Wednesday, February 8, 2012
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Financial Security and Capital Allocation

Financial security and capital allocation are the topics for this week's letter. I have been wanting to write about these for some time. What a background in the capital markets -- a very rough week for people.


I am extremely busy on the business front.  As you can imagine, we face a very challenging time in UK Property.  If you are waiting for an email reply then I will get to you, just need some more time. Each day, I have had to parcel my energy, prioritize tasks and schedule recovery.

OK -- a couple of announcements...

***I turned on comments so that so we can interact. Take it easy on me. You'll find that moderation is 'on' so I need to review before they go live.

***Endurance Corner Radio has podcasts from Joe Friel and Chris McDonald. Send feedback to D.J. J.D., who is leading our effort.  Joe is talking about his background (very interesting) and training. Chris explains how we can break Chris Lieto's course record at IM-Moo by using IM-Loo as part of our taper -- its easy if you just follow his point-by-point instruction for race week...

***Joe is going to be speaking at our Boulder Triathlon Camp next July. The camp is open to all levels/distances and will have a mix of hands-on instruction, training and discussions. Cost is $1,250 -- drop me a line for more details.  We've got some great speakers lined up.

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Who knew the markets would melt down? Personally, I don't blame the short sellers. They are only acting on what insiders and smart researchers have been telling us for months... our financial system needs to be recapitalized. Massive global deleverage is tough. In my own ventures, it is the main cause of the difficult situation faced by friends and clients. 


What lessons can we learn?

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Acquisition of capital is different than borrowing debt. Because debt comes from third party sources, we need to be wary of the tendency to view it as 'free' money. When I work with individuals, or companies, that run into trouble, it is often a crisis created by borrowing to the maximum extent permitted. Permitted under law, permitted under debt agreements, permitted by running X creditcards. An appropriate amount of leverage is well, well below the maximum that can be borrowed.

To me, capital in its most simple form is cash and liquid assets. Before we talk about how to allocate, let's consider how to acquire:

1 -- spend less than you make
2 -- pay yourself first

Physically, I have been overweight before. When I was heavy, I would often wish that I could wave a wand and "be thin". If I could just get a chance to start all over then everything would be alright. I would tell myself that I wouldn't make the same mistakes again.

Finances are a lot like that. When we have no capital, we can spend a lot of time wishing that we had capital.

Physical fitness is just like financial health. Until we take actions, and create habits, that change the direction we are heading... we will keep heading the same direction. We have to make the change.

The two tips that I shared above come from The Richest Man in Babylon -- a good read on the topic of personal finances. I like that book because it doesn't make things too complicated.


3 -- Protect core capital.

What is core capital?  Put simply, it is capital that you cannot afford to lose.  Having no assets at 65 years old is a far different situation than being wiped out in your 20s.

At 40 years old, my view on core capital is ten years living expenses.  While the income from that capital doesn't come close to covering my living expenses, it does give me years to adjust when faced with an unexpected setback.  Across a full career in business, we can be certain that we will face multiple setbacks.  After the past 14 days, the importance of core capital has become very apparent. 

How do I protect core capital?

4 -- Be wary of leverage.

My core capital is completely unleveraged.  While this reduces my return, it greatly reduces the risk profile on my portfolio.

I go even further in that I don't care about my investment return on core capital, I care about safety.

Within my business projects, I am willing to use leverage but, these days, only with capital that is above my core capital.  Why am I so conservative?

5 -- You only need to achieve financial security once.

By following the basic principles in my book recommendation you can give yourself an excellent chance to achieve financial security over your lifetime.

Sure we are exposed to Black Swans but you can stack the deck in your favor if you educate yourself and stick to the basics.

It is surprisingly difficult to stick to the basics.  We let our guard down, we cut corners, we are less careful.  We need to be constantly vigilant!

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For capital allocation, my first consideration is where I will be living in the future.


This is important to make sure that I have assets (and currencies) that will balance my future liabilities.  While I don't trade currencies, I consider purchasing power parity when deciding about large investments which match, or don't match, future plans.

I don't have a lot of sophistication in my review -- I look at things such as daily living costs, relative prices of accommodation, interest rates.

When I think about property purchases, I am very specific -- seeking good value, in a specific neighborhood, of an appealing city.  I define value back to my long term currency.  For me, that means converting back to USD, the US is my likely home.

The cities that I really like are: Edinburgh (GBP); Paris (EUR); San Francisco (USD); Hong Kong (quasi-USD).  I don't have any exposure to those markets presently but I keep an eye on them.

Currencies that I like are USD (matched to long term liabilities); CHF/EUR (long term stability).  Some people like Singapore dollars but you only need to look at a map to see that there is real political risk in the neighborhood.  In terms of Asian exposure, my preference would be a moderate yielding real property investment in Hong Kong.

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When I was starting out, I thought that it would be nice to "be rich" -- whatever that means.  Along my journey, I have realized that wealth is neither the goal, not the benefit of financial security.

The two main benefits are ethical reinforcement and personal freedom.  If the pursuit of wealth forces you to compromise your values, or ties you to unpleasant situations... then one really needs to consider if that is a benefit at all.

Following the events of this past week, a very relevant consideration.

gordo