Everything is an “Alternative”
Exploring the consideration of alternatives in decision making
Before I begin on this topic, please take everything I say with more than a few grains of salt. I am not from the field of professional investment management, did not major in finance, and have no special insight into this field. I am a guy sitting in Middle Tennessee trying to make sound investment and managerial decisions on behalf of our employees, their families, my family, and our charitable giving partners.
As I have worked to educate myself about how others make investment decisions, I have regularly heard folks refer to certain classes of investments as “alternatives”. It got me thinking about what an ‘alternative’ really is, which is a topic much broader, more qualitative and much more applicable than only improving investment thinking.
As the title says, I really view everything as an alternative. More precisely, I try to view everything in existence as an alternative to something else (except when there are no alternatives…that can be a fantastic or damaging position).
In my personal decision making process, whether this is investing, hiring, how to spend my time each day, what book to read next, which doctor to see, whom to marry, what home to buy, where to live, which school to select for my daughter, and so on I first think about the other primary options. I want to know all other options that 1) have a substantially similar proposition to what I am considering where 2) I fully understand what is being offered, 3) are better than what I already do and 4) are available to me.
From what I can see, the generally accepted wisdom in the field of professional investment management is that all investment opportunities are just an alternative to public equities (stock) and bond portfolios. It seems that this public asset portfolio is viewed as the default because it is safer (read: less ‘volatile’), more reliable, more understood, etc, and therefore everything else should be considered an alternative to this option.
I think this misses one of the key principles in investing. The most basic explanation of investing is that you are trading some money today for a stream of money going forward, starting at some future date. You have to determine how much money you’re getting, when you’re getting it, and how long that stream of money will last. Don’t take my word for it, Warren Buffett makes that extremely clear here.
So then why would someone leap to the conclusion that the public portfolio, at all times, contains the best configuration of 1) how much money, 2) when and 3) for how long, no matter what else is available?
The primary rationale is that the public portfolio affords you maximum liquidity (which it does) and, if a ‘balanced portfolio’ is well constructed, then it would give you the smoothest, least volatile ride. I agree with all of that, but those two elements (liquidity and volatility) are only part of the feature set of the public portfolio as one investment option. I think there is a major difference between features and desired results. I am wary of letting really desirable features prevent me from checking all alternatives that might better achieve my desired results.
Granted, for some people investing may be about smoothing the ride or maintaining maximum liquidity. I can absolutely understand this in the situation of a retiree, for example, or where capital preservation at all costs is the only goal. This seems to be usually achieved at the cost of performance and returns and may not even keep up with inflation after management fees are considered. If the desired result for an investor is lowest volatility and maximum liquidity, then ideally those desired results are selected consciously and with the trade-offs well understood. For all others, I think we can agree that best available returns combined with the lowest probability of permanent loss of capital is the desired result.
Nice features can often be the tail that wags the dog. For example, let’s think about the decision to buy a particular home. It is generally a personal decision that folks can see differently, so it might be a good case study to view the difference between results and features. I’ll review why we purchased the home we did.
Scenario: We find out my wife is pregnant with our first child so I immediately go into provider mode and think we need to buy our first home (...possibly a fallacious fear reaction, but nevertheless, we’re human). First I listed my desired results.
What desired results matter to me?
Buying the option for high quality public (free) schools while still generally accessible to the Nashville metro area via an enjoyable commute.
A family community and well developed neighborhood.
A good price that implied some upside over time.
A high quality, newer home that is pleasant to live in with some extra room for additional kids, but not so much that I would feel wasteful.
A mortgage payment that would allow us to keep our lifestyle requirements very low and reasonable so as to not burden our company (this was easier to achieve since we were looking to purchase in 2020 and lucked into a once-in-a-lifetime mortgage rate).
Let’s start looking for options filtered by our desired results. Over the course of four weekends we toured 26 different homes in Williamson County, the county just south of Nashville with the best public schools in Tennessee. We toured homes in Franklin, Brentwood, and Nolensville. We also toured more homes in different adjacent counties with school districts that are quite good or improving: Hendersonville, Mt. Juliet, Lebanon, Gallatin, etc.
Summary: We reviewed a sizable sample of the alternative locations and homes. I mentally summarized the results like this:
Franklin and Brentwood homes are older (not desired result), but more highway accessible (nice feature), and are priced at or above what I think they’re worth (not desired result). These communities are popular and have had more time to develop, so everything seemed to be pretty fully priced.
Hendersonville, Mt. Juliet, Lebanon and Gallatin have interesting price options (desired result) but the neighborhoods we saw were not as well developed as we wanted them to be (not desired result). We also did not think the commute to Nashville was enjoyable (not desired result).
Nolensville is 15 minutes from the nicest highway in our area (not a nice feature), however:
The schools are as good or better than all the other towns in Williamson County (desired result).
The homes are generally priced lower than Brentwood and Franklin (desired result), which share the same school district. The mispricing is due to Nolensville’s distance from the highway. I thought, to future buyers, the schools would matter more than highway access.
There is a nice, high quality, custom home built in 2014 in a well-developed family neighborhood of 800+ other homes available at a price per square foot 30-40% below the other current Williamson County alternatives. We could comfortably fit a family with three kids in this home, if we got there (desired result). In the meantime, we can rent half of the home to another married couple whom we love (we did this for three and a half years!).
My commute is 35 minutes door to door, but it consists of 15 minutes of driving through beautiful, cool green woods and then 20 minutes of driving on our area’s nicest highway (desired result).
Bet: That our Nolensville home would provide us (and future buyers) with the option for fantastic public schools, in a desirable, family friendly community where we would enjoy living each day. It was available at a price well below what I think those features were worth despite being less highway accessible than its direct alternatives.
I mentally summarized the features of all the alternatives down into what would help me get the desired results (option for a great free public school, good price, family community, pleasantness) and had to give up what I considered to be one key feature (immediate highway access).
It is true that choosing to look at highway access as a feature and not a desirable result is purely a personal assessment. There are very few things about the reviewing of alternatives that are objective or quantifiable. I think the key in assessing alternatives is to know what result I want. Alternatives can look very different to different players based on what they are trying to achieve. Highway access may have mattered MUCH more to a different buyer than it did to us. However, I believe this is the part of decision making where clarity with oneself is of paramount importance. If I am unclear on my desired results or not willing to be honest about what I am seeing in my research, I may delude myself and turn a nice feature into the entire reason for making this decision.
I am trying to train myself to think of each decision point as an optional game (like a hands of cards) that I could or could not choose to play, relative to all other options available to me. I could have chosen to play out the “rent a home” hand vs the “buy a home” hand, but I thought the “buy a home” hand had more desirable results and favorable features. That is purely a personal choice but one that bears keeping in mind. You don’t have to play every game you’re presented with. The games themselves are alternatives. One of the alternatives you always have is to abstain from playing.
Applied to investments, here is a list of various questions I ask when thinking about alternatives:
Is this a game I want to participate in? What other games are available to me right now that I might like better, be better at, give me more of my desired results, etc?
Is this game better than the “do nothing” or “do more of what I already know” options?
If I choose to participate in this game, what results matter to me? Can I be honest about those and stick to them?
How well do I actually understand this game? Am I being honest about this? To quote Charlie Munger; “What do I not yet know that I need to know [to decide if I am playing this game]?”
If I am working to understand a potential game, I always start with Porter’s Five Forces (P5F). At its core P5F is just an assessment of alternatives. Let’s assume the game we’re considering is to buy one of a few businesses available to us. I could restate P5F like this using alternatives language:
What are all the available alternatives to the business’s key suppliers? Are there plenty of folks out there who can sell this business what it needs?
How many accessible alternatives do my customers actually have? What prevents them from developing new alternatives to what this business provides? What can we do to make the development of new suppliers less desirable?
If other people with capital are looking for opportunities, how attractive or repellant is this [industry, segment, product line, etc] relative to their other alternative uses of capital? What makes this area a hard or undesirable alternative to choose when outside money is looking for new, greener pastures?
What does this business bring to the table vs its current competitors that make it a desirable and interesting alternative for current and potential new customers?
Are there true substitutes to this company’s value proposition that I need to consider as real alternatives a customer might consider?
I love the way Buffett describes leveling out the investment decision making process. He says “Pretend every investment opportunity is a bond where you do not know the yield or the maturity date.” That way of thinking is so helpful to me. It equalizes all the alternatives, puts their nice features into second position, and focuses on the elements that really matter to achieving the desired result; how much cash is generated over time, when and for how long?
Finally, I'll leave you with this. My dad has said for years, “Keep your options open. Keep your baggage light.” May not be great relationship advice, but it has worked wonders for my thinking and decision making. It reminds me to 1) consider all options and 2) do not be in a situation where you are restricted from selecting any of them.
