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.

Decision-Making not God-Making

Profit is not the point. Efficiency is not the point. If you are profitable and efficient, but live hand-to-mouth consuming everything you create, you still expose yourself to shocks and stress. Good ideas are not enough. What you see is not all there is. 

The point is also not seeing the future and every possibility. It is not gambling. You can build endurance and resilience, for whatever outcomes occur. It is not about maybe doing well, maybe doing badly. Create space. Reinvest. Gradually have more capacity because more of your money is being put to work. 

It is not a case of if others do well, you do badly, or vice versa. Fundamental investing is not a zero-sum game, where wealth is extracted. It is not a competition against other people. If you spend your entire career judging yourself relative to other people, it is more likely than not that by your own measure, you will have added no value. 

The point is not to find your place on Mount Olympus and prove to other people that you are awesome. Building capital allows you to free yourself from that judgement. To make decisions based on the unseen. To make decisions based on what you know to be true, for you. 

Money is made by solving known communicable problems for decision-makers with money. If you have money, you can, by your own choice, finance the wordless, shapeless, problems and non-problems you wrestle or sit with.

Don't make Gods, make decisions

Grow or Shrink

The value of a business can be zero. Price can join it there. Now or later. Analysts will attempt to calculate their view of the intrinsic value of a business, and then compare it to the price. Value is dynamic, relative, and personal, and so no estimate of intrinsic value is the “correct” price. 

It is possible to get caught in valuation no man’s land. Seduced by a model of what you think reality should be. Seduced by the impenetrable complexity of your perspective, and how smart that makes you feel. 

Instead, calculating intrinsic value is like doing due diligence on a company you plan to work for. It’s not just about the quality of the job offer. It then matters what work gets done. 

Investors with a quality mindset, will seek out businesses at a reasonable price, but what they are really looking for is what is being done. We tend to undervalue the future, and so it is profitable finding companies that sustainably do something of value and reinvest, creating wealth through a process. 

A good idea is not enough. Those investors will very much consider the strength of the balance sheet of these companies, and the container (barriers to entry) in which value is created. Understanding the barriers that allow winners to keep on winning. 

You don’t have to know what is going to happen in the future. If you don’t pay an excessive price, then the focus shifts to the quality of work being done, and the habit of reinvestment. It is not about outperforming others, or even looking at what they are doing. Not gambling. Not chance. 

If a business creates and reinvests, with a resilient container, it will grow. If it consumes capital, it will shrink.

No Man's Land

Flander's Field, Belgium (1919)

Solution or Problem

The magic of fundamental investing is reinvestment and compounding. Where what is being produced has the space and time to reproduce. It is not about consumption. It is not about predicting the future. It is not about relative performance. 

It is about doing work. Solving problems. Allocating capital to good business ideas. Ideas that meet, and excel within, specific constraints of numbers-based endurance, resilience, and creativity... generating enough to support a different form of values-based endurance, resilience, and creativity. Financing good ideas that would otherwise get mangled when forced through the filters needed to fit money-making boxes. 

Property could be a productive asset in the sense that you get rent from it and then invest that in something else. Residential property doesn’t sit well with me as an investment in that sense, because “affordable housing” is a problem we want to solve. Housing as an investment, and housing as an expense, are in direct competition. 

We want spending problems to go away. We want investments to grow. We all sleep for eight(ish) hours (ideally). In one bed. It doesn’t matter how many rooms you have or how rich you are, when you close your eyes (if you are safe and warm). Is the goal for the same house to rise in price? It is important for us to ask ourselves if we are even trying to solve the problems we know we have. 

Or would a solution be a problem?

Tutankhamun's Gilded Bed

Waves of Life

The vast majority of people, even those earning a lot of money, live hand-to-mouth. One way to view meritocracy is that it shifts capital to where it is working the hardest. Another way to view meritocracy is that people who are "better", deserve to live better lives. That how much you spend should be in line with how much value you add to society. For that to be “true”, people need to spend what they earn, and be paid what they are worth. That is not how capital, money, or price works. 

One of the challenges of building capital is that there are always emergencies. There are always events that can stop you and set you back to zero and hand-to-mouth. 

In Australia, they have famously changed national saving habits and built huge superannuation funds. One of the philosophical questions is whether people should be able to access their retirement savings in emergencies. For proponents of Universal Basic Income, a key question stands around whether lenders should have a claim over those payments. Can you borrow against that guaranteed stream of money?

In the early stages of building capital, the waves of life can destroy any capacity to protect, cultivate, and invest in merit. It is hard to grow capital when it is being harassed. It is hard to see each other when we are living hand-to-mouth. 

Doubling Time

Part of the story I tell myself about money comes from the micro-world I grew up in. The bubble within a bubble where my parents were the decision makers. One of the ways I was taught saving was that my parents used to match what I saved. How do you instill the concept of compound interest, and delaying getting something now, so that it can build for later? Saving and Investing are worth thinking of as different things. You save *for* something. Investing puts money to work (reinvesting rather than consumption). You can then spend some of what the investment earns, and reinvest some. But it is hard enough learning delayed gratification by saving, so... baby steps. Compound interest also takes time to kick in. 5% real return would double your money in roughly “rule of 70” 14 years (70 divided by return equals roughly the doubling time). No kid is still a kid if they have to wait that long. The big thing I wanted was a music system. I saved half by starting a sweet business, and my Mom matched what I saved. Where she got the magic “compound interest”, I don’t know. But she managed. She was a bit of a hero.

Funny Faces sold individually were my biggest winner

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.

 

Consuming or Reinvesting

“No decision” can be “the decision”. Building wealth is capital allocation. Getting money a job. If  everything there is, is spent, there is nothing to put to work. If you are going to build capital, you first need to build buffers that control for the waves that knock you off course. To do that, instead of “nothing left” being the enforcer of discipline, you need to internalise self-discipline so extra is allowed to exist. Not extra in the sense of a Scrooge McDuck pool of hoarded coins. Extra in the sense of reinvestment. Extra in the sense of circle of life rain-cycles, where energy is neither consumed nor destroyed, but just changes shape and form. It is the story of the Ant and the Grasshopper and Aesop's Fables. The Ant works hard during the Summer and builds up a lot of reserves. And when it gets to Winter where there is nothing to eat, Ant has extra. Grasshopper plays during the Summer, when it is beautiful, and there is plenty, and there is enough to eat. But then when it gets to Winter doesn't have enough. If you are going to build capital and buffers... the money is there, but it is not there. Which is quite abstract. The money is working at a job. It is not there to be spent.

Consuming vs Reinvesting

I am not Playing

I don’t like the term “playing the markets”, but even I have to admit that it is possible to hype it up and play it as a game. Throw in some American Football Style commentary and every bump and drop can be dramatized. It is true that you can trade anything with a pulse. It is also true, that while some people believe it is 50/50 whether an active investor making conscious decisions can beat the market (pre fees), it is far far easier to lose money than it is to make money. It is incredibly easy to make stupid decisions and lose money fast. The equivalent of going on tilt in poker. Which normally means trying too hard to make money too fast. That is “playing the markets”. The best way to play that game is to be patient, and avoid being stupid. Feed off the mistakes of others. Investing is different. Investing is slow. Investing is getting your money a job, and reinvesting its salary rather than spending it. Investing is the win-win daily practice of creating mutually positive futures. Investing is channeling resources to the solving of problems.

Investing isn't Win-Lose

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.

Thriving Too

I view investing as getting my money a job. When things are complicated, we simplify them into stories (based on what we already understand) to make sense of it all. To provide a way to make decisions. I started by investing in the funds that I was studying. Which, unsurprisingly, were the funds of the companies I worked at. Which, unsurprisingly, were companies that recognised the qualifications and studies I had done. Then I got an Interactive Brokers account, and started by getting my money four jobs. Gradually over a couple of years, I got my money more jobs until I had a portfolio of 20. Unlike my current personal job hunt, my money did not get interviewed. It did not have to find vacancies in roles that fit my profile. Money does not specialise. Money does not make decisions that limit its world view. Money does not have confirmation bias that looks to explain away its inadequacies in comfortable, but false, fairy tales. Money does not define itself by the work it does. It works, and either it grows or shrinks. The secret of nature, David Attenborough says, is that “a species can only thrive when everything around it thrives too”. Making money is not a win-lose ego competition. It is win-win capital allocation.

Rain Forest

Full of  Sustainable Growth

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

Sustainable Growth

A focus on short term profits is doomed to fail. The energy is in the wrong place. Profit isn’t the driving force of wealth creation. Reinvestment is. The Business Graveyard is full of stars that shone bright. Sustainability is the real driver of wealth creation, because the magic comes from compounding. Taking profits, yes, but putting them back. Putting them to work. Again, and again, and again. Which is why sustainable profits aren’t sneaky. Both parties need to get a genuinely good deal, with full transparency. Sustainable Growth is about building systems, institutions, communities, relationships and value that endure. Sustainable Growth is about building the resilience to look at both short term losses and short term gains with the same Poker Face. To see the fundamental long-term value creation through the noise. Sustainable Growth is about connecting the past, to the present, to the future.

Thinking Sustainably

The hardest part of most businesses is finding new clients. Even if you are good at it, there is always the existential risk that there is a limit to the number of people who want what you are offering. Needing new clients isn’t sustainable. Big Game Hunting is also seductively attractive. A single big client can let you think you have seen the matrix, and pop the Champagne. But. There isn’t much big game in a world with an excess of hunters. Hand-to-Mouth living requires a constant, replenishing source. That is why sustainability has to be at the heart of every solution. Now is only worth celebrating in the context of later. We have to eat.  So Hand-to-Mouth is the only first step. Depending on others while you don’t have the necessary skills and knowledge. Depending on yourself when you do. Smoothing and softening that dependence with a Buffer. Building an Engine to detach dependence. Making sure you can comeback. Making sure today provides a platform for tomorrow. Softening the hardest part every day by strengthening and deepening relationships.

Impressive but not Sustainable

Prove or Build

Conspicuous allows you to justify yourself. Something you can count. In a world that is complex, ambiguous, and random, having a cause for every effect gives you something to hold on to. An explanation. This inhibits foundational investing. A need to prove swamps the need to build. It makes ego and confidence our primary focus. The most powerful investment forces are time and compounding. The time frames we think in are too short. This means the real impact of what you do is only felt after you are gone. Unless you live hand-to-mouth. Then what you do is felt now. That is the problem. You need a genuine sense of ownership to be willing to reinvest rather than consume. For that to become a habit, until the amount reinvested makes the amount consumed a rounding error. Until you are a custodian. What you see is not all there is. Don’t prove. Build.

Time Matters

A dollar in ten years is not worth the same as a dollar now. Even ignoring inflation. A dollar in ten years doesn’t get the next decade. That is a huge disadvantage. This is if you are thinking of that dollar as a Productive Asset. Something that can get a job. Something that generates an income. A Discount Rate is how much you should discount valuing that dollar, if you wanted to compare its financial value to money today. Interest/Return is the salary money gets. Discount Rate thinks in reverse. It is the salary needed to grow money. It allows you to work out what the Present Value of a stream of income is. Time Value of Money is a useful idea. It is a reminder that the job money does, matters. A dollar may be worth the same (ignoring inflation) if you put it under your bed for ten years, but that is just because it is being lazy. Not taking advantage of its advantage. Productive things grow with reinvestment. Sustainable Growth means there is more to go around tomorrow. What we do, matters.

1525 Joachimsthaler of the Kingdom of Bohemia 

was the first thaler (dollar)

Staying Sweet

Capital can earn money. Capital can grow. If Capital is allowed to grow until it earns enough money, something magic can happen. People *have to* earn money. Most of us have to filter the decisions we make about how to spend our time through the question “How do I get paid?”. Capital can become the Engine for Human Creativity. At the heart of this idea is Sustainable Growth and Reinvestment. The idea that resources and activity can be like the water cycle. Being used in such a way that there is more once the creativity has been applied. That once the Capital is put to work there is a “Real Return”. After all expenses, there is something left. If that something left is regularly reinvested, and more is invested than consumed then activity can be a source for life. In “Honeyland”, the Natural Beekeeper insists on leaving half the honey for the bees. Consumption without constraint kills the source. It may make the Summer sweeter, but the Winter will get you.

Leave some for the Bees

Start with Half

The point of an Engine is to finance your life. Not everything we do makes money, nor should it. Without an Engine, you need an income stream to finance your spending needs. Building an Engine aims to replace your role (completely or partially) as a productive asset. To give you permission to release the filter of “how will this make money” in your decision making. Three things matter. 1) The Real Return (after everyone has fed – tax, costs) 2) The Time you allow your money to grow unmolested (In which the Real Return is reinvested. Reinvestment is the pumping heart of compounding growth.) 3) The Share of your income stream that gets put to work rather than spent. The “5-15-50” method is one target model. Unmolested, I believe well invested Equities put to work for a long period (i.e. 15 years) have a good chance of earning an average 5% real return. 50% (one for me, one for you) is a super aggressive savings rate. But recognises that nothing gets built if everything gets eaten. If an income is sufficient to finance your consumption and investment in this way, and you get the 5% return for 15 years… you will have built an Engine capable of continuing to finance that income stream. Capital to release you.

Start with a Half

Destruction

Capital is a living organism, and Consumption is a form of killing. We need to consume to live, and so we need to ask how much of the Consumption is part of the cycle, shifting energy from one form to another, and how much is destructive. Sustainable Consumption reinvests. Meaning that not all that is produced is consumed. Reinvestment leads to Sustainable Growth. Consuming more than is produced gradually destroys what is there. Living hand-to-mouth with zero reinvestment is destructive. It is living in the present to the exclusion of all that will follow. Actuaries typically talk about a “Sustainable Rate of Return” of 3.5% for the average retiree aged 65 years old with a prudent base of Capital working for them. This means if you “see” a million dollars (ka-ching!), you should really “see” a sustainable stream of $35,000 a year if you are a custodian. See Capital as the trees, and sustainable income as the fruit. Ash doesn’t produce fruit.