12 Entertaining Finance Movies that will Teach you Finance

Finance is a broad subject with many facets that make learning it a large undertaking for anyone.  These films, watched in order, will lead to a relatively comprehensive understanding of what finance is, how it works, and how it affects our society.

Foundations of money, finance, and the corporate structure:

  1. The Ascent of Money: A Financial History of the World (2009)
    This is literally a full history of how finance has developed through time.  From the first currencies ever used, to financing wars with bonds.  Watching this film beginning to end really does create a strong foundation for understanding how finance has developed through time.
     
  2. The Corporation (2003)
    One of the most important concepts that drives modern finance is the corporation.  Understanding how the corporate structure influences business decisions is fundamental to grasping the general ideas of finance.
     
  3. Capitalism: A Love Story (2009)
    The social effects of the corporate structure on a capitalist society are examined in this film.  Widening income gaps have often been attributed to finance.  This film furthers the ideas introduced by The Corporation and applies them directly to a real financial crisis.

    Failures in the financial system, fraud, greed, and regulatory issues:
     
  4. Enron: The Smartest Guys in the Room (2005)
    A comprehensive look at how a corporation was able to defraud thousands of people with its accounting practices leading to massive changes in the regulatory systems for financial reporting.
     
  5. Too Big to Fail (2011)
    Understanding the actual finance behind finance is only half of the battle in truly understanding finance.  This dramatization of the fall of Lehman Brothers, and the beginning of the financial crisis, shows how personalities, government decisions, and personal relationships all play a massive role in driving the financial markets.
     
  6. Margin Call (2011)
    When the US financial institutions began to crumble, they began to unload their worthless securities to other institutions and clients to avoid their own collapse.  This film gives further insight into the decisions that nearly collapsed the financial markets.
     
  7. Inside job (2010)
    Further reflection on the 2008 financial crisis with insights from global policy makers and academics.  This film further reinforces the concepts introduced in Too Big to Fail and Margin Call, but it is not a drama.

    How financial markets actually work, the buying and selling of securities, and the retail environment:
     
  8. Floored (2009)
    This documentary looks at floor traders, the people buying and selling securities on an open outcry trading floor.  Although this film gives plenty of insight into this part of the financial markets, floor traders have been replaced by electronic trading.
     
  9. Money and Speed: Inside the Black Box (2011)
    The level of influence that automated trading has on the financial markets today is intimidating.  This is an area that is constantly evolving and will continue to evolve.  Eugene Fama argues that the algorithms used in this type of trading make markets more efficient.
     
  10. Boiler room (2000)
    This movie does not by any means depict every stock broker.  It does, however, give insight into the way that the business works at the retail level, and shows how sales driven the industry can be.
     
  11. Wolf of Wall Street (2013)
    Similar to Boiler Room, this film shows an extreme case of how sales driven financial markets are.  The film is quite wild, but it does offer another opportunity to see how securities are created, bought, and sold.
     
  12. The Retirement Gamble (2013)
    From the perspective of an investor, this film is the most important.  It shows how all of the pieces fit together to make the investment climate for retail investors extremely difficult to navigate.

21 Rules for Young Professionals

You just broke into the workforce as a professional.  Your first real job in the real world.  It won’t always be easy to navigate, or obvious what to do.   This list of timeless rules can serve as a guide to anyone hoping to survive their first foray into the life of a young professional.

1.       Understand failure
It is a thing that will happen.  Be prepared for it, and be prepared to learn from it.

2.       Embrace criticism
There’s nothing worse than seeing a person pout after they receive negative feedback.  You’ve just been given an opportunity to get better, use it. 

3.       Live outside of your comfort zone
Hate public speaking? Look for opportunities to speak in public.  No good at writing? Start a blog. 

4.       Stay humble
Everything that you have achieved up to this point is great, but it means a whole lot less if you start to act entitled.  Let your results speak for themselves.

5.       Have confidence in your work
There may be times when you feel like you have no idea what you're doing, but you landed in your role because someone trusted your ability to figure it out.

6.       Be reliable
There's no substitute for being on time, and being prepared.  Whether it's a meeting, a presentation, or drinks after work, show up on time and be organized.

7.       Become an expert in your field
School's over, and the skills you need for your job won’t always come from your education in the classroom.  Taking the initiative to master your role  can be the difference between a job and a career.

8.       Invest in your appearance
A professional appearance means a lot more when you’re 25 and don’t have ten years of workplace performance to back you up.  Nice clothes, shoes, and a haircut are all good places to start.

9.       Keep your work area clean
Whether you are in an office, a cubicle, or working out of your apartment, people can see your workspace and it reflects directly on your professionalism.

10.   Under promise, over deliver
Doing what you say you will do is one of the straightest paths to credibility.  No amount of education or connections will be able to overcome the damage of failing to follow through.

11.   Use your network, and let it use you
Who you know can make a world of difference, especially when you’re starting out.  Ask for help, ask for introductions, and be prepared for people in your network to ask you for the same.

12.   Handle yourself appropriately in social situations
It’s ok to have drinks with colleagues, even a few, but people never forget the time you make a fool of yourself.  One rough night can be a career limiting move.

13.   Always maintain your integrity
Compromising yourself for any short term gain is not an option, it will be outweighed by the repercussions and become a permanent part of your reputation.

14.   Be a great teammate
Help, support, and encourage everyone that you work with.  Whether they are peers, superiors, or interns, everyone is working toward the same goal.

15.   Manage your online presence
One of the first things someone will do when they want to know about you is Google your name.  Clean up Facebook (or make it private), put some time into your LinkedIn, and be responsible on Twitter.

16.   If you don’t know the answer, admit you don’t know
Honesty defines credibility, ignorance will dig a hole you can’t crawl out of.  Telling someone that you will get back to them with an answer will be understood and appreciated.

17.   Get your hands dirty
If you’re asked to do something, do it.  Nothing is below you at this point in your career, and you will learn something from every task you complete.  If you’re stuck doing paperwork for a week, get really good at doing paperwork.

18.   It’s ok to start small
No matter where you start, it will be your persistence, patience, and consistent effort that will lead you to success.

19.   Learn from your mistakes
You will make mistakes, it is normal and acceptable. Mistakes only become problematic if you make the same ones multiple times.

20.   Own your mistakes
When something goes wrong, deflecting responsibility makes your trustworthiness and dependability evaporate.

21.   Be a good person
Everything else in this list is moot if you’re not a good person, and being a good person is the best networking you will ever do.  Help people, volunteer, say thank you, leave a tip, and hold the door open.  You never know who is watching.

Contributors to this post:

@theaearl (Shopify)

@simonwlove (Ernst & Young)

@Marius_Felix (Brentwood College)

@beesureman (CBRE)

@MaxLanePWL (PWL Capital Inc)

Risks Worth Taking

Wealth creation takes place when cash flow is steady, there is time to recover losses, and risk is tolerable. 

It's not uncommon for the ability to take risk in the market to be confused with the desire to gamble.  There are some risks worth taking, and some risks that can turn an investment account into a sophisticated platform for placing bets.

Of course, it's a lot of fun to do research and be immersed in the latest information about a company or an industry with the hopes of taking action before the market does.  Consider, though, the amount of other individuals, and more importantly institutions and mutual funds, that are trying to do the same thing.

By the time you read a Bloomberg News headline, the market has already reacted.  By the time the company you're following discovers a new reserve, institutions have already started trading.  The ability of the collective players in the market to price a security as soon as new information develops is intimidating.

It's easy to think that with enough research, it should be possible to outsmart the market by predicting new information before it happens, but new information develops randomly.  If we could predict all new information accurately we wouldn't need the market to create wealth.

So what's a risk worth taking?   It has been proven through years of research that small cap and value stocks produce superior returns over the long term.  Constructing a portfolio tilted toward these asset classes can increase expected returns without relying on speculation.  With these tilts in place, diversifying globally, and across asset classes can almost eliminate non-systematic risk.  You may never make 200% on a speculative bet, but major losses will likewise be reduced.

In creating wealth, the sequence of returns is just as important as the returns themselves.  It's very difficult to beat the long term compounded returns of a robust portfolio with a series of speculative bets.

This may not sound exciting, and it shouldn't.  Well documented research stands behind these remarks - I'm talking about using science to invest, and science is not nearly as exciting as gambling. 


Market Based Investing

In 1991 William Sharpe wrote an article in the Financial Analyst’s Journal titled The Arithmetic of Active Management.  The main point of the article is that after costs the return on the average actively managed dollar will be less than the return on the average passively managed dollar.

Sharpe is only addressing the average actively managed dollar, so there must be some actively managed dollars that are outperforming the market.  Over the five years from 2007 to 2012, actively managed Canadian equity funds only outperformed the S&P/TSX Composite 9.8% of the time, and actively managed US equity funds over the same period only outperformed the S&P 500 4.6% of the time.  It would be great to be able to pick these outperformers ahead of time, but predicting the future would offer many other benefits, too.

I am happy to disagree with the idea of predictive investment management, but don’t condone the idea of passive investing either. I stand behind a strategy called market based investing.  It is the idea of harnessing what the market has to offer, while taking advantage of asset classes within the market that have been shown over the long term to produce higher returns than the market itself. The idea is to hold the entire market, and then increase the proportion of certain asset classes relative to the market to take advantage of their higher expected returns. Trying to determine which markets would be the best to apply this strategy at any given time would be betraying a scientific approach in favor of prediction. The solution is to build globally diversified portfolios in order to capture the returns of markets around the world while reducing the impact of any single market.

These globally diversified portfolios tilted towards specific asset classes are then rebalanced systematically to eliminate predictive and emotional tendencies as markets move. Implementing this rules-based system ensures that emotions and predictions are removed from investment decisions, and sets a market based portfolio apart from the active vs. passive debate.

Understanding the Stock Market

Why People Invest

I already explained what a stock is, so I should have the foundation to go ahead and discuss what the stock market is in some detail.

Before I do that, I need to explain why we want to invest in the first place.  In the chart below you can see some different lines.  The ones to focus on for right now are the orange line, which is a representation of a dollar invested in the US stock market, and the light green line, which is a representation of a dollar invested in US treasury bills.  It is obvious that a dollar invested in the stock market will grow more than a dollar invested in a treasury bill, but why is that?  A treasury bill is issued by the US government and is what is referred to as a risk free investment because it is very unlikely that the US government will fail to pay someone holding a treasury bill.  Being invested in the stock market is riskier because you are owning pieces of companies which can go down in price, even go to zero if the company goes bankrupt.  Investors need to be compensated for taking risks when they are investing in companies, otherwise they would only invest in the treasury bills.

The difference in returns between the treasury bills line and the stock market line is called the market premium, or the amount of investment return over and above a risk free investment that can be expected for investing in stocks.  So when you are saving for a long-term goal, it can make sense to invest in stocks because they will give you a higher expected return over time.  The chart below shows the returns of the total US stock market minus the returns of US treasury bills every year from 1927-2012.  On average, the market premium was 8.05%.  This means that on average, being invested in stocks meant that you could expect a return 8.05% higher than the return from being invested in treasury bills.  Notice that the red bars are years where stocks had negative returns; that is the risk of being invested in stocks rather than treasury bills.

 

The Market

We know stocks are pieces of ownership of companies that allow individuals to partake in the company's growth and losses.  Partaking in the growth and losses of a company by buying an ownership stake is called investing in the company, and investors receive higher expected returns for being invested in companies because of the risk involved.  All of the investors that buy stocks need a place to buy and sell their stocks, and that is where the idea of the stock markets becomes important.  If there was not a stock market, people that wanted to buy and sell stocks would have to find each other manually; it would be like Craigslist for stocks.  Having consolidated public stock exchanges makes it much more certain that a stock will be available to buy when you want to buy, and you will be able to sell when you want to sell.  This makes stocks much more liquid, or much easier to convert back into money.  If stocks became illiquid they would go down in value drastically because people would not be able to convert their ownership in a company into money when they need to.  The integrity of the stock market is a very important part of investing, and there are safeguards built into public exchanges to ensure that the markets remain liquid.  So it's easy enough to understand that the stock market is just a big public marketplace where investors can buy and sell stocks, but what are people talking about when they say the market is up or down?  Or when they talk about beating the market?  There are different stock markets around the world, and within different markets there are different stock exchanges.  So what is the market that people talk about in the media?

To explain this further I need to explain what an index is.

How an Index Works

You might have heard about the S&P 500, or the S&P/TSX Composite.  These are indexes.  An index is a grouping of stocks that has been selected to represent a particular market.  The S&P 500 is one of the best known indexes in the world; it is 500 stocks that have been selected by Standard and Poor's (a financial research company) to represent the US stock market.  When you hear that the S&P 500 is up, it means that the overall value of all of the 500 stocks included in the index is up.  It is important to keep in mind that although the S&P 500 has been selected by the very smart people at Standard and Poor's to represent the US market, it only contains 500 of the largest, most well known companies that are traded on public exchanges in the US; overall, there are about 5000 companies with stock that trades on public exchanges in the US.  One of the major uses of an index like the S&P 500 is benchmarking.  Benchmarking is using the performance of an index as a tool to compare the performance of other groupings of stocks, or individual stocks.  When you invest in a mutual fund, or have a broker tell you that they will build you a portfolio that will beat the market, they are saying that they will pick a stock or a grouping of stocks that is different from their benchmark index that they think will allow your investment to perform better than investing in the companies in the index.  If a fund invests in American companies it will likely use the S&P 500 as a benchmark index, and a fund that invests in Canadian companies will likely use the S&P/TSX Composite as a benchmark index.  The whole idea here is that if someone has the ability to predict which companies within a market will perform well, they can buy those companies instead of buying the companies in the benchmark index so that their fund will perform better than the index.  Now, because there is a lot of research involved in deciding which stocks will do well and which ones will do poorly, there are fees that have to be paid to the investment manager if they are going to try and beat the market for you.

Investing in the Market

You can choose to invest in an index that has been built to represent a given market for a very minimal cost, or you can choose to pay a significant cost to invest in a fund that is going to try and do better than the index.  It is very easy to invest using both of these methods.  You can buy something called an Exchange Traded Fund (ETF) which will track an index, or an index mutual fund which will do the same.  Companies like Vanguard and iShares allow people to invest in an index of their choice for a very low cost; you can choose to invest in the S&P 500 which we know is 500 of the largest companies listed on US exchanges, or the Russell 3000 which is an index that is designed to represent all  of the companies in the US market, or the MSCI EAFE which represents all developed markets outside of the US and Canada, and the possibilities of indexes to invest in go on forever.  Investing in a fund that will try and beat the market is equally easy to do, companies like Fidelity have plenty of different funds with different strategies designed to outperform a given index.  To illustrate the difference in cost of these two strategies, the Vanguard Total Market Index which invests in 3000 American companies designed to represent the total US market costs you .05% of your investment account to hold, and the Fidelity US All Cap fund which is designed to "seek the best in US equity opportunities" costs you 2.4% of your investment account to hold.  Both of these funds allow you to invest in the American market, but one is designed to do whatever the market does, and the other is designed to beat the market.

Remember Efficient Markets?

I write about markets being efficient often.  Remember that if markets are efficient, all available information is included in the price of a stock.  With that in mind, let's look at the idea of trying to pick which stocks will be the best ones to invest in.  The people that are picking the stocks that will be included in a portfolio that is trying to beat the market are using massive amounts of information to make their investment decisions.  These people will know everything that there is to know about a stock before they select a company to invest in.  But think about all information.  That's a lot of information, and there's new information coming out all of the time.  Even if an analyst does know everything about a stock before they buy it, it is impossible to predict all new information, and all new information will be included in the price of the stock as soon as it becomes available to the public.  So, we should try and get information about stocks before the information is public? No.  That is insider trading which is illegal.  Point is, all information is included in the price of a stock, and new information is random, so stock prices are random.  Still want to try and pick the stocks that are going to beat the market?  Good luck.  My opinion is that if you can't beat them, join them.  Indexes are beautiful tools that should be taken advantage of when constructing a portfolio.  Which indexes?  That will have to be another day's post.

Explaining Stocks

I write because it helps me to understand concepts.  I do think it's neat to have a blog so that I have a medium to share my thoughts, but the main purpose is to give myself a reason to write stuff.  I didn't think anyone really read the things I post.

I have now had multiple people tell me that they read my blog posts, and that they actually enjoy reading them.  Too many of the people that told me this said that they enjoyed reading my writing despite not knowing what I'm talking about.  After hearing that feedback, I took it as a challenge to explain the things that I write about in terms that people can comprehend.

I won't stop writing about heavy finance things, but I want to try to bit by bit explain the fundamental concepts of finance to the non-finance people that grace my website with their presence.

Where to start?  I will first give my rendition of what a stock is.  Establishing what a stock is will give me the foundation to go into detail about lots of other things.

What is a Stock?

A stock is a piece of ownership of a company.  When we say that a stock is publicly traded, it means that the pieces (shares) of that company are able to be bought and sold by anyone in the public marketplace, something that we refer to simply as the market.

Understanding that a stock is a piece of a company should be easy enough, but how and why a stock comes into existence is a little bit more complicated.  It all comes back to money (capital).  Companies need capital to do business.  If a company sells coffee they need money to buy coffee beans, cups, machines, and pay employees and rent space.  That capital can come from lots of different places (which I will have to discuss in another post), but once things are going the company should eventually be able to make enough money selling coffee to pay its expenses and buy more supplies to sell more coffee.  If this business decides that it wants to open another location, the capital that the first location is producing by selling coffee might not be enough to open a second location; they need more capital.  To get this capital, they can choose to sell part of their company on a stock exchange.  When a company chooses to do this, they are going public.  A company consisting of two coffee shops would not likely go public, but for the sake of the example they do decide to go public.  When a company decides to go public they have to be underwritten to determine the price that the public might pay for their shares.  This is where an investment bank comes in; so our coffee company would approach Goldman Sachs and tell them that they want to issue shares to the public in an initial public offering (IPO).  Goldman Sachs will examine the company very closely to try and determine how much the public will pay for shares of this company, and then they will either buy all of the share themselves with the intention to resell them to the public (a bought deal), or they will do their best to sell as many of the shares as they can to the public without giving our coffee company any guarantee that all of their shares will be sold.  This initial sale into the market is referred to as the primary market.  Once these shares have been sold into the market for the first time, they can be bought and sold by anyone in the market.  The market after the first sale is called the secondary market, and that is where most people buy and sell stocks.

So now we have these shares, these pieces of a company, that can be bought and sold by people very easily.  As they are bought and sold by people, the price of these shares will move based on a bunch of factors.  It's like  anything else that can be bought and sold, the more people want to buy it, the more the price will go up.  There is an infinite amount of information that can affect the price of a stock, and there are people researching as much of the information as they can all the time to try and predict where the price of a stock is going to go so that they can make money by buying it at one price and selling it at another.  It is also possible to make money by betting that a stock will go down in price, but that is another story.  I often write about efficient markets, and when you understand how stocks get their prices the idea that markets are efficient makes a lot of sense.  If markets are efficient it just means that all available information has been taken into account in the price of any stock at any given time.  This happens because of all of those people that are out there researching stocks to try and make money; they collectively influence the price of a stock until it ends up at a value that reflects how much all of the people in the market will pay for it based on all of the information that is available.

I feel like that was harder to explain than I wanted it to be.  If you read this explanation and have questions, please ask me,  I love answering questions about this stuff.

Using Visual Basic for Financial Modelling

I learned a fair amount of programming when I studied mechanical engineering, and it is always fun when I get to apply those skills to problems that I see in finance.

I was recently asked to determine if a particular client would be better suited to deposit money into an RRSP or to leave it in non-registered investments.

The problems I had to solve revolved around the following issues:

  • Minimizing taxes
  • Minimizing OAS clawback
  • Maximizing net income

But which strategy would produce superior cash flows based on these parameters?  I structured my model as I would structure a discounted cash flow analysis for a company, selecting my inputs to match an individual.  Gross income became a proxy for revenue, and then I added minimum RRIF payments after age 71, and CPP and OAS benefits at age 65.  I treated taxes and OAS clawback like cash outflows .  I calculated taxes based on marginal tax rates, and OAS clawback based on 15% of any income over $70,954 in any year OAS is received.

I wrote functions in visual basic to find the appropriate tax bracket for a given income, to find the minimum RRIF payment based on age and RRIF amount, and to find the amount of OAS clawback.  The calculations in the model lead to two numbers: the present value of the free cash flow in each scenario.  I was able to link the difference between these two numbers to a sensitivity analysis; using scenario 1 (no RRSP contribution) minus scenario 2 ($31,000 RRSP contribution) shows that when the result is negative (red) it makes more sense to make an RRSP contribution, and positive means it is better to forego RRSPs.

The value of writing these programs did not come in creating the original spreadsheet; I could have realistically input all of that data by hand.  The value in coding a fully linked model is that it allowed me to perform the sensitivity analysis for varying growth rates, inflation rates, and levels of CPP income.

I had hoped that there would be a conclusive answer to the initial question, but the result shows that it all depends on what the market does.  If market performance is strong, the RRIF becomes so large that taxes and OAS clawback are overpowered, but with lower market returns, the tax savings make avoiding the massive RRIF accumulation a better option.

For some context, the client is 47 today and will live to 100.  They are making a one time $31,000 RRSP contribution.  The RRSPs value today before any new contribution is $100,000.  Earned income is $110,000.

My very boring and simple code is linked here.

The Grossman-Stiglitz Paradox

I have mentioned this paradox before, so I thought it deserved some discussion.  The Grossman-Stiglitz paradox states:

  1. If markets are efficient and securities' prices reflect all available information and,

  2. obtaining information about securities requires resources (time, money)

Then

  1. Why do people commit resources to researching securities at all, and

  2. if people don't need to commit resources to researching securities, then how did the prices get right to begin with?

To me it is a very simple relationship. If there are people that do believe that there are mispricings to be exploited, they will spend their resources to exploit them. It only takes a few mispricings to make people believe that it is possible to find more mispricings. When mispricings do exist, as soon as enough people exploit them, the prices will tend toward their true value. So, markets are efficient because there are a bunch of people out there that don't think that markets are efficient. It becomes an equilibrium situation.

I remember a discussion with a Carleton University finance professor where I asked what would happen if everyone started to buy the index and stopped trying to beat the market. Following our discussion, if everyone started to buy the index, mispricings would start to develop regularly, and arbitrageurs would be able to profit. The profits that these people made would attract other people, and eventually everyone would return to chasing the dream of beating the market. It really all comes back to psychology; nobody wants to accept being average and moving with the market when there are hot shot managers out there that promise to produce double digit returns. There is a lot more emotional attraction to investing with the guy, or to being the guy that can beat the market.

At the end of the day some people will beat the market, sometimes. Statistically, it is very unlikely that anyone will consistently beat the market over a long period of time, and whenever one manager beats the market, another manager must underperform. I love the idea of active management. It is flashy, glamorous, and exciting. Nobody wants to accept being average, but it is far better to be consistently average than to outperform the market one year and underperform the next. Remember how important the effects of compound returns are in building up wealth.

I say let the stock pickers, the gurus, and the hotshot managers try to beat the market. They get to have fun spending their clients' money to make bets and predictions, and they keep the markets efficient for the rest of us.  To look at it another way, it is all of the dollars paid to active fund managers that keep markets efficient - nothing's free, I'm just glad I'm not the one paying for it.