[Duke’s we have a new honored guest dining with us as we celebrate his arrival, a blogger and forbes contributor – Camilo @ The Finance Twins. Learn more about the lessons he learned about personal finance when working as an Investment Banker!]
Hi everyone! My name is Camilo and I am the Co-Founder of The Finance Twins. A site dedicated to covering and teaching about the basics of personal finance. I am also a contributor for Forbes and several other sites, and you can read some of those articles here: https://www.forbes.com/sites/camilomaldonado/
I began my career on Wall Street at J.P. Morgan, one of the premier investment banking franchises in the world. As a fresh-eyed 22 year old entering the world of investment banking, I knew I’d be spending a lot of time at the office working hard on projects for our clients (the world’s largest companies). With a freshly minted bachelor’s degree in finance from Wharton and two summer internships at J.P. Morgan, I had the skills, toolkit and knowledge to do the work I was hired to do.
However, what I wasn’t ready for were the regular calls from friends and family asking for personal finance advice. Their questions ranged from ‘which student loan should be paid first?’ and ‘should they rent or buy a car?’, to ‘how do I make a monthly budget?’ and ‘what is a 401K?’.
What they didn’t realize is that my job as an investment banking analyst really had nothing to do with managing my personal money at all. They assumed that because I worked in corporate finance that surely, I must be a personal finance expert. It was this experience that helped solidify my passion and interest in personal finance. A topic everyone wishes they knew more about.
Today, I’ll be sharing how investment banking differs from investing your own money and also what my time in investment banking taught me about personal finance.
As an investment banker you must be able to value companies.
As a financial advisory firm, J.P. Morgan’s investment banking practice advises the world’s largest companies on their financial transactions. Traditionally, the bread and butter of investment banking is mergers and acquisitions advisory work. This jargon simply means that we’d help our clients acquire other companies, or help them sell their company to someone else.
As the entry level employee, or analyst, on my team, it was my job to crunch the numbers for these transactions. This often included running valuing businesses that our clients were interested in purchasing, to help arrive at a fair purchase price. We’d do this in a number of different ways.
There were three primary ways investment bankers would do company valuations:
1The first is by using a DCF or discounted cash flow analysis. To do this, we’d project all of the future cash flows (how much money a company was expected to make over it’s future lifetime) and find what that set of future profits would be worth today.
The 2nd method would rely on looking at other similar companies and we’d compare their value based on a set of metrics. This would give us an idea of how shareholders would value the company.
Lastly, we would look at other recent buyout transactions in similar industries so that we’d see what these kinds of businesses were currently selling for. This is similar to how real estate agents will look at ‘comps’ or comparable homes to arrive at a valuation for a house.
These are some of the methods that professional investors use to value companies and decide whether to buy or a sell a given stock.
One of the biggest lessons I learned at J.P. Morgan is that the amount of work to accurately value a company’s fair share price is astounding. We had access to the best tools and research in the world, yet we would regularly be at the office working until 2am or 3am every night.
In personal finance I don’t really care about individual company valuations.
After I left J.P. Morgan, I had more time to spend thinking about my personal finances. And I realized that a lot of the hard valuation skills I learned and practiced daily didn’t really matter for my own portfolio.
First, I quickly learned that picking individual stocks is a bad idea.
There are a couple of reasons for this. First, the fees that you’ll incur actively buying and selling stocks will mean that you’ll have to beat the market average by a couple of points to even make it worth doing. Second, very, very few investors can consistently beat the market average over a long time horizon. In fact, the majority of hedge funds are unable to beat the market.
To keep things simple, you can think of a hedge fund as a company in Manhattan where a bunch of Harvard grads wear Patagonia vests and do research on stocks around the clock in the hopes of beating the market average, while being hopped up on caffeine.
If the average hedge fund can’t beat the stock market average over the long-term, it’s just plain dumb to think you can do that. Unless you have a room full of Princeton grads helping you research pick stocks, it’s better to leave losing money to them.
Even Warren Buffett, who is regarded as the world’s most shrewd investor, still recommends investing in index funds.
But I do care about financial discipline.
After valuing countless companies I started to see that the companies with the highest profits were the ones that kept their costs the lowest. This simple fact became a core part of my personal finance strategy and it is your first line of defense when it comes to personal finance.
Seeing how the world’s largest companies produced detailed financials highlighting where every penny was spent, was truly remarkable. This experience instilled in my the importance of the personal budget.
If you don’t track something, you’re never going to change it. Heck, you might not even know you have to change it.
Anyone can master personal finance, not just an Investment Banker.
The last lesson I learned is that making a lot of money, or knowing how to manage money isn’t enough. I saw plenty of my colleagues across Wall Street buying weekend homes or cars that they couldn’t afford. Sure they had the money, but they were going into debt or under saving for retirement to fund their lifestyles.
Many of them were “rich” but not wealthy.
Living within your means takes a lot of discipline and hard work. It just also happens to be that the things that bring you the most happiness are the shared experiences you have with your loved ones. In a world where we are pushed to spend like crazy, the best things often come without a price tag.
We could not agree more! Thank you Camilo! To someone who has no knowledge of what investment bankers truly do, this has been one insightful post into the field.