Skill, Luck, and Strategy: What Chess Can Teach You About Investing with Rubin Miller (EP.169)

0:28We all need to make smart decisions with our money. down with Ruben Miller, a chess master, experienced investor, and author behind one of my favorite blogs, Fortunes and Frictions. Ruben's unique background provides a fascinating lens through which he views the world of investing, combining the strategic thinking required in chess with the complexities and uncertainties inherent in financial markets. Ruben and I discuss a wide range of topics in this episode, but they all seem to center around the idea of navigating the unpredictable waters of investing. As always, this episode is packed with practical advice and thoughtful reflections, all of which you can read about in detail in the show notes at thelongterminvestor.com.

1:15And now, here is my conversation with Ruben Miller. Ruben Miller, welcome to The Long-Term Investor. Peter, thank you. Now, you know this. I always tell people that your blog, Fortunes and Frictions, might be my favorite investing blog out there. And I think part of the reason that you are such a great writer is that you have such a great background of very heady, intelligent, thoughtful things. I mean, you were an options trader, you were a chess master. I love when you wrote about chess. You said chess is complex, but it's not random. And I think it'd be really easy for somebody with a marketing background and zero investment knowledge to look at you and spin up this idea that like being really good at chess makes you really good as an investor.

2:04I'd love to start there. First of all, tell people about your experience becoming a chess master at a young age, but then sort of some differences between a game like chess and a quote game like investing. Sure. Thank you. My second time joining on you is a pleasure. Last time I feel I'm glad to be here alone this time. I had it. I always kind of say kind of a unique childhood. I was introduced to chess at a pretty young age, probably like six or seven. And I lived in a city. I lived in Rochester, in New York at the time that had this really robust chess scene. And there was this very sort of well-regarded chess club.

2:41And my parents could just drop me off there. It's like free daycare after school or free babysitting. And there was something to do probably five or six nights a week. And then also on the weekend. So I was mostly like interested in a game. I'm not like IQ off the charts or anything like that, but I was really interested in the game. I played a lot. And when you play a lot of a game against good players, you get a really good feedback loop, right so like when you do something wrong against good players you get punished for it it's really easy to get better at chess relative to other games by just playing a lot because even just games against good players become lessons if you play games that have randomness and uncertainty like if you sat down and played poker for a while and you weren't really trying to learn but you're trying to glean things from outcomes you wouldn't become a very good poker player because a lot of times you're going to have good outcomes even though you did the wrong thing you'll have bad outcomes, even though you did the right thing.

3:33In chess, that doesn't happen because all the information's right there. So this childhood I had of playing so much sort of allowed me to elevate to some levels in the chess world that I probably wouldn't have been able to do on raw talent alone. I'm just not as smart as a lot of my other peers that I was sort of competitive with at the top tier. I do like writing and talking about chess a lot because it's kind of a perfect laboratory to talk about luck versus skill, which Peter, as you know, in our job is one of the hardest conversations to have with investors and many of our clients or prospective clients, because it's so rare that someone has the humility to accept that how random many of their outcomes are.

4:13And if you think about the people that might talk to our firms, like I work with a lot of people in Silicon Valley and they have worked at companies like Meta or Google or Amazon or Apple or something like that. And they've worked there for 15 years and they have stock and they never sold it and it's grown a zillion percent and blah, blah, blah. And they've had this really amazing outcome. And they come to me and they say like, what should I do with my money? And I'm like, well, don't do stuff like that. Well, you're way better off having not talked to me 15 years ago because I would have told you the same thing and the same thing about my philosophy, which is that you can make those decisions.

4:47You can hold on to single stocks. And there is a small probability that you'll do really well. And for many people, that is true. And that has happened. But looking back, you have to basically say, was that knowable ahead of time? And I would argue it wasn't. And there's a lot of people who had bad outcomes by owning single stocks or having concentrated positions. And we just don't hear about that as often. Chess is just very different from that because in chess, there's no randomness. All of the information is there on the board. You don't necessarily become a great player for knowing that you can still make mistakes, right?

5:24But there is no randomness. So the blog post you're referring to, which was titled, I believe, do chess players make good investors? I would love to tell you that yes, they do. Because like, I'm a pretty good chess player, hire me, I'll make great investment decisions for you. In reality, it's not true. Having a mind that can be tactical and strategic is not enough to go and outguess the stock market. And so while I think and I mentioned this in the blog, I think that being good at things like chess can help you be a strategic thinker when it comes to financial planning and being strategic about the risks and rewards you might be choosing or not choosing in your life.

5:58Being a good chess player is not going to help you pick stocks any better. Well, let me test this analogy with you, because you'd mentioned like knowable outcomes. And so if I think about chess, for example, there are some known knowns, like we know what the different pieces do. There are some known unknowns, which are, we don't really know what our opponent is going to do with those pieces. Although if you're really good at chess, maybe you can see certain developments happening, but then there are unknown unknowns. And in chess, if I were going to compare it to investing, it'd be something like half of the board is torn off or suddenly someone comes by and just adds a bunch of pieces to your opponent or to you or takes it.

6:36I mean, that's sort of where the fixed outcome versus randomness of the investment world works. Do you think that's a fair comparison? Absolutely. Because like there really are no unknown unknowns in chess, this thread of no knowns, no unknowns, unknown unknowns for those less familiar. That's how Donald Rumsfeld, that's what he used to describe weapons of mass destruction back in the early 2000s or mid 2000s when we were looking for them. And he was basically saying, we don't have all the information. There's no knowns, there's known unknowns, and then there's unknown unknowns. making decisions when unknown unknowns are present or potentially present it's probably a better way to say it is extremely challenging you have to do the best you can with the information you have and i think that human brains are just not wired so great for that again that's why chess is such a great laboratory as you describe an unknown unknown in chess it's not going to happen on the board it's going to be someone doing something weird something illegal it's a really fascinating thing.

7:31I mean, if you look at world champions in various games, if you look at the world champion in Scrabble, there's a little bit of randomness in how you select tiles when it's your turn to pick new tiles. You might get really good ones, you might get really bad ones. But we all know if you go play Scrabble against someone who's like really, really good, it's not enough to pick a few good tiles. They're going to smoke you. The world champion in Scrabble is not the same every year. But if you look at the last 10 or 20 years, you'll see the same name a few times. So they can compensate for some of that randomness if you're really, really good.

8:05Same thing with poker. It's a little bit more random. It's a little harder. There's a lot of good players. You look at chess, we have years, there was a period in the 1800s where the same person was world chess champion for almost 30 years in a row. The last 15 years have been dominated by one person, Magnus Carlsen. So once you're the best chess player in the world, you're just the best chess player in the world. and it's going to take a lot potentially to have thrown you. If you all of a sudden win the poker championship one year, you don't have a right to say you are definitely the best poker player in the world.

8:38There's an element of randomness that happened to work in your favor that got you there. Same thing with Scrabble. You don't have a right to say that it's a truth. It's a possibility and a not unlikely possibility that you're the best Scrabble or poker player in the world. Certainly you have a claim to it. You won the tournament, but it's a tournament that has randomness. If you win the chess championship, you are the best player in the world. There was no randomness. I think that's a big difference. Again, something that we don't think so much about. Our brains aren't necessarily wired to think that way, that someone might win the poker championship and someone still might be able to say, that doesn't mean you're the best player in the world.

9:12That's hard for us to think about, but that is true. Yeah. And this idea of there's skill and luck in any activity is probably one of the most important ideas that I had learned about earlier in my career. And I think it's Michael Mobison who talks about how something is pure skill if you can lose on purpose. And so if you think about chess, it would be easy to lose on purpose because there are these fixed rules. In poker, you can't necessarily lose on purpose. And investing, you definitely can't lose on purpose. I actually had a conversation a couple of weeks ago with somebody who's like, well, of course, I could lose on purpose with stocks.

9:48I just picked the worst ones. And I'm like, well, that's what shorting is. and short selling is even more difficult, arguably, than just buying and holding a stock. So I think recognizing with investing that there is some mix of skill and luck is really important. But I also think that you sort of mentioned this yourself, where investors, they're just really focused on the known knowns and the known unknowns at any given point in time. But our brains aren't really wired to think about the unknown unknowns. Our brains weren't wired to think about, hey, here comes COVID. Even though people were looking at all these different risks, then COVID hits.

10:25That's just something you can't predict. Or you can't predict that somebody is going to fly airplanes into buildings. You can't predict some of these things that just ultimately, if you were trying to protect against them, there really wouldn't be any way to do so without giving up all return. Part of the reason why we as investors get the long-term returns that are available to us, why there is a long-term return available there is because we have to accept unknown, unknown risks that planes might hit buildings, that viruses might become pandemics, things like that. I mean, that is part of why we get a return because we're willing to buy stocks despite that those might happen.

11:03But I agree with you entirely. And I think it is something that gets vastly overlooked in a world of sort of quick hit media bites and dopamine hits is people love comparing things or thinking about things or discussing things that really aren't big needle movers. They're not going to have impactful outcomes in your life. So for instance, people will compare two very similar index funds. I see this all the time on the internet. Like, do you like this Vanguard index fund that owns US large cap stocks? Or do you like this index fund that owns US large cap stocks? It's slightly different. And it's like, I think you should probably be thinking about planes hitting buildings and viruses instead.

11:41Like that is a much bigger driver of your long-term outcomes is how are you going to act on September 12, 2001? What are you going to do at the end of March, 2020? What are you going to do with your portfolio? Do you have a thought partner, an advisor you work with, or do you have the ability to sort of make decisions on your own? Those things, what you do in those very small windows of time that have these dramatically outsized impacts on our long-term outcomes as people, as family members, as investors, it impacts our money, our happiness, our health. All these things are way bigger topics to explore and inform the way you design a portfolio rather than some really good index fund is better than some other really good index fund.

12:23Sometimes I think that's more fun for people that really love investing, but the truth is it's less impactful. Well, and I think that in general, I know that you've said something along these lines in your writing before is that like when you invest in stocks, you know, they're going to go up over time. You don't necessarily know that the time horizon that you have for any given goal will match up perfectly along with when stocks are up or they're down. But we know that downturns are going to happen with a similar magnitude and frequency as they have in the past. We just know that. And so we can, like you said, design a portfolio, design a process that allows us to not even really have to make any decisions.

12:59So you had a blog post I loved about a hundred plus year old Japanese mochi company. If you can somehow pull that anecdote out of the back of your mind to share? I think there may be a simulation here. Yeah, that was a while ago. There was this story I read. It was in the Times, the journal or something. I think her name was Naomi Isagawa or something like that. She was, I don't know, 60s or 70s. This mochi, which is like a Japanese tea, I believe. This mochi store in Japan has served tourists for like a thousand years, just coming to the store to buy the product. And when you have a restaurant and you're trying to make more money, like any business, you think about scale.

13:43Okay. People are already here. Can we sell not just the tea, but can we also sell biscuits? Can we also sell cookies? Can we sell bagel? Whatever you're going to sell, they're there. Try to sell more. And what was so cool about her family store that again, had been in her family for centuries and centuries was they just wanted to do one thing really well, which was make mochi. And that was it. And they thought, if we do that really well, we'll be known for that. We can set expectations with people who might come here. We can deliver on those expectations. And those people will tell other people about this experience they have.

14:18If we start to add more products and hopefully increase revenue, that comes with a trade-off of sacrificing what we're really good at. It's almost a distraction, right? It's like in the US or something, I'd be like a coffee shop that really just does coffee incredibly well versus Starbucks, which has expanded to all these various product lines. And every quarter they announce their earnings and stock investors and analysts are all over like, oh, this part of their business was up. This part was down. This is growing. What Naomi was trying to do was say, let's just focus on the one thing we're really, really fantastic at.

14:55And just do that. And anytime there's a downturn, talking heads start forecasting what's going to happen next, what tactical moves you should make in your portfolios. And the reason I wrote that article is because what I firmly believe in is that when you design an investment portfolio with the way you describe it, sort of a process, you want a process. And our process is focused on identifying what's a perfect life look like to an investor. They say, I want to be able to send my kids to college and this year, this type of college. I want to retire at this age or maybe this age. My spouse, maybe this age, that age.

15:31We want to buy a second home. We want to sell a second home. Whatever it is, I need to identify what a perfect life looks like to you. That's going to then inform the portfolio that we're likely going to have. Once we've identified that portfolio, if you have an investment process that's steeped in humility at the way you manage money the way my firm manages money, you are no longer going out there trying to outguess all the other market participants and where you think prices are going in stocks. And so for me, if someone comes to me and we build a perfect life, and let's say we've identified that someone needs to own 75 % global stocks and 25 % bonds, this very basic portfolio, right?

16:14That is now my one thing that I need to take Naomi's philosophy about Mochi and implement with. 75-25. If we get to 85-15, there's an action item to get back in line. There's no action item because I read the Wall Street Journal this morning and I think something's going to happen. There's no action item because I watch the news and I think something's going to happen. Those aren't reasons to do anything. We have one job. Manage risk accordingly based on the life someone's trying to live. And to me, there's only one way to do that, which is identify a sort of long-term investment portfolio that we want to thoughtfully implement.

16:48That's going to evolve as their life evolves, but with the information we have now, and then implement it. And I don't really care what else is going on. And I think that's so hard for people to do to tune out that noise, which is why I wrote the blog post, which is like, look how beautiful the business model of this Moji story is by avoiding all the distractions. And I think that you and I and people like us that have our philosophy can deliver the same investment experience to people. Well, I will definitely link to that article in the show notes at the long term investor.com. Incredible that you're able to remember all these things that you've written over the years.

17:22And let's focus in a little on what you were talking about, where we're trying to come up with that thoughtful process, build that thoughtful portfolio. You have to kind of choose what your certainties and uncertainties are. So for example, as of this recording, the 10-year treasury is about 3.8 % the yield. Even if you bought that certain return over the next 10 years, there would be some inflation uncertainty. And so maybe I ought to say we go and buy a 10 year treasury inflation protected security, and that yield is maybe like 1.7, 1.8. So you could guarantee after inflation, your money's growing at 1.7 and 1.8 % each and every year.

18:00And you've eliminated generally all uncertainties, but you couldn't really grow your wealth at a rate that would allow you to either live your life, you know, do anything other than save or ever have any sort of chance to retire. So if we know that we need to add some uncertainties to the portfolio, how do you start going through thinking of those different trade-offs, those different expected returns, et cetera? I remember talking to my mom before I posted this blog post about that topic, about once you buy risk-free investments like treasuries, and then you buy real treasuries, which means you adjust for inflation so that you're not inflation risk, right?

18:42And the 1.7 % you described, that's if you protect against risk and then protect against inflation, that's what you can guarantee yourself. And it's just not enough to grow someone's wealth 99.9 % plus the people in the world. They're not going to live the life they want to live if they grow at 1.7 % guaranteed. So to your point, we have to take risks. But I remember calling my mom and be like, this blog post is going to go wild. I called it the Jimmy Buffett portfolio because you have no worries anymore. You manage risk, you manage inflation, you are toes in the sand, Corona in your hand, Jimmy Buffett lifestyle.

19:18And it was like not a very well read blog post of mine. But I thought like the idea of like, oh, people are going to start calling it the Jimmy Buffett portfolio. Just go buy all real treasuries. Well, maybe this is what's going to allow it to catch on now. We're going to have a second coming here. Sort of like something that doesn't do well in the movie theaters, but crushes once it goes into people's homes. Now people will know when I submit for conference presentations about the Jimmy Buffett portfolio, that'll maybe let me in. So I agree with you. Our firm, we think about it this way, which is there's three asset classes we primarily care about.

19:51Global stocks, normals, sort of nominal intermediate term bonds. That's just kind of what somebody think was a normal bond. And then ultra short term bonds, which is very similar to cash. The reason why we think about those three is because if we start with the last one, so ultra short term, and we'll use treasuries here for a second. So ultra term treasury, that'd be like a three month treasury bill. It's risk free and it's going to mature really quickly. So if you say you can get a 6 % yield in a short term treasury and it's a three month treasury, I know that three months is one fourth out of the year.

20:26So I'll get one fourth of 6 % or I'll get one and a half percent. I have a very, very high clarity, basically the utmost clarity of getting one and a half percent over the next three months. That's super helpful for planning. If you can provide certainty, right? When you put in an input into someone's financial plan, or you're just describing how much certainty or uncertainty you're willing to accept someone being like, nah, I basically guarantee myself one and a half percent over the next three months, as Peter, you described earlier, maybe there's some inflation risk there. But for the most part, that's a really, really robust input with very little uncertainty around it.

20:58That's helpful for planning. Then there's bonds and bonds, which have the same structure as a short-term treasury that could be very similar as far as like, it's a debt security. You're loaning your money out to someone. You'll get a stated yield and it'll say, you can buy, as you described, a 3.8 % yielding 10-year bond. That means your expectation is, I'm basically going to get around that for the next 10 years. To your point, you don't quite know what will happen with inflation. It's definitely a little bit more complex than you and I are sort of talking about through here. But that's the idea.

21:28Now, in the ultra short-term treasuries, your reality is going to match your expectation. I don't expect any surprises around that. When you buy a 10-year treasury, all of a sudden, you sign up for being a little bit surprised through time. Now, if you can hold on for all 10 years, you should expect to get your yield or something close to it. However, just look back to 2022. 2022, we had this spike in inflation and intermediate term bonds had a terrible year, I think down about 15 % at one point. So you don't expect to say, oh yeah, you'll get about 4 % every year and then have your advisor say, oh, by the way, this year we were down 15%.

22:02That's a really harsh outcome or a frustrating outcome for someone that wasn't aware that could happen. And so bonds are different than ultra short-term treasuries. As you said earlier, the longer you hold them, the more reliable your outcomes, but you can have quick shocks to the system based on factors like a shock in inflation or something. So bonds really have to be tied to someone's investment horizon. And then even more so are stocks, because with stocks, you don't get a helpful yield. You can Google a stock yield, and it'll tell you the dividend yield is X, Y, Z or something. I saw, I know Taylor Schulte was on your show recently, and dividend yields aren't helpful.

22:39They don't tell you anything. That's just your investment giving you some of your own money back. It's not like a bond where your return is on top of your investment. So what people should know is that stocks don't give you any helpful information about what to expect, except they have a long-term average. And as you described earlier, Peter, sort of like, that's what's going to inform how we should expect to do. We have about 100 years of data. Stocks tend to do between 8 % and 10 % per year. Certainly makes sense that, I believe you described a 10-year bond, risk-free bond at around 4%. I know even shorter-term bonds right now are about risk-free for 5%.

23:13If someone's going to convince me to buy stocks or anything else that has risk, I better expect more than 5%. Otherwise, I'll just go buy what's for free that would yield me more. So for stocks, you'd always expect them to be more than 5%. Turns out the long-term average is about 8 % to 10%. That's reasonable. If I'm going to give my money away and buy companies across the globe and own small pieces of them all over and not have any say in how they're run or anything, just sort of a passive owner of them, I could have a really bad outcome, right? We know periods, global financial crisis, the three weeks after COVID hit, you can have really bad outcomes as a stock investor.

23:47You need to be rewarded for that. You'd expect to be rewarded above any risk-free rate. Turns out it's about 8 % to 10 % a year, but over a really long time horizon. So your initial question of sort of like certainty to uncertainty, expected returns, I would say you always want to take a snapshot of the risk-free returns. So the ultra short-term one, call it three months or six months. The 10-year treasury, what you can guarantee yourself not including inflation for 10 years, you're always going to buy stocks thinking you're going to get more than that, but that there's some variability around that.

24:18And also that you might be wrong. We can have decades where stocks don't do what we wanted them to do. They can't underperform treasuries for longer than 10 years. And so that's why our business is so fascinating because it's like, hey, we can make all the best decisions just like at a poker table and we can do terribly. The longer time horizon you have, the higher probability you will achieve sort of well calibrated capital markets expectations, what you thought would happen. But as you know, investors are commonly frustrated and that's because expectations don't have to match reality. It's why it helps to really understand the things that you own.

24:57So that's how we think about certainty to uncertainty. When you design someone's perfect life through their portfolio, you are taking this timeline of things they're trying to accomplish, whether it's college for the kids, weddings, homes, retirement homes, nursing homes, whatever it might be. Those are all inputs. And we have to basically connect the types of assets they own and the uncertainty embedded within those assets or the expected uncertainty, I should say. And that's how you and I design portfolios. One of the hardest things I find as an allocator, as an advisor, is just that good decisions can lead to bad outcomes.