“Success is a lousy teacher. It seduces smart people into thinking they can’t lose.”
--Bill Gates “The Road Ahead” (1996)
Tell me if this sounds familiar.
A high-income earner in his early 30s making six-figures a year doesn’t want to hire an investment advisor. The person can’t find one that went to a school equal to or superior to the one they attended. They try to learn to invest on their own and start buying stocks. Maybe they look up what other well-known investors are buying, they hear about which companies have great technology, and they have a few big winners. And why wouldn’t they? They are smart.
Making easy money is intoxicating.
The person starts to pour money into stocks, maybe even borrowing money, because they think they have a natural talent that is just now being revealed. They might even make spreadsheets showing how much they’ll be worth in their 50s, 60s, and 70s if they keep compounding at these rates. They are essentially worth hundreds of millions, it’s only a matter of time.
Then the first crack appears with a big loss on a stock. They rationalize that everyone makes mistakes, it’s a part of the game. Then more cracks appear, and they rationalize that if the winners make up for the losers, it’s still a winning formula.
Then there is a market correction; everything goes down and doesn’t rebound. They are sick to their stomach that they just lost hundreds of thousands of hard-earned dollars. They were trying to be responsible and save money instead of spending it, yet they would’ve been better off spending the money on cars, home improvements, paying down the mortgage, etc. Worse than the losses though, is the shame. They are smart, so how could they have been so foolish to lose a few years’ salary?
The reasons, of course, have nothing to do with IQ and have everything to do with risk management. Isaac Newton, one of the most brilliant people to ever live, lost nearly everything in the South Sea Bubble. People less intelligent than him were getting rich quickly and he finally succumbed to emotional pressure. In investing jargon, we call this behavioral tendency “Fear of Missing Out”. He made some money initially, but like all bubbles, it ended in a crash.
Charlie Munger, the multi-billionaire partner of Warren Buffett, attributes the success of Berkshire Hathaway to risk management: “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” Trying to do extraordinary things usually results in high risk-taking and that catches up with you eventually—it’s a poor long-term strategy. Instead of trying to do extraordinary things in investing, try to do ordinary things extremely well.
You work hard to earn your income and you make sacrifices to save money. The first rule of intelligent investing is not to lose that hard-earned money.
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The definition of intelligent investing: great risk management.
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“…the taxes are indeed very heavy, and if those laid on by the government were the only ones we had to pay, we might more easily discharge them; but we have many others, and much more grievous to some of us. We are taxed twice as much by our idleness, three times as much by our pride, and four times as much by our folly…”
–Benjamin Franklin in The Way to Wealth
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