So, you've missed the great bull market. But that isn't as irritating as that of seeing the neighbor - whose IQ is close to room temperature - drive up in his third new Jaguar in as many years. You consider yourself a 'value' investor at a time when such concept seems to be totally discredited. Year after year, you expected - convincingly - that the great bull would crumble. But it hasn't. You purchased gold and lost. You sold Amazon.Com short. You lost. You've missed out on Microsoft, Dell, Qualcomm, Intel, Cisco, Yahoo and the assorted Internet wannabes. You expected an end to the mania but it has not come. O.K., you've simply earned the right to be frustrated. But now what?
If, on the other hand, you are the bold and lucky fellow who loaded up on Cisco five years ago, your knees must be a little shaky as you stand at the Temple of Unrealized Gains. 'This bull will go on' you reason, but then you doubt yourself. You don't know. You aren't sure. You hear little voices, conflicting opinions; you see the volatility, the excess, the mania, and the mother of all bubbles staring you in the face - not to speak of a hefty capital gains tax lurking out there. So, what will it be?
What are we, investors, to do?
Let's talk about it. But first, let us examine the great investment paradox. The making of a fortune, whether small or large, in one's chosen profession is certainly a significant achievement. To put it aside for a rainy day, the next generation, or as a source of future income and financial security is also prudent and wise. But to preserve and manage this wealth is an endeavor far more difficult than that of making it in the first place. And this is the paradox.
Tom was a very successful, now retired, American construction executive who was born in a poor family. For forty years, he toiled as an entrepreneur. He chose the right location to build houses. He wisely determined what type of house he should build, what price range, who would buy it and what such potential buyer would want to have. He studied the competitive costs, prices and construction methods. He carefully chose his suppliers, negotiated the quality of each component, prices, and terms. He hired and kept the best people he could afford. He was very good at what he did, since year after year, he managed to save, after tax, a nice tidy sum. About $5,000,000. In retirement, bored with golf, with time in his hands, and supremely confident in his own entrepreneurial ability, he started dabbling in the investment process. Eight years later and very unsuccessful, this once-proud man, took his last $500,000 and, swearing off any further speculation, placed them in a time deposit with a local bank. We spent an evening together discussing this great paradox.
Michael is another American entrepreneur. Over a lifetime, he made and lost several fortunes, but something good happened a few years ago. At the brink of bankruptcy, he took a small sum and, on the advice of his broker, bought stock in Nokia, a fledgling Norwegian cellular phone maker. Today, the market price of his stock is in the millions. He took some of the profits and bought Oracle. Another fortune. He is - perhaps justifiably - convinced of his stock picking ability. He's made only two investments, which clearly qualifies him to purvey investment advice to anyone who'll listen. Why argue with prosperity? Day after day, his net worth goes up. Sometimes by a million dollars at a time. America is truly a wonderful country, yes?
A visiting European marvels at the American miracle. He observes this great number of people who, despite humble beginnings and a questionable education, manage to succeed financially. In the Old World this isn't so easy to do. But here is the second observation he'd make: much of this new wealth is eventually lost within the lifetime of its founder. The bulk of it, in most cases, is lost (or eaten up) within the subsequent generation. And, this too, is an American phenomenon. Making money is clearly easier than keeping it. But why? Prosperity, in the eyes of history, is troubling.
To our mythical European visitor, the possibility of losing such a fortune would be unthinkable. After all, if Bill Gates were from France, he'd keep his fortune by buying all the real property he could (i.e. the entire country) and passing it on to his heirs. Even if they didn't have much income, they'd never sell the land. If he were German, he'd buy government bonds and live happily forever. If he were Italian, well, he'd make a banker in Lugano so happy. But he surely would not want to lose what he had.
Before we come to any conclusions, and the risk of unfairly stereotyping American and European mentalities about money, you should also know about another friend, and this time, from Europe. His name is Pieter and he runs a family manufacturing business that started over 150 years ago. I admire him greatly. He is no great entrepreneur by American standards but he knows one or two things about money. His family, through several wars, hyperinflations, depressions, expropriations, government plunder and hundreds of other obstacles, has managed not only to survive but also to prosper. He is not looking to an IPO to enrich himself - he understands prosperity. His sole secret to success is a desire to build a great product that most customers want and to leave the company to his son, a little better than what his father left him. His secret is a way of thinking. To you and me, in simple terms, Pieter has an intellectual anchor. And despite the day to day - not to speak of the long-term - problems he faces, his prosperity is fairly secure. If you appreciate the great investment paradox, Pieter has a lot to teach.
The basics in wealth management, i.e. "how not to lose money after you've made it," have been around for generations. And if, as they say, one learns from past mistakes, then we clearly have two choices. We can learn from the mistakes of others, or, our own. Or, perhaps, not learn at all. Tom made his own mistakes, although he may not have learned any lessons from it. Michael also, will eventually lose much of his paper worth. He may start all over again but he is not likely to sit and reflect on these issues nor learn anything about the trouble with prosperity (thank you, Jim Grant).
Finally, there is one Warren Buffett, the celebrated American billionaire-CEO of Berkshire Hathaway. His politics aside, he is clearly the most successful investor in modern times and he is quoted, interviewed, emulated and deified, from time to time, when his ideas happen to be in temporary favor. Yet, what is extraordinary - but least understood - about Mr. Buffett, is not how much money he's made as much as how little real risk he's taken in the process or how sound his intellectual anchor happens to be. Both Warren and Pieter, even though they've never met, are entrepreneurs. They share a common, unshakable, permanent and cardinal rule. Their principal objective is to acquire as much productive and valuable property having the least long-term risks, for the least amount of capital. There is one more thing they both share, and it would make great sense for the rest of us to remember: they make no prognostications or forecasts about the future. To them, the future is uncertain. They deal in a world they can understand. For their focus is on risk rather than reward-at-any-price.
We look to economists, theorists, columnists and other assorted experts for clues about the direction of future events. Neither Warren nor Pieter have any use for forecasters. No successful entrepreneurs depend on the economic policy committee of a big bank to tell them much. Rather, they have a feeling about what is right and wrong. They buy when something goes on sale. They sell it when it is in great demand. They don't know the length of the cycle for it isn't important. So, why is it that when entrepreneurs become investors they just start following the crowd?
The incomparable Austrian economist Ludwig von Mises said it clearly: "There are no rules according to which the duration of the boom or of the following depression can be computed. And even if such rules were available, they would be of no use to businessmen." (Human Action, 1998 Ed., p. 867)
I submit to you that the investment process is not any different than any entrepreneurial endeavor. And so, the answer to the question we posed 'What are we, investors, to do?' can be formulated within the lessons we can learn and the foundation we can build as wise entrepreneurs. There is no need to 'look for fish' in tip sheets, CNBC or the volumes of Internet bandwidth offering unsolicited investment advice. It is far preferable to 'learn how to fish.'
Instead of waiting for the price of Coca Cola to come down to a reasonable level so that you, too, can be, eventually, like Warren Buffett, let me share with you the lessons in investing/entrepreneurship that I have learned from Warren and from Pieter (Tom and Michael contributed to the education as well...)
Lessons from Warren and Pieter
- Approach the investment process with a sense of financial detachment, a clear head and, possibly, an understanding of history. Get your own compass with which to navigate. If you haven't made money in your profession, it is unlikely that you'll strike it rich in the stock market.
- Be skeptical of government, of authorities and of experts. Skepticism guards one against exaggerated expectations and builds faith in his own judgment.
- Be realistic and entirely indifferent to opinion polls and majority opinion.
- Make certain you understand risk. Do not seek to avoid it, for you can not. Risk is not volatility. It isn't beta or any of the other nonsense. Risk is paying two dollars for a one-dollar bill. Risk is buying an asset that can not produce a profit commensurate with the business risk. Risk is a large premium on present day value for a business whose future is uncertain. Risk is owning a business whose manager is more interested in enriching himself than building your company.
- Be confident in understanding your own needs and objectives. And be confident in understanding an investment you make. If you don't really understand what a company does, you'll never know what can go wrong and you'll never know what it is worth.
- Understand the value of capital. The management and safeguarding of wealth is about making good investments when they are unpopular, cheap and valuable. Not in relative terms, but absolutely. It is not about joining the herd but about thinking for one's self. It is about understanding that markets are not detached from reality. It is not about stampeding from idea to idea in a desperate attempt to outsmart the roulette dealer. It is about considering the sacredness of capital. It is not about being under pressure to perform or having an irrational fear of missing out. It is about foregoing immediate gratification for the purpose of long-term value. And if you are an investment adviser, it is not about making your clients feel happy (entertainment is cheaper) as much as it is about telling them the truth.
- Safeguard your financial privacy. Privacy does not mean that we are crooks or drug dealers. Privacy means we have liberty and that our financial matters are no one's concern. Privacy is not something someone gives you or promises you in a fancy private banking brochure. It is something one creates for himself. The less someone knows about your finances, the less the chances they can hurt you.
- Avoid conflicts of interest. Clearly one does not ask a butcher whether meat or fish is better for him. Neither does he ask a banker as to whether another bank can give him a better deal on his loan. What is dangerous is the presence of conflicts that are hidden throughout the financial world. At a time when manias reign supreme, conflicts even masquerade as investment advice. It is doubtful that Mr. Buffett depends on his broker for investment ideas, reads Wall Street 'research' or surfs the Internet for a hot tip. Most of what he'd find is worthless, inadequate or intellectually dishonest. The business of playing with other people's money is fraught with incredible conflicts. In fact, in boom times, far more so.
- Use intermediaries for what they are good at. If you want the finest meat, the freshest vegetables and the best bread, it is surely impossible that you'll find them all at the local supermarket - however fancy as it may be. Oh, you'll find some poor substitutes but never the real thing. Learn to visit the right butcher, the right grocer and the right baker. In the financial world, find a real bank and use it for what it can do without hidden conflicts. Find a broker (if necessary) and do the same. If you need to have an adviser, make certain that he's going in the same destination you are and not the other way around. Avoid asking the broker to sell you banking services or the banker to give you investment advice. Above anything else, a wise entrepreneur is a good judge of people and he's successful in finding the right person to handle a specific job. Emulate him.
So, what are we, investors, to do?
Just ask Tom, Michael, Pieter and Warren. They know.