Have you ever heard the expression, do as I say not as I do? I’m sure we all have. This expression typically roles off the tongue of someone that’s been there and done that. Typically these words come form a person that has accumulated great wisdom having been around the block a time or two. They are experts. It’s not a bad idea to listen to these people and take their advice. It’s important to understand their perspective before you do however. The reason I believe is because there is much to learn from how they came to these conclusions or wisdom. If you don’t know the why of the wisdom you quickly forget the advice. Learn the why.
This is a tale in part about America’s most successful investor. It should be read in conjunction with A Sweet Tale to reinforce one of the lessons. For those that don’t know his name it is Warren Buffett, The Oracle of Omaha, and he’s the Chairman of a firm called Berkshire Hathaway. This is a man that has amassed a multi-billion dollar fortune by following what some call a disciplined approach to investing throughout his career. Along the way he has adapted his investment style to his portfolio size. His wisdom is legendary and he epitomizes the quintessential capital allocator. Most of what people read and hear about Mr. Buffett concentrates on his wisdom and of course the wisdom that he preaches today. But how did he amass his wealth? This tale concentrates on his early years because for most investors, what Mr. Buffett does today has little to do with what he did when he was younger. The lesson for the young wealth builder, or Buffett wannabe, in this tale is “don’t do what I do now, do what I did then.” It’s important to recognize the opportunities he had with a smaller amount of capital to allocate were far better than the opportunities he has today. I think it’s instructive to see how he made his fortune, since many of the readers of these tales are looking to build wealth.
I have heard The Oracle say on more than one occasion, other than of course investing your money in the stock of his company and never selling it, the best thing people can do with their money is establish a diversified portfolio. This is the same man that adamantly refuses to concede the professorial position that investors can’t “beat the market.” So what is he really saying when he recommends that you not try to beat the market and that you simply accept the professorial advice of a diversified portfolio? What he means is “While I and a few others like me can beat the market, you can’t.” You should re-read the last sentence and then take it to heart. What he’s saying in a very positive and fatherly manner is—I’ve been around the block a time or two and have seen few full-time investment professionals who can beat the market and they dedicate 100% of their time to this goal. How on earth can someone that is in the game part-time compete with them? Don’t try it. It won’t work for you.
Nevertheless, there are those that are ambitious and think they can compete. So what was Mr. Buffett’s secret as a young man? I call it “Right with Might.” Mr. Buffett is the ultimate wealth builder because he knew then, as he knows now but can no longer do because his portfolio’s size prevents him from doing so, that how much you invest in something is far more important than whether you are right or wrong about your investment decision. We learned this in A Sweet Tale. This is something that is difficult to accept but upon inspection it’s obvious. Mr. Buffett allocated what anyone today would characterize as a disproportionate amount into particular investments or situations on more than one occasion. I find it laughable when I hear people describe Mr. Buffett as someone that built his fortune managing a diversified portfolio. It couldn’t be further from reality. But let’s explain what Right with Might means and what can be construed as disproportionate.
Let’s look at the following hypothetical example,
If a person, we’ll call him Mr. Diversified, has $10 and invests $1 in 10 different stocks or funds he has built what many would call a diversified portfolio. Let’s suppose that one stock goes up 100% and the other 9 each goes up 10%. He has $11.90 when it’s all over. This is a pretty good result that most people would be delighted to see. Mr. Diversified was Right but not with Might. The antithesis of Mr. Diversified is Mr. Might. Mr. Might also has $10 but chooses to invest it in 2 stocks instead of 10. He invests $9 in a stock that goes up 100% and $1 in a stock that goes down 100%. Mr. Might has $18.00 when it’s all over. The investor was Right with Might. The problem with this approach is when you concentrate your money in the losing stock instead of Right with Might you are Wrong with Aplomb. Had Mr. Might invested $9 in the stock that went down 100% and $1 in the stock that went up 100% he would have $2 when it’s all over.
All great investors understand this Right with Might trade-off. It’s just common sense. It’s no different than putting all or most of your eggs in one basket. The problem of course is that many investors are Wrong with Aplomb and end up either temporarily or permanently broke.
Getting back to Mr. Buffett as a young man. Based on interviews and stories I have read, it seems that more than once he was willing to bet a disproportionate amount of money on an opportunity he found irresistible. His most chronicled Right with Might bet or investment as many like to call it was when he purchased stock in what seemed at the time like a failing insurance company named Geico. It seems that Mr. Buffett had already amassed a considerable fortune, well in excess of $20 million dollars, when he invested almost his entire net worth in this one stock. He was right and thus the legend grew. What I find most intriguing about this particular investment is not that he was right and with might. What amazes me is why a person, any person, would put almost their entire net worth at risk when they have already amassed a fortune. Perhaps the next few paragraphs might explain why. I suspect Mr. Buffett had the same confidence in his abilities and future as the next fellow you are about to read about.
Let me tell you about another Right with Might investment.
I was 28 years old when I had an opportunity to meet a legend in the brokerage business. This fellow had been a broker at Legg Mason for 60 years at the time and had seen it all. I spent as many hours as I could with him and he was kind enough to let me spend time with him and his broker buddies. The lessons were lasting.
These brokers gave me some words of wisdom that are still relevant today. They would say things like “Take care of the customer and the customer will take care of you.” They would tell me to “Never increase your standard of living while in a bull market, wait until deep into a bear market.” In an almost connoisseur of the obvious manner they would also tell me “To be successful in this business you have to stay in the business.” Finally I remember all of them universally saying “Never trade stocks on margin.” I follow these 4 principles even today. The following story is about the most successful of the lot and the 60-year-old veteran of the business that was a legend at the firm. Let’s call him Mac.
Mac had been a broker for almost 60 years. He started just before the Great Depression and had never quit. Even though he had a stint where he had to unload railroad cars filled with produce to supplement what he wasn’t making as a broker. Mac was probably worth in excess of $50 million dollars at the time I met him. I asked him how he did it, fully expecting to glean some of his investment acumen. He told me a simple story. He said that when he turned 65 the brokerage firm that he worked for was in danger of going out of business. He was offered an opportunity to be one of the main shareholders in the firm if he was willing to take a risk. He invested $1 million dollars into the firm, the firm prospered and he was rewarded handsomely.
Upon further interrogation on my part I asked him why he did it. His answer stays with me to this day. He said, “Unlike the other brokers at the firm that were asked to invest, the money I invested in the firm was everything I had. But I figured that I had a good business, loved what I did and that regardless of the outcome that I would be all right. Besides, I liked working at the firm.” I am sure Mr. Buffett had similar thoughts when he invested almost all his money in one stock as well.
I couldn’t believe what I had heard. At the time, still ingrained with the professorial wisdom of a diversified portfolio, I thought that no one should invest almost 100% of their capital in one investment much less at the age of 65. Yet right before me stood a man that had done just that and succeeded. I asked him to explain his rationale a little better and he went on to say that “If you’ve been in this business as long as I’ve been in the business then after a certain period of time you accumulate some knowledge and some assets. When you ponder retirement you realize that you’re not going to turn your assets over to someone else to manage because after all, who better to manage your money than yourself. So, you decide to never retire and if you are going to do the necessary work to invest your money intelligently then the leap to managing other people’s money isn’t a large one. So you see, I wasn’t taking any risk when I invested everything I had because I could still work, I would still be wealthy from my income, I loved what I did and I could rebuild my capital if the investment didn’t work out.” Again, I suspect that Mr. Buffett had much the same reasoning when he also invested almost his entire net worth in one stock.
The story about Mac is a story of a man that had spent his entire life building wealth in a slow, methodical fashion only to build extraordinary wealth by investing in one stock. In an instant he went from Mr. Diversified to Mr. Might. It paid off and his investment went up more than 50 fold. I will be forever grateful to have met this man. He showed me a spirit that I’ve rarely seen, an optimism that is unmatched and a confidence that I can only hope to emulate.
The story of Warren Buffett and Mac are instructive because they teach us that Right with Might is the way to build extraordinary wealth. They are great stories but there’s a larger question for the investor. The question is can you hire someone to act like Warren Buffett or Mac? Can you hire someone to make Right with Might decisions for you? The answer is no. Only you can make those decisions. Let me repeat this. Only you can make Right with Might decisions. My firm wouldn’t even contemplate a Right with Might portfolio. If you hire us or any other reputable firm we will act like Mr. Diversified did in the example above. Right with Might is an instance where you are on your own. With that knowledge, should you choose to invest disproportionately there are consequences when you are wrong. You will pay for your mistakes. Firms such as mine are geared towards highly predictable outcomes. You can be certain that if you establish a diversified portfolio and maintain it throughout your life that you will more than likely meet a wealth target that is acceptable. However, forget extraordinary wealth unless you earn extraordinary income throughout your career or come to us with extraordinary wealth already.