2015 marks my 24th year professionally advising wonderful people on their path to acquiring and retaining financial independence. I’ve met hundreds (if not thousands… I’ve never really thought about it until just now) of people who all basically had the same goal: To not outlive their money.
Early in my career I thought there were many goals my clients had but over the years I’ve come to understand that it really all boils down to just this… accumulating enough to get to that point where you can do what you want, when you want, and not have to worry about being comfortable for the rest of your days. That’s it.
Over that same period of time I’ve also come to realize that most investors, whether individuals or professionals, have no basic principles about how markets really work. Nearly every day I am exposed to professionals who are charged with guiding their clients through the maze of investment choices that, purely based on the investment choices they are recommending, have no idea how markets work. Without a sound set of principles how can you develop a set of practices? In other words, if you don’t understand how something really works, how can you set up rules to benefit from it? Kind of a basic truth in everything.
With each passing year it has become crystal clear to me that there are three absolute principles that a participant in global capital markets has to have, or the chances of them having a favorable investment experience is going to be very low. If you are missing any of these three, I’m going to bet against you. Two out of three and your chances of success are the same as if you had zero.
The first is the most critical: Faith in our future.
Now relax… I didn’t just get all religious or preachy on you. It has nothing to do with your spiritual or religious beliefs. What I mean is that successful investing ultimately comes down to a battle that takes place in the investor’s unconscious mind – a battle between faith in the future or fear of the future. After perhaps 40 years of accumulating and 30 years of living off of those assets the success or failure will be dependent on which impulse ultimately wins.
Lest you think I’m talking about blind faith let me stop you right there. I’m referring to an optimism from an investors perspective that is simply the only world view that matches the historical record. My view of this requirement that you have to have faith in the future is not in spite of the historical record… it’s entirely because of the historical record.
In short, optimism is the only realism.
Look at the curve of human progress just in your lifetime and you’ll find that the huge majority of the medical, scientific, technological and economic progress mankind has experienced has occurred in your lifetime. Certainly that is the case for me.
It’s not always a smooth curve but when you spread it out over just a little time its remarkable how much we advance in what through retrospect seems like an incredibly short period of time. But what does human progress have to do with investing? Everything. Absolutely everything. Because as we advance, capital markets grow. The total value of all goods and services grows, and the historical record says it grows pretty robustly.
Think of the value of all hard-wired, landline telephones in every home in the country in the 1950’s. Now think of the sum value of all cell phones owned by consumers today. A multi-million dollar industry became a multi-billion dollar one.
Apply that same growth to a hundred other industries and sectors, including automobiles, televisions, medical, pharmaceuticals, etc. Then add in all the market segments that didn’t even exist a few decades ago: Computers, downloadable music, streaming movies. Our investment strategy can be looked at simply as carving out a slice of the pie, then enjoying the rewards as the pie grows… and grows… and grows. But that is a strategy you will only stick with if you have faith that the pie will grow.
We don’t do Armageddon here
But the amazing rate of progress may become more than many people can fathom. How, they ask, can this continue? It’s just not possible, they say. It doesn’t occur to them that people have been saying that for hundreds of years. It’s these people that the peddlers of the apocalypse du jour prey upon. Currently I’m hearing it’s the total collapse of the international monetary system. Next year or perhaps next month, it’ll be something different.
And in short runs often markets tend to support apocalyptic theories. The human capacity for folly and the proclivity of markets to overreact to episodes of folly never ceases to amaze me. But here’s what I know that apparently a lot of investors don’t understand… in the long run capital is rational, and it flows away from environments in which it is punished and towards environments in which it is rewarded.
Profit seeking companies run by rational managers who are ultimately disciplined by the marketplace will move away from unrewarding ventures and will search for more advantageous situations. That’s capitalism. Look at history… wars, depressions, inflation caused by currency debasement, natural disasters and virtually every known catastrophe has proven incapable of disrupting the rational movement of capital over time.
The market is batting 1,000, folks. The market has never failed us. What has failed has been our faith in the market. When the market absorbs that short-term, on paper only, depreciation in value it’s our faith and understanding of the real situation at hand that is being tested. Those who don’t measure up take the loss, and their destiny is locked in. They already failed. Those who understand it for what it really is embrace it and we later call those people “successful.”
Through every single disaster in history, capital has ultimately figured out a way around it and seeks out adequate long-term returns far in excess of inflation and “risk-free” investments. We have faith in our future because it’s the only thing that makes rational sense when you account for the entirety of the historical record.
So what are the other two lofty principles one simply has to have to be successful? I’ll tell you next month, but I bet some of you already know what they are. If you do, drop me a line.