Lessons from “Morgan Housel on What Other Industries Teach Us About Investing”
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Let me start today with a story of two investors, neither of whom knew each other, but their paths kind of serendipitously crossed a few years ago. The first is a lady named Grace Grahner. Grace was born in 1909, just right outside of Chicago nearby. And she had kind of a hard life. She was orphaned as a child, she began her career in the bottom of the Great Depression. Finally found a career as a secretary, where she worked her entire life. Never married, never had kids, never learned how to drive a car. Lived almost her entire life in a one room house, not far from here. By all accounts, she was a lovely lady, but lived kind of a sad life. And Grace Grahner died in 2010, she was 100 years old. And everyone who knew her was completely shocked to learn, when she died, that she had seven million dollars to her name, that she left all of it to charity, and that began kind of a search among the people who knew her, that said, "How does this humble secretary accumulate seven million dollars?" And her secret was, she really had no secret at all. She saved what little she could, she put it in the stock market, she let it compound for 80 years and that was it, end of story.
The second investor I want to talk about today is a guy named Richard. Save his last name, because you're not supposed to criticize people in public. Although I do a lot. Richard had almost the exact opposite background of Grace Grahner. Born into a wealthy family, went to the University of Chicago, got his MBA at Harvard Business School, went to work on Wall Street, worked his way up at some of the biggest investment firms, became the vice chairman of one of the largest investment banks and without exaggerating was one of the most powerful people in global finance. The day after Grace Grahner died, Richard filed for personal bankruptcy. He told the bankruptcy judge that the financial crisis completely wiped him out, he had no more assets, no more income and he was fighting to save foreclosure on his house. And what's interesting about these stories, I think, is that in no other industry except finance are those stories possible. There's no other industry in which someone with no education, no background and no experience can vastly outperform someone with the best background, the best education, the best experience.
And what I think it shows is that investing is not necessarily about what you know, it's about how you behave. And behavior is hard to teach. It's not analytical, you can't sum it up very well, hard to measure, a lot of it is counterintuitive, and because of that you have some of the most important parts of investing, this topic of behavior, that gets kind of swept under the rug. Particularly, as we are taught investing in academia and in the professional setting
when people think about risk, they don't necessarily do it in an analytical way. They do it in a cultural way. What you think is risky and how you think about the topic of risk is heavily influenced by the culture you live in, the generation you were born into. The values instilled in you by your parents. All of which are not only outside of your control, but differ vastly across all of us. And we want to think about risk as a force of nature that applies to everyone in the same way, and it is, but that's not how people actually think about risk in their own lives. Particularly, I would say, in investing
Now, this is true for inflation as well. This is average annual inflation in the United States in your 20s. For my parents, who kind of came of age in the 1970s and 80s, inflation averaged about 8% a year. For myself, in the 2000s, it averaged about 2% a year. For my grandparents, let's say around the time of the Great Depression, it was about negative 2% a year. In Germany, in the 1920s, inflation was one quadrillion percent. Some think it's more, but that's plenty of zeroes, you get the point. And here I would ask, too, do you think these generations went through their life thinking the same thing about the risk of inflation? I don't think so, and one of the areas where we saw this was gold as an investment in the last decade was extremely with one demographic.
It was baby boomers who came of age in the 70s and 80s, when inflation was really high. Most people from my generation couldn't understand what they were thinking about, because we haven't experienced inflation. So, you have people who have completely different views about what is happening in the investment world, not based off of better data, better models, better calculations, just different life experiences that were outside of their control.
Now, about 10 years ago, there was a group of researchers from Stanford University who crunched a bunch of data and they really wanted to see, analytically, how does this impact how people invest? And what they came up with, they said, if you grew up during the Great Depression, you are half as likely to invest in stocks, compared to those who grew up in the 1960s, at the same period of your life. If you grew up in the 1970s, you are a third as likely to invest in bonds later in life, compared to those who grew up in the 1950s. If you grew up in the 1980s, when the market was prospering, you are more likely to buy stocks, compared to those who grew up in the 1970s, when the market was pretty poor.
And their big summary from all this is, they said, "Our findings suggest that individual investors' willingness to bear risk depends on their personal history." Personal histories that are largely outside of your control, but influence how you think about the world.
Kahneman mentioned that he was the most pessimistic person he had ever met. He said, no one is more pessimistic about life in general than he is. And I said, "Wow, that's interesting. Are you a pessimist because you have all these insights into human behavior and all the different mistakes and biases that we make?" And he said, "No." He said, "I'm a pessimist because I grew up in Nazi-occupied France." And he said, "I saw from an early age how evil people can be."
we asked Kahneman what we can do about this, as in investors, as investors, and he had three ideas. The first one was, "Talk to as many people as you can."
His second point was, "Talk to people who you disagree with."
And number three, he said, "Talk to people who are in different emotional states than you are."
I think my advice from all this is take a simple idea and take it seriously. I think that's the best investment advice that anyone can give, particularly as you become more advanced and more successful in your investment career.
there are two types of risk. There is direct risk, which in this case is the actual terrorism, and then there is indirect risk, which is when our behaviors and actions to respond to that risk backfire on us and it's hard to wrap your head around the idea that we can take actions that we think are making ourselves safer but is actually injecting more risk into our life, but we see it all the time in investing.
I just want to show you, these are the average annual returns, 94 to 2014, stocks in America did about 9% a year, bonds did about 6% and the average investor during this period did something like 4% a year, during a period when inflation was something like two and a half percent a year. So, you have a 20 year period where markets in general do quite well, produce big returns, and the average investor doesn't. And a lot of focus and energy has gone into why this happens. Some of it is fees or some other factors that go into it, but what we know by far, the bigger cause from this is poor behavior based on how people respond to volatility in the market.
this is the periods when the market was in a 5% drawdown from its previous high. That's when it's in a 10% drawdown. And that's when it's a 20% or more drawdown. So, you start with the picture of success and then you layer on the nuance of what happened in-between and you get a totally different picture. And even when investors go into investing, knowing the history of the stock market and the wealth that it's generated, at every point in these times, particularly at a 10 or 20% drawdown, you have a large legion of investors that say, "This is wrong, this is broken and I need to make myself safer and get out."
And really important, they do that with the mindset that they are making themselves safer. They're making their families money, their retirement money, their kids' college money, they're injecting safety into their life. Without realizing what they're almost certainly doing is reducing their long term returns, which is one of the biggest risks that they can take as an investor.
And I think if you study the history of the stock market, volatility is not the risk. Volatility is par for the course in investing. And in fact, the reason that market's produced high returns over time, have historically, is because of volatility. That's the cost of admission that it demands that you pay. But that's just not how people look at it. They're always trying to view it as something is wrong and I need to make myself safer. This is even more true for individual stocks.
The top performing stock in the last 20 years is Monster Beverage. It's up about 211,000%. The chart is in scale, but it's just been an incredible beast over the last 20 years. This, I want to show you, are drawdowns over the same period, over 20 years. I mean, you had a half dozen 50% drawdowns, one 70% drawdowns, countless 30% drawdowns. So, how many people do you think actually were able to withstand the volatility of Monster Beverage over the last 20 years? During the period where it was up 200,000%, this is what you had to pay for for getting it. And a lot of people just don't want to pay that price. It seems too risky and they try to cling towards safety without realizing that this is the cost of admission for returns.
And so, to summarize this, one of my favorite quotes is Eisenhower's definition of a military genius. Someone that's asking him, he said, "A military genius is the man who can do the average thing when everyone else around him is losing his mind." And I think that's so true in investing. You don't need to make a lot of great decisions in investing, you just have to not screw up when it matters most and take actions that you think are going to help you but that are actually breaking your long term strategy that's going to keep you on course.
if we are making forward looking decisions and predictions, how do we operate as Morgan Housel on What Other Industries Teach Us About Investing Page 16 of 19 investors if, as someone like myself believes, it's so difficult to predict what's going to happen next?
And I came across a great quote from Ben Graham that I love. He says, "The purpose of the margin of safety is to render the forecast unnecessary." And I think that just sums up so much of what good investing is, that if you have a margin of safety not just in your portfolio but in your career, with your friends, with how much cash you hold on the side, flexibility in your career, flexibility in your time horizon, that's how you can forego making the predictions that are so difficult to make.
what I think from the Wright Brothers' story is that when innovation is measured generationally, results shouldn't be measured quarterly.
Larry Fink was having lunch with the CEO was one of the largest sovereign wealth funds and the CEO of the sovereign wealth fund said, "Our goal as investors is to think generationally. We're not thinking about this quarter or next year or even the next 10 years, we're thinking about the next generation and the generation after that." And Larry Fink said, "Great, how do you measure returns?" And the CEO said, "Monthly."
To wrap this up, I think if there is something that underlines all of these stories today, it's that the biggest risk to you as investor is yourself and your own biases, your own misconceptions, your own behaviors that impact your returns as an investor.
When people talk about risk, they talk about, what is the economy doing? What is the Fed going to do? What is the CEO of the company I own going to do? And those are all risks. I think they absolutely compare to the risks that you yourself pose to yourself as an investor. And for some people, that's kind of a difficult realization, to know that you are maybe taking all these actions that hurt yourself. To me, I think it's one of the most optimistic realizations in investing, because you can't control what the economy's going to do next. You can't control what the Fed is going to do next. The only thing you can control in investing is your own behaviors. And when you realize that the one thing you can control is the thing that makes the biggest difference over time that, I think, is a pretty optimistic realization.
So, I want to end today with a quote from an investor named Bill Bonner. He says, "People don't get what they want or what they expect from markets, they get what they deserve."
