no discussion, no mention of the financial plan we had put in place, nothing. Instead, he just screamed at us for two hours. Back home, I was told a few weeks later that I was relieved of my duties as the investment manager for Mr. X. Mr. X and his client adviser decided to sell everything and put a portfolio in place that consisted only of emerging market bonds with high yields. This way, every month he would see a positive return in his investment statement in every line item.

In the end, I learned a valuable lesson from this episode. First, Mr. X ended up with a portfolio that was likely underperforming the portfolio that we designed for him in the long run. At the very least, it was much less diversified and riskier than the portfolio he originally had. Yet, because he was so focused on seeing positive returns every month, it was the only kind of portfolio he could stick to in the long run. 

Second, I learned that it is not enough to explain a financial plan to an investor. If the investor isn’t fully on board with the plan and the investment strategy, you are going to run into trouble. Could I have done better in educating the client? Probably, though in the case of Mr. X I think he was so driven by short-term gains that it would have been impossible for him to stick to any plan in the long run. He is the kind of person who will always be driven to the next venture and abandon it as soon as things turn sour. He had been lucky with his pharmaceutical company and that’s great for him. But in the end, he will never have what the virtuous investor has: Peace of mind.