Behavioural finance expert Morgan Housel, partner at Collaborative Fund and an award-winning author, was a speaker at the Allan Gray Investment Summit and the CFA Investment Conference this year.
Housel, in almost identical presentations at both events, spoke about how we can think about money, risk and investing in more productive ways.
Here are the main take-aways from his presentation at the Allan Gray summit.
1. Timing is meaningless. Time is everything.
Warren Buffett accumulated 99% of his net worth after his 55th birthday, and 97% after he turned 65. If Buffett had retired at age 60, he wouldn’t have become the household name he is today.
Investors spend much time trying to answer the question how Buffett become wealthy and successful. We go into great detail about how he thinks about business models, moats and market cycles. These are important, and Buffett is a great investor.
But Buffett’s real “secret” is that he’s been a good investor for 80 years – that’s the secret to 99% of his success.
A graph of the maximum and minimum total returns over different holding periods in the US stock market between 1871 and 2012 shows that it is not until you have a holding period of between 10 and 20 years that you finish every holding period with a positive return. Not a good return, just a positive return.
Most investors think they are long-term investors. But if you ask them what “long term” means, many will say one year, or perhaps five years; and 10 years is definitely “long term”.
The central problem is that investors underestimate the amount of time required to put the odds of success in their favour.
No matter how smart, educated or sophisticated investors are, and no matter how long they’ve been investing, the concept of compounding is not intuitive to them.
2. Stop moving the goalposts
Many Americans believe the 1950s was the golden age of prosperity in the US. In fact, even in the 1950s, people believed they were living in a time when it was “as good as it gets”.
But it’s easy to show analytically that this is not true. For example:
- The median household income in 1955, adjusted for inflation, was $29 000; it was $64 000 in 2020. This is not only because more women have entered the workforce and are adding to household income. Average hourly wages have also more than doubled during this period, adjusted for inflation.
- Food took up about 29% of the average household budget in the 1950s, compared with 13% today.
- Workplace deaths were three times higher than they are today.
- In 1950, half of men aged 65+ were still working, compared with 23% today.
So why the nostalgia for the 1950s?
At least one answer is that the 1950s were a unique time in the US and in many other areas around the world, because wealth inequality was very low relative to what it is today.
The top marginal tax rate was 91% in the 1950s, so there weren’t CEOs making a thousand times what their workers made; there weren’t athletes making $30 million a year; and there weren’t hedge fund managers making a billion dollars a year.
It was easier for the ordinary family to keep their expectations of the good life in check, because there was not a group of very wealthy people inflating aspirations of what the good life was meant to be.
In the past 70 years, our incomes have doubled, but our expectations have more than doubled, because we are bombarded by pictures, on social media or in the news, of people living a very good life.
What matters in life is not your circumstances, but your circumstances relative to your expectations.
If your expectations grow faster than your income, you will never be happy with your money.
Wealth is a two-part equation: you need to grow your income and net worth, and then you need to keep that net worth in check relative to your expectations. It’s easy to ignore the second part of this equation and only focus on growing your income.
Being an adviser has as much to do with managing a client’s expectations as it does with growing his or her income.
3. Risk is what you don’t see
How risky something is depends on whether you are prepared for it, not how big a risk it is.
The biggest economic risk is the one no one is talking about.
For the better part of a decade, the investment community in the US discussed whether the biggest risk to the US economy was Barack Obama, or whether it was Ben Bernanke, the former chairman of the Federal Reserve, and the money printing after the global financial crisis, or whether it was Donald Trump and the erratic policies of the past four years.
In hindsight, we now know that the biggest risk to the economy wasn’t any of those people. It was a virus that no one was talking about it.
If you look back through history, this has always been the case.
The things that make the news every day (budget deficits, company earnings, trade wars) are not risky, because everyone knows they are going to happen.
What actually makes a difference in the global economy are things such as Covid-19 or Lehman Brothers not finding a buyer in 2008, which started the financial crisis.
The common denominator of these events is not that they were big; it’s that they were surprises that no one saw coming.
There are two things to keep in mind in a world where risk is what you don’t see:
- Think about risk in the economy in the same way that Californians think of earthquakes. If you live in California, you know that earthquakes will be a big part of your future. No one can predict when the next earthquake will occur, so rather than trying to make a prediction, you live with the expectation that an earthquake is probably going to occur at any moment. Rather trying to forecast the next recession, remember that historically there have been on average two recessions a decade, and expect this to be the case going forward. Think: “I don’t know when that’s going to happen. I don’t know what’s going to cause it, but that’s my expectation.”
- Understand the difference between getting rich and staying rich. These are two different skills that need to be nurtured in their own way. Getting rich requires being an optimist and taking risks. Staying rich requires the exact opposite. It requires a degree of pessimism and paranoia. All of history is a series of setbacks and disappointments, recessions, bear markets and pandemics.
A final thought
Historically, the biggest innovations and technology breakthroughs do not occur when everything is going well. The biggest innovations occur when the world is on fire, when everyone is a little bit panicked and scared, and the stakes are high to solve problems.
We are living through one of those periods right now.
You or your clients might find it worthwhile to watch the entire presentation, which is slightly longer than 26 minutes.
