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James: Welcome young investors to YIS broadcast with Morgan Housel. Morgan Housel is a partner at the Collaborative Fund which is an early stage venture capital fund. He is also a former columnist at The Motley Fool. Morgan, we’ve featured many of your articles in the past. I mean the kids just love your articles and they love The Motley Fool. Morgan is also a former columnist at The Wall Street Journal.
He’s the two-time winner of the Best in Business Award from the Society of American Business Editors and Writers. The two-time finalist for the Gerald Leob Award for Distinguished Business and Financial Journalism selected as the Columbia Journalism Review for the Best Business Writing 2012, In 2013, he was a finalist for the Scripps Howard Award. And as an investor, I can say that when he writes, everyone reads. He’s just thoughtful. He’s a student of the market, a student of history and it’s just an honor, Morgan, to have you here today.
Morgan: Thanks for that. It is certainly an honor to be here tonight. So, I am looking forward to chatting with everyone. This is fun!
James: We did an introduction in the beginning. We have students from Agoura High School, Thousands Oaks High School, Westlake High School from Southern California, who are some of the student leaders of Young Investors Society. Thank you all for being on. I will let them ask a lot of the questions today but I will kick it off, Morgan, to you.
I guess the first question if you could just kind of a big picture question. Talk about the lessons you’ve learned. You’ve covered the market and you’re a student of finance and investing. Talk about the lessons that you’ve learned in more than a decade that you’ve been studying the markets. What are the key things that you’ve learned? What would you pass on to kind of kick off to this discussion?
Morgan: Yeah, I would say that biggest kind of high- level lesson that I have learned in the past 10 or 15 years. I really started my career in investing in 2008, which was when the economy melted down, the markets melted down. It was the end of the world in 2008. That was when I began. My career started there – started in the meltdown. We’ve had this big bull market ever since. I tried to be a student of history as well. Looking back at what has the market done over the last century, what have different global economies have done over time.
I would say the big lesson in all of that both in recent history and broader approach to history is that investing is often taught as a math-based topic. It is taught as formulas and data. You take your data and put in your formula and you get an answer. And then, the answer tells you what to do. It’s kind of how it’s thought about and taught very often.
The big lesson for me is that I’ve really noticed that investing is much more a soft behavioral science. That’s how I view it. The best way that I put it is, finance is really not a study of finance, it’s a study of human behavior. That’s what investing is. How do people in big groups respond to incentives? How do we respond to risk? That is what investing is to me.
I tried to research investing and think about investing not as data and formulas but as a study on how do people in big groups respond to threats and incentives, I think if you view it through that lens, you started to think of investing in which influenced by sociology, psychology, history, politics and all kinds of different fields that kind of fit under this umbrella of human behavior. Rather than just the little tiny umbrella of finance and formulas.
It’s not to denigrate the formula. It’s an important part of investing. But investing is such a broader topic; just finance.
James: Yeah. I love it. With that why don’t we kick it off over to you in Southern California? Feel free to ask Morgan Housel any questions that you like.
Student: I am kind of looking to get into investing as my future career, not just a hobby or something on the side. I’ve been reading about it. It seems like all these people are majoring in Computer Science. I just want to know what you thought because you said that investing is more like psychology.
Morgan: Good question. I would say in general, what you major in college won’t have a huge impact on your career as an investor, particularly later on. A lot of the greatest investors that I know have degrees in English, Psychology, Biology and a lot of them have degrees in Finance. Business and Economics. This kind of gets back to what we talked about investing being a broad topic of human behavior. Because that is the case. You have different people from different fields and end up really doing well in investment careers.
That’s not the case if you want to be a doctor, then you have to go to med school. If you want to be a lawyer, you have to go to law school. Whereas in investing, a lot of people throughout the course of their career, throughout the course of their education learned a certain thing about how people behave in general. It’s just a different view of the world. And they learned a view that teaches them something useful about investing.
I think it’s important early on in your career that you can demonstrate to your potential employers. You have a clear a short-term and mid-term interest in and commitment to finance. I would encourage people that they really have interest in investing – you know if you want to major in finance. business or economics, I think that’s great. But if someone said they interested in a career in finance and they’re major in computer science. I would say that’s great too!
So if someone is interested in a career in finance and say “Do I need a degree in computer science?” I would say “No”. I would say “Pick your degree based on what is most interesting to you.” Because what is most interesting to you, it is probably what you going to do the best at. I think investing is one of the few careers that no matter what you major in you”ll ended up doing well if you are passionate about investing, to begin with.
I majored in finance and economics. I can tell you with certainty that nothing that I learned in school, no direct lessons that I learned as an economics major became truly relevant in my career as investing. There are certain frameworks or what not, but there is no – I can’t think a single time in my career as an investor that I said, I remember when I learned this when I was in freshman year and now, it teaches me… It’s never been the case. Again, that’s not the case for other careers. If you want to be a good computer programmer, you probably need to major in computer science. Again, I just want to go back to picking your major based on what you are really passionate and interested in.
Student: What would be the most valuable skill that you learned through your experience in your field? Something that can not be taught in a book or at college. Something that you learned through working in world investing.
Morgan: Good question. I would say no matter what type of investor you’re going to be, one of the biggest skills is your ability to deal with uncomfortable situations. Because all investing is that you have markets over time that is going to produce a good return over time. Markets are going to go up over a long period of time. You are looking at 10 or 20 years. But the cost of those returns, what the market is going to make you give up to earn those returns over time is putting up and dealing with their markets and recessions. The market going down 10 or 20%, and volatility up and down.
The people who can endure that discomfort over time, I think are the ones who end up doing the best. This comes back again, I don’t want to keep beating a dead horse but why do I think investing is such a multidisciplinary field? Here’s a great example: The best investors are the ones who can endure the most discomfort and the most volatility. That is really sociology and psychology. I mean if there’s one skill that is hard to teach that is absolutely imperative to successful long-term investing is the ability to think long-term. That’s not natural for most people and that’s easier said than done.
I think if you have a natural disposition towards long-term thinking and you can really force yourself to take a longer-term view and not focus on what is the market going through this month, this year but what’s likely to happen in the next over 10 -20 years. If you can really force yourself to think like that; and again, very difficult for most people to do that. But if you can, I think that is the most important investing skill that is hard to teach if not impossible to teach at a school.
Student: I would honestly love to hear more about your specific, particularly as a columnist writing about finance and how you found that job and what made you interested in doing that.
Morgan: Great question. I started my career – well, I go back a little bit. All throughout college, my plan for a career was investment banking. I have to go back. I was in college 2004, 05, 06, 07 and during that time, investment banking was the coolest thing to do. I kind of feel that it still has that idea but back in the mid-2000s, there was no better career for finance students than investment banking. It had so much glamour to it. You can make a lot of money and you have power as an investment banker. That’s what everyone wanted to do. That’s all I wanted to do as an investment banking.
I got an internship as investment banking in my junior year. Instantly, on the first day, I hated it. I couldn’t stand it. It was my dream. It’s all I wanted to do. But on day one, I was like “get me out of here.” Such an intense culture that was based on, I mean it felt like hazing. It felt like working 18 hours a day. It’s not like you needed to work 18 hours a day, because it’s just that you have a boss above you that just wanted to see you score on hours that kind of thing. I can do much better if I can be in a much quieter environment where I can think the problem through rather than a really high pressure and high stakes environment. It wasn’t just really for me.
So then soon after that, I got an internship in private equity. I really like private equity. The culture was great. It was a good mix of operating a business and investing. It’s a good mix between the two. This was 2007 – 2008. The economy blew up. I think most of you probably were too young to remember but it was really a brutal time. In 2008 – 2009, if you were looking for a job in finance, 2008 – 2009 was not a good place to be because everyone was getting laid off. None of the banks were hiring. All of the hedge funds were blowing up. No one was hiring.
This private equity firm I was interning with said “Hey, you are a summer intern. We’re not going to offer you a full- time spot. We’re not hiring anyone right now.” They were laying people off. I was okay. I was finishing my senior year. I didn’t have a job. I didn’t really know what I was going to do and Congress was falling apart. I had a friend who was a writer for The Motley Fool and said “Hey, you should come and give this a shot. Maybe you can write about investing.” I didn’t have any intention or plan writing about investing but I was very interested in finance and investing. So I said “Okay, I’ll give it a shot. They’re probably not going to hire me anyway. But I will send in my application and see what will happen from there.” They hired me as an investment writer. I have never written about anything before because I was an economics major so I don’t have to write anything except you have to write your name on the paper.
James: Were a writer before, Morgan? Because you are a really great writer.
Morgan: No, not at all. Well, thanks. No, not at all in the slightest. So I started there and said I will do this for six months until I find another private equity job. And ended up staying for 10 years. I just really fell in love in the process of writing. I always have been and always will be totally fascinated with finance and investing. But writing is something that I really fell in love with because I think everybody has a lot of thoughts on their heads in about all different kinds of topics. They can’t really put it into words. You have feelings but you don’t know how to put them into words. But if you sit down and force yourself to write something, that is when you crystallize a lot of those crazy feelings that you have in your head. It’s really a great way to crystallize your thoughts.
This is how I would frame it and I heard a lot of writers said this too “you sit down to write a piece. You have no idea what you’re going to say.” Because it’s the process of writing it that crystallizes all those thoughts. It’s not like I have all these ideas and I spin it out on the keyboard. It’s like the process of being at the keyboard is what gets all those ideas going.
I just love the process of writing for that. I encourage everyone, even if you are not looking for a career in writing because most people are not, to write as much as you can whether you are writing for yourself something like an informal journal or write a blog or just being on Twitter. Forcing yourself to write and putting your thoughts on paper. I think it is very helpful for everyone.
I would say too to that point that a lot of the world’s best investors are also phenomenal writers. Warren Buffet is a great writer. Benjamin Graham was a great writer. That’s not a coincidence. I think a lot of these people are good writers because they forced themselves to write because that’s how they crystallize and clarify their investing thoughts.
Student: How do you think people who wanted to have a career in investing, what should they apply for? What specific job?
Morgan: It’s probably so different now from when I was in college. You know I’ll take you back when I was graduating. What were people applying for? If you look at the universe of my class of people who would like to get into investing, I would say at least half of them wanted to get into and applied for to work at a large investment bank. I think that’s probably that’s still the case but it’s not half now; probably, a quarter of students who wanted to do that.
A lot of people in my class wanted to work at hedge funds. I was like next to investment banking – it’s the second coolest thing to do, working at the hedge fund. I would say kind of ironic or even sad about that is that almost none of those categories making a hedge funds are what people with a couple of years of experience I would say were most interested in. It’s the most glamorous for new students but people with five years experience, It’s like “I don’t want to work in investment banking anymore.”
That was also true for me too. After working for investment banking for six months. I was like “Get me out of here.” I don’t regret that at all. I think it’s a great experience to see and also to learn about myself. What kind of working condition that I like? What kind of culture that I am looking for? How do I like to work? Do I like to work being in a high pressured environment working with a bunch of people in suits or do I like working from home sitting on my sweatpants and write about silly finance articles? I didn’t know that back then but I learned it the hard way. I think that is definitely true for everybody.
I would say what jobs that people can apply to. Again, I would like to – what’s really interesting to you? I think one way to frame it is what do you think about on weekends? What do you think about when you’re not in school, when you’re not thinking about your jobs and have free time for yourself? What are finance topics are you interested in? Maybe the stock market or the economy or running a small business. There are probably investing or finance job for you in one of the fields that you are interested in.
What you are interested in is what you are going to do the best at. I think that’s the advice that a lot of people give. It’s really cliche at this point but it’s really so true. I think for anyone that’s been in their career for 5 or 10 years, most people would say that. Just find what you’re interested in and that’s what you’re going to do the best at.
Trying to do good in the world
Student: I know that you are more recently became involved in, I think it’s the Collaborative Fund? Is that correct? I would like to know more about that?
Morgan: I started the Collaborative Fund almost 2 years ago but the firm is about 8 or 9 years old so I didn’t found it, I came on later. What we do is all about private investing. It’s not investing in stocks. It’s backing young startups in venture capital way. Young startups come to us, pitch their idea and we and other investors back them early on. The idea would grow up and become a most successful company one day.
I think the differences between private markets and public markets has been really interesting to me too because on one hand, it’s exactly the same. You are investing for the long run and there are certain characteristics and criteria that you are looking for at companies that you want to back. On the other hand, the difference between private and public markets is just couldn’t be more different. The biggest difference for me and one reason I was really interested to be back into private investment market versus stuff in the stock market. If the competition is thinking about the next six months, how can we think about the next six years? And using that as your competitive advantage. It’s just so very hard to be a long-term thinker in the public stock market because it’s so short-term focused, everything is happening so fast. And the time horizons that public company can focus on is the next quarter or maybe the next two or three quarters.
There are not a lot of things you can do in terms of taking on long-term projects. Public companies are really forced to think about the next quarter or two. Whereas in private markets, there are private investors that truly can think about the next 5 years or 10 years. And since you don’t have the squawking in your ear of the public market – what do the markets do today? Oh, the market is down today – None of that in private markets. You can just really focused on how can we grow this business to the best that we can over the next 5 or 10 years and not have any distraction from the market. That is what I really like about it, about private markets.
Another big thesis that we have at the Collaborative Fund is just this idea that the companies that most likely the most value, the companies that most successful in the next 10 years are the companies that are going to do the most good in the world. It’s not always the case but it’s becoming the case I think not in my generation but in your generation. Since you grow up with technology that most older adults did not grow up with it even though they are familiar with it, but they did not grow up with it. I think your generation has less tolerance for nonsense and misbehavior than other generations. It is much easier in previous generations to hide behind poor business practices. No one really knew how poorly you are treating your employees. No one knew how poorly treating your customers because it’s kind of hidden behind a curtain.
Now, there is so much information like Yelp and Twitter. If the company misbehaves, the world is going to know about it. Because of that, the companies are going to perform the best over time. The companies are truly treating everyone under their roof whether that is a customer or employees or their suppliers the best.
I think in the last year, you have Uber that has imploded, but it has had a pretty tough year in the past 12 months. Because a lot of their business practices came to light that they were treating a lot of people very poorly. Treating their employees very poorly particularly females. Treating a lot of their drivers poorly. Treating some of their customers poorly. And then, on the other hand, you have Lyft which is identical when it comes to services that they are providing. Lyft and Uber it is as if they are almost the same product. But Lyft has a different ethos. Maybe we can treat people a little better. Maybe treat our employees a little better. They put forth a friendlier brand. And Lyft has run laps around Uber in the last year. Uber still is the larger company. But Lyft has gained a tremendous market share from Uber over the last year based on the one factor to just do a little bit better in the world. Trying to be a little bit nicer to people over time.
Whereas if you think back 30 or 40 years ago, the company that did the best are the companies that were most aggressive. Part of our thesis is not going to be the case over in the next 10 or 20 years. We are trying to back companies that have a social mission in their strategy to do good in the world. Treating people the best as they can and using that strategy to their competitive advantage over companies that haven’t figured that out yet.
Article or book recommendation
James: That’s just fantastic, Morgan. I couldn’t agree more. We all have our favorites. We have our favorite stock picks or favorite recommendation for investment class or favorite article. When you look back in your career, do you have a couple of highlights that you would like to highlight? I know I read your article about capitalism and power of a story that was just an amazing article. But what are your favorites looking back? Or your favorite articles or columns looking back?
Morgan: I think not a favorite articles but I would say a favorite book that I really kind of change how I thought about investing quite a bit. It’s an older book. There’s a historian about hundred years ago named Frederick Lewis Allen. He wrote a trilogy in US history. One book was called The Big Change about how American culture changed from 1900 – 1950. There’s another book called Since Yesterday. It was about America in the 1920s. And the third book was called Only Yesterday. That’s about America in the 1930s.
There are these fascinating history books about US culture. He focuses a lot on the economy not investing but how the economy changed during this period. It was like how everyday life of the average American back then. What did they eat? Where did they get information? What was work like? What was marriage like? What was school like? What was their life back then? And it just open my eyes how much change there has been in not that long time period. Looking at the just the last since 1930, 80 years or so. How much change since then is just astronomical. I think he put it in such clear terms what was life back then compared to life today was just astounding.
It highlighted for me the power of capitalism I would say. Look at how much has changed just exponentially in the last 80 years. And you kind of start daydreaming about what’s it going to be like 80 years from now. If we changed this much in the past 80 years, what is life like for me I am much older but for my children, for my grandchildren? It was a profound shift of how I thought about both capitalism and compounding I would say. Because that is what the story really is. It is the power of compounding things. Compounding is always easy to underestimate in the short run. What’s going to happen over the next 5 or 10 years? There can be some changes but it’s not going to be that impressive. You wouldn’t even notice in the day to day basis. But if you look at in the next 50 or 80 years, it’s just staggering. So that framework brought a deeper sense. It is just a long- term thinking is one of the most important concepts in investing.
Again, it’s the power of compounding. What’s going to happen in the next 5 to 10 years isn’t that impressive but what’s going to happen in the next 50 years is sensational. I think that piece of writing is the biggest paradigm shift of my thinking.
I would say too in early on in my career, I was most interested in specific stock picks and business analysis. And I still am. I gained a much deeper appreciation for bigger picture behavioral stuff over time. That is just my personal preference. There are people out there that really still love digging into individual stock picks and I think that is great. It’s not that I lost interest in it. I just got fascinated by the 30,000-foot view of investing about how people think about risk and behavior versus the 1,000-foot view of investing in markets and stock picks.
Student: Do you believe that there’s going to be a shift in the next 20 years from Wall Street to Silicon Valley? Is that going to be a big shift in finance? Will we still name Wall Street the headquarter of finance?
Morgan: Great question. This has been a huge question over the past 5 years as Fin-tech kind of came in into the picture. Five years ago, the view was “Of course that’s going to happen.” You have these old banks run by old guys with grey hair that are based on technology made of in the late 1950s running these huge banks. Most of which went bankrupt 10 years ago and got bailed out by the government.
You have those old banks competing against Silicon Valley where the smartest programmers in the world and all these venture capital money. Young people understand how this technology works. How could Silicon Valley not disrupt Wall Street?
There is a big surge of investing in Fin-tech over the 5 to 10 years. Interestingly, 5 or 10 years is not that long of a time. There has not been that much disruption, to be honest. I think much less than people thought. I think people would really realize that the incumbent banks, JP Morgan, Wells Fargo, Citigroup, Bank of America were much more entrenched than most people realized. Some of that is due to regulations. Some of the big banks have regulatory advantages that a small Silicon Valley startup can’t enjoy. And those banks are so big too. Those banks have more than a trillion dollars in their balance sheet. I think Wells Fargo or JP Morgan has maybe 2 or 3 trillion dollars in their balance sheet.
It’s just so hard to compete against those banks because they always have a cost advantage over the smaller bank. I think the answer and this is how you are going to frame is there a shift over the next 20 years? I would say “Absolutely!” There are already is in some parts of the financial market. I think companies like Betterment and Wealthfront have significantly shook up how Merrill Lynch and Morgan Stanley give financial advice. You have just like the company of Betterment. In 5 years, they are already starting to give a lot of financial advisory firms a run for their money.
Five or ten years ago, the view was that by 2018 no one is going to have a checking account at JP Morgan anymore. They’re going to have a Silicon Valley bank. That hasn’t been the case yet. I still think that’s the case over time. But the big banks are still entrenched. There are a lot of fascinating Fin-tech startups and investment going on in Silicon Valley and there is way more exciting stuff going on there than on Wall Street. There’s almost no innovation in Wall Street. They have their process down for 50 or 80 years. They’re just kind of keep that machine running. Not no innovation, but very little innovation on Wall Street. And when they think they have innovated, they think they found a big idea oftentimes it ends up blowing up in their faces. It’s less innovation and more of kind of leverage.
To sum up your question, so yes there will be a big change in 20 years but it’s happening slower than people thought it would.
Student: With the Collaborative Fund, investing in start-ups, how do you know which start-up to invest in?
Morgan: I miss out the last part of the question but I think you said that are we more involved in the cultural side of businesses. Is that it?
Student: Yeah.
Morgan: I think what’s interesting about startups is that it’s a startup. Often times than not, there is not a lot of information to look at. Whereas if you are doing an analysis on Coca-Cola, there are 50 years of annual reports that you can go back. There are tons of information that you can use to analyze the company to make your investment thesis.
If for startup, there’s often little to no information to look at. These companies don’t have 10 years of financials that you can look at and build your financial model to get an idea of what this company might be worth. Because of that what is important in the startup world is summing up and judging the founders of a company just as people. Just like, do I trust you that you’re going to have enough grit, determination and intellectual honesty to make this company work? That is how you analyze the company at the venture stage that you don’t have other sources of information.
James: How do you analyze grit and determination?
Morgan: That’s the hard part. There’s no and you can go back to it. In any form of finance, you can create a formula. Say this is how you do it and it fits in this framework. Even if it’s not precise but you can come up a framework to fit it in.
Whereas at VC, it is truly a people business. I would relate it to – how do you find the right spouse? There’s no formula for that. You just have to meet someone and get to know them. It takes awhile to get to know them. Sometimes you get it right and sometimes you get it wrong. But there’s no formula. You just have to go out and learn from the person and view how they operated in the past. How are you done with past projects? Who did you work with in the past? What did they say about how you worked?
I think what’s important for me is how did someone cope and deal with a stressful situation in the past. In your previous job or company that you worked for, what was the most stressful thing that you dealt with and how did you deal with it? I think those kinds of skills, viewing how people deal with stress is something that is highly indicative of how they deal with stress in the future. So, someone who dealt with stress poorly in the past is probably will deal with it poorly in the future.
It’s also one of my favorite critical skills particularly in startups because every startup goes through a really stressful period. VC is a monumentally softer form of investing than say private equity or leveraged buyouts or something where is heavily analytical. Whereas, VC is highly a people business. It’s not a 100% people business. You still have to size up you know you have to do market sizing and what is your cost of customer acquisition. There are still finance modeling components to it but it is much softer than any other form of investing.
Markets today relative to history
James: So the markets are up. Last 2017, it was the big year of the markets. Dow is up over 20%. By a lot of valuation metrics markets seem to be pretty expensive. You’re a student of history and the markets – where do you see the markets today relative to history?
Morgan: I would say yes by any measure you know we are at not only a high valuation but the highest valuations. There’s that and there’s part of me wants to say ‘Well, that should make us cautious.’ Not necessarily that we know the market would crash anytime soon. But just to lower our expectations for future returns. I think that’s the smartest way to think about it. And that’s 80% percent of me that wants to say that.
And there’s 20% of me that wants to say “Look! When we look at the PE ratio or pay evaluations or price per sale, these are different valuation metrics and compare them over the last 100 years. Things have changed considerably over the last 100 years in many aspects. If you look at the S&P 500 which for most valuation metrics that’s kind of the base index that most people use, the composition of S&P 500 has changed drastically over the last 50 or 60 years. S&P 500 didn’t even include banking stocks until in the 1970s. If you looked at how it was composed in the 1950s and 60s. It was a bunch of utility companies and industrial companies. That just because of how those companies operated, they are very capital intensive. They’re probably going to trade at a lower multiple than how the S&P 500 is composed today of technology companies today like Facebook, Google and what not.
There has been a lot of changes in just the composition over time. There have been changes in how S&P 500 companies account for their earnings over time. These are small changes. It’s not drastically all of sudden justify today’s valuation because that’s how these things change over time. But there have been enough changes over time to make me think that even though I desperately want to be a student of history and use history as kind of like the framework for the future. I think when people start comparing the current market environment to the average over the last 100 years, I think it can send the people astray.
I think the best example of that there’s a valuation metrics called CAPE, Cyclically Adjusted Price to Earnings Ratio. It’s one of the most popular and most logical valuation metrics. CAPE has been above its long-term average in all but 9 months in the past 28 years. So when something is above its average 98% of the time, maybe we should start to think that maybe the average has changed. I think that’s a reasonable way to think about it.
That’s 20% of me versus the 80% of me that says, ‘Yes’ stocks are expensive and we should expect lower returns. But I think there is a big important point to make it too. Just because stocks are expensive that we should expect them to crash over the next month or next year. Because if you and I were having this conversation in 2012, we’d be saying the same thing. Stocks are really expensive and have gone up a lot. It didn’t mean that it’s going to crash in the next year. It’s just meant that we should lower our expectation of returns over the next decade. That’s how I feel again today too. It would not surprise me in the least if the market kept rising for 2 or 3 or even 5 years. I think that’s within kind of normal confines of history.
But I wouldn’t surprise me if the market crash next month. I think it’s one thing to expect a level of return over a long period of time. I think it’s completely different to say what’s going to happen next in the next 6 months or the next year.
20-year periods
Student: What S & P companies over the next 20 years do you think would perform the best?
Morgan: Good question. I think the way to frame that is if we were here in 1998 – 20 years ago answering that question, I guarantee you what we would have said are Lucent and Enron. We would certainly have said Enron. Enron was like everyone’s favorite company in 1998. What else would we have said? We would have said Kodak. We would have AIG. We would have said Lee & Brothers. Yeah, Circuit City.
I think that and if we went 20 years before that we would have talked about some steel companies something called like Commodore computer or something. I don’t think there has ever been a 20-year period in history where any well-educated person could really say this is going to be the next winner in the next 20 years.
There’s a famous investor named Bill Miller. He’s truly one of the greatest investors of modern times. Famous investor. Everyone loves him. He is a great track record. I found an article that he wrote in 2000. I believe it was the year 2000. And the article was like “Ten Stocks for the Next Decade”. I am not making this up. I will try to find it. His 10 Top Stock Picks for the next decade were: Enron, AIG, Kodak… I forgot all. You go down the list and it was like – It couldn’t have been worse stock picks.
There’s a couple of lessons in this. One is the importance of good diversification. If you have good enough diversification, you don’t truly need to know what are the few companies that are going to do the best in the next 20 years. But also, it instills a lot of humility in the investing process. To look back. And this is where history is really important. To study history as an investor. To look back at again, what would people say in 1998 about the next 20 years, through today. No one had a clue in the next 20 years or what industry that’s going to do well in the next 20 years.
We have vague ideas. Okay, the internet is going to do well in the next 20 years. People were saying that in 1998. They were right about that. But there were so many different layers that they didn’t get. No concept of social media. No concept of mobile. They had no concept that two companies Facebook and Google can capture 80% of the online advertising market or whatever. The most important things to know – the people didn’t know back then. Even if they have the broad concept that the internet is going to be huge, everything that you need to know to really make money as an investor of the subsequent 20 years, nobody knew back then.
And a lot of that even if 20 years ago, people were excited about the Internet, Google started in 1998 but no one knew about it for several years after that. Facebook was not even close to being founded. Those are two companies that made a lot of money out of the internet and no one was talking about it in 1998.
I would be almost certain that if we would be talking 20 years from now about companies in previous in 2018 to 2038, what companies did the best? It would be a company and an industry that is not around yet, if it’s around today, it’s just a start-up that nobody’s talking about. I would be completely surprised that 20 years from if anyone is even talking about Facebook and Google and Apple. Maybe it’ll still be around. I am sure they’re still be around but I think they’ll be around in the same way that you know Walmart is still around and it still is a great company. They are still making a lot of money. But no one is really in terms of like innovation and great investment. No one really talks about it anymore.
I would be surprised too if there are some huge names that’s making it up in the forecast. But Google or Facebook or Uber or Apple that don’t exist in 20 years. I think that’s the history of markets. It’s a brutally competitive place in history of companies especially companies that really get successful to the point that they’re letting their guard down and getting cocky about things. Those are the companies that tend to go out of business overtime.
If we were talking 40 years ago, what’s the best company to own? I think a lot of people would say Sears.. Sears has been like – people talk about Sears today because they talk about like when it’s going to go bankrupt kind of thing.
I think we were talking about 20-year periods, Diversification gets so important because history of 20-year period of the market at the end of the individual company level is really humbling.
The kind of investors
Student: What is the best ratio for stocks to bonds in diversifying your portfolio?
Morgan: Good question. The right answer is something that you don’t want to hear. But the right answer is it depends. It’s not necessarily that it depends on your age. It depends on your disposition. Your ability to handle risks. I think there are people who can be in retirement and have 100% of their money in stocks. Because they have the mentality and the psychology that if the market to fall 50%, they would be okay. They would still sleep at night and they would not panic and sell everything.
There are young people who are in their teens or twenties who should have most if not all of their money in cash and bonds because they don’t have the right temperament to be a long term investor. Normally, when this topic is discussed. It depends on how old you are, formulas and a hundred minus your age. This is what you should be in stocks – whatever those formulas are. I think those are good rules of thumb. But I think for me in practical purposes is just, what is your tolerance for risk? And that tolerance is heavily based on who you are as a person not necessarily what your age is.
How I like to frame on this and it takes a little bit of time to learn all this about yourself, is how did you behave in the previous bear market. For us, I don’t think many of you invested back then, for older investors, what did you do in 2008? How did you behave in 2008 when the market collapsed? Did you panic and sell? Were you totally okay with it? Did you view it as an opportunity and you bought a lot more? Because that behavior is indicative in how you’re going to behave in the next bear market.
In terms of being a financial advisor, this is what I’d like to tell people. If you did panic in 2008, then you probably have a pretty low-risk tolerance. And no matter what you think today and how bullish you feel today in 2018, you should have a pretty good percentage of your money in bonds. Because you’ve proven in your past behaviors that you don’t have much tolerance for risk. And even though if you don’t like being in bonds today because oh they earn a low return, stocks are going to do better. You’d probably going to do better in bonds because the devastation that you do to your wealth in stocks if you panic and sell in a 2008 moment where there was a big bear market. The pain that that does to your portfolio is 10 times worse than the pain you are going to get from owning low returning bond over the course of your lifetime as an investor.
That’s how I would sum up the question. There’s no – I truly don’t think there’s a good formula of what it should be. You just have to get to know yourself as an investor over time and go for it from there. I, myself, probably have low-risk tolerance than most traditional financial advisory formulas would put me in. For my age and my income bracket, most people would say ‘Oh, I should have X percent of my assets in stocks.’ For me personally, I would say ‘Thank you but I would have a little bit less.’ I have more cash than most people think I need. But I like that. It helps me sleep at night. It makes me feel safe. And it helps me a longer-term view that since I know I have this much cash in the bank, my wife and my son are going to be fine if something happens to me or lose my job or there’s a bad recession. And because of that, I can take a long-term view so the stocks that I truly own I can do hold those stocks for 40 or 50 or 60 years. That’s how I think about it general.
James; That’s the best financial advice that probably I’ve ever heard.
Morgan: Thanks.
Job opportunities for risk management
James: I know we have to wrap it up at some point. Do you have any more questions from California? Maybe one last question and then we’ll finalize.
Student: How important do you think risk assessment is and is there a lot of job opportunities for risk assessment?
Morgan: Is there job opportunities for risk assessment?
Student: Yeah.
Morgan: I would say it changed a lot because a lot of the risk models that were really popular before 2008 were shown to be not very useful after 2008. Because a lot of risk models you know in 2007 predicted smooth sailing ahead. How things have changed since then in terms of risk management? On one hand, a lot of those models were thrown out people don’t use them anymore. On the other hand, you know jobs that have really blown up and done really well in Wall St in those years are people with deep science and math backgrounds. That can be really super fancy sophisticated risk models. Much more sophisticated than they’ve even done in the past and leverage by some of the best and fastest computers out there.
I just want to think this through. A lot of old models are just kind of high-level theoretical concept of risk. It was like capital-asset-pricing model or what not which is not very complicated but somewhat sophisticated way to measure how investors should think about the percentage of stocks and bonds that they should own. I think those kinds of models are largely being thrown out and being replaced by really sophisticated big data kind of AI kinda-type of models to measure risk over time.
I think the most important thing about this is to be determined those models end up doing. You’ll never know the risk models are going to perform until it is going to be tested in a big way like in 2008. And a lot of new models have been invented and put into use in the last 10 years haven’t been tested yet. I think when they are tested, whenever the next recession is I think we’ll learn that a lot of them didn’t work very well. I think the reason they don’t work and I am cautious that they will ever work. Again, we can’t measure and predict human behavior with data and formulas. It’s just that how people respond to incentives is based on emotion. Which is like adrenaline and dopamine. It’s not something that you can summarize even with big data and AI. It’s not something that you can put in your formula and say ‘This is what the economy is going to do in February 2022.’ People desperately wanted to do that but I think there’s so much evidence that we can’t.
Because of that, maybe this is wrapping it up, if you accept the humility that we’re less able to predict what’s going to happen next than we want to. The solution for me like ‘Okay, how can I set up my personal finances and my career?’ Just how I think about life in general. Rather than predict and avoid those ups and downs, just to try to endure them overtime. Just say ‘Look! There’s going to be recessions. There’s going to be bear markets. I don’t know when. And I am not going to try to predict when to avoid it. I am just going to set myself up so when it happens I just kind of ride it out so that I can stick around for the longest period of time. Let compounding works its magic over 50 or 60 or 70 years rather than trying to pinpoint what’s going to happen in the next year.’
Last message for young investors
James: Morgan, this has been so good. I am going to put you on the spot to finalize if you don’t mind. You’ve been honestly, one of the best speakers that we had. Incredibly knowledgeable. I’d like to put on the spot to personally address Young Investors Society members and maybe a minute or two. And then we’ll use that clip and blast it over Youtube to make sure that all of the kids see it. Maybe you could just wrap it up and just address the thousands of kids all throughout the world what advice that you would give them in just a minute.
Morgan: The single most important part of investing is time. How much time do you have to invest? That’s how compounding works. That is something to take place over 50 or 60 or 70 years. That is something that you as a young investor has way more of than I do or Warren Buffet does. It’s a huge asset that you have in your pocket. The fact that you have decades in front of you to invest. That is such a valuable and powerful asset. I would encourage everyone to recognize how powerful it is that you have many decades in front of you to invest. And start learning as soon as you can so that you can utilize and leverage that asset as best as you can. By the time you are older, even when you are in your 20s or 30s but particularly you’re getting into 50s, or 60s or 70s, people who started investing in their teens and 20s have so much advantage over those people who started investing in their 30s and 40s. Not just a little bit. Not just 10 years more. It’s exponentially more overtime.
I think if anyone can really get serious about investing in their teens and twenties, they’re setting themselves up. It’s really fun and rewarding career or just lifetime as an investor.
James: Thank you so much!
Students; Thank you so much!
Morgan: That was fun. Thank you so much, guys. Take care. Bye!
