Schrodinger's Portfolio

November 09, 2022

Remember learning about quantum mechanics in high school? Neither did I. Until I picked up a book on the subject a few years ago. Quantum mechanics is the study of subatomic particles. It’s… weird. Trying to understand quantum mechanics is a bit like being color blind and having someone try to describe the color orange to you. Orange, you know, like citrus fruit in Florida or like basketballs. Not helpful. It’s a different language. Subatomic reality is quite different than the world we observe with our eyes and ears. There’s no helpful frame of reference.

When physicists started studying electrons they found something strange – their location is difficult to pinpoint. They seem to be in multiple places at once. In fact, the one thing we know about a given electron is that we don’t know where it is at any particular time. Physicists call it superposition. It’s both here and it’s also there. Two places at the same time. Kind of. Or they sort of blink from one place to another. But they seem to be nowhere in between. They’re definitely not in one place at one time though. Impossible, right?

Erwin Schrodinger, a physicist, thought so. He devised a thought experiment – Schrodinger’s Cat – to explain how ridiculous quantum mechanics is. You gather a cat, a Geiger counter, a hammer, a vial of poison, and some radioactive material. You put them all in the box and seal it. I know, right? Erwin must have been a dog guy. Back to the box – it’s sealed. What scientists call a “closed system.” No one can see inside. No one can observe what’s going on in there. Not even a hint.

But there’s radioactive material in the box. It may decay. Or it may not. It’s 50/50. If it doesn’t decay, nothing happens. Kitty is fine. But if it does, the radiation triggers the Geiger counter. The Geiger counter going off trips the hammer, which breaks the vial of poison. Not such a good day for the kitty (as I said – dog guy). How do you know if the cat is still alive? You open the box. According to the thinking of Quantum mechanics – our best understanding of the movements of subatomic particles – until you open the box, the cat is both alive and dead. Not 50% chance alive or 50% chance dead. 100% alive and 100% dead. Both. Superposition.

Schrodinger’s thought experiment initially had its intended effect. This quantum mechanics stuff is nuts.  Perhaps it also to ticked off some cat lovers. All this talk about superposition is crazy. How can the cat be alive and dead? One problem. The more quantum mechanics has been studied, the more Schrodinger’s Cat seems an accurate depiction of this quirky subatomic reality. A guy named Einstein looked into it. He thought Schrodinger had a point – this quantum mechanics stuff can’t be right. He tried to disprove it.

He failed.

The electron is here and it’s there. The cat is dead and it’s alive. You don’t know if it’s dead or alive until you open the box.

It’s a bit like the value of an illiquid asset.

You probably own at least one illiquid asset – your house. What is your house worth? It’s hard to tell. You could look at Zillow to get a “Zestimate.” They called it that for a reason. It’s an estimate. Not actually what your house is worth. If you want to find out what it’s worth, you have to list it for sale. “Put it on the market” – you’ve heard that phrase – is another way to say the same thing. Your agent lists your home for sale. You schedule an open house on Sunday afternoon. People show up to take a look. They’ll chat with their realtor to determine what they’re willing to pay for it. If they’re serious, they’ll inspect every nook and cranny. Hopefully they make you an offer. Now you know what your house is worth.

That’s why we use the phrase “put your home on the market.” It wasn’t on the market, then you put it up for sale, and now it is. Once it was on the market, someone can make an offer. Now you know what it’s worth. You know how much you’ll make or lose if you sell it relative to what you paid for it. Much better than a Zestimate.

When your house is not on the market, and you’re not interested in selling anytime soon, do you care how the market values your home? The answer should be no. If the answer is yes, you should get a hobby instead of wasting time tracking your home’s “Zestimate.” Imagine you bought a home for $400,000 in 2007. Right before the housing crash. You bought it knowing you were going to raise your kids there, no plans to sell for at least eighteen years – that gets you to 2025. I suspect it was worth less than $400,000 by 2009. Possibly substantially less. The housing crisis, remember? But why would you care? You don’t have plans to sell until the kids are out of the house. Sometime in the mid to late 2020s. You’re not putting it on the market in 2009. Who cares what someone would pay for it then? It’s not for sale.

Your long-term equity portfolio is different. It’s always on the market, and the market is open 8:30am-3pm CST, Monday-Friday. You can get the actual value instantly. Gone are the days when you had to wait for a monthly statement in the mail. You can login online and check it in about five seconds. If you want to sell, you can sell for the price showing on your computer screen. Instantly. The price on the screen indicates nothing more than what someone else will buy it for. Like the folks who showed up at your open house and made an offer. In today’s world, there aren’t (there shouldn’t be) any transaction fees. It takes a few seconds to complete the transaction. Because your equity portfolio is always on the market. And in the market, there are buyers ready to buy.

But there’s a reason you have long-term equity portfolio. It’s for retirement, or for college for the kids, or an inheritance for your grandchildren, or something else. Something important. You know your timeline. You know approximately when you’ll retire and when the kids will be in school. You have a rough range of when you expect to be passing your hard-earned wealth to the next generation. The point of a long-term equity portfolio is you don’t plan to use it for a long time. Maybe not until 2030. Perhaps 2040. My wife and I don’t anticipate tapping ours until the 2050s. Why would you put that portfolio on the market in 2022? Who cares how it’s valued in 2022? What does that matter?

This is one of the best features of illiquid assets. In a market downturn/correct/recession/bear market/whatever, you don’t see the value of your illiquid assets marked down. The housing market is on fire just about everywhere presently. That will change at some point. When it does, you won’t notice the value of your home decline. You won’t know what someone would pay for your house. Maybe you can get an idea from Zillow, but that’s not the point. It’s just an estimate and if you’re not selling you don’t care. It’s not on the market. The same is true of other illiquid assets – fine art, private equity funds, etc. It doesn’t make them better; it makes them easier to handle psychologically when their value is decreasing.

I think you should take your long-term equity portfolio off the market. There’s a right way and a wrong way to do that. The wrong way is to sell your equities. Go to cash. That takes your portfolio off the market alright. Why would you do that? You’re not planning on using that money for years, probably decades. The right way is to take your portfolio off the market in your mind. Treat it like an illiquid asset – like your house. It’s not for sale. It won’t be for a long time.

You should put your portfolio in Schrodinger’s box. Maybe your equity portfolio is up today. Maybe it’s down. Maybe the cat is alive. Maybe it’s dead. You don’t know because it’s in Schrodinger’s box. Right next to that darn cat. When you need the money in a few decades you can open the box. On that day, it’s 50/50 for the feline. The vial of poison might have killed the cat; it won’t have done anything to your equity portfolio.

Sean Cawley, CFP®

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