Our Investing Philosophy

Just because a game exists, doesn't mean you should play it. - Sal Armstrong

The financial markets are like a casino. Both are a collection of games.

Each game has its own level of difficulty, and criteria for what it takes to win.

Poker requires more skill than simply pulling a lever on a slot machine, which relies completely on luck. But poker also provides more opportunity to put the odds in your favor than slots.

Your job as an investor is to play the easiest game that meets your goals.

Here's an overview of possible games you can play as an investor, roughly in order of ease.

Game	Difficulty	What it Takes to Win
Passive index holding	Very easy to achieve average results. Impossible to achieve compelling results.	Depends on definition of "winning". Adhering to strategies guarantees an average result.
Tactical portfolio management	Easy to achieve moderate results. Moderate to achieve compelling results.	Proper back testing & adhering to signals.
Stock picking (including "dividend investing")	Moderate to achieve average results. Hard to achieve compelling results.	Durable analytical or informational advantage over professional equity analysts, or luck.
Real estate investing	Easy to achieve moderate results, but requires high amount of labor or capital.	Either large amounts of capital and/or labor. Plus, a competent team of professionals.
Day & discretionary trading	Very hard. Consistently, only the top few % succeed in a meaningful way.	Durable analytical edge over market makers who have more resources and technology than you.

We believe investing is a vehicle to achieve an extraordinary life, which involves reaching financial independence as early as possible.

This is why we practice tactical portfolio management. When compared to other investment styles, it produces compelling results with the easiest level of difficulty, controlling for luck.

Therefore, it offers early financial independence to the largest number of people.

Let's briefly see why other popular investing strategies do not work as well.

Passive index holding

Passive index holding is a very easy investing style. The issue with it is that it produces mediocre results by design. And mediocre results do not generate early financial independence for the average person.

Assume you are 65 years old.

If you had:

• Started working at age 18

• Increased your nominal wage by 2% per year, hitting the average US salary of $60,575 at age 35

• Saved the national average rate of 4.00% of your salary every year

• Achieved the same returns as the total stock market index $VTI did over the past 48 years

Then you would have $156,624.58 at age 65 - hardly enough to survive on, let alone retire early.

If you were a go-getter and achieved double the US average salary by age 35, and maintained double the average savings rate, you would still only have $548,786.96 at age 65.

Therefore, we believe passive index holding is more appropriate for people who:

1. Are born already wealthy

2. Have no interest in becoming wealthy

Stock picking & day trading

Stock picking and day trading produces more variability in returns than the market. In practice, the returns are also random.

This makes sense, as stock picking and day trading rely on an investor's ability to to predict the market. But they cannot. The wisest investors like Warren Buffett openly admit they cannot. You cannot either. Do not fight this.

A study conducted by Burton Malkiel and Charles Ellis in 1975 examined the performance of investment experts compared to randomly selected stocks. The study found that the experts' stock selections did not outperform the randomly selected portfolio.

How, then, do you explain stock pickers and day traders who seem to defy gravity year after year?

Consider this scenario.

• Assume there are 10,000,000 stock pickers in the US.

• Over the next 50 years, the S&P 500 generates an average return of 10%, as it has in the past 50 years.

• Each year, the stock pickers each generate random returns between -30% and 50%, which is +/- 40% from the S&P 500's 10% returns.

• This means that all of their performance is as good as monkeys throwing darts.

We ran this simulation, which generated these results:

Average annual performance	Number of stock pickers
returns < -5%	324
-5% ≤ returns < 0%	97,176
0% ≤ returns < 5%	2,113,927
5% ≤ returns < 10%	5,506,154
10% ≤ returns < 15%	2,152,637
15% ≤ returns < 20%	128,777
20% ≤ returns	1,005

Notice that 77% of the stock pickers performed worse than the market. This is because negative returns hurt long term performance more than positive returns.

And because the random returns had more variability than the market as a whole, the average stock picker's performance drifted lower over time.

Despite this, over 1,000 stock pickers generated average annual returns of over 20% for 50 years - all through sheer dumb luck!

These 1,005 stock pickers could no doubt write best-selling books, easily raise capital, and make a name for themselves across the news and social media. A track record of 20%+ returns over 50 years is better than Warren Buffett's 50 year track record of 19.8%, after all.

My point is that any investment style that produces a high variability of returns, and attracts a large amount of investors, will inevitably produce track records that are indistinguishable from genius.

This is true even if the strategy itself has a lower expected value compared to holding the market as a whole.

Real estate investing

Real estate investing can be broken into its own collection of games, each with their own pros & cons, capital & skill requirements, and localizations.

These games range from high-labor ventures like fixing & flipping single family homes, to passively holding private equity funds that invest in broad baskets of commercial real estate.

It is therefore futile to box real estate investing into a single analysis. Rather, we will provide a framework for how we think about real estate investing strategies.

We find it useful to index real estate strategies across two spectrums:

1. Active vs passive

2. Speculative vs cash flow

These two spectrums together for a matrix for this to map real estate investing strategies.

Below is an incomplete collection of examples.

	Active	Passive
Cash flow	Fix & flip Buy, fix, rent	Dividend-oriented REITs Single family home rentals
Speculation	Timing cyclical markets such as LA & Miami	Private equity real estate funds. REIT picking

Speculative real estate investment strategies suffer from the same weakness as day trading & stock picking - the results are not consistently reproduceable after controlling for luck.

The active strategies are off limits for two reasons:

1. Active strategies are usually specific to a particular location, and therefore mostly not relevant to the majority of our readers, and

2. We believe investing is a means to time freedom, and thus do not share strategies that require a considerable amount of time and labor to implement.

This leaves passive, cash flow-oriented strategies on the table for our analyses & research. We therefore consider these strategies as components within our portfolios.

How tactical portfolio management works

It's not what happens to you, but how you react to it that matters." - Epictetus

Earlier, I criticized stock picking & day trading strategies for their reliance on an investor's ability to predict the market, which largely does not exist.

Specifically, these strategies rely on an investor's ability to predict how the market will value a specific company for in the future. This is one of the hardest things to predict in the world. It is a bit like predicting the number of vehicles in Manhattan at any given moment. There are just two many variables.

In short, tactical portfolio management works by:

1. Predicting only stable properties of the market

2. Reacting to erratic outputs of the market

Stable properties of the market are used to crease assumptions. Examples include:

• Long standing correlations between asset classes will continue into the future, such as the anticorrelation between stocks and bonds.

• Long standing price behaviors of asset classes will persist into the future, such as the cyclical and trending nature of commodity prices.

• Specific types of assets will respond to economic environments as they did in the past, such as growth stocks benefiting from a low interest rate environment.

We then construct strategies that profit from these assumptions.

For example, lets assume asset class A and asset class B have been negatively correlated long into the past, and we predict this anticorrelation will continue into the future.

From this, we can construct a portfolio that utilizes a rebalance strategy to profit from this anticorrelation.

Say we have a $1,000,000 portfolio with these two asset classes, A and B, each with 50% target weights.

Over time, component A grows by 100% while component B falls by 50%. This means component A's current weight is now 80% while B's is 20%. Our portfolio now totals $1,250,000.

We rebalance back to 50% each:

Then, component A falls by 50% while component B grows by 100%.

We, again, rebalance back to 50/50. Our portfolio now totals $1,562,500, a gain of 56.25%.

Had we never rebalanced, our portfolio would still total $1,00,000. Rebalancing increased our portfolio’s performance by 56.25% by locking in profits from the oscillations between these two anticorrelated asset classes.

To recap, we:

1. Relied on an assumption about a property of the market (anticorrelation between asset classes A and B), and

2. Reacted to erratic market prices by rebalancing at specific thresholds.

How to practice tactical portfolio management

Anyone can practice tactical portfolio management. It does not require intense analytical skills, insider knowledge, or for you to be glued to a trading monitor every morning.

The knowledge and activities involved are as follows:

1. Learn how to form assumptions via back testing, basic quantitative analysis, and fundamental rationale.

2. Learn the various exposure strategies for each asset class: the instruments (ETFs, options, etc.), and techniques for turning assumptions into profits.

3. Learn how to design and manage a portfolio.

4. Learn how to automate this process to reliably adhere to your strategies and maximize your freedom.

The purpose of Portfolio Tools is to make this process as easy as possible by doing most of the heavy lifting for you.

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To your sovereignty,

Sal