By Dr. Daniel Smith, WCI Columnist
I’m at the financial “age” now where the majority of the practicalities that I read regarding finance and investing are repetition, nearly rote. This is great news because it suggests I should be fairly competent to manage my own financial affairs. I am, however, much like a chief resident—replete with academic knowledge and well-studied didactic lessons but bereft of much practical experience, relatively speaking. In fact, much of the more practical medicine is learned either via admonitions from more experienced physicians or by one’s own professional trial and error. To prevent myself from the more injurious and fraught latter pathway to practical financial wisdom, I’ve been reading more books on financial history—including John Rothchild's A Fool and His Money: The Odyssey of an Average Investor—and fewer on ideas and technical application.
Many of you readers are similarly experienced, and you can often guess how Jim will answer a speak pipe question on the podcast before he even begins. If that’s the case, I encourage you to dive headlong into the revealing and often humorous tales of financial eras of yesteryear. Titles like Where Are the Customers Yachts?, Devil Take the Hindmost, and The Delusions of Crowds are fantastic fodder for continuing financial education and, simultaneously, a good laugh. (By the way, if you’re looking for a particular book and want to compare prices, try www.findbookprices.com. I find almost all of my books this way.)
Today, I’d like to walk you through a few of the high points from a book older than almost every medical student in training right now, Rothchild's A Fool and His Money. The premise of the book released in 1998 is thus: during a roaring bull market, this average Joe without any background in investing devotes a year to seeing exactly how the investing sausage is made. You can get a feel for the style with this excerpt:
“Thinking about money is a well-known consequence of middle age. As the waist expands and the arteries contract, sex seems to take a merciful back seat in the libido, supplanted by an obsession with where to eat and how to increase one’s net worth. The frequency of thought has no apparent correlation to practical success in either instance.”
If just reading that paragraph offended your sensibilities, I caution you not to read this book and instead devote leisure reading to the day’s Sudoku. If you’re still with us, I want to point out that in the last smirking sentence of the quote, he buries a gem: worrying about finances more does not necessarily improve outcomes. The Pareto principle states that roughly 20% of effort yields 80% of reward. This should be a passive investor’s mantra. Avoid the unnecessary yet frenetic mental activity associated with overwrought equations, options, and yield-chasing and simply let a reasonable asset allocation do the work for you.
Rothchild starts by saying that we are inundated with ads, calls, and TV programs (and now YouTube and TikTok money gurus) all telling us how to spend, save, and invest our money. He follows this commentary with the lamentation that with all of the information coming at you, it’s hard to tell what’s worthwhile and what’s not, comparing Louis Rukeyser to the average investor’s Virgil though I’d say Jim Cramer. There are a couple of things to keep in mind as you’re constantly bombarded with schemes, ideas, and pitches.
First, if the talking head on YouTube really knew how to wring these eye-popping amounts out of investing schemes, do you think they’d let you in on it? With tongue firmly in cheek, Rothchild characterizes such a philanthrope thusly,
“One man described how he’d upgraded himself from short-order cook to millionaire in just a few months purchasing distressed properties with his credit cards. Though, of course, he no longer lacked for money, he was selling a mail-order course to share his techniques as a public service.”
Second, keep in mind that good investing is boring. Sure, you could go wildcatting for oil in Alaska and hit it big, or you could invest your portfolio reasonably and let compounding work in your favor. Tune out the noise and enjoy your life!
Chapter 2 of the book begins with Rothschild laying out his heretofore investment-picking credentials.
“I managed to spare enough cash to buy two shares of Technical Tape at $14 a share. These were worth $4 apiece 20 years later. The two shares, plus some worthless employee stock from a liberal magazine in perpetual Chapter 11, were the only assets for which I could take sole credit . . . I [then] began to apply my talent to the spousal holdings, which was too bad for them . . . [So] I reviewed my previous gains and losses overall and concluded that I’d ‘broken about even.’ So many friends and acquaintances told me they’d also ‘broken about even’ on their stocks . . . that I’m convinced this result is not unusual . . . This convinced me I was fully qualified to speak for the average investor.”
This “breaking even” is an interesting example of cognitive dissonance to which stock pickers of all stripes are susceptible. Writes Bill Bernstein in The Delusions of Crowds, “More often than not, we avoid contrary facts and data, [and] when we cannot avoid them, our erroneous assessments will occasionally even harden them and yet more amazingly make us more likely to proselytize them.”
Bookending the concept that investing should be boring, Charles Ellis points out that active investing is, generally speaking, a loser’s game. The concept is that with something like amateur tennis, the winner is not the person who tries to “win” the hardest but rather the person who focuses on making the fewest mistakes. I think this even understates the position, however. In active stock and mutual fund picking, you’re not playing another amateur on the other side of the court; you’re playing Serena Williams. Because most stock trades occur between major investment firms, the odds are that you’re making a bet opposite a gaggle of Goldman Sachs economists, chartered financial analysts, and finance Ph.D.s.
Can you get lucky a few times? Sure! But even seasoned gamblers will tell you that it’s hard to beat the odds.
Says Rothchild, “An acquaintance with a seat on the American Stock Exchange proposed an IBM option spread, where you buy the June ‘call’ and sell the October ‘put’ simultaneously. Until then, I would have thought a June call was a duck whistle and an October put a geranium bulb.”
In the book, Rothchild is fascinated by the flexibility with which plays could be made on stocks with the use of options. He did, however, realize that this was playing with financial fire and subsequently disavowed the use of options.
Indebtedness and Leverage
Tying nicely into the paragraph below was Rothchild’s commentary on banks and S&Ls (Savings and Loan) at the time of publishing.
“In all the various banks and S&Ls, I sensed a greater enthusiasm for increasing my indebtedness than encouraging my savings . . . in fact, our so-called thrift institutions would be better understood if they were called debt institutions, since the current level of public saving is at its lowest in modern American history, while public borrowing approaches infinity.”
Remember that financial professionals make their living selling you something. It can very well be something that you need: a home loan, a (term) life insurance policy, investment real estate, etc. However, even the most well-intentioned professionals, to say nothing of patently unctuous salespeople disguised as professionals, can be led astray by the siren’s call of the dollar. Another quote brings this point home.
“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” — Upton Sinclair
With just a tinge of hyperbole, Rothchild lampoons latter-day financial planners, quipping “It’s very easy to call yourself a financial planner. In fact, any out-of-work saxophonist or diesel mechanic can become one by putting up a shingle to that effect. The 10,000 stockbrokers at Merrill Lynch have renamed themselves financial consultants.” Fortunately, more and more financial professionals have some kind of education credential that confers some degree of certitude that training and, in the case of the CFP, alignment of values (i.e. a fiduciary duty to you) are appropriate for one’s needs.
“Act as if every broker, insurance salesman, mutual fund salesperson, and financial advisor you encounter is a hardened criminal, and stick to low-cost index funds, and you’ll do just fine.” — William Bernstein, If You Can: How Millennials Can Get Rich Slowly.
Dr. Bernstein will tell you this is a bit of an overstatement, a word of caution when allowing others a say in how you save, spend, and invest your money. Keep an eye on three big things for planners: fee structure (are they paid by time, sales, “managing” your money, or some combination), educational and work background (credentials, degrees, and ADV), and investment philosophy (low-cost, broad market index funds for the majority).
Brokers and Money Managers
Though this maxim should be extended beyond just brokers, which are now more likely to be digital than physical, the idea is impactful nonetheless: “The first thing the broker recommends will make him the highest commission.” Later, in a meaningful interaction with a portfolio manager, Rothchild writes:
“. . . the portfolio manager is on shaky footing, and must look over his shoulder at the other portfolio managers, plus stay awake nights worrying if he’s going to lose his job. In fact, the dozen or so portfolio managers at Bankers Trust had made a recent pact to all buy the same stocks, so nobody would look bad compared with the others . . . You’d think a portfolio manager would welcome diverse performance, but Mr. Platt [a portfolio manager] convinced me they’d gladly forgo the chance at relative glory in return for reasonable job security.”
Analysts, Economists, and Forecasters
Analysts have a difficult job to do. They scour companies' earnings reports, prospectuses, tax filings and amendments, quarterly calls, etc., for indicators of future profits and losses that could affect prices. Much of this information comes directly from the companies’ public relations desks, which the analyst is *supposed* to parse for accuracy and misleading or opaque information. However, analysts, like all financial professionals, know that their bread is buttered by the investment groups or periodicals that hire them. This, coupled with the sources for large amounts of their income data, leaves lots of room for error. This is not news for Rothchild who paraphrases an analyst that he met during his investing pilgrimage: “Mr. Glass [the analyst] didn't doubt that at some companies, the skeptical analyst, like the skeptical newspaper reporter, might fall out of grace with official sources.”
The old gag goes, “Why did God create economists? To make weathermen look good.” Similarly, Rothchild comments about forecasters.
“. . . the Drexel experts gave a skittish, and even negative, prognosis for stocks. In December 1985, they still hadn’t foreseen that a marvelous run-up was about to occur. Instead, they worried that the economy would pick up steam, which for some reason would depress the stock market . . . [Later] During February-March, Drexel came out with an update . . . mentioning none of the negatives cited above. This time the forecasters listed the new reasons for optimism in the market. These included a ‘rebounding economy’ and an observation that the ‘business climate is good.’ This was doubly curious, since these reasons for optimism were the same as the reasons for pessimism offered three months earlier.”
King Solomon and John Rothchild would have agreed that there is nothing new under the financial sun. The same motivating factors that existed in the 1980s financial world still exist today: greed/FOMO, fear, quid pro quo, etc. Protect yourselves from becoming the next hapless John Rothchild and pursue financial literacy and continuing education (including at WCICON23!). Regardless of what form the next four decades’ financial landscape looks like, you’ll be well prepared.
Have you read Rothchild's A Fool and His Money? What did you take away from it? Does it still hold up today? What other financial education books did you read this year that you'd recommend? Comment below!