Full Disclosure: The only stock my immediate family owns is Berkshire Hathaway, Inc. and an insignificant amount of the S&P 500.
Money doesn’t buy hapiness. Really! In Stumbling on Happiness Dan Gilbert refers to study after study which demonstrates this observation. Adam Smith noted this long ago in the Wealth of Nations (quoted in ibid):
The pleasures of wealth and greatness […] strike the imagination as something grand and beautiful and noble, of which the attainment is well worth all the toil and anxiety which we are so apt to bestow upon it. […] It is this deception which rouses and keeps in continual motion the industry of mankind.
Happiness and wealth are very related, however. We are very good at deceiving ourselves about what will make us rich and/or happy. This article is about becoming rich, the sure way. Most of you who read this will ignore my advice, as billions before you have. That’s too bad. If you truly want to be believe me, then you might want to watch Gilbert’s video before reading the rest of this article.
I’m not rich
When I left Sun in 1986, Tom Lyon, a wealthy co-worker said to me, “Rob, you’ll never be rich!” He’s right so far. He did good work for many years, and struck it rich early in his career. This happened to a surprisingly large handful of my colleagues, and the vast majority of them deserved it. Yet, there is a much, much larger group of my friends who are just as talented, and are not rich.
Tom’s smarts do not make him any better at predicting the future than anybody else, even Richard Olsen, a man who has dedicated the last 30 years of his life at financial forecasting. I spent nine years working with Richard at Olsen & Associates AG (O&A) trying to get rich.
Crystal Ball Society
Richard is a brilliant man, just like Tom. Unlike Tom, he was born very rich. The Olsen family spent tens of millions of dollars and probably as much of other people’s money perfecting a crystal ball at O&A. In 2001 O&A went bankrupt. Many of my co-workers had already left O&A but some hung on. None are rich, or even close to it. Richard and a few of my colleagues are still working hard at Olsen Ltd.
O&A’s main competitor was The Prediction Company, now a wholly owned subsidiary of the publicly traded Union Bank of Switzerland. Yes, you should click on that link. UBS was the largest bank in Switzerland for many years, but an attack from a Black Swan turned the one-time behemoth into the most mauled European financial player in the global credit crisis. Apparently, the folks at the Prediction Company failed to forecast its owner’s mauling.
Like O&A, the Prediction Company, and a host of other Crystal Ball Society companies, we all lost money in the credit default swap (CDS) crisis. Most of us were not in any position to control our investments. If you had taken long positions in the markets, you would have lost some money. Those few brave souls who took short positions made out like bandits before the US government declared short-selling illegal. Why the Bush Administration failed to eliminate the root cause, and declare CDSes (sophisticated short-selling) illegal is for historians to ponder. I digress…
Law of large numbers
The one crystal ball I do place my trust in is the law of large numbers. In a decade or so, the economy and the stock market will be bigger than it is today. A decade may seem forever to young folk, and it certainly did to me when I was in my 20s. Yet the law of large numbers is very hard to argue with.
There are two important large numbers that define investment returns: time and diversification. The more diversified a portfolio is, the safer the return. The size of the return is directly correlated with the time it is held. At O&A, we called his last statement the scaling law. Ben Franklin just said, a penny saved is a dollar earned. The two are equivalent.
Diversification is the tricky bit. Berkshire has 60 wholly-owned subsidiaries and large portions of 40 other companies. That’s a pretty sizable portfolio. The S&P 500 is on a similar order of magnitude. The individual companies within the Dow are sufficiently diversified in themselves that the Dow is reasonably diversified. The NASDAQ 100 is an example of insufficient diversification for an investment horizon of less than a decade.
Another way to say this is: If you work hard, save, and invest wisely, you will be rich. The Chinese are buying us out of this mess. As they say, “a great fortune depends on luck, a small one on diligence.” Old people say stuff like this. I must be old.
Yikes, I am old! Time keeps on ticking. We have two choices: use it or lose it. Most people choose the latter. To take advantage of time, you need to manage a sufficiently diversified portfolio.
Money Management 101
The first rule of money management is: Spend less than you earn. If you don’t do this now, figure it out, then come back to this article.
The second rule of money management is: Borrow only when the guaranteed investment return beats the interest rate. An example of guaranteed investment is a certificate of deposit (CD). During the credit craze, you could borrow at “0%”, which was 0.5% including transaction fees. You could then put that money in a CD earning 2%. This would net you $300 on $20,000 of credit card debt. For all practical purposes, anybody with easy access to $20K of credit probably has better ways to make money than playing this game.
Borrowing to buy your primary home is a better example of this rule. Primary home mortgages are fully tax-deductible in the US. It’s like having tax-deductible rent, which is most people’s biggest expense. Thirty year mortgages are common, which gives enough time for the scaling law to have a positive effect. A single home is not in any sense a diversified investment. There always has to be a gotcha, and it’s a judgement call most people have to make, which is why the next rule comes into play.
Rule #3: Invest wisely. I am a lazy money manager so I put all my liquid assets in Berkshire Hathaway. I consider it wise to trust the second richest man in the world, who is obviously the best investor in the world (see below), and who puts all his money in his own fund. His public and diversified portfolio also lets me sleep at night.
You could also put your money in the S&P 500. Berkshire only does a bit better than the S&P, and you can surely sleep nights knowing that you are investing in the world’s economy. If that investment crashes, you will have more important things to deal with (like foraging for food).
Some people recommend bonds and real estate, the problem with real estate is that to make any money, you have to break rule #2. I draw the line at my primary home, but your definition of guaranteed return may be different. Government bonds are fine investments in periods of low inflation, but inflation is not dead, expecially the way the US government is printing money lately.
The fourth rule is to sell only when you have no choice. If you are following the first rule, you probably do not have to sell. You may want to maintain a slush fund available at all times that is not invested in the market, just so you do not have to break this rule.
The trickiest rule to follow is #3, of course. After nine years working in the Crystal Ball Society and ten years running various businesses one of which provides investment partnership accounting and tax services, I can say quite emphatically: the wisest portfolio to invest in is Berkshire Hathaway. It’s more than being lazy. Berkshire is run by the best money manager in the world.
Best Money Manager
There seem to two ways people get on the Forbes Billionaires list: inheritance or self-made. Of the 25 richest people in the world, about half are self-made and the other inherited. The Waltons take up four of the twelve inherited slots.
Looking a little deeper at the self-made category, nine guys made all their money from a single company: Gates, Ellison, Kamprad, Albrecht(s), Ortega, Mittal, Bloomberg and Dell. The others are Buffet, Helu, Alsaud, and Ka-shing who are investors, that is, they make their money over time by buying up large chunks of publicly and privately traded companies, and helping them be successful, in whatever way they can (usually by being on the board of directors).
Totally missing from the Forbes top 25 are traders, that is, the people who used their gut instincts and/or computer models to buy and sell publicly-traded instruments frequently. The richest trader on the Forbes list is George Soros (#29, $11B). Note that Soros and Buffet are the same age, earned their first million at 30 or so, and are US-based. The primary distinction between the two is their money management styles. Helu, Alsaud, and Ka-shing are also richer than Soros.
That’s my objective measure: not a single trader in the top 25 richest people. Trading loses to investing, and Buffet is objectively the best money manager in the world.
How to get rich
According to Forbes, the easiest path to wealth is to inherit it. After that, start your own company. I have a bit more control over my fate by running my own business than waiting for my inheritance.
Your next best chance is to be a money manager. Wow! I forgot, you are one! You took my Money Management 101 course already. You now know how to get rich, objectively. The question you should ask yourself is: Are you diligent enough?