Beyond Etch-a-Sketch

Time is the foundation of property rights. If you know that whatever you are going to do is going to get etch-a-sketched, then you rightly will think with a temporary mindset. Live in the now. You can’t trust there will be a tomorrow. 

If you know you have got a plot of family land for the next thousand years, and no one is ever going to take it from you... the connection to that land will run deep. If you feel a connection to your future family, you will be willing to build something where each generation successively acts as custodians. 

That is why really deep, old money, is family wealth. Where you have family constitutions, and succession planning, and even set up family offices that employ lawyers, accountants, investment professionals and others to help with the complexity of support structures. You are training the grandchildren to take the reins of the family one day. There is a connection across time. 

That is very different from someone who plans to consume their money during their life time... no inheritance, no worries! 

Real wealth is built over incredibly long timeframes. Not even necessarily at high rates of return. Slow, stable, reliably positive return that just keeps quietly coming. 

You may worry if the return is too high, because that raises the possibility of an explosion in the other direction.

Two Marshmallows

I don’t like being the bad guy. I don’t think most people like that, but I don’t subscribe to the “it doesn’t matter what other people think” philosophy. You can only make purely independent decisions if you are a hermit. If relationships matter to you, then connections and consequences matter. Yet there is a balance. Your interests matter too. One behaviour that creates capital is delayed gratification. If you are living purely in the now, then every decision is about the now. You are not building space. You are not building time. You are not building capacity. Because everything is about now. There is a story (controversial in its scientific rigour) about putting Marshmallows in front of children. If they can wait for the researcher to return, they get two. The test was meant to evaluate the ability to take charge of your emotions. A powerful life skill. The controversy is over whether this an innate or learnable skill. Imposing delayed gratification on others isn’t fun, and building capital is a team sport. We make many of our financial decisions together. Our joint decisions are the key to whether we consume what is created or whether we act as custodians and reinvest. Building space, time, and capacity.

 

Hubris Factory

“The real secret to investing is that there is no secret to investing. Every important element of value investing has been made available to the public many times over, beginning in 1934 with the first edition of Security Analysis.” Investing is enticingly easy to monetise. You get cost centres (need money) and profit centres (make money). A good business is one where you have something that is easy to count and communicate. “I’ll grow your money” fits the bill. Pricing is also easy with, “I’ll take a percentage”. The two key elements are good capital allocation (what work the money does) and reversion to mean (prices typically overreact and true normal is less noisy). The downside of all this simplicity is that investing is a hubris factory. The real work gets done by the underlying businesses, but investors often think it is an extension of classroom exam results (which also oversimplify the process of ranking people). An Investor’s entire career of being a rock star can come tumbling down with factual evidence that they have done no better than average. They’ internalise the good times and excuse the bad. The real secret of investing and good businesses is that it is not about you. It is about putting money to work, and reinvesting. Custodianship, not proof of worth.

When All Thrive

Fundamental investment management is the simple idea that the job that money does matters. You can trade anything with a pulse. Buying and selling based on a moving price, without even looking at what the price is connected to. Speculating on whether the price is going to go up or down. With fundamental investing, it is the underlying business that does the heavy lifting. A share is a slice of ownership in a real business with real products solving real problems. The price is not just a good or bad deal. Buying or selling is not a way of tricking other people. The price represents Capital that the business is custodian of. If the company handles the complex, random, and ambiguous world in way that solves problems creatively, it should be able to create value. It ceases to matter whether other companies do well or badly. Adam Smith’s great insight was that Capitalism can be Win-Win rather than a battle between Nation States. David Attenborough points out that Nature’s great insight is that a species can only thrive when those around them thrive.

What we do, matters

False Gods

Money makes money. This allows wealth to compound (the growth also produces), if not everything that is produced is consumed. If some of the fruit is planted, and given the space to grow. This is both powerful and dangerous. Ideally, you want to fail hard and memorably early on, to knock the delusions of grandeur out of you. You do not want to be that false god who complains that the (clean and comfortable) guest room is not up to the standards to which they are accustomed. Because if you do not regularly suffer some misfortune, chances are life will one day smack you hard and repeatedly in the face. Probably when you are managing other peoples’ money. As Mike Tyson said, “Everyone has a plan until they get punched in the mouth”. You cannot just judge yourself on how your path has played out. You cannot judge others without looking in a mirror and reflecting on your potential unwalked paths. We are communal animals, and every path is an alternative reality. One you could have easily been on. The key is not profit making and ego building. It is reinvestment, and building buffers and capacity for whatever punches are thrown.

Nergal Gate in Ninevah

Learning to Work

During the first decade of building your Engine, you won’t see the dramatic effects of compounding. If you think of your money as a mini version of you, the first years are still school time. The most important focus during that time is laying solid foundations. Creating the habit of paying yourself first. Where every time money comes in, you spend less than you could, because some immediately gets invested. Where every time money comes in, you get some of it a job. You internalise the discipline of having money “that is there, but isn’t”. Learning to live dramatically within your means. Finding a way to have a buffer for life’s emergencies, so you aren’t continually starting from scratch. This isn’t hoarded money. It doesn’t sit sunning in a pool. It works, then takes the money it earns and (if you leave it alone) gets it more work. Shifting from a hand-to-mouth life dependent on your earning ability, to a custodial life where the task of financing problem solving is shared with your past self. Then gradually, the magic of compounding can power the realisation that life isn’t a problem to be solved.

"Thresher" Van Gogh (1889)

Much to Well

My path to financial security involved very little out the box thinking. The cold hard reality of London visits while I was working as a Gap Student (teacher’s assistant) made me think 100% pragmatically. I wasn’t starting from nothing. I had already had a great education that gave me options. Networks and education are a form of capital. I studied full time for 4 years, and part time for 4 more. My formal earning period was the decade from 2004 to 2014. I had few enough external obligations to build an Engine. Capital that could earn income. I could decide I had enough. That is the out the box thinking. “How much is enough?” usually comes before "more". To attempt stepping away from filtering my productive hours through the rules of money, constraint had to be self-imposed. I still work. Mostly unpaid. I still tend the Engine, and if I spend consistently more than it makes, it will go bang. A different kind of stress. If the unexpected pops its head, I have to do repairs. In a world addicted to growth, this is a question we are all going to have to answer collectively. When does measuring growth shift from how much we consume? From how much to how well? And obviously, I am able to ask these questions from a very privileged position. The box that matters is shared.

Beware the Tail

Always throw half the CVs of applicants away without reading them. You don’t want to hire someone who is unlucky. There is an existential problem with investing if your goal is to outperform a benchmark. There is always the risk of massive underperformance wiping out even the best of track records. Tail Risks are high impact, low probability events. They can carry the only information that matters, and if you miss them… you didn’t add any value. Two of the most intelligent, clearest thinking, stock pickers I know don’t pick stocks anymore because of mistakes carved into their souls. That lifts them in my esteem. I also know unextraordinary stock pickers with the gift of the gab and political skill. Confidence sells. Wisdom often stays silent. I don’t believe in Gods of investing. I think you make sensible choices and let the cards fall. Manage the risks and do something else that inherently adds value in and of itself. Take ideas like Meritocracy with a pinch of salt. There is normally too little information to see clearly, or so much that it is stale. Our lives, and particularly our working careers, are just blips in the time scales of long-term wealth creation. The key is custodianship, not immortality.

Not Corn

Rich lists don’t show the resources people have hoarded. The figure isn’t the same as a weight. It isn’t a pile of bags of corn that could be divided up by the kilogram. You can figure out your own Net Worth. Net Worth is the value of the assets a person owns, minus the money they owe. Owning an asset doesn’t mean you “have” the asset. Asset Managers themselves don’t even have the Assets. They use Custodian Banks who keep a record, but the Assets are companies doing work. The Share Prices are a combination of the Tangible (stuff you can touch) Assets (Factories, Equipment, etc. that could be sold) included in a quote of what the market would pay for ownership of future profits. Like someone giving you money now, up front, for the salary you are going to earn going forward (not that unlike a Mortgage Loan). Worthless if the work isn’t done. The beauty of Public Equity is that it penalises hoarding and rewards Capital that solves real problems for real people.

Income Addicts

You can live off an Income, a Buffer, or an Engine, but they are very different beasts. If you live off an Income, it has to come in. What you get, you spend. So if you don’t work, you don’t get, and you can’t spend. A Buffer has to be very liquid. You have to be able to sell it quickly if it isn’t already cash. That means it can’t be working too hard, or be doing something where the benefits only come in the future. If you are living off a Buffer, the clock starts ticking. It will run out. But, it gives you time to retrain or find more work. An Engine is a long-term vehicle. It provides Endurance if you can live off less than it produces. If you are a good custodian who doesn’t extract all its future potential during the short term. If it is protected by a resilient Buffer, and invested in when there is work available. Unfortunately, the world focuses on humans as productive assets and calls this “Work Ethic”. With no Buffer, and no Engine, there is no space to pause. To breathe. To reflect. When you have no choice but to stop, the cost suddenly becomes real. When the world restarts, we must never again forget the need for Buffers and Engines.

Work (1852 - 1865) - Ford Madox Brown

Complex Web

What you see is not all there is. Even if you know more than the average bear. No one understands. No one can. We live in a complex web of relationships, where every action has knock-on effects and unintended consequences. In a pass-the-parcel economy where we live hand-to-mouth, there is reduced capacity to pause. The strength of a business to survive isn’t evident in the size of their offices, and the image of success presented by their sales staff. You have to look at the Balance Sheet. The Cash Reserves. The Cash Flows. The Pipeline of Sales. The endurance and resilience of their suppliers, customers, competitors, and regulators. The laws can change. The technology can change. The people involved can change. Sustainable Creativity doesn’t exist in a vacuum. It starts by shifting from a consumer mindset to a custodial one. How do you maintain awareness of a complex environment? Gentle trial and error with fire breaks and retreats for when you misstep. A balance of conserving what you love and chipping away at obstacles that aren’t completely understood.

Natural Stock Keeping

Investing is unavoidably philosophical. It is challenging to build up evidence when there is so much noise. A choice between too short for the noise to wash out, and so long that the evidence is stale. A single decision, whether right or wrong, large or small, is almost irrelevant in the very long run. It is the process that matters. “Time in the market, rather than timing the market”. An individual career (15-40 years) barely lets proper compounding kick in. Real wealth is created across generations, within communities, through institution building. My philosophy has shifted towards that of my father-in-law’s approach to Natural Bee Keeping, and a friend working on re-Wilding in farming. Focusing on Endurance and Resilience. Letting the Bees, Nature and Businesses do the work. A single decision that ends things does matter, so the focus needs to be on Custodianship. Keep breathing. Keep moving. Keep creating. Sustainable Growth is the pumping heart that keeps the cycle of creation and reinvestment going.

Reciprocal Care

A Buffer helps take care of the noise. An Engine is Capital that earns (on average) more than you spend (on average). Spending is noisy. Which means there are expected unexpected expenses. Sometimes the answer to “Why did this bad thing happen?” is “bad things happen”. Don’t be surprised. There is a difference between noise – “Good Months, Bad Months” – and Permanent Impairment. Starting again. A Buffer is only a Buffer with reciprocal care. If it is topping up your earnings when they are less than your expenses, but never being topped up, then you are leaning towards Permanent Impairment. Neglect. The Buffer will fade away. Engines are bigger (and can work on longer term projects because they aren’t needed for smoothing) but also need care and maintenance. Like fruit producing trees. You can live off the fruit, but you can’t consistently cut down trees. Buffers and Engines can provide care. But they need caring.

Overexploiting Resources

See a Stream

Disability Insurance covers the risk that you are unable to work. If you can’t work, you still have to live, and the way society is structured… it is a problem if you aren’t a productive asset. Should you get disabled, depending on the product you bought, the cover is paid out as a Lump Sum or an Income stream. This is intended to replace your earning ability, and the adjustments to your lifestyle. A useful analogy for Engine building. People don’t have to be productive assets. You can replace a salary stream with sufficient Capital. You don’t have to get disabled. You do have to build the Capital. The challenge is changing the way you see money. As something to look after, rather than something to spend. $1,000,000 is not a big pile of cash to be spent. It can be an income stream. Put to work on your behalf, it *can* last for life *if* you spend less (on average) than it makes (on average). 3.5% real return (after tax, inflation etc.) would give you $35,000/year. Capital for life. For life.

Streams create Life

Team Sport

Delayed Gratification is a powerful investment tool. Warren Buffett talks of multiplying the price of anything by ten to see if it is still worth buying. This is because spending money is functionally equivalent to firing it. if you think of money as Capital you are a custodian of, rather than your spending budget. Spending money means it can’t grow. Buffett backs himself, given enough time, to turn a dollar into ten. There is some pleasure in this kind of discipline. Seeing the number grow. You don’t “get” anything, but the “score” gets bigger. It is obviously much much easier to be harsh on yourself in this kind of way than on others. This is why building and investing is a team sport. It is easier to spend less if your friends and family are spending roughly the same. Otherwise the self-discipline required multiplies because the choices take on emotional content. Conspicuous Consumption is a particularly dangerous virus to spread. Conspicuous Consumption is a stupidity tax. That’s fine if you have cash to burn, but not if you are just starting on the path of wealth creation.

Still the Waves

Spending decisions always require trade-offs. Economics is the study of scarcity. It is a Social Science. Value is determined at an individual and community level and can’t be reduced to numbers. That doesn’t stop people trying, but all the quantifying and modeling are, are attempts to simplify incredibly fuzzy comparisons, moods, desires, beliefs and relationships. One of the biggest obstacles to building Capital is that there are always things that shout and scream for attention. Often unplanned expenses that insist they are more important NOW than building a theoretical Engine. We are natural-born consumers, and the idea of becoming custodians fights with clear and present dangers. That is why Capital building starts with a Buffer. Something to still the financial waves. An Emergency Fund that can be repaired when the unexpected bites at it, so that the Engine can be built unmolested. Start with a Buffer. Start with space to breathe.

Spend or Grow

Dividing requires trade-offs. Spending less on one thing doesn’t mean you want it less. It means you have different priorities. Preference, urgency, consequences, values, risks, relationships, responsibilities, and various other considerations get taken into account. Or not. Often, we override the complexity and just make a choice so we don’t get stuck in the middle like Buridan’s Donkey. This unfortunate creature died of thirst and hunger, stuck half-way between water and food. Building Capital is one of these choices. There are always things worth spending money on now. Except Capital grows. Money spent doesn’t. I favour fruit-focused spending. Be a custodian of the Forest (the Capital). Eat (spend) part of what grows. Plant (reinvest) what remains. Custodians are in it for the long-term. Consumers may just be consuming their future before it takes form.

Buriden's Donkey

Stepping Through

The difference between Saving and Investing is like Alice stepping through the looking glass. It is a completely different world. In the first, you may be “good with money”, but you are giving your money no time to breathe. Saving *for* something is still living hand to mouth. The money may work a little, half-heartedly, but it is on death row. Waiting to be reincarnated into a different thing. Investing is getting your money a real job. Real jobs take time. It takes 6 months to learn where the toilet is and who on your team is good at what they do. It likely takes more than 5 years to really feel like you have had a significant impact. Investing isn’t about Consumption. The pumping heart of investing is “Reinvestment”. Taking the profits and putting them to work too. Building. If you step through the mirror, you change from a consumer into a custodian.

Rainforest

Hand-to-mouth living enforces external discipline. You can only spend what you have. If you get paid once a month, and run out, you have to wait till the next pay-check. Living off Capital requires internalised discipline. A long-term sustainability perspective. Think of the Tropical rainforests. The “lungs of the planet”. We can cut them down and sell the wood, if we are only thinking about our lives. Living off Capital requires a “sustainable drawdown”. You have to spend less than is made, despite there being more “available”. This requires a fundamental shift from a consumer mindset, to us becoming custodians.

Rainforest

Social Capital

Warren Buffett made 99% of his wealth since the age of 50. Our World in Data points out average incomes in England were unchanged at around £1,000 in todays terms for the 400 years to 1650. The second part is significantly shorter, to over £30,000 today. Wealth compounds. The personalities disappear. 10,000 plus years laid the groundwork – numbers, words, the internet, travel, laws, shared stories and other bits of the machine that lets us create. Social Capital outlives us all. The key is better coordination and cooperation, with tools for risk control. A world with more fire power, is also a world that needs restraint. When growth explodes, there is value in thinking about the shift to a custodial mindset.