Chapitre 1
Go Global: Breaking the Home Country Bias
Portfolio patriotism blinds investors to global opportunities. In 2010, US investors had 72% of their money in US stocks despite US companies making up only 43% of the global market. UK investors showed similar bias, with 50% allocation to UK stocks that represented just 8.6% of global markets.
This home-country bias ignores that many "American" companies like Budweiser (Belgian-owned) and Burger King (Brazilian-majority owned) are already global. Even iconic American brands earn substantial revenues abroad-Coca-Cola generated 65% of sales outside North America in 2012.
While the US still leads in innovation, countries like Switzerland, Sweden, and the Netherlands now rank higher in global innovation metrics. As US research spending slows (with negative real growth in 2013), Asian countries are rapidly increasing investment-China growing research spending by over 10% annually for a decade, while Japan and South Korea now outspend the US per capita.
Investing abroad provides valuable protection against a weakening dollar. When buying foreign stocks, you earn two returns: the stock's performance in its local currency plus any currency exchange rate changes. For example, if Samsung rises 10% in Korean won while the won strengthens 5% against the dollar, a US investor earns roughly 15% total.
This currency diversification acts as insurance against dollar weakness. Historically, this effect has been significant-global stock returns measured in local currencies from 1970-2013 were 3,632%, but measured in US dollars, the return jumped to 5,065% due to dollar weakness.
The global market offers a vastly larger opportunity set than any single country. Only 25% of stocks in the MSCI All Country World Index are American companies, with the remaining 75% representing diverse businesses worldwide-often trading at discounts to US stocks. Over 600 international companies from 45 countries trade easily on US exchanges, and brokerages like Charles Schwab are making thousands more accessible to individual investors.
Unlike most of the 20th century when international investing was difficult due to country restrictions and limited access, today's investors can easily buy global stocks. Global investing reduces risk while potentially improving returns-a true win-win as our generation witnesses unprecedented global integration and falling barriers between nations.
My career in money management began at the worst possible time-July 2007, just before one of history's largest market crashes. While the overall market crashed 50% in 2008-2009, some of our strategies performed even worse, with our flagship down 60%. Being different is excruciating when underperforming, and many clients fired us. But our commitment to our unique approach paid off-our flagship strategy returned 347% from the 2009 bottom through 2013, vastly outperforming the market's 179%.
"The market" refers to indexes tracking stocks in specific categories or regions. Common US indexes include the S&P 500 (500 largest American companies) and the Dow Jones Industrial Average (30 companies, established 1896). For modern investors, global indexes like the MSCI All Country World Index, which represents major companies from 45 countries, are better benchmarks.
Index funds have grown from 3.2% market share in 1993 to 17.4% by 2012, with over $1 trillion now invested in stock market index products. Their popularity stems from two compelling advantages: extremely low fees (typically 0.09-0.2% annually) and surprisingly strong performance compared to actively managed alternatives. Only about 30% of mutual funds beat the market over rolling ten-year periods.
The fatal flaw in market-cap weighted indexes is their backward investment strategy: owning more of a company simply because it's bigger. Even random approaches like buying all large US stocks starting with "C" have outperformed the S&P 500 by 0.5% annually since 1962.
Consider the "Sector Leaders" strategy that buys the largest US stock in each of ten major economic sectors. In January 2014, these titans included Amazon, Apple, AT&T, ExxonMobil, and others that collectively represented 15% of the S&P 500. Despite their prominence, these sector leaders have underperformed the overall market by 1% annually since 1962-a seemingly small difference that compounds to a 4,400% gap in total returns.
Rather than buying the biggest companies, purchasing the cheapest ones in each sector can dramatically outperform the market. This "Sector Bargains" strategy resembles the "Moneyball" approach-finding undervalued assets through statistical analysis rather than reputation. In the stock market, price reflects expectations-the higher the price relative to fundamentals, the higher the expectations.
Since 1962, this strategy has delivered 15.9% annual returns versus 9.1% for the Sector Leaders approach. Over 30 years, a $10,000 investment would grow to $830,000 compared to just $136,000 with Sector Leaders. The global version of this strategy shows even more dramatic results-21% annual returns versus just 4.75% for global Sector Leaders between 1990-2013.
Beyond buying cheap stocks, several other strategies have proven effective at beating the market. These include approaches based on market momentum (Sector Winners-14.2% annual returns), shareholder orientation (Sector Stewards-14.7%), earnings quality (Sector Stalwarts-12.1%), and low volatility (Sector Steadies-11.5%). Each has significantly outperformed both the Sector Leaders strategy (9.1%) and the S&P 500 (10.0%).
The more a portfolio differs from the market index, the better its chances of outperformance. This differentiation can be measured through "active share"-a score between 1 and 100 indicating how much a portfolio differs from an index. Research shows that while the average mutual fund underperforms by 0.43% annually after fees, funds with the highest active share outperform their benchmarks by 1.13% after fees.
However, being different requires emotional fortitude-the Sector Bargains strategy underperforms the market 30% of the time in one-year periods and 12% of the time over three-year periods. These challenging periods explain why many investors avoid high active-share strategies despite their long-term advantages.
Building on these insights, the Millennial Money strategy combines multiple attributes into a concentrated portfolio to deliver impressive returns. Success in investing requires both a great strategy and the perseverance to stick with it, even during periods of underperformance.
Benjamin Graham's classic checklist for defensive investors has proven remarkably effective over time, requiring stocks with P/E ratios below 15, P/B ratios below 1.5, strong short-term assets, manageable debt, and growing profits. Testing shows Graham's approach has delivered 14.7% annual returns, beating the S&P 500 by 4,400% over 30-year periods.
The Millennial Money strategy identifies companies with five key attributes: shareholder-friendly practices, strong returns on their investments, high-quality earnings, attractive valuations, and improving market expectations.
The first rule examines how companies allocate capital. Testing reveals four categories of companies with dramatically different performance outcomes. "Empire builders" underperform the market by 4.6% annually. "Reckless acquirers" lag by 2.6% per year. "Cash fiends" (companies raising substantial capital through debt or equity) underperform by 4.25% annually.
By contrast, "Stakeholder Stewards"-companies paying down debt and returning cash to shareholders through dividends or share repurchases-have posted annual gains of 15.4%, outperforming the S&P 500 by 5.4% per year. Over a 30-year period, this could compound to a 5,700% advantage.
The second rule focuses on companies that earn high returns on their investments. Return on invested capital measures how effectively companies use their resources. Companies in the top 10% by return on invested capital have grown by 13% annually since 1965, significantly outperforming the market's 9.6% return-a 2,350% advantage over 30 years.
The third rule examines earnings quality. While investors often focus on reported earnings, cash flow provides a more reliable indicator of company health. Cash is fact; profit is opinion. Research shows 78% of financial executives would sacrifice shareholder value to smooth earnings, and 55% would avoid valuable projects that might cause them to miss quarterly expectations.
Quality companies generate substantial positive cash flows through operations rather than accounting tricks. Companies with the highest quality earnings (top 10%) have grown at 14.4% annually, beating the market by 3,850% over 30-year periods.
The fourth rule focuses on valuation. Value investing means buying in the face of fear, pessimism, and negativity. The cheapest stocks by price-to-cash flow and enterprise-value-to-free cash flow have grown at 16.1% and 15.9% annually, both beating the market's 10% return.
The fifth rule incorporates momentum to determine when to buy cheap stocks by identifying those the market is just beginning to notice. High-momentum stocks have delivered outstanding returns (15.2% annually versus the market's 10%), but with 50% more volatility. Momentum works best when combined with value-buying stocks in the cheapest 20% that are also in the fastest growing 20% yields 17.2% annual returns versus just 11.7% for cheap stocks with poor momentum.
The Millennial Money checklist requires five criteria: stakeholder yield greater than 5%, return on invested capital above 30%, operating cash flow exceeding reported profits, enterprise-value-to-free cash flow less than 10 times, and six-month momentum in the top three-quarters of the market.
Since 1973, companies passing this checklist (averaging 26 stocks at any time) have grown at an annual rate of 19.95%-almost double the market's growth rate. A $10,000 investment would surge to $2.35 million over 30 years, twelve times more than the market's return.
Even the best investment strategy fails if you can't stick with it through market turbulence. Our genetic programming makes us terrible investors-we're wired for survival in ancient environments, not success in modern markets.
Studies of identical twins reveal how deeply our behaviors are genetically programmed. Research on Swedish twins demonstrated that common investing mistakes-home country bias, performance chasing, excessive trading, and reluctance to sell losers-are highly genetic.
These instincts create a significant gap between theoretical market returns and what investors actually earn. While a buy-and-hold strategy in the S&P 500 would have earned 8.7% annually over twenty years, investors who bought high and sold low might earn just 5.5%. This "human tax" compounds dramatically over time-a 1.5% annual performance gap becomes a 20% loss over 15 years and 35% over 30 years.
Data from the American Association of Individual Investors reveals this pattern clearly. Their surveys show members averaged 60% allocation to stocks long-term, but reached their highest allocation (77%) at the peak of the Internet bubble in early 2000, and their lowest (41%) at the exact market bottom in March 2009.
Our brains process information largely outside our conscious control, making investing decisions particularly challenging. Simple environmental factors significantly influence our behavior: stocks with pronounceable ticker symbols outperform during IPOs (15% vs 7%), markets perform better on sunny days than cloudy ones (24.8% vs 8.7% in NYC), and our economic experiences growing up shape our risk tolerance.
Default settings wield enormous power over our behavior. Just as countries with opt-out organ donation systems achieve nearly 100% participation compared to opt-in countries' meager rates, changing your investment defaults can overcome behavioral biases.
The solution is automating your investments through regular contributions from your paycheck directly to investment accounts. When one large corporation switched from opt-in to opt-out 401(k) enrollment, participation jumped from 37.5% to 85.9%, with even more dramatic increases among lower-paid employees (12.5% to 79.5%).
By removing decision points and making investing automatic, you bypass the faulty brain programming that leads to poor investment choices. Start with your 401(k), then set up additional automatic contributions to a separate brokerage account for implementing the Millennial Money strategy.
Modern life has chopped our existence into ever-smaller time slices, making us pathologically focused on the short term. While instant gratification dominates our culture, investing success demands the opposite mindset.
The famous marshmallow experiment revealed that children who could delay gratification for a larger reward later had better life outcomes-higher SAT scores, college completion rates, and incomes. Most humans irrationally prefer immediate rewards, requiring outrageous future returns (like 300% annually) to forgo instant gratification.
Brain scans show our limbic system (emotional brain) drives us toward immediate rewards, while the prefrontal cortex (rational brain) activates when choosing future rewards. Like children who distracted themselves from marshmallows, successful investors ignore short-term market fluctuations, check portfolios infrequently, and avoid exciting but expensive stocks.
After the 2008 crisis, investors became obsessed with "risk" over "return," but they fundamentally misunderstand risk. True risk isn't short-term volatility but rather the odds of not achieving long-term goals. While stocks appear risky in the short term (dropping 64% in 1931-1932 or 43% in 2008-2009), they become remarkably safe over longer periods.
Stocks have never lost money in any 20-year period, while supposedly "safe" bonds have negative real returns in half of all 20-year periods and 40% of 30-year periods due to inflation. Millennials must evaluate risk relative to their decades-long time horizons and ignore short-term volatility.
Our brains are pattern-seeking machines that lead us astray in markets. We extrapolate recent trends too far into the future and make decisions based on these biased expectations. In one study, humans performed worse than pigeons at predicting random light flashes because we tried to find patterns where none existed.
Despite professionals' advanced degrees and resources, individual investors have a significant advantage-freedom from career risk. Professional managers face termination if they underperform for just three years, leading many to become "closet indexers" with portfolios similar to the market to minimize career risk.
When tempted to react to market movements, ask yourself: looking back in ten years, will this decision appear driven by long-term financial well-being or short-term market circumstances? This future perspective helps untangle you from the market's mood.
Our evolutionary wiring makes us prone to both fear and greed in the market, two destructive forces that have ruined more portfolios than any crash.
Our brains are wired to respond faster and stronger to negative experiences than positive ones-a survival mechanism that backfires in investing. This "loss aversion" makes losing $100 feel about as painful as winning $200 feels pleasurable. Studies show people with damage to emotional brain centers actually make better investment decisions because they're not affected by loss aversion.
Since the 2009 market bottom, investors have bought nearly $1 trillion in "safe" bonds while selling $200 billion in stocks-missing a 130% stock market gain while bonds grew just 16%. We hate uncertainty even more than pain itself, with brain scans showing anticipation of pain activates pain centers more than actual pain.
The best investors overcome fear and uncertainty, recognizing that doom and gloom often signal buying opportunities. As Joseph Campbell said, "The cave you fear to enter holds the treasure you seek." Market valuation measured by the ten-year price-to-earnings ratio confirms this wisdom.
When the S&P 500 trades below 15 times earnings (when pessimism reigns), future ten-year returns average 11.9% annually versus the normal 8.8%. But when the market trades above 25 times earnings (during optimism), future returns drop to just 2.5% annually.
While fear is the more powerful motivator, greed must also be tamed to avoid portfolio decimation. Brain scans reveal that financial gains activate the same brain patterns as cocaine use and sex. The anticipation of reward, not the reward itself, triggers the largest dopamine surges-explaining why we feel most excited right before buying into a market bubble.
Uncertainty amplifies this effect; when rewards are uncertain (like a 50% chance), dopamine levels spike higher than when rewards are guaranteed. This explains why gambling and market speculation can be so addictive.
Greed is compounded by human overconfidence. One study found entrepreneurs believed their businesses had an 81% chance of surviving five years, with one-third claiming 100% certainty-yet the actual survival rate is just 35%.
Every market bubble throughout history follows the same pattern: a convincing story fuels greed and dreams of quick riches, making rational exit nearly impossible. The South Sea Bubble of 1720 saw stocks rise 640% in six months before collapsing.
Despite modern information access, millennials have already witnessed five major bubbles: the Japanese Nikkei, technology stocks, real estate, gold, and Bitcoin-all rising at least fivefold before crashing.
We must acknowledge our susceptibility to the same mistakes countless investors have made before us. Greed and fear will always tempt us to action during bubbles and panics, but the wisest response is often inaction: "Don't just do something, sit there!"
The long-term nature of financial opportunity makes it difficult to think decades ahead and take action with such a distant future in mind. Yet time is the greatest investing advantage-there is no substitute for it and no investing edge like youth.
Warren Buffett bought his first shares at age 11, became a millionaire by 32, but didn't reach billionaire status until age 60. Had he started at 40, he might never have achieved his legendary wealth.
Despite this clear advantage, millennials owned just 6% of mutual fund assets in 2013 compared to boomers' 54%. The 2008 financial crisis severely damaged millennials' risk tolerance-the percentage of risk-averse millennials jumped from 14% in 2008 to 25% by 2013, making them even more risk-averse than people aged 35-64.
For those with limited 401(k) options, a global index fund mimicking the MSCI All Country World Index is the "good" option-always choosing global over domestic-only and selecting the lowest fee option. If "value" and "growth" options exist, value is the "better" choice.
Stock picking is a treacherous path-difficult, time-consuming, and inconsistent. We naturally gravitate toward exciting, expensive stocks like Facebook, Twitter, Tesla, and Google rather than undervalued companies like Seagate or Gap.
When creating your own strategy, focus on four key principles: Value over Growth (prioritize cheap stocks using metrics like low enterprise value-to-free cash flow); Quality over Junk (favor companies with high returns on invested capital, strong cash flows, and reasonable leverage); Follow the Trend (avoid falling knives by selecting stocks with strong recent momentum); and Follow the Leaders (track management actions like dividends, buybacks and debt reduction rather than their words).
In India, two animals represent different worldviews: kittens who are carried to safety by their mothers, and baby monkeys who must hold on for dear life. We millennials must be monkeys-self-reliant rather than dependent on government support.
Despite our unique obstacles-supporting the aging boomer generation, witnessing two market disasters, facing student loans and difficult job markets-we have significant advantages. Our generation matches boomers in size, and technology has made stock ownership easy and affordable for all income levels.
The winning approach is patience, avoiding market timing, buying solid but unloved companies, and ignoring news noise. Index funds offer decent returns, but superior results are possible using the principles in this book. Fortunes start small-you have the acorns that can become mighty oaks.
