Episode #206: Meb’s take on Investment Plans, Building and Maintaining Wealth, How Meb Invests, and Investing in the time of Corona
Guest: Episode #206 has no guest, It’s a Mebisode.
Date Recorded: 2/20/20
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Summary: Episode 206 is a Mebisode. Meb reads a few of his recently penned pieces. He covers the importance of being prepared for market turbulence with an investment plan. He then walks through some core ideas for building and maintaining wealth. He ties these ideas together with a chat on how he invests his own money. He concludes with some thoughts on investing in the time of the Coronavirus.
If the markets have you concerned, make sure you don’t miss what Meb has to share to help you stay on track in episode 206.
Links from the Episode:
- 0:40 – Introduction
- 1:15 – Part 1: Time to Panic? (Faber)
- 5:06 – Part 2: The Get Rich Portfolio (Faber)
- 7:22 – Getting rich through luck
- 8:25 – The Millionaire Next Door: The Surprising Secrets of America’s Wealthy (Stanley, Danko)
- 8:45 – Getting rich as a professional
- 10:35 – com
- 12:12 – getting rich through prudent investing
- 12:53 – A janitor secretly amassed an $8 million fortune and left most of it to his library and hospital
- 17:54 – Getting rich fast with concentration and leverage
- 20:18 – The Idea Farm
- 20:31 – Timing Model Equity Curves (Faber)
- 21:29 – Even God Would Get Fired as an Active Investor (Gray)
- 25:47 – Get rich faster by being your own boss
- 30:45 – Investing in other businesses
- 30:27 – Angel: How to Invest in Technology Startups–Timeless Advice from an Angel Investor Who Turned $100,000 into $100,000,000 (Calacanis)
- 30:28 – The Meb Faber Show Podcast – Episode #69: Jason Calacanis, “This is a Little, Secret Way… A Dark Art of Becoming Truly Wealthy… Massive Wealth”
- 31:22 – The Meb Faber Show Podcast – Episode #165: Chris Mayer, “I Do Think The Biggest Challenge…Is Keeping It, Holding On To It”
- 31:26 – 100 Baggers: Stocks That Return 100-to-1 and How To Find Them (Mayer)
- 32:50 – The Meb Faber Show Podcast – Episode #101: Paul Merriman, “The People That Have Come Out Ahead Are the People Who Have Put Their Trust in the System Over the Long-Term”
- 33:13 – The Illiquidity Discount? (Asness)
- 34:15 – The Meb Faber Show Podcast – Episode #156: Steve Glickman, “I Think There’s A Lot Weighing On How Successful We Are At Achieving The Goals Of Opportunity Zones” & The Meb Faber Show Podcast – Episode #177: Alex Rubalcava, “We Want To Help Build Companies That Are Solving Hard Problems That Matter”
- 34:29 – Meb’s AngelList ideas
- 34:53 – Takeaway
- 36:18 – Part 3: The Stay Rich Portfolio (Faber)
- 38:53 – How safe are risk-free treasury bills
- 44:17 – Building a minimal loss portfolio
- 44:52 – Global Asset Allocation (Faber)
- 50:04 – Part 4: How I Invest My Money (Faber)
- 51:21 – Disclaimers
- 53:31 – Largest allocation
- 55:08 – Farmland
- 55:47 – Private investments
- 58:58 – Public investments
- 1:01:05 – The Trinity Portfolio
- 1:04:30 – The Cannabis Opportunity
- 1:05:47 – The Meb Faber Show Podcast – Episode #48: Van Simmons, “The Rare Coin Market Can Go Up Dramatically, Quickly”
- 1:07:48 – Climbing Everest (Mallory)
- 1:08:47 – Conclusion: Investing in the Time of Corona (Faber)
- 1:13:46 – Where the Black Swans Hide & The 10 Best Days Myth (Faber)
- 1:14:22 – Keeping it Simple: Trend and Valuation (Faber)
- 1:14:34 – Worried About the Market? It Might Be Time for this Strategy (Faber)
- 1:15:14 – How Long Can You Handle Underperforming? (or, How To Beat 94% Of All Mutual Funds) (Faber)
- 1:15:48 – The Trinity Portfolio (Faber)
- 1:19:41 – Investing Strategies in a crisis
- 1:19:45 – 1. Over-rebalancing
- 1:23:25 – 2. Opportunistic Investing
- 1:25:01 – 3. Blood in the Streets
Transcript of Episode 206:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber’s the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestment.com.
Meb: Hello, podcast listeners. Wow. Imagine you’re listening this at home, quarantined, hopefully safe and sound. It’s been a pretty extraordinary couple of days, weeks, month, year in 2020. We wanted to take the time to do a few Mebisodes. We’ve published a handful of articles on the blog and our email list to try to help investors through this time to think long-term. And, really, we’re gonna outline our thoughts in this four-part series. Today is the intro to the series. So, let’s jump right in and get started.
Today’s topic, time to panic. This was an email list we sent out to shareholders, but we’ll get started. I remember pre-season training for sports back in the day. I went to high school in North Carolina. I remember being on the baseball field, and after running wind sprint after wind sprint, most of us would be standing there, gasping with our hands on our knees, barely able to catch a breath, sweating in the humid summer of North Carolina. Coach would say, “This is why we run after practice. We train hard. So, then when we get to the regular season, it’s easy. We’ll plan ahead of time to be in better shape than the other team, and when the game is on the line, we’ll be prepared and they won’t.”
Right now, global markets are experiencing large moves up and down, and many investors are freaking out. U.S. stocks have declined multiple times on the open enough to trigger circuit breakers and pause trading. Also, to the upside, investors all over social media are panicking, largely because they don’t have a plan. But you do. You’ve put in the work over the past decade, you read our blog posts and books, you’ve listened to podcasts, and eventually, you built a plan. And, take note, they’re not all the same plan, but at least you have one, so when it hits the fan like it is now, you’re prepared.
My firm has over 45,000 investors, and very few have emailed or called today in a panic over the last week, and that makes me really happy. However, for those that do feel rudderless and a sense of panic, take a breath, step back, I’m here to help. In the coming podcast, we have three pieces that I’ve pinned recently on the blog, which you can find, we’ll put in the show notes, that outline a long-term view on how I think about investing.
Part one upcoming is called “The Get Rich Portfolio.” It’s an attempt to address our collective quest to make more money, but on a holistic level. I’m talking wealth generation, preservation, and, finally, a rubber meets the road example of strategic implementation. After all, if your goal is to be a philanthropist, an inconspicuous millionaire next door, or a flashy big spender who likes to line the kitty box with hundreds, you need to amass some wealth first. So, that’s where we have to start. Do you have a plan to generate wealth? That’s number one. And most people don’t. But even if you do, are you consistently following it with discipline or are you allowing shifting market conditions like today to change your personal finances and allow it to push you around?
Now, next, let’s make a leap and say you’re one of the lucky investors who has made it to the promised land. You’ve won the game. You’ve saved, invested, and made your nut, and now you’re looking to preserve your wealth rather than grow it. What strategy is best for you? Likely, it’s not what you think. We’ll tackle this topic in part two of the series called “The Stay Rich Portfolio.”
Lastly, we conclude it with a final segment on how I put both parts of these portfolios, “Get Rich” and “Stay Rich,” into one cohesive portfolio with my own assets and investments called “How I Invest My Money.” Lastly, we’ll tackle one on the very end, which is relevant to today, which is called “Investing in the Time of Corona,” where we talk about this three-part series and how we’re implementing it today, and any deviations, any opportunities to make some changes on the periphery to your portfolio and plan as other people react emotionally.
“Get Rich Portfolio.” If we allow ourselves to let go of appearances, we’re all here for one simple reason, more money. Now, more money, of course, is always relative. $100,000 in net worth places you in the global top 10%. But for many that would not last a hot minute, $1 million vaults you into the top 1% globally, but for some only Tres Comas would suffice. Research has shown that regardless of how much money people have, everyone says they always want more. And I think the rough numbers around twice as much as everyone already has.
Now, what you plan to do with that money can be noble and altruistic or ignoble and self-serving and that’s not the point. And I’m not judging either way. I’m merely noting the reality that what unites us here on this podcast, on the blog, is a desire for more wealth. The challenge is accomplishing this goal. We all often lose sight of the forest for the trees where the flip side is true, we stay so big picture that we don’t implement our strategies well. I realized those are contradictory problems yet that’s the point, investing is challenging.
Before you judge that comment as banal, really think about why it’s true. The market environment itself is always changing. The return potential of any individual investment is always changing. Our individual resources and financial pictures are always changing and our specific goals are always changing. Not only is the target moving, so is the platform you’re standing on. And then there’s the potentially other targets you may want to shoot at. Investing’s a lot like golf. You don’t really win, you just try to improve your entire game bit by bit while avoiding a massive blow up.
Today, we’re beginning a three-part series that’s humbly offered to try to help you improve your overall game. It’s an attempt to address our collective quest to make more money, but now on a holistic level. I’m talking wealth generation, preservation, and finally, a rubber meets the road example of strategic implementation. In our first podcast today, we dig into wealth generation. After all, whether your goal is to be a philanthropist, an inconspicuous millionaire next door, or a flashy big spender who lines the kitty box litter with hundreds of dollars, you need to amass some wealth first. So that’s where we have to start. Enough introduction. Let’s jump in.
Getting rich through luck. The quote, “I’d rather be lucky than good,” allegedly comes from Yankees player, Lefty Gomez. Of course, if that’s misattributed, there’s also, “I don’t want a good general, I want a lucky one,” from Napoleon. With this in mind, let’s start with what many want, wealth the easy when what they really mean is lucky way. Obviously, this part will be short since luck is largely out of our hands. Now, the top of our luck list are inheriting it, winning the lottery, or perhaps marrying into wealth. Not much we can say about any of these, although if you google strategies for marrying rich, you’ll be met with a shocking number of humorous entries. Ken Fisher has a funny chapter in one of his books that walks people through a very deliberate and intentional approach to marrying rich, which is pretty funny, but let’s get more serious.
The good news is most millionaires actually don’t inherit their wealth. They create it themselves. Fidelity Investments found that 88% of millionaires are self-made. The great Tom Stanley’s book “The Millionaire Next Door: The Surprising Secrets of America’s Wealthy” found a similar result at 80%. So how do all these millionaires get there? Many of them did it through what’s next up on our get rich strategies list, becoming a high earning exec. Think a doctor, a lawyer, or upper-level management in a company, so getting rich as a professional. While historically this is traditional path to wealth, there’s a couple issues with it. First, rather than a path to real opulence today, this is more of a means of reaching financial security. In other words, while the salaries from these jobs are far greater than average U.S. salaries, they are likely to insulate you from the, “Can I pay this bill?” financial pressures that plague so many Americans. Today’s typical doctor isn’t likely to generate obscene wealth from salary loan.
Kayee Tong from the University of Texas Medical Branch recently explained it this way. “Remember that doctors today could start off with a negative net worth of sometimes even 500 grand if they took private college and medical school. Note, half of medical schools are private and doctors are generally in the 99 percentile for student loan amounts. The average doctor makes about 50 bucks an hour when accounting for opportunity costs, loans, taxes, insurance, etc. Don’t be fooled by the absolute amount in terms of salary. The average doctor is underpaid and overworked. You spend 7 to 12 years initially like you’re working 2 full-time jobs as a student studying 80 hours a week. Many residencies are essentially a less than minimum wage job with much more than 80 hours a week. Even though 80 hours is supposedly the maximum you clock in. By the time you’re doctor, the average doctor spends even more time clocked in with documentation, compliance and insurance, not to mention continuing education. Of course, there are options to better lifestyle-type specialties such as dermatology and you might become a millionaire relatively quicker, but those are reserved for the top of the top students because it is highly competitive.”
Now, before you feel too bad for these high-earning pros, consider that a $250,000 annual salary bolts them into the top 0.04% richest people in the world by income. There’s a great website, I think it’s called Get Rich List. You google something like that, it’ll tell you where you fall based on income as well as net worth. By the way, all of these references are hyperlinked on the blog at Meb Faber. There’s a second problem with going the route of the doctor/lawyer. Not only does this path typically lead to mere financial comfort rather than obscene wealth, it’s also a very long path. Tong also hits on this point, “If we are purely discussing a millionaire in terms of net worth, including real estate and retirement, probably it would take 12, 20 years if a doctor lived very frugally and had the average amount of student loans and expenses.”
So if you go the exec or doctor route, you’re likely in for financial comfort eventually, depending on your spending habits, obviously, but for most individuals that fall in this group, there will be a ballpark cap to the riches you can generate. Also, be prepared for your journey to take a while. However, you can combine any amount of savings with enough time regardless of income level, you can still amass a fortune. The keywords here, savings and time. And that’s a good reminder of the difference here between being a millionaire and spending a million bucks. Most self-made millionaires aren’t living a life of conspicuous wealth. According to “The Millionaire Next Door,” the average millionaire lives on less than 7% of his or her wealth, wears inexpensive suits, and drives cars that are not this year’s current model. But returning to our point, savings and time are important for building wealth. But when you add in a specific third variable to that equation, that’s when the true wealth building begins to happen and carry its own weight, do some of the lifting for you and come a bit faster. And that dovetails us into the next wealth generation strategy, getting rich slowly with prudent investing.
Okay, so let’s turn to a topic that unites all of us on the podcast, and that’s investing. It’s really a simple formula that supplies the missing variable we just referenced, which is savings plus investment plus time equals wealth. By adding the essential element of investing, your hard-earned and saved cash harnesses the power of compounding over the long term. To see the real-world power of this, look no further than Ronald Reed, a janitor from Vermont who died in 2014 with an $8 million fortune. Obviously, a janitor salary isn’t going to go too far, so this fortune came about through saving as much paycheck as possible then routinely investing those savings into quality stocks. The CNBC article, which detailed Reed’s story, quoted from one of his friends saying, “I’m sure if he earned 50 bucks in a week, he probably invested $40 of it.”
It turns out Reed owned at least 95 stocks at the time of his death, many of which he’d held for decades. That list was full of blue chips you’d recognize including Procter & Gamble, JP Morgan, General Electric, Dow Chemicals, CVS, and Johnson & Johnson. U.S. stock market has historically returned about 10% a year. Now, if you compound your money at 10% in 25 years, you 10X your money. That means 100 grand turns into a million bucks. Now, if you’re smart enough to start saving and investing early, then in 50 years at 10% means you 100X your money. And I want you to seriously pause, let that sink in and think about that for a minute. That means 100 grand in 50 years turns into $10 million, 100 grand turns into $10 million. It’s a mathematical magic trick, requires zero brains and zero effort. Anyone can do it and it’s a reminder to all you parents and/or grandparents, think about the huge potential favour you’re doing for your little ones by putting even a modest amount into an account, where it reinvests dividends over time and compounds.
Many listening this will respond, “Well, sure, that’s easy if you have 100 grand to start with. I don’t have anything saved.” Well, do you think you could follow Ronald and save 40 bucks a week? Most of us could find a way. Well, let’s say you graduated college, saved 40 bucks a week for 10 years. I mean, that’s literally like one dinner a week. Instead, you eat rice and beans, some ramen. Say 40 bucks a week for 10 years, invested that money in stocks. By the time you retired, you’d be a millionaire. Now, you don’t even have to contribute anything after the initial 10 years, so literally it’s 40 bucks a week for 10 years. You only saved about 20K in total, by the way, in your 20s. I don’t even remember the money I spent my 20s. Yet eventually, that modest amount turned into a million bucks. That’s the power of time in compounding. Now, had you been really thrifty and continued to save and invest in your 30s and 40s and 50s, that final amount could be much, much, much bigger.
Now, if you think this is easy, it is, at the same time, it’s not. So let me try to prepare you for the biggest challenge ahead, the monotony. You have no hot stock to talk about. Usually, no explosive market gains happening in just a short period. Instead, it’s just boring low-cost funds and ETFs, slowly grinding higher, the investing equivalent of watching paint dry. The other challenge is that it requires for most people some degree of penny-pinching in order to fund your growing nest egg. Obviously, the amount of that pinch is a function of your active income and lifestyle, but this ties in a quote from Morgan Housel who touches on the same point we made earlier. “When most people say they want to be a millionaire, what they really mean is I wanna spend $1 million, which is literally the opposite of being a millionaire.”
So if we’re all being honest, most of us harbour the fantasy of spending lots of money, but in order to do that, we need to have that money now, not wait decades for it scrimping and saving. After all, the fantasy isn’t paper wealth while living a pauper lifestyle. The truth is most of us aren’t all that excited about slow investing riches. When we imagine wealth through investing, we’re likely fantasizing about putting money into Bitcoin at the start of 2017 when it’s was like 1,000 bucks and then selling it a year later as it hit $20,000, a 20 bagger in just one year. Most of us are not willing to forgo next week’s vacation so that our future self may enjoy greater financial security. To be fair, that $2,000 you’re about to spend on spring break in Cancun or Ibiza may be better spent on your vacation rather than as an investment. After all, it could bring you a lifetime of good memories, maybe even a partner and children.
But just to be intellectually honest about the opportunity cost, you could sock away that money, go on a cheaper road trip, maybe go camping and turn that cash into a nice starter nest egg for retirement. The problem is will the 70-year-old you value that $200,000 more than the 20-year-old you values $2,000? Can you even empathize with the old you at 20? And perhaps it’s maybe easier in 2020 now that we have these Russian iPhone photo-ageing apps, I did one and it looked eerily too accurate. Again, this is the simple path. It takes zero brains. It takes only the effort of living within your means and investing in time.
Investing in global portfolio of stocks and bonds can be implemented today for almost zero cost. You could then put that portfolio on autopilot, allowing it to compound away without any fiddling or interventions from you. And we’ve demonstrated in many old articles that almost everyone would be better off with spending zero time on their portfolio or on portfolio decisions. But then there are those listening to this that are not here for the slow, dependable path. So what’s realistic in terms of getting wealthy with investing faster than Ronald Reed? Next, I’ll outline a few ways you can make big gains happen.
Next up, getting rich fast with concentration and leverage. To get rich quickly, you need to compound your wealth with highly outsized returns. If you doubled your market returns to 20% per year, you 10X money in 13 years instead of 25. You hit 100X and only 26 versus 50 for the slow zero effort route. Keep that in mind. It’s still 13 years and 26 years. If you wanna get rich in just one or two, you can do the math on just how high your returns have to be. Either way, how you generate these outside returns if your principal economic engine is going to be public stocks.
First, you could be the world’s best market timer. Let’s say you had a crystal ball and a time machine. You travel back to 1920 with Marty McFly and Doc in your time machine in the DeLorean, and your time machine takes you all the way back to the roaring ’20s. Then each year, your crystal ball gives you, predicted accurately, which asset class between stocks and bonds would perform best over the coming year. So Jan 1 every year, crystal ball says you gotta be in stocks or you gotta be in bonds with perfect one-year foresight. What do you think your returns would be? The world’s greatest market timer. The answer is only 17%.
The funny part to me, by the way, is the opposite. If you are the world’s worst market timer, and I feel like I know so many of these, each year, you pick the world’s worst asset class between stocks and bonds, your return is minus 0.9% so it’s almost impossible to lose money investing, but people still find a way. So not even perfect market timing will get you to 20%. What about stock-picking? To even attempt to get big returns, you need to move away from market capitalization-weighted indices into more concentrated exposures. Think Warren Buffett’s portfolio containing only a handful of stocks. The first problem is it’s hard to devise strategies in public markets that generate 20% returns per year historically, and by the way, that includes the benefit of hindsight bias here in 2020.
The second problem is these portfolios end up looking super-weird, concentrated, indifferent from the broad indices. As an example, a basic highly concentrated small-cap value and momentum stock allocation gets you about 16% per year. And by the way, listeners, many of you know I have a research service called The Idea Farm that sends out curated research each week. But also provides an Excel backtester that lets you test a lot of these historical asset allocation strategies. And so on the blog post at Meb Faber, we publish the equity curve of this small-cap value and momentum strategy going all the way back to 1920 and it looks absolutely beautiful. We all want this equity curve. It just looks up and to the right. To the moon, Alice. I’m already thinking about sitting courtside at the Lakers and sipping champagne in the Mediterranean.
But still, this is just 16% and not 20% and guess what? Even if you could concoct this equity curve, so we’re ignoring transaction costs and taxes and everything else, at one point you would lose 85% of your money during the Great Depression and at other points, 60% multiple times over the years. Ouch. That’s the painful path of the public market investor. At some point on your quest for big returns, you will likely experience a massive, massive loss. Can you handle getting daily updates on how fast you’re losing all your hard-earned money? Probably not. Our buds at Alpha Architect talk about how, “Even God would get fired as an active manager.” You google that or go to Meb Faber and see the link. It’s a great walkthrough example. If you had perfect foresight into which stocks would do best, you end up with great returns, but also you have these huge, terrible drawdowns that almost no one can avoid or sit through.
But is it possible to have the wherewithal to endure the pain it takes to outperform? Sure. Buffett’s been through many rough patches over the years. The famous trend for commodity trading advisor Bill Dunn has been through big drawdowns over a dozen times on the path to big returns. Jeff Bezos has been through a 95% price loss on Amazon on the way to building a trillion-dollar company. But it is vital to be honest with yourself. Do you really have the resolve of a Bezos, Dunn, or Buffet? All investors eventually have large drawdowns, but it’s even harder for most to sit through periods of underperformance versus a broad stock market index like the S&P 500. Even worse is underperforming your neighbour. That’s likely the hardest psychological challenge to overcome. Remember, to outperform the indices, you need to be different, which is fine when you’re winning, but impossible when you’re losing. Charlie Munger has a great expression where he says, “I’ve heard Warren say half a dozen times, ‘It’s not greed that drives the world, but envy.'”
I asked my Twitter followers the same question, a similar question, what stretch of underperformance by a portfolio manager would you be willing to tolerate before selling to allocation? Over half said less than 3 years, 93% said less than 10 years. How would you react if I told you that Buffett’s stock picks have underperformed the broad S&P for the past 17 years? What if I said he underperformed 11 out of those 17 years? Yet had you invested in Berkshire at the turn of the century, his picks would have outperformed the S&P by three percentage points per year. And we’re looking at top 10 stock holdings, equal-weighted, rebalanced quarterly. Berkshire has very similar returns, by the way. In fact, his performance would have beaten over 94% of all mutual funds during that period and the best part is he didn’t charge you any management fees. This incredible basic strategy has crushed the market but has also gone through underperforming periods where 93% of investors would have capitulated and sold Warren Buffet as portfolio manager. But that’s what it takes to outperform over time. Long periods of being weird, different, and wrong.
But let’s say you really are on the nerves of steel camp of Buffet and Bezos, can handle big drawdowns and long periods of underperformance, what then? Well, if I had to put on my portfolio manager hat with the goal of generating 20% returns using only public markets, I would expand from just stocks and apply those theories that underperformed the trinity portfolio, but with leverage. That means I would include highly concentrated tilts towards global value stocks and global momentum stocks. I would also pair it with an aggressive global trend following strategy. Then I’d leverage that puppy up the entire allocation to around one-and-a-half, maybe even two times. And I think that potentially gets you to around 20%.
However, as you’ll see in the third part of the series, I don’t do that. Why? Because I don’t think I could handle it. Munger famously said there are only three ways to go broke: liquor, ladies, and leverage. And it’s 2020, so maybe a 2020 Me Too version of that would be liquor, love, and leverage, but the same rules apply. I’m looking at one such simulation that just went through a painful 30% loss during the financial crisis, another 66% drawdown during the Great Depression. And again, that’s with an idealized portfolio that benefits from hindsight bias. Reality would likely be much worse in line with the old investment saying, “Your largest drawdown is always in the future.” Most couldn’t sit through that pain or if they could, it certainly wouldn’t be enjoyable. And isn’t that point at the end of the day, to find an allocation that lets you enjoy the benefits of compounding returns but doesn’t cost you your sleep at night? And I really, really, really love to sleep.
Anything else we could try? Get rich faster. Entrepreneurialism embodies the truly American ideal of the self-made person. It’s also one of the fastest ways to get incredibly wealthy or bankrupt. So next on our list is being the boss. There’s no need to describe the basics of starting a business. There’s also no real need to explain the financial benefit. Everyone is aware that big dollars come through ownership of a thriving business and enjoy significant growth, whether that’s hyper-growth over a short period or slow and steady growth over several decades. But the bottom line is the life of a founder is brutally hard and even then the business may fail due to forces outside your control, success is never guaranteed. But for those founders who do find big success, the payoff can be extraordinary.
All you must do is look at the “Forbes” billionaire list to see that the top echelon of wealth, and it’s inextricably tied to business ownership: Bezos, Gates, Buffet, Ellison, Zuckerberg, Page. By the way, who’s not on the list? Athletes, rock stars, actors, and pretty much everyone besides business owners. The celebrities, singers, or athletes that do make lists often don’t do it for their singing or pass-catching abilities, but rather their business acumen. Take Jay Z, he was one of the most successful rappers of all time, but it wasn’t before he expanded his empire to include a music streaming service, liquor, art, real estate, and stakes and other companies that his net worth topped a billion.
So rather than patronize you, fine readers, with the standard platitudes, I’d rather just make one point about starting a business. The common lament of would-be entrepreneurs is the risk-reward is just too high for me. I’m gonna suggest this may not be accurate, but let’s break this down on a numerator-denominator basis and compare it to that of being an employee to be intellectually honest about it. The kneejerk reaction is to focus on the risk associated with starting your own business. Yes, the failure rate is high. There are no guarantees, of course, but the massive potential financial reward from starting a business, the denominator does level out the high-risk level, the numerator. As a result, the overall proposition of starting a business isn’t as downright crazy as many timid entrepreneurs may believe.
And what about the risk-reward ratio of working for someone else? After all, to be fair, you must evaluate how this looks if you decide to remain an employee. In this case, the kneejerk reaction is, I remain an employee because I have low risk, ergo, it’s the better option. But really, two problems with this. One, look at the denominator, reward, barring the abnormal situation in which you continue to make huge paycheck leaps due to repeated, consistent promotions, then you’re probably locked into the standard 3% cost of living salary increase every year. Translation, your denominator reward is massively capped. So while the risk numerator of being an employee might be lower than that of being an entrepreneur, the reward is so drastically lower that the quotient of the ratio itself is basically the same or worse than that of being an entrepreneur.
Second point, is being an employee really safer? By now, I’m sure you’ve read articles that basically strike the fear of God into you as they point toward the coming reality. The robots are coming for our jobs. And don’t make the mistake of thinking these robots will be limited to your standard production line machinery roles. There’ll be replacing pharmacists, lawyers, and paralegals, drivers, astronauts, store clerk, sportswriters and other reporters, soldiers, even your 13-year-old daughter when she tries to babysit. Oh, and for our business, how about computerized trading and robo-investing? It’s only a matter of time before you’re reading automated blog posts from the cyber-quant, Meb 2000. The point is just because you have a job today does not mean you’ll have the future-proof job tomorrow, even if you’re good at it. So toss out the belief that this is the safe, better option.
So do you wanna get rich? Starting your own business is one of the best ways to do it. And before you say it’s too risky, really consider the opportunity costs of what you’re giving up by remaining employee as well as the risks you’re actually accepting by remaining in that safe job. Now, let’s say you’re devoid of any business ideas or perhaps you’re just too lazy to be a founder. It’s damn hard. This points us to our second, faster way of acquiring big riches faster, invest in other people who have taken the risk of starting businesses. In other words, be an angel investor. You could certainly take the public route we talked about earlier, but let’s talk about angel private investing first where you take some of the capital earned by your sweat and toil and invest it in other people with great business ideas.
If you’re gonna go the effort investing in early-stage private companies, you’re looking for ideas that have the potential to massively scale. And we’ve covered angel investing quite a bit on the podcast and online on the show note link, there’s an appendix that lists over a dozen episodes focused on the topic of angel investing. A great intro book would be “Angel” by Jason Calacanis. We’ve also had him on the show. But to get rich, you need outliers on the return distribution scale. Doubling your money isn’t gonna cut it. You’re looking for a true 100 bagger or 10 grand investment turns into a million bucks.
While power laws dominate both private and public markets, the lower starting point of angel investments with, say, a $10 million market cap allows for potential moonshot to occur perhaps more easily than a public stock trading at a $10 billion market cap. And online, we have good papers on return distributions in public markets by Longboard, [inaudible [00:27:02], JP Morgan, Vanguard, etc. And by the way, this is one of the reasons that investing in broad stock market indices work. You’re guaranteed to own a small minority of big winners, which generate all the return. Stat’s something like 5% of stocks generate all the return, the McDonalds, the Amazons, the Googles, the Apples.
We’ve also had Chris Mayer on the podcast, which was wonderful when he talks about a 100 baggers, also in his book of the same name. But the size issue isn’t the only reason why private investments can get you rich faster and perhaps easier than our 20% from the public markets route. Private investments help you sidestep one of the biggest threats to your money, you. Letting a public investment compound to reach 100 bagger status is all but impossible. Why? Because every single day you can pull up your brokerage account on your phone or computer and check the price, which puts you at a risk of selling to lock in gains or selling to avoid prospective losses. Do you think you’ll still let 100% ride after it makes you 5 times your initial investment? If you say yes, then okay, well, what happens when it goes down by half? How many people would have sat through that 95% drawdown in Amazon on the way to trillion-dollar status? Not many.
While this concept of buying and holding stock for the long run is a nice theory, like the old coffee can portfolio, it can be hard or near impossible to implement and practice given our behavioural blind spots. But with the private investment, it’s different. Your money’s locked in. It’s interesting, without even having to think about it, many people do this already with their largest financial asset, their house. Others do it with annuities that lock you in, but most choices here are way, way too expensive. I think the average is around 2.25% per year. You can find, on an old podcast, my friend Paul Merriman talking about his unique solution to this where he gifts his grandchildren annuities and wrap them in a trust. Pretty cool idea. But most people don’t think twice about the illiquidity of their home, yet see the illiquidity of private companies as a problem. But given our discussion so far, it actually may be a positive feature, not a bug. Cliff Asness recently talked about this topic in his piece, “The Illiquidity Discount,” which I agree with.
There are other benefits of investing in private startups that many people don’t talk about. We’ve covered a lot on the podcast. Buried in the recent tax legislation was the Qualified Small Business Tax Treatment, QSBS for short. Investments that qualify allow investors to exclude 100% of capital gains with a cap of $10 million or 10 times the adjusted basis of the stock, whichever is greater. That’s a monster tax hack. Investors can play these private angel investments into retirement accounts to avoid capital gain hits on massive wins. We’ve talked about PayPal mafia alum Max Levchin who utilized his Roth IRA to invest in Yelp. Peter Thiel did the same with Facebook stock too. Romney even did it with his IRA, which got to be worth over $100 million. We talk about the ability to invest in these private companies with the podcast with Alto IRA founder, which is a good opportunity.
Opportunity zones are another tax opportunity for long-term private market investments and you can find more in-depth in a few of our podcasts with Steve Glickman and Alexander Rubalcava. There are many platforms that allow for angel investing, but by far, to me, the best deal flow is concentrate on angel lists. By the way, I may start sharing some of the deals and you can find the link on show notes. Other platforms that are perfectly fine include Republic, Wefunder, SeedInvest, Bioverge, and others. When you think about it, starting your own company or investing in other founders are really extensions of what made Ronald Reed rich. Different paths, of course, yet whether by your own sweat or investing your labour in the sweat of others, both are great ways to get rich if you can behave along the way.
What’s the takeaway? Though it’s hardly illuminating, there’s no single path everyone should take to generate wealth. After all, what is safe anyway? Can your money safely compound in any asset class? No. And we’ve written many times about how all asset classes have suffered huge double-digit losses on a real basis over the past century. Even diversified portfolios go through long losing periods. Plus, to outperform the indices and hit the big returns, you need to be weird, concentrated, different. Mini simply can’t handle that feeling for years on end when they’re losing out to a basic index. And what about the safety of starting a business? Well, the stats suggest you’ll fail. So your seed capital and your blood, sweat, and tears are at risk.
The bottom line is huge riches don’t come both fast and safely. So as much of a letdown as it is, we’d all be far better off holding Ronald Reed as our investment hero, not because he invested in stocks or blue chips or anything like that. The real reason Ronald Reed is our hero is because he had a game plan and he stuck to it. Do you have a plan to generate wealth? That’s number one. And most people we talk to don’t. But even if you do, are you consistently falling a discipline or are you allowing shifting market conditions and your changing personal finances push you around?
But let’s make a leap and say you’re one of the lucky investors who made it to the promised land. You’ve won the game, you’ve saved, invested, and made your nut, and now you’re looking to preserve your wealth rather than grow it. What strategy now is best for you? Likely, it’s not the one you think. We’ll tackle this topic in the next part in the series with the “Stay Rich Portfolio.”
Welcome to the second installment of our new series on generating wealth, preserving it, and then looking at a real world illustration of strategically implementing these concepts. In our first podcast we discussed generating riches through a high-paying career, investing in public and private markets, and starting your own business. The takeaway was there’s no fast, safe path to riches, rather it’s which path is right for you, given your temperament, financial needs, goals, and abilities. In the second part of this series, we’ll look at what happens after you’ve made it. In other words, you’ve amassed your wealth and now your principal goal is preserving it. That’s not as easy as it sounds. Also, just because you generate a wealth doesn’t mean you have the skill to keep it. After all, strategies for preserving wealth can be quite different than strategies for generating wealth. Enough introduction, let’s jump right in.
From $35 billion to broke in 2 years. In 2012, Eike Batista had an estimated net worth of more than $35 billion. The self-made Brazilian billionaire created an empire that stretched from mining to oil, to public works. Many considered him the pride of Brazil. Barely 2 years later, he had lost all $35 billion and owed another billion to creditors. How does this happen? How does a $35 billion portfolio evaporate practically overnight?
You could point to several poor decisions. But perhaps the biggest of all was concentration risk and Buffett’s favorite destroyer, leverage. Batista’s wealth was overwhelmingly tied to the global commodities boom. While that investment concentration was a huge tailwind in helping Batista become rich, it eventually proved his downfall as well. This points to a critical takeaway every investor needs to be aware of. The portfolio that helps you get rich isn’t necessarily the portfolio that’s going to help you remain rich. Research backs us up with the old saying, “Shirt sleeves to shirt sleeves in three generations.” The Asian equivalent is, “Rice paddy to rice paddy in three generations.”
Seventy percent of wealthy families lose their wealth by the second generation and a whopping 90% by the third. Granted some of that is due to high spending, addiction, bad luck, leverage or just poor decisions, but a lot of it is simply how people invest their money. Can you invest in a certain way to bomb proof your portfolio to minimize losses? In this podcast, let’s do what Batista should have done, spend a few minutes focusing on the stay rich part of the equation. If you’re an investor who has already amassed great wealth and won the game, what’s the right market approach that will help you keep and potentially even grow your wealth?
First up, how safe are risk-free treasury bills? When trying to engineer a stay rich portfolio, it makes sense to start with what the investing community refers to as the risk-free rate. Most often we find this as the rate of current treasury bills. Many investors believe T-bills to be the safest, most conservative investment around. In fact, if you look at T-bills back in 1926, they returned 3.4% per year with no drawdown or losses. Pretty safe, right? Not exactly. These are nominal returns, and nominal returns are an illusion because they don’t take into account inflation. All that matters to any investor is returns after inflation or what we call real returns or returns you can eat.
And if you measure the returns of T-bills after inflation, you see a different story. Unfortunately, this is a story most investors haven’t seen. I recently asked my Twitter followers the question below. Let’s say you’re a conservative investor and put all of your money into safe U.S. government short term treasury bills. How big of a drawdown from peak to trough loss after inflation did you experience in the 20th century? The options were 0 to 15, 15 to 30, 30 to 45, and worse than a 45% loss.
The vast majority of people said less than 45% and about half said less than 30%. About 16% said less than 15. The actual real max drawdown was a whopping half. You lost half your money in safety bills. Two thirds of the people got the answer wrong. And these are very intelligent people with far greater investing experience than most. You kind of have to be to follow me on Twitter. It’s a lot of quant and nerdery. Yet they seriously underestimated the losses in short term bonds. So the risk-free rate isn’t risk-free at all. And by the way, I’m ignoring other global sovereign bond markets, including some that produced 100% loss.
The original version of this article ignored what a lot of people do with their money. They actually leave it in the bank. Today that’s 0% interest, the modern day version of stuffing it under the mattress. A full third of investors responded to the poll that they earned 0% interest on their bank deposits or “don’t know” what interest they are. If you just put your money at 0% and under mattress, you eventually lose all of your assets minus 97% and an inflation clip of about 3% per year. Ouch.
Okay, so what about parking your dough in other asset classes? Might real returns be safer elsewhere? Unfortunately, not. The losses are even worse when we expand our analysis to other asset classes. So if you go back to 1926, here are the max real drawdowns for various assets. U.S. stocks, minus 79%. Foreign stocks, ex-U.S., minus 78%. Ten-year U.S. government bonds, minus 61%. Foreign bonds, minus 78%. Gold, minus 85%. Ouch. The naysayer might hear this and say, “Look, these are max drawdowns that likely played out over several years. A smart investor would have gotten out after, say, one year bad returns.” Well, with that in mind, we’ll post this online. I’ll try to read it here. The table highlights the worst 12-month period of real returns for each of the asset classes after this annualised inflation of around 3%. And as you’ll see, nothing was truly safe.
So if you go back to 1926, real returns, cash under the mattress, minus three. Cash and T-bills, plus 0.5. So you basically kept it up with inflation but made a little money. U.S. stocks after inflation, 7%. Awesome. Foreign stocks, about five. Long-term U.S. bonds, around two. Foreign bonds, also around two. Gold, also around two. We just read those max returns. And if you look at the worst year, so the worst 12 months, cash under the mattress and T-bills both had about minus 17%. So imagine that, your safe money, you lose almost 20% a year. Now, the volatile assets like stocks lost two-thirds in a year. Foreign stocks, 57%. Foreign bonds, 42%. And gold, same, 42%.
Again, you can look at this online, it will be easier to read and listen too. But it could be reasonable argue that people would prefer a slow erosion of wealth to a sharp loss. And in this case, T-bills do indeed look safest on these metrics. Remember, in 1 year, they only lost 17, versus stocks who has lost two-third. They had lower volatility, more positive months, and the lowest were 12-month period. However, the slower erosion of bonds might appear less painful at first glance, but consider the analogy of the frog in the boiling water. As the analogy goes, if you throw a frog into a pot of boiling water, it’ll feel the pain and jump right out. But if you put a frog into a pot of cool water and turn on the burner, the frog will remain in the water until it boils. I don’t know if that’s true or not, but just stick with me.
The slow erosion of wealth with T-bills is a bit like a frog sitting in water that’s simmering towards a boil. So let’s pause and briefly recap. At this point, it’s clear there’s no single asset that’s guaranteed to preserve your wealth. The best we’ve done is a 49% decline. In the safest asset, you still lost half your money at some point. So what now? Is there a way to combine assets and build a minimum loss portfolio? Asset allocation strategies have long been known to reduce risk for a portfolio. So what’s the worst drawdown we’ve seen with the venerated institutional 60/40 portfolio, 60% stocks, 40% bonds. You still lose 54% of your money.
What if we expanded to global 60/40? Okay, then you only lose 46% of your money, still almost half. Okay, that’s a little bit better and shows the benefits of diversification, but you still lost half your money. How about adding real assets like gold? So if we combine this all into what we call the global market portfolio, and we discuss this in our book “Global Asset Allocation,” which is free to download online at Meb Faber or Cambria Investments, it’s roughly half stocks, half bonds, and of that it’s roughly half U.S. and half foreign. Well, you end up with around the same return as 60/40 with lower volatility. And you give up some real return, but we do lower our maximum drawdown.
So from 54% in U.S. stocks, it comes down to 39%. So better, and it’s a mixed bag. You have about a percent lower returns, too. So this all points that takeaway, which I think is vastly understated by almost every investor on the planet. Nearly every allocation or single asset classes will likely decline by at least 30% on a real basis and probably more in your lifetime. And that’s a hard pill for most to swallow. But at least you have this knowledge ahead of time, which will hopefully help you anticipate it better and weather the storm. So what does this all mean? Are T-bills still the safest?
So you might have listened to this and think, “Okay, you’ve been a real ray of sunshine, Meb, and showing me that every asset class and portfolio is still susceptible to huge drawdowns. So if it’s all bad, then I might as well start back at the beginning. T-bills seem to offer the lowest drawdown so that’s where I’ll park my wealth.” Let me propose an alternative suggestion. Our studies have shown that historically an investor can combine a diversified global market portfolio with some cash to produce an outcome with similar loss levels as T-bills but with better returns.
This approach enables an investor to engineer a strategy that offers comparable loss levels T-bills yet while generating an additional two plus percentage points of return per year or perhaps framing the return as yield would make more sense as comparison. So at a minimum, the global market portfolio, or we call it GAA, part of the equation offers some protection from the catastrophic losses Batista incurred when concentrating all his wealth in just one asset class. So let me read this. Again, you can go online. It’ll help you better. If you look at the real returns, remember cash, T-bills gets you about half a percent. The global market portfolio gets you up to four and a half, but with a much drawdown that’s probably not survivable.
So let’s say we put two-thirds in the global market portfolio stocks and bonds and a third in T-bills like cash. Well, you end up with a portfolio
So across all metrics of volatility and drawdown, it’s pretty darn similar. But you end up with over 2.5% points higher return. And so we posted these charts and it’s hard to…you can’t see it visually while listening to this, but online if you go to the blog post and you can see the chart of T-bills versus two-thirds investing in the global market and a third in T-bills. And as you can see, there’s a little bit more volatility with the combo of GAA and T-bills, but it’s well worth it for higher returns over time. And this is on monthly level. If you take it out to yearly level and zoom out and you only use yearly values, the volatility looks even lower. You can hardly tell the difference between the volatility of GAA and T-bills versus just T-bills, and you end up with a vastly higher return. So of course, this is a philosophical departure for many.
My friend, Dan Egan, at Betterment, has spoken on this topic recently and my perspective it’s evolved over the years. I used to think the safe option was T-bills. But many conservative investors keep their safe money in a savings account that earns T-bill like returns. Think about, by the way, most of you probably have your money in Bank of America or one of these crappy banks that earns 0%. Well, first of all you should be earning, if you’re even gonna do it in that account, a high yielding account that’s protected, Betterment does it as others. That’s probably well up above one. I don’t know now. Actually the Fed funds have been coming down, but there was too not too long ago, but you should at least be getting paid on that.
But even then, is that really the safest place for it? History would suggest that investing across a broad portfolio with some cash has been a safer allocation than T-bills alone. And if you think about it, it makes sense. If our biggest enemy over time is inflation, the best possible thing you can do is invest in a huge spectrum of businesses globally that grow your money over time and pair that with T-bills, too. Now, as to the threat of your wealth posed by that high spending child and your derelict spouse, that’s another problem.
So we conclude this and move on to the last part of our three-part series with the final segment. How does Meb put both these parts of these portfolios, “Get Rich” and “Stay Rich,” into one cohesive portfolio with my own assets and own investments?
This is an extension of a piece I’ve been writing for years, namely, how I invest my own money.
I began noticing an interest in this topic from years ago, usually as December rolled into January of a new year. I suppose some investors found it useful to see how someone whose career in investments allocated his money, others perhaps found the process instructive for application to their own portfolio or perhaps they just like to watch from the stands so they can cheer throw tomatoes, virtually, in 2020 on Twitter. What’s important is you find an approach that works for you. From the late great John Bogle, that was low cost index investing. He had a great quote, which he said, “To repeat, while such an index driven strategy may not be the best investment strategy ever devised, the number of investment strategies that are worse is infinite.”
Will my strategy be the best strategy device or the best strategy for everyone? Absolutely not. But is it the best strategy for me? I think so. Without a mind, let’s pull back the curtain. Of course, there’s nothing too dramatic about what’s behind. As I mentioned a moment ago, I’ve been publicly detailing what I do with my own money for years and I’m happy to continue doing so. There’s a lot of shame and embarrassment when it comes to personal finances and we want to end that. But a couple disclaimers before we launch in. First, the reality is this information shouldn’t matter to anyone outside of my family. Let’s be clear, none of them listen to this.
However, I recognise that many investors appreciate the thoughts behind the process either as a template for their own portfolio or just to stir up some questions. That said, please understand I’m not offering this information as a recommendation for how you should invest personally. My situation is not yours. And even if it were, there are a million different market approaches that work just fine. The challenge, of course, is avoiding the 10 million approaches that are terrible. Channeling Bogle.
Second, look, the numbers aren’t exact and forget about decimal points. Attempting to provide that degree of specificity would be pointless. Furthermore, the most instructive part of this exercise is simply understanding how big financial pieces fit together to create a holistic financial portrait. So the specifics aren’t really that helpful. Third, this podcast tends to be a bit anticlimactic for some investors and some of where that most people are looking to get a read on how to position their portfolios or thinking about their stocks specifically.
I’ll provide you with 100% transparency about how my investments are positioned. But you’ll see that doesn’t materially change from one year to the next, as most of the funds do all the work and the heavy lifting and adjustments for me. So, unfortunately, I don’t have any hot stock tips for you in this podcast. Though, if you want to gossip about investments and ideas over a meal or beer, I’m always game. I’ll tell you my opinions all night, but they don’t make it into my portfolio. Finally, you’ll see that I’m somewhere in between when it comes to wealth generation and wealth preservation strategies. I have a young family with plenty of financial needs. So I’m still trying to generate wealth. On the other hand, I’m trying to be thoughtful about my family’s financial future. So that means certain preservation strategies too.
And as I mentioned before, in prior podcasts, I really, really like to sleep soundly. Again, this is what works for me at the moment, which will change over time and I don’t hold it out as a suggestion or for any specific reader to follow. It’s merely an illustration. Enough intro, let’s dive in.
The biggest pieces of my net worth, the vast majority of my net worth is concentrated in entrepreneurial ventures I founded, namely in my asset management company, Cambria, and my research company, The Idea Farm. While the exact percentage is open to debate, it’s likely is between somewhere between, I don’t know, half and 99%. While not quite as extreme as Elan Musk, “If Tesla and SpaceX go bankrupt, so will I as it should be.” The ownership stake in my companies are the largest determinant to my net worth. This is likely true for many business owners around the world.
Echoing our prior essays and podcasts on getting rich and staying rich, I think it is useful to bucket my holdings into these two categories. Being a founder and owner of Cambria and The Idea Farm fall into the get rich bucket. That having been said, if you exclude Cambria and The Idea Farm, my largest holdings are about a 30 each in farmland investments in over 150 private companies and my public investment portfolio. All you historians and longtime followers recognize this allocation is approximating the 2000-year-old Talmud portfolio that is spread equally across real assets, businesses, and safe reserves. I think the quote is something along the lines of, “Let every man devote a third of his wealth each to land, his business, and keep the third in reserve.”
And by the way, you can download a free copy of “Global Asset Allocation” book we wrote with chapters on various asset allocations, including the Talmud portfolio, and stay tune on the lookout for a second edition hopefully this year, but all that can be found at Cambria Investments or mebfaber.com. We post a pie chart on the show notes here if you want to take a look at this exactly, but I’ll read it out here in order. You know, farmland is a pretty stable income producing asset and is about as non-correlated as you can get to the rest of the portfolio. So I put that in the stay rich bucket. Plus, it offers a very real sentimental and emotional value for me due to some family roots to farmland.
We’ve talked about on the podcast, my father and grandfather side of the family grew up in Nebraska, Kansas. Plus, if you ever really want to seriously disconnect with some quiet time, there’s no better place. You couldn’t connect if you wanted to. Or if you want to shoot guns, drive around an ATV or just not be bothered by anyone, get some good reading time in or walk around and be in nature. So if you guys ever want to do a meeting, meet up in western Kansas, let me know.
I’ve also detailed my private angel investing journey over the years on the blog and podcast. This goes in the get rich bucket, though, depending on the outcome, it could also be in the get poor bucket. The long, indefinite holding periods and big tax breaks are the major benefits of this approach. Plus, it’s a lot of fun, incredibly engaging, and you wake up every day a lot more optimistic. You contrast that with a consistent negative geopolitical news flow and public markets, my God, if you turn on the TV and watch CNN and all these other channels or read the internet and Twitter, all you want to do is just panic and sell everything. But if you look at a lot of these private investments all day long, it’s people that are changing the world. If you’re like the most optimistic person in the world, try to find a balance in between the two.
I’ve considered my private investments so far as tuition. And while the performance hurdle for me is U.S. stock market, the hope is the portfolio will do much better. Yet, if it’s a bit fat zero, I would be okay with that. I wouldn’t really, but I’ve come into it expecting that it could be zero. As the performance of these so far, look, of the 150-plus deals in which I participated, most are still in their infancy. I understand that each of these investments really has a 10-year time horizon, if not more, sometimes less. But I’ve done in 50. There’s been about 10 exits. I’ve had two bankrupt zeros, six acquisitions, one IPO, one secondary liquidity. Together these have produced an average total return of 125% on dollars invested or about a 42% CAGR if you include the time held, they might still open investments.
There’s a lot of follow on rounds, even a unicorn or two on paper, keyword being on paper. While these results are so far incomplete and produce a rosy view of angel investing, I’m very aware this period has been incredibly favorable for private angel equity investments as well as public markets. What’s important in this endeavor is seeing it through a full cycle over the next decade. Believe me, I lived in San Francisco during the early 2000 decimation and internet winner, I’m sure I’ll see a range of winners and losers. And the goal for me is to do this for a full business cycle, so for at least another 5 years and hopefully end up with a portfolio maybe in 300 companies. Most of this I do through auto IRA as well as in my own account. That takes advantage of QSPS. We’ll talk we’ll talk about more in a minute.
The biggest cash return so far was a 16 bagger, which provided a good lesson in power laws of private and public markets. Again, if you want to go online, we’ll send you a lot of academic links that I think are super interesting from Vanguard and JP Morgan and Longboard and Chris Meyer. You know, it’s just a different mindset when you can’t sell an investment. Had my money be invested in a public stock, what are the odds I would have sold after a double or a triple?
I’m going to say high to very high. While the concept of buying and holding a stock for the long run is a nice theory, it can be hard to implement in practice. I think it was either the very first or second investment on angle list is probably my best. And I guarantee you if that was a public stock, I would have sold it a million times along the way. By the way, I’ll likely start sharing some of these private investments that we may do in the coming year. You can follow along and join the syndicate on angel list. Link on the show notes.
Let’s move on to public investments. First, just a note to anyone listening to this who has money in our various funds or ETFs, which is most of us. Ask any mutual fund manager why you should invest with them and you’ll likely find yourself met with a barrage of sales points, all of which will underscore one takeaway. Their fund deserves lots of your money. But when you ask that manager what they do with their own money, it may surprise you. Often many managers have zero dollars invested in their own fund. You don’t have to believe me. Thanks to Russ Kennel of “Morningstar,” he publishes a post where he discloses the percent of money managers that have nothing, zero, zip, invested alongside their client money they manage. And in many cases, it’s half all the way up to 80% have zero invested, zero. And if you include those who invest a nominal amount but less than 100 grand, the numbers are even higher in some categories, 65%, 75%, 85%, 95% have nothing invested in their own fund.
If you follow the blog or podcast for a while, you know where I’m headed. That is absurd. But I guess it shouldn’t be surprising. The mutual fund industry has long been an area dominated by high fees, tax inefficiencies, sales load 12B-1, and other investor unfriendly practices. Maybe these fund managers are actually smart enough not to invest in their own funds they manage, but the world is wising up and investors are voting with their checkbooks and the fund flows tell the story. I think it’s important to have skin in the game.
If I don’t believe in our funds enough to invest my own money, why should anyone else? So for better or worse, I invest all of the public assets I manage into funds I manage, then I leave it on autopilot. And this goes in the stay rich bucket. Even though the right portfolio is whatever lets you sleep at night, I prefer a moderate risk portfolio that targets higher returns in buy and hold with lower volatility and draw downs. And that’s quite a tall order. So that translates into my current allocation and market sensitive assets which I have described many times before as buy and trend or what we like to call the Trinity strategy.
You can find the pie chart online. This Trinity approach invests roughly half in global strategic buy and hold asset allocation that is allocated across stocks, bonds, real assets. The strategy includes tilts towards value and momentum instead of standard market cap weighted portfolios. The other half of the Trinity approach is invested in various trend following strategies. The goal of these strategies is to reduce volatility and drawdowns while still targeting similar returns to buy and hold with low correlation. This works for me because if you’ve read my blog, listened to podcast, you know I’m a trend follower at heart but I’m also a value investor. This approach lets me scratch both pitches. As a trend follower, I like the idea of having half my portfolio available to move the cash or hedges if markets trend down. But as a value investor, I want exposure to assets that may be cheap over long horizons like I believe foreign stock markets are now.
I get both with this approach. I want all my public investments totally on autopilot. I don’t want to have to make trades or think about buying that cheap country when my emotions are arguing against it, they’re unlikely tripping me up. I don’t want to have to think about selling that amazing market as the trend ends. In fact, I don’t want to think about it at all. But I do want the funds and strategies themselves to make all the adjustments for me and in an objective, automated, and tax efficient manner. This allocation includes what I consider to be my cash account. This has been a big change over the years in my thinking, namely, that you should be investing at least some or all of your safe money had tipped Dan Egan at Betterment as well as the last discussion on the get rich portfolio and stay rich, excuse me.
The earlier piece we did on the stay rich demonstrates what many to believe to be the safest portfolio isn’t. I believe when measured on a real after inflation basis, a cash account is as risky as a nice asset allocation with much less return potential. So I invest nearly all the cash type investments I would have in a broad allocation ETF and only retain a small amount for short-term living expenses. The next slice is the foreign funds category, which represents my 401K and 529 plans, both of which, sadly, only offer me mutual fund choices. So I just tossed them in the best low cost investment I can find, which as I write as I podcast, or foreign stock markets in emerging markets.
Of course, we had a link on this we talked about before you can see Twitter, lose their mind over that revelation. My company is trying to get access to our own funds here with Cambria qualified plan offerings, in which case, I’ll move my funds over at that time. Next up, you’ll see an allocation to tail risk strategies. I consider this a hedge against my career beta as well as a hedge for all my private stock holdings. And this is funny because I wrote this earlier in the first quarter and I said, “I’ll look to add a lot more if the stock market ever enters a downtrend again.” Isn’t that funny?
So I have about 14% in the tail allocation, 12%, it’s probably 14% now. And then we’ve also mentioned many times in my company. And the balance sheet actually allocates about a quarter of its balance sheet to tail risk strategies, about half to short-term bond strategies and another quarter to Trinity, which I think is a pretty big departure for most people. But the whole point of this is showing we actually put our money where our mouth is, not just personally but also with the company as well. Once you get to the very, very right side of the decimal point, and these are rounding errors at this point, there’s a smidgen in cannabis, a theme I’m bullish on over the next decade. I’ve detailed my plan on the blog last summer as well as on the podcast. I’m planning on adding more “and more and more” as cannabis stocks decline “and decline and decline.”
We actually said this when we were on Bloomberg, but also, you know, in past posts when we looked at the historical prohibition ending with a lot of the [inaudible 00:30:59] stocks in the 1930s, they almost double the return of the broad market for the decade after prohibition ended. But it was lumpy and most of it came actually in the second half of that decade. So I would expect as the cannabis industry matures, as these companies start to get more and more professional incorporated in a lot of the big dudes, the big money moved down the vertical chain, that it’ll actually be a great industry over time.
Next up, I’m bullish on Africa as a theme. We’ll look to make an allocation in the coming years. Haven’t yet but we’d really like to. I don’t like a lot of the offerings so we may actually devise and launch a fund there. I would also like to add more to my farm allocation as the asset class has been somewhat challenged in the past few years. But we’d love to own more there. Lastly, there are tiny amounts in rare coins, comic books, and even cryptocurrencies. The rare coin allocation goes back to our Van Simmons episode, which was an early days the podcast. One of my favorites though. And this fits in the stay rich bucket and also maybe in the fund bucket. Comics I’ve had for 30-plus years. Shout out. Thanks, Mom. And fit into the fund bucket too.
The greatest irony there I laugh about is, despite the thousands of comics I own, mom wants to dug a few out of the attic that were some sort of cowboy comic from like, who knows, the 1960s or something that’s probably worth more than my entire collection combined along with her Jordan rookie card. I mean, you can’t make it up. Anyway. Crypto, well, that falls what I call into the regret minimization bucket. As I’ve said many times before, I’m not really attracted to crypto as an asset class, but I’m willing to make an allocation in line with the global market cap, which is about 0.05% of the global assets, mainly to avoid regret. If the space ever goes up in value 100,000 times and also to quiet all my friends from the badgering me if they do. It’s well worth it to some cost.
Listeners, that’s about it. Feel free to shoot me any thoughts. I would love to hear feedback at the mebfabershow.com, and best of luck with your own investment journey. But let’s end on an important note that is often overlooked in the countless hours we all spend on our investments. What’s the point? Remember that money is only a means to an end. It’s there to help you achieve your life goals and happiness. Does it help you fulfill your dream of travel? What about putting your grandkids through college? Perhaps it’s there for you to support a local charity or social cause that’s dear to you. Or maybe you just want to help establish the next generation of entrepreneurs through capitalism. Or maybe you just want to fish with your buds, whatever. Let the investments help get you there. Or the shorter version, my mom and grandma used to have a habit of saying, “Look, you can’t take it with you.”
And lastly, we’ll end with a longer version we’ve had on the blog since inception over a decade ago. It’s actually in our first book. This is George Mallory from the book “Climbing Everest.” The complete writings of George Mallory. “People ask me, ‘What is the use of climbing Mount Everest?'” My answer must at once be, “It is of no use.” There is not the slightest prospect of any gain whatsoever. Oh, we may learn a little about the behavior of the human body at high altitudes and possibly medical men may turn our observation to some account for the purposes of aviation. But otherwise nothing will come of it. We should not bring back a single bit of gold or silver, not a gem, nor any coal or iron. If you cannot understand that there is something in man which responds to the challenge of this mountain and goes out to meet it that the struggle is the struggle of life itself upward and forever upward, then you won’t see why we go. What we get from this adventure is just sheer joy. And joy is, after all the end of life. We do not live to eat and make money. We eat and make money to be able to live. That’s what life means and what life is for.
“Investing in the time of Corona.” Minus 9%, 5%, minus 5%, minus 10%, 9%. Those are the daily returns at the stock market last week. As my grandmother used to say, “Lord have mercy.” That’s enough to get most market participants an ulcer, the coronavirus is wrecking economies and overloading health care systems around the globe. Due to the uncertainty involved, one could easily make a case for two wildly different outcomes.
Let’s start with the bull case.
Following the dire experience of Italy, countries around the world take the threat seriously. Tests are plentiful, events are canceled, and citizens self-quarantined, governments around the world coordinate fiscal, monetary and healthcare policies to address most major threats. The infection rate peak soon. We’re already seeing the number of new infections in China drop to single digits for the first time since recording began back in mid-January with hospitals well-staffed and able to manage the patient load. Death totals are mild. Treatments are developed, vaccines are distributed and global immunity prevents any major future outbreaks. Economies and markets rebound vigorously. Citizens around the world are euphoric and risk-on markets rebound with a fury not seen in decades. Financial markets hit new highs by year-end.
Now, let’s look at the bear case.
Some countries around the world take this threat seriously, but it’s too late and the virus has already spread too far. Much of the global population ignore suggestions to self-quarantine, cases grow exponential and hospitals are overwhelmed and unable to manage the patient load. Death total soar beyond expectations. World leaders, celebrities, and athletes are not spared. Most people know a friend or family member that dies from the virus. Treatments are ineffective, vaccines are years away, and experiments with hard immunity are a disaster. Governments try to implement various financial and social stimulus policies to no avail. Previously expected to be a short-term problem, economies and markets are impacted massively. Citizens around the world are fearful and depressed and risky financial markets continue to plummet. The U.S. stock market declines 30% after its current declines, taking it back to historically average cape ratio valuations of around 18. Oil, real estate, gold, and most financial assets slide as well. The summer brings some relief from the virus and economies improve and markets stabilize. People sense the nightmare is over. However, by fall the virus re-emerges, prompting despair amongst global citizens and markets continue to decline to valuation levels not seen since the bottom of the global financial crisis. Another 30% down to a long-term valuation of around 12, which takes us 60%, down from the peak in early 2020. So which scenario is most likely to occur? I don’t know. No one really knows. But the reality, like many things, is likely somewhere in the middle.
But with such massively different future possibilities, many investors are wondering what to do. And the answer for most of us is nothing. Or as the late John Bogle stated, “My rule. And it’s good only about 99% of the time, so I have to be careful here. When these crises come along, the best rule you can possibly follow is not don’t stand there, do something, but rather, don’t do something, stand there.” We tried to drive this point home in our letter to shareholders last week titled “Time To Panic,” which was the beginning of this series. And it’s worth read but we’re listening. But here’s an excerpt, “Global markets are experiencing large moves up and down recently, as many investors are freaking out. U.S. stocks have declined by some of the most in history, often triggering circuit breakers to pause trading. Investors all over social media are panicking because they don’t have a plan. But you do. You put in work over the past decade, you’ve read our blog posts, and books, you listened to podcasts, and eventually, you built a plan. And take note, they’re not all the same plan, but at least you have one. So when it hits the fan like it is now, you’re prepared.”
Our investors have read our old pieces for the past 14 years that have prepared them for this. There was the piece on how really big daily stock market moves of 5% to 10% are pretty normal, but also they tend to cluster together, particularly in downtrends. And that’s in the old paper called “Where the Black Swans Hide.”
We also talked about the four quadrants of stock markets, meaning you could put the stock market into cheap or expensive, but also is it an uptrend or downtrend? And we found that the best performing market was a cheap uptrend. But the second-best was an expensive uptrend, which is what we’ve had for the past few years. The problem always came when it flipped from an expensive uptrend to an expensive downtrend. And that’s when returns get really nasty like they have. And we profiled that in a post called “Keeping It Simple.” We also published a piece that demonstrated what assets help to hedge these big down periods in stocks. It’s in a piece we did called, “Worried about the market.” And as it turns out, the assets that hedged historically, so tail-risk strategies, bonds, cash, gold, trend following strategies actually helped this time too.
And the ones you wouldn’t expect to help, real estate, most commodities like energy and oil, and particularly foreign stocks didn’t help and in some cases did worse. You mentally prepared for the fallow periods because you read the piece that demonstrated many assets can go long periods experiencing measly returns, and underperforming other assets, but still, be worth investing in. And that was called, “How long can you handle underperforming?” You learn to think in terms of decades rather than days, quarters, months or even years by taking the long view after reading and listening to the prior parts of the series “The Get Rich and Stay Rich Portfolio.” Let’s say you read all these pieces, you’ve listened to podcasts and you put your plan into place. Congrats, well done. Now, you get to sit back, relax and do nothing. Easier said than done, of course. But that’s what I plan to do with my allocation which you’ve also read about in our old papers, “The Trinity Portfolio” as well as part of the series called “How I Invest My Money,” which is nice. We love to see professional investors do this, not just to show and demonstrate they have skin in the game. As you guys remember, most mutual fund managers don’t put anything in their own funds, but also show that none of us are perfect. All of our portfolios, including the pros, have their warts and underperformers as well.
Now, to be fair, it’s easy to do nothing when many of us have private assets, where you couldn’t do anything even if you wanted to. So for most people listening to this, a relevant example is their house. A lot of people have most of their net worth invested in a private asset that you couldn’t price every day. Couldn’t sell it today if you wanted to. Maybe you could, but probably not the price you want. And for me, we posted a picture on the blog that’s few years old, walking through a wheat field in Kansas. I couldn’t price farmland today if probably I wanted to. On the public side, again, it’s a lot easier said than done, because you can look at quotes every day on your phone or computer. And it’s really hard to resist the temptation to check your brokerage balance every minute. But this market to me, it really illustrates the beauty of the approach that I’ve adapted, The Trinity Strategies, where half of my allocation is in a global buy and hold allocation across stocks, bonds, real assets with tilts towards value and momentum. So, if for the rest of the year, we hit the bull case, we conquer the virus and markets rip right back up I’m covered. And the portfolio will also rebalance and keep tilting more and more to the cheap stuff as it gets cheaper and cheaper.
Now, the other half of the allocation is in various trend strategies, and if markets continue their freefall down, and maybe there’s parts of this bear case that happen, I hope not, I’m also protected. Granted, assumption strategies didn’t help as much as normal this year as markets race down. As many of you know, trend usually takes its little time to adjust from all-time highs. And for U.S. stocks, for example, we had the fastest move ever, from all-time highs to a bear market. And that goes along with the lines with something we’ve talked about a lot on the podcast before, which is, in times of stress professional investors love to reach out to clients and say, “Okay, it’s okay, clients. Relax. This has happened before.” But we always used to joke that eventually, we’ll all experience something that’s never happened before. And in this case, this market environment has had a few things that have never happened before. And the speed at which we went from all-time highs to a bear market is one.
So, for me, I mentioned this many times before and this is the technical term, but I like to go half-Z’s, half in buy and hold and half in trend or what I call “Buy and trend.” Frankly, I never wanna be all in on any outcome, because after all, the future is uncertain. Plus, I think it’s important for me, it’s automated, so I don’t have to think about it. So I mainly plan to just stand there. But the thing about big market dislocations is they create massive stress, emotional stress, financial stress, marital stress, and probably 10 other kinds. And these stresses lead people to act bananas crazy with their money. So, let that be your opportunity and not your downfall. So I’m gonna outline a few ideas to put in your quiver in the coming days, weeks, months. You don’t need to watch the markets for these. But during times of market dislocations, there are some steps I think one can make that are reasonable and could add some value over time. So let’s discuss a few.
Number one, over rebalancing.
Over rebalancing is a concept we talked about both on our own old Rob Arnott podcast, as well as in the Howard Marks one, he called it, a different phrase, calibrating. Where most people and listeners here set a schedule to rebalance their portfolio. Let’s say you got a traditional 60/40 stocks-bonds portfolio you rebalance once a year, at the end of the year. However, given an extreme move down in stocks, you do a rebound, say, about 60 to 40. But if they got really cheap, and some markets, in my opinion, are right now emerging markets are probably in P/E ratio is down around 10, many of which are probably single-digit P/E ratios, you may consider taking the portfolio to a little past target. So instead of say 60/40, you may go 65/35. Now, take note, I didn’t say going from 60/40 to 90/10. And you should also identify what extreme means to you ahead of time for valuations on both sides and try to codify it. So when these things happen you have a set of rules to work with.
Again, think in terms of over rebalancing, trimming, calibrating, and not bet the house all in or all out. That’s a prescription for the poorhouse. And try not to burden yourself with the requirement of perfect timing for adding your portfolio during the sell-off. For example, let’s say you we’re a prude investor, a massive stockpile of dry powder cash ready for crisis investing, and also toilet paper. Now, you have it in, when to put it to work? Of course, that’s not an easy question to answer though it is in hindsight, of course. After all, if the markets rebound quickly the answer is now. But if the coronavirus is destined to hit us with a second wave in the fall and the markets drop another 30% then investment today would be premature and quite painful. Again, no one has a crystal ball so no one can time the markets perfectly, so stop making that demand of yourself. Perhaps the better approach is simply considering at what levels of pullback you’d feel it’s appropriate to deploy your cash.
No, I didn’t write or say “feel comfortable but appropriate.” After all, it will probably feel scary putting money in the market anytime in the near future given this volatility. But now might be worthy of one tranche to your capital, down another 10% might warrant a second tranche and so on. The answer is specific to you. The amount of capital you have to invest and your belief about how our world in the markets will respond to the situation. For others, they’ll just continue to dollar cost average each month into their 401k. As many of you know, I’ve said this many times, mine simply goes into an emerging markets each month, and I am stoked, I’m so excited for that to go in every month for the rest of the year. I’ve had friends reach out and say, “Meb, should I continue allocating to my retirement account?” And, my Lord, if you’re young, this is a fantastic opportunity.
So if you haven’t started saving and investing, if you haven’t started maxing out your retirement accounts. This goes back to one of my favorite investing quotes I attribute to Mark Yusko, who’s been on the podcast, that goes along the lines of, “Investing is the only business when things go on sale, everyone runs out of the store.” And I think that’s a good indication if you’re a long-term investor, you should be elated, that markets are down and you can buy them at cheaper and cheaper prices. So regardless, the appropriate question to ask yourself isn’t, “Is this the bottom?” But rather, “In five or 10 years, is there a good chance I’ll be happy I invested at this level?”
Number two, opportunistic investing, buying $1 for 50 cents.
In times of market panic, many assets can trade away from fair value. I mentioned on Twitter they’re placing limit orders a little bit below the bid on names you’d like to own can be a tool to pick up some shares at nice discounts. Now, make sure you wanna own them in the first place because you just might get filled. And that’s good advice always, you should always, always, always use limit orders.
Another similar concept is investing in funds that really trade far away from their net asset value. And in general, I’m talking about closed in funds here. ETFs usually don’t trade that far away from the net asset value because they have market makers that can arbitrage it, but closing funds are different. Most of the time, these funds trade within a few percent of NAV, but at times of stress, they can get to 20%, 30%, 40% or more discounts. Now, you have to be careful and do your own homework. Many of these funds use leverage. They are tax-inefficient, and they have higher expense ratios. So do your homework, but I’m looking into it. There’s a great website Closed-End Funds Connect, where you can sort the discounts. There’s even we profiled these way back in my book “The Ivy Portfolio” where there’s a number of hedge funds that trade in different venues around the world. Bill Ackman is one, Dan Loeb at Third Point is another, and some of these are getting to as high as 40% discount the net asset value. But anyway, take a look, do your own due diligence. But it could be interesting in the coming months.
Lastly, blood in the streets. Buying totally hated, blood in the streets, bombed-out assets can be a great idea. We used to do a lot of old posts detailing how buying assets by closing your eyes, holding your nose, and buying sectors, industries, countries down a lot meaning 60%, 80%, 90% and then holding for a few years can be a great strategy. And this dislocation has caused a lot of markets like oil and gas exploration to be currently down 90%. And there’s a lot of ways to approach this again, it’s not all of a sudden cannonball into the pool and put all your money in one tiny industry that’s down 90%. This goes back to another favorite investing joke, what do you call something down 90% that was something that was down 80% and then went down 50% more? These can still be risky despite being down that much, but it can be fertile areas to look. And there’s a couple of different ways you could do it. You could scale into these markets over time. So you could say “Maybe I’m gonna identify five of these markets down 90%. I’m gonna put in some this quarter, some next quarter, some the following quarter, maybe it’s this year, some next year.” Or maybe it’s you wait till they reenter an uptrend and cross their long term moving average, I don’t know. But both sound reasonable to me.
Again, the takeaway for all three of these are these should be on your periphery. You should have 90%, 95% of your investing plan set. But if you wanna act like you’re doing some things, it’s time to take advantage of other’s irrationality, there is that little dial you can turn a little bit. But try to avoid binary thinking of in or out on anything, but rather, how can I calibrate trim or over rebalance?
So we’re gonna wind down. Look, I hope this helps. As always, we’re here for our investors if you wanna talk, shoot me an e-mail, give us a call. Hit me up on Twitter, shoot me a DM. But likely you don’t need to, because you prepared for this. Stay safe and healthy, everyone. Thanks for listening and good investing.