William Green (00:03:14):

And so when I went to interview him, I’m sort of sitting knee to knee with this sage. And he’s kind of peering at me through these very thick glasses cause he’s blind in one eye and he can barely see. And I knew that I didn’t have much time. So I said to him, I had to cut right to the chase. So I said, “Charlie, I regard you as the grandmaster of stupidity reduction,” alright? I said, “Why, why is that such a critical focus for you?”

William Green (00:03:42):

And he said, “Because it works. It works.” And he starts to explain that what he does is instead of trying to be brilliant the whole time, which comes more naturally to him than that, it does to most of us. What he, what he does is he says, “Okay, let me figure out what a dumb person would do in this situation, whether it’s investing or anything else in life.

William Green (00:04:00):

And so, so he says, “If, for example, you want to be a good investor, a very successful investor, start by thinking what a terrible investor would do.” And so list all of the dumb mistakes that terrible investors routinely make. And then having figured that out, don’t do that. So, so it’s something that he’s taken from this 19th century mathematician guy called Carl Gustav Jacobi who said, “Invert, always invert.”

William Green (00:04:26):

This is what Charlie is doing. He’s inverting; he’s solving the problem backwards. So he’s not saying, “Let me figure out how to be a great investor.” He’s saying, “Let me figure out first how to be a terrible investor.” And that’s really helpful, because actually, it’s really easy to identify dumb mistakes, what, what he calls standard stupidities or idiotic behavior. So, so he’ll look at things like the fact that investors routinely buy whatever’s going up and Wall Street will convince them that whatever’s going up is worth buying because Wall Street gets paid to do that.

William Green (00:05:00):

They, they don’t really care whether it’s going up or down. They get paid for commissions frequently. And so, so people will buy stocks that are at the top of the cycle, for example, assuming that it’s going to continue to be good. And then the stock goes off a cliff and the investor gets hosed. Or another thing people routinely do is they listen to predictions that market seers, market strategists at these big Wall Street firms or, or idiot journalists like me are making where they say, you know, “The market’s going to go up 20% over the next year, or this sector is going to be the best sector.”

William Green (00:05:36):

And the truth is nobody knows, and this is a really chilling realization. But once you actually start to be like, “Well wait, so all of these predictions are kind of bogus.” It’s pretty liberating because you know that you can stop listening to all of these prognosticators who pretend that they know the future.

William Green (00:05:54):

And so for me, I’m, I’m, I’m happy to say, “Well, look, if, if Buffett can’t predict the future, if Munger can’t predict the future, if Howard Marks can’t predict the future, then I sure as hell can’t.” And so if they’re saying that that’s a standard stupidity, to believe that you can, you can tell whether the market’s going up or down, that’s a really good default position for me to say, “Okay, let, let, let me not fall into that trap of trying to guess where the market’s going to go.”

William Green (00:06:23):

I’ve got to position myself, so I’m going to be okay, whether the market falls or rises. If, if it plunges, I’m going to survive, I’m going to stay in the game. And if it goes up, I’m going to benefit from it. And, and over the long term, the market has always gone up. The, the trajectory has been amazing because productivity increases, populations increase. It has this incredible upward trajectory over centuries.

William Green (00:06:48):

So, so the long-term prognosis is likely to be good, but you have to avoid these standard stupidities of jumping in and out, believing people who make predictions, trading hyperactively, having excessively high expenses. For example, if you jump in and out where you have short-term, short-term tax liabilities, because you’ve been trading in and out, constantly saying, “How could this go wrong? How could this, how could this ruin me? What would a really dumb person do in this situation?” And let me, let me at least not do that.

Clay Finck (00:07:23):

I love referring back to William’s book and the timeless principles he has in there to help me form a framework for how I want to invest. Next, I wanted to play a clip from Nick Maggiulli, who was asked why he prefers to invest in index funds rather than individual stocks. I think this is a really important consideration for someone just getting into investing. And this is a big reason why I always have some portion of my portfolio in index funds. Here it is.

Robert Leonard (00:07:52):

The advice to not buy individual stocks isn’t new. Jack Bogle, J.L. Collins, even Warren Buffett and many, many others have said that most people shouldn’t buy individual stocks. However, rarely when this advice is given is it actually backed by real data and facts. I’m not saying that data and facts don’t exist, but usually when people on social media say you shouldn’t buy individual stocks, they don’t provide data and facts to back up their argument. Since you are someone who studies data religiously, break down with data why individual investors don’t know if they’re just lucky when they pick a good individual stock, and why most investors shouldn’t do it.

Nick Maggiulli (00:08:30):

Yeah. So when, I think how I like to think about this and how I broke it down in the book is there’s two different arguments. The main argument that when most people, Buffet and Collins and all these people are saying, don’t buy individual stocks. I do think they have some data. And that data is basically like, you look at like what I, there’s the SPIVA reports, S-P-I-V-A, you look those up on Google, and you’ll see that over like any five year period, something like 60 to 80% of active managers cannot beat their benchmarks. It’s usually like 75% after fees and everything. You know most of the professionals with analysts and all these resources, can’t be just a passive index fund. Right? So after a five year period. So what it shows is like, it’s really tough to do so just by picking a passive index fund you at the 80th percentile.

Nick Maggiulli (00:09:06):

So I’m going to call that the financial argument, right? And that’s the argument that most people make. They’re saying, “Hey, you shouldn’t do this because you’re going to make less money.” And that’s fine. That’s the argument, that’s what I’m saying. I brought that up, I have to address it because that’s the one most people talk about and that’s fine in its own right. But that’s not the argument I make.

Nick Maggiulli (00:09:19):

The argument I make is what I call the existential argument, which is what you’re talking about. And the existential argument is basically, how do you know that you’re good at stock picking, alright? With so many endeavors in life, you can identify skill relatively quickly. The example that I give, let’s say you, myself, and LeBron, James went out to a basketball court. You would tell pretty quickly, let’s say you didn’t know who LeBron James was. You’ve never heard of this guy or just a similar LeBron James figure.

Nick Maggiulli (00:09:42):

We go out and play. You’re going to know pretty quickly. I can’t play basketball and he can. You’re not going to, there’s no luck. You’re not going to get lucky and beat him. Right? Unless something happens, or like he hurts himself on the very first play. There’s no way I’m going to be there. Right? You can tell skill pretty quickly. Same thing with if you’re a computer programmer. You’re going to know like, “Oh, does this person know what they’re doing?” Or they don’t know how to run the program. It’s going to be obvious within minutes if someone knows what they’re talking about.

Nick Maggiulli (00:10:02):

Right. Well, with picking stocks, you don’t know. The fact is we can go, like you and I, Robert, can go and buy. You can pick a portfolio. I can pick a portfolio. And we may not know, like after a month, a year, five years, 10 years. I could just get lucky. I could put my money in Amazon in 2002, and you could have put it in something else. And I just held on and I just beat you because I got one lucky pick that crushed all your other picks, and there’s nothing you could have done.

Nick Maggiulli (00:10:25):

So luck can overpower skill. And so there’s some data, there was a great paper called, I think it’s called “Can mutual funds pick stars?” or something like that. I can’t remember the exact name of it. But there’s basically a paper I reference in the book. But like basically what they’re asking, “Is there stock picking skill?” And they found that they can identify, they bootstrapped and did all these things, which basically means they just like, they took some data and they tried to reimagine what the distribution of returns looks like. That’s what bootstrapping means. And basically they said 10% of people have actual skill. And that’s the number they pick.

Nick Maggiulli (00:10:53):

Not saying it’s a perfect number. Let’s say it’s 10, 15%. Doesn’t really matter. But let’s just use the 10% figure. So let’s say 10% of people have skill with certainty and it can be identified. Right? And let’s assume that another 10% don’t have skill. And we can also identify them. So we can identify the best and the worst pretty easily. That means that four to five people, 80%. You’re not going to know if you’re good. So why would you play this game, pick individual stocks, when you don’t even know if you’re good at it? Who I’m addressing here, I’m not addressing people that say, “Oh, I’m going to take 5% of my money and put individual stocks.” I would consider that fun money you’re doing for fun. You like doing it, that’s fine. Have a ball, enjoy it. I have nothing against that.

Nick Maggiulli (00:11:25):

I’m talking about the people that have 80, 90, a hundred percent of their money in individual stock picks. I think it’s really difficult to do that. And I think the existential crisis is, you have to look yourself in the mirror every day and say, “Am I actually good at this, or am I just lucky?” And you’re not going to know. Unlike almost everything else people out there are doing things like, you know if you’re good at doing something or not. You have some idea of your skill and your values in most endeavors. It’s just really tough for me to recommend that people pick stocks given you’re not going to know if you’re good and even if you are good, the best managers, Baird did a study where they found that the absolute best managers will underperform at some point. So it’s like, is that under-performance just a natural lull?

Nick Maggiulli (00:11:59):

Or have I lost my skill? Did I used to be good and now I’m not? There’s all sorts of questions that you’re going to just eat yourself up mentally over. And I’m like, “Why go through all that? Avoid it all.” Be a passive investor and beat the 80th percentile. And people say, “Passive investors have no conviction. Oh, you guys are just, you have no conviction or anything.” No, I have more conviction than active investors because I’ve seen the data. I’m convinced that me just picking the default option of being a passive investor is going to beat 75 to 80% of people. And that is why that’s important for me, because I have conviction that just doing that is going to win out. And the fact is, mostly stock pickers, they say, “Oh, I have commission for these companies, but they could underperform.” Right? So why spend all this time and still underperform at the end of the day? That’s the question I have.

Clay Finck (00:12:38):

Another big debate in the personal finance industry is market timing. Many people try and time the market’s tops and bottoms, but Nick believes that dollar-cost averaging is the best strategy. Here’s a clip from Robert’s interview with him where he explains his thinking on this.

Robert Leonard (00:12:55):

I was working a part-time job in college at a large credit union, and we had an in-house financial advisor who randomly taught me one day about dollar-cost averaging. He knew I was a finance enthusiast and was studying it in school. So he decided to come into my office and teach me about dollar-cost averaging because he believed in it. After that, I had always found articles to support my idea that DCA is the best way to go. I’m not sure if this was confirmation bias just working its magic or if DCA is truly the best. But after starting this podcast, I’ve had some guests say they don’t think DCA is the best and that they have data that supports lump-sum investing. Your opinion is that no one can beat dollar-cost averaging, and people should invest as frequently as they can. Breakdown why dollar cost averaging is the best strategy.

Nick Maggiulli (00:13:39):

Of course. So I think the first thing we need to address is when we say we, I don’t even know if you just realized it, but you just referenced two different definitions of dollar-cost averaging. And this is nothing that you’ve done wrong. This is a huge issue in the personal finance and investment community. There are two different definitions of dollar-cost averaging, and they mean very different things. So the dollar-cost averaging, the original definition Benjamin Graham came up with, he says, “Winner’s buying overtime.” Every time, let’s say you get your money in your 401k every two weeks or twice a month, whatever it is. And you’re buying like every time. You get the money, you buy right away, that’s considered dollar-cost averaging. Every time you get paid, you invest your money, right? That’s dollar-cost averaging.

Nick Maggiulli (00:14:14):

But then the dollar-cost averaging you just referred to is like, if someone got inheritance of like $100,000 or they sold a business or something, and they have that $100,000, instead of putting it into the market right away, they slowly, what I call average it. And in the book, I don’t like calling that dollar-cost averaging. I call that averaging into the market because you have the sum already and you’re averaging it in. Versus dollar-cost averaging, I think the original definition is just buying over time and buying as frequently as you can.

Nick Maggiulli (00:14:37):

So if you really think about it, every time you get paid, let’s say you get paid and you invest in your 401k, you’re really doing a miniature lump sum. It’s like you took a little bit of money and you did a lump sum straight into the market because buying as frequently as you can, that is dollar-cost averaging, but really it is, it’s a form of like lump sum. You’re lump summing, but just these little tiny lump sums over time. And so when we’re talking about lump sum versus that other version of dollar-cost averaging, which I call average in, lump sum’s clearly superior.

Nick Maggiulli (00:15:04):

So, but that just means like buy as soon as you can. Generally that pays off because markets generally go up, right? So you want to get in sooner. I’ve given examples already at the beginning of this podcast, but the data in there is pretty clear. There’s like basically like an 80% chance that you’re going to make more money if you just put the money in now versus if you wait or if you average in over the course of a year. So when I say dollar-cost averaging, even God couldn’t be dollar-cost averaging, that what I’m talking about that, I’m saying like market timing, trying to pick when to buy dips is less optimal than just buying every single month for forever. So that’s the whole idea. Dollar-cost averaging, just keep buying are basically synonyms, but just keep buying has less syllables, so it’s a little bit easier to say.

Nick Maggiulli (00:15:40):

So that’s the whole idea. So I just want to make sure we’re clear on definitions, because when we start throwing those terms around, people are talking about different things and not even realizing, and it can be very confusing. And I don’t know how to solve this as a community. I’m not going to be like, oh, we need to say this. Like I can’t make people choose language. I just think we should start saying, lump sum versus average in. And then dollar-cost averaging is like what you do in your 401k or every time you get paid and you buy, right? You’re just buying overtime. You’re buying as soon as you can. So the main point is to buy as soon as possible. Buy quickly, I think is the phrase I would use. So I hope that clarifies my stance.

Clay Finck (00:16:12):

As most of you know, I enjoy learning about individual stocks and having some portion of my portfolio in individual companies. Buffett is a huge fan of owning high quality companies in particular. He’s known for saying that it’s better to buy a great company at a fair price than a fair company at a great price, because over the long run, the company will grow its per-share earnings that more than make up for the higher price you’re paying originally. Here’s a clip for my conversation with Alex Morris, where he discusses his thoughts on paying up for a quality company.

Clay Finck (00:16:48):

I also wanted to pull in a Charlie Munger quote, who I know you are a huge fan of. And his quote is, “If the business earns 6% on capital over 40 years and you hold it for 40 years, you’re not going to make much different than a 6% return. Even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.” Now with that, how are you able to balance buying businesses that earn a high return on capital without paying too extraordinary of a price?

Alex Morris (00:17:26):

Well, the short answer is that it’s very difficult, and let’s stick with Charlie Munger or Berkshire because that’s probably a good way to think about it. Coca-Cola is a business that would probably fit in this bucket of willing to own at a high price because it has attractive returns on capital. I think what’s probably happened over the past 20 years or so is that the returns on capital have remained very strong, but it’s harder for them to generate attractive growth because just of the underlying dynamics and the categories that they really compete in and thrive in. So, that’s basically a long way of saying that it’s very, very difficult to make long-term comments about the sustainability of a business and the sustainability of ROIC and growth.

Alex Morris (00:18:09):

At the DJCO meeting. Charlie was basically asked this question as it relates to Costco. And I think his answer was really interesting. He basically said in a roundabout way, “For me, Costco fits the definition of that quote.” And you know, I think the underlying logic for that belief is, I’m going to get these numbers wrong off the top of my head, but they have roughly 600 warehouses in the US, which is a small number relative to most retail concepts. Obviously it’s a different animal, but you have 600 warehouses in the US and a couple outside the US, 200 or 300.

Alex Morris (00:18:42):

They’ve shown a proven ability to get that warehouse concept to travel internationally, which is massive as you think about the ability to grow for not the next five or 10 years, the next 20, 30, 40, 50 years. So I think he’s effectively saying, I think the growth algorithm that they have, call it this 3 to 4% unit growth, low to mid single digit comps, really attractive unit economics, and an ability to return capital to shareholders as they’ve primarily done with special dividends over the past 10 to 20 years.

Alex Morris (00:19:12):

I think he’s effectively saying to you, “I realize that you think the headline valuation looks expensive, but I see a path for this business to continue to grow its per share intrinsic value by something north of 10% per year for a very long period of time, and with a very high degree of confidence.” And anybody can go run the numbers, the multiple going from, pulling these numbers out of my head, the multiple going from 40 to 20 in five years is a huge headwind to IRRs.

Alex Morris (00:19:39):

The multiple going from 40 to 20 in 50 years is a much lower headwind to IRRs. So I think, and again, this is incredibly difficult to do and yet to be very picky in order to find even five or 10 businesses that really pass that test for you. But when you find them, it makes it very difficult to, I think it’s an error, I’ll be even a little bit more affirmative in this belief. It’s an error to look at a business like that and go, well, it trades at a PE of 30, the market’s at 20 it’s expensive. That’s faulty logic, in my opinion, if you’re truly a long term investor.

Clay Finck (00:20:14):

On the contrary to Nick Maggiulli’s point on only investing in index funds, I asked John Huber what advantages he believes he has as an individual stock picker. He’s a fund manager himself and runs a pretty concentrated portfolio. Here’s his take on why he believes he actually has a big advantage over most other fund managers.

Clay Finck (00:20:36):

Now you wrote a piece that outlines that investors need to have some sort of an edge if they want to have above average returns, such as beating the market. What kind of investing edge do you believe that you have relative to others?

John Huber (00:20:51):

I think the biggest edge that investors have today, and I would include myself in this cohort, is the ability to think long term. And so I know this is a sort of a phrase, long-term thinking, there’s a term out there called time arbitrage, which is basically being able to capture the spread between the current conditions and maybe the conditions five years out or seven years out. The term basically means being able to look out further than most market participants have the ability to look out.

John Huber (00:21:20):

And the reason why it’s so difficult for people is number one, I think it’s just human emotion, human nature. People want results now. They want results quickly. And so there’s an extreme amount of emphasis on catalysts and things that might drive stock prices in the short run. And obviously if you can make money, now it’s better than making money later, but that game has become so difficult.

John Huber (00:21:39):

And so I think like the informational advantage that once was out there has now been marginalized, and there may still be informational edge in certain pockets of the market, and at certain times, perhaps, it’s possible to gain small edges here and there. But I think the biggest edge in the market is just the ability to behave in a way that’s very difficult for other investors to behave, whether it’s due to their own impatience or more often is due to just the institutional constraints that so many investors have, meaning the career risks that they have. I’ve talked a lot about investors who for a variety of reasons are forced to try to produce a result this year because they’re worried about their bonus. They’re worried about their job security and it’s very difficult to do that, and if you’re trying to compete in that space, you’re competing with an enormous amount of resources and enormous amount of talent. It’s a hard game to begin with.

John Huber (00:22:35):

For me, I think the edge for me is the way I’ve structure my firm, is number one, I don’t have career risk. I have my own money invested. I’m not worried about, I think of Saber capital as my firm, as a family partnership of sorts that happens to have outside investor capital, but I’m under no constraints when it comes to being forced to try to make money this year. I can look out five years, seven years, 10 years, and not worry about what happens to my portfolio in a downturn. What happens if we hit a recession next year, those types of things I try not to think about or worry about because it’s outside of my control.

John Huber (00:23:10):

And so I’ve tried to structure it in a way where those institutional constraints that are part and parcel to the industry don’t impact me as much as they do other investors. And so that I think that’s the biggest edge for individual investors that aren’t in the profession. It’s a huge advantage because you don’t need to, you don’t have a boss, you’re not answering to anyone. You don’t need to look at your portfolio next quarter. You’re not going to get fired. And so you can take advantage of that if you have the right frame of mind. So I think it’s an important advantage that individual investors have that is probably underutilized, but it is a big if you’re to use it.

Clay Finck (00:23:46):

I’ve chatted about a number of individual stocks I’ve been interested in learning more about, one of them being Amazon. At the time of this recording, Amazon is down nearly 40% from its highs, and it’s trading at the price it was in early 2020, so over two years ago. For investors with a long time horizon, I think this brings a potential opportunity. John recently made Amazon his largest holding in his fund. So I was curious to hear why he made such a move.

Clay Finck (00:24:17):

I noticed that your allocation to Amazon over the past year went from 0% to your biggest position. Could you talk about what led you to making this drastic shift in your portfolio?

John Huber (00:24:31):

Yeah, I think Amazon is one that I spent some time. So I’ve owned Facebook for a number of years, and I’m always studying the digital advertising industry. And so I’m always trying to talk to people who are advertisers. I’m always doing a bunch of research, just whether it’s talking to advertisers, whether it’s talking to people who work at ad agencies, I just like to stay up to speed with what’s happening in the advertising market generally. One of the things I was thinking about last summer is, I happened to be talking to someone who was talking about how a lot of the dollars at this particular firm was shifting from Google to Amazon. And so Amazon in this case was with this particular customer was taking share essentially.

John Huber (00:25:13):

And so if you think about Amazon, if you are a merchant or you’re selling something, a product you can advertise on Google, you can advertise on Facebook or you can advertise on Amazon, but Amazon is such a great place to advertise because the only reason people are really going to Amazon is to search for something that they want to buy. So they have specific intent. And so it’s a very high return on ad-spend business for advertisers, because if you can get your product in front of a customer, the conversion rate is going to be higher perhaps than you might find for the same type of product on Facebook or Google, although both of those platforms are very valid sources of return on investment, return on ad-spend as well.

John Huber (00:25:53):

But Amazon, I think for that particular use case is probably the best and they are taking share. I think over 50% of the product searches begin on Amazon. And so as I started to do more research, just started to think about that specific situation, Amazon taking share from Google in search advertising, product-related search advertising, it got me thinking how valuable the digital real estate that Amazon owns is. And then I started just thinking more about, and this coincided with a decline in the stock price, stock price going down makes the company more valuable. It doesn’t make the company more valuable, it makes the stock more attractive. Thinking about the value of the digital real estate that the company has, the enormous growth runway and the potential for growth in advertising and being very familiar with digital advertising is a great business. It’s very profitable. It’s very high margin.

John Huber (00:26:42):

And then coupling that with just the enormous amount of infrastructure spending that the company has engaged in over the last two years. I think they’ve doubled the size of their square footage in their fulfillment network in just the last two years. And so if you think about back to the economies of scale, the infrastructure that Amazon possesses is essentially impossible to recreate, because it’s not just the capital that would be required, which is north of a hundred billion, but it’s the operational expertise that the company has. So the ability to couple the software with the infrastructure, robots running around in these warehouses now. Just the operational expertise that company possesses, the human capital combined with the physical capital, and the infrastructure that it owns creates a very durable, very valuable mode.

John Huber (00:27:31):

And to me, I think it makes it very predictable that we can look out 10, 20 years and that company is still going to be providing the services and the products that they are today. I think it’s a very predictable business, it’s durable, and there’s a huge amount of growth in some of these higher margin businesses, whether it’s the enterprise software business, AWS, whether it’s the advertising business, whether it’s third party logistics, whether it’s video games, there’s so many businesses tucked inside of Amazon that make it a very interesting business. And then couple that again, with the increased earning power and the decline in the stock price is essentially the reason why I decided to make it a big position. I think it’s one of those stocks that offers attractive risk reward with very low downside over time. It doesn’t mean the stock can’t go lower. The stocks can go anywhere in the near term, but I think there’s very low risk of losing money in stock like that over the long run.

Clay Finck (00:28:18):

Speaking of Amazon and big tech in general, I also had Bill Nygren and Mike Nicolas on the show from Oakmark. And that was definitely one of the highlights of my year. Oakmark manages over $60 billion. They’re generally focused on value, and they’ve added Google and Facebook to some of their funds Hear their take on why they’ve expanded to these companies.

Clay Finck (00:28:42):

Your Oakmark funds are typically more value funds with companies like those in the financial and energy sectors. And they tend to have lower PE ratios. You know, it’s something like Pfizer where you’re adjusting the PE and saying it’s lower than the market multiple. However, Alphabet and Facebook are both holdings of yours in your large cap funds Could you talk about what led you to own these higher growth and very large companies and your fund that’s more value focused?

Bill Nygren (00:29:14):

Yeah, it’s funny. I think a lot of times people get the idea that value investors are stuck investing in below-average businesses, what Warren Buffett or Benjamin Graham called the cigar butt companies. But to us, value just means that you’re getting a lot more than you’re paying for. And through some of these accounting issues where a company is making a lot of investments for the future that aren’t creating current earnings, it’s creating the misperception that the company’s expensive.

Bill Nygren (00:29:48):

Now you look at a company like Alphabet and they’re investing a tremendous amount in autonomous vehicles in health care, in Google Cloud, none of which really is earning any money today. In fact, it’s losing significant money. We think about it, like if they made those investments with a venture capital firm, instead, the accounting would be very different. It would be a big asset that goes on their balance sheet, and the losses that are going through those venture companies don’t go through the income statement.

Bill Nygren (00:30:20):

So we add them back. We look at something like cash, both Facebook and Alphabet have a ton of cash. You’re lucky if you can earn 1% on cash today that, maybe is two-thirds of 1% after you pay income taxes on it. So if you had a dollar that was invested in a Treasury bill earning 1%, two-thirds of 1% after tax, that dollar is selling it 150 times earnings. So any company that’s got a lot of excess cash today has almost a hidden asset there. So when we look piece by piece at the values, we separate out the cash. We look at the venture cap investments that aren’t earning money. We look at the under monetized investments like YouTube at Alphabet that still, through either subscriptions or advertising, is monetizing at a fraction of what other streaming services are.

Bill Nygren (00:31:13):

And we do a piece by piece valuation. And when we sum up the parts, we subtract that from the stock price and say, we’re really getting the search business at less than a market multiple. Or in the case of Facebook, if you look at WhatsApp, the investments in artificial intelligence and Oculus. Look, you try and break it down to get down to what are you really paying for Instagram and blue Facebook? And again, we think we’re able to purchase those at substantially less than a market multiple, because the market just isn’t paying much for cash and those venture cap like investments.

Bill Nygren (00:31:52):

And as we move to more and more of a business world that’s based on intangible assets, intellectual property, venture capital, like investing R&D, we think there are more and more of these opportunities where really good businesses look like they’re selling at an expensive PE ratio, but by the time you do the work and dig into it, there’s a core piece of the business that everybody agrees is a great business. And we think we’re buying them at less than a market multiple. So to us, this is still just as much value investing as buying GM at six times earnings was. It’s just a little more complicated to get there.

Clay Finck (00:32:34):

Next I wanted to transition from individual stocks and more so into other asset classes. Let’s move on to a clip from Preston Pysh, which is one of my favorites of the year. Preston has really helped me get a better understanding of how our economic system really works, and how it’s all just based on debt, which can create these cascading effects when counterparties start to fail. Today with the Federal Reserve performing quantitative tightening, I think this clip is really important to understand, and really for long term investors, I think this can bring some fantastic buying opportunities as the Fed just lets pain come into the markets. I’ll just let Preston explain it here.

Clay Finck (00:33:20):

Yeah, I totally agree whether it’s stocks, Bitcoin, or whatever asset you need to have that understanding and conviction in what you’re investing in. Now, I wanted to dive deeper on how you define inflation. I’ve seen you mention that you use the M2 money supply growth. I’m curious, why don’t you account for any deflation due to the rapid technological advancements that we know is happening in real time?

Preston Pysh (00:33:47):

So I think that’s where the terminology, that last part is where the terminology gets really confusing for, for a lot of people, when they talk about technology being a deflationary force, which it is in a way. So what do I mean by that? Let’s say we had a form of money. Well, this is what Bitcoin is. Bitcoin has 21 million units, but it has 10 to the negative eighth that you can move the decimal point over to a Satoshi. So I think there’s like 210 quadrillion units in it. Like they don’t divide lower than that, or become divisible lower than that.

Preston Pysh (00:34:20):

So if you have all these units in the system, and let’s just say the whole planet is using this as their units of account, and there’s still people can build credit on top of that. So if I said to you, Hey, lend me this many Bitcoin or this many Satoshis, lend me a million Satoshis and I’ll pay them back to you at this interest rate, right?

Preston Pysh (00:34:40):

Then a person can go and then trade that promise because for you, that promise is an asset for me, it’s a liability. You could then trade that asset. And then there could be this growth in the “money supply” because that credit spends like money. And so with any type of monetary baseline unit, in this case we’re talking about Bitcoin, there’s going to be credit that’s constructed on top of it. The reason Bitcoin is more optimal to talk about for me personally, is because in that type of world where you’d be using Bitcoin, the amount of credit that would be constructed on top of it would be extremely minimal relative to the world that we live in today, where it’s just fiat units and they keep adding more and more of the units into it. With the base, with the Bitcoin system is totally fixed at that 21 million Bitcoin.

Preston Pysh (00:35:30):

So when that credit gets constructed on top of it, and those promises get broke, that will blow up and it will always come back to always being 21 million units in the system. It won’t contract below that. Let’s say every promise in the system blew up. Everything would come back down to the 21 million number of units in the system. And then that’s really important. When you’re talking about a fractional reserve-based system like the one we live in today, you might have, we’re going to use the same numbers, just as an example, you might have 21 million baseline units in the system, but then you might have a hundred X units in credit constructed on top of that, because the baseline units in there are fractional reserve from the start, meaning that the banks are already putting a money multiplier on top of that. And then as they’re put into the system, there’s more credit constructed on top of that.

Preston Pysh (00:36:26):

So just to kind of give you an idea of like how much growth is built on top of this, the credit on top of the system. So in the fiat system in 1971, when we came off the gold standard and we were strictly on a fiat based global system, for every $1 of monetary baseline in the system, there were 55 units of credit, M2, that was on top of that, one to 55. Today we are at one to 314 units. So for every one monetary baseline unit in the system, there’s 314, M2 on top of that. For a six X growth, just in the fractional reserve since 71. And it’s aggressively expanding when you look at that rate of change. So now you can have M3, you can have more and more credit that’s constructed on top of this. So when you talk about what people will say is in the economy, there’s this deflationary contraction and deflation that happens.

Preston Pysh (00:37:32):

What they’re talking about is all that credit is blowing up. The promises are blowing up and let’s say it’s 314 to one. Maybe it goes down to 200 to one, and then the central bank doesn’t step in. And reflate things by adding more monetary baseline units into the system. Cause that’s what they’re doing is they’re adding more monetary baseline into it so that they can make up for the credit that basically vanished in the system because the promises were broke. And then when they put more monetary baseline into it, more credit is again constructed on top of it at an even lower interest rate. That’s how they’re able to keep this Ponzi scheme going. And this is really fundamental and really important. I think this is probably one of the most misunderstood things for amateurs and people that are first coming into the market that they don’t understand.

Preston Pysh (00:38:21):

So when you say deflation, what I know is that is short term in nature, that is something that is ephemeral where it’s only going to last as long as the central banks allow the pain to continue to persist in the market. So COVID perfect example, huge, massive supply demand, shock to the system. They could have just, “Hey, let’s see what the market just naturally does to itself. Who has been saving for the rainy day? In a free and open market, that’s what should happen is like all these companies should have blown up. The people who are ultra conservative with the way that they manage their finances and their balance sheet then step, in buy those assets for 10 cents on the dollar. They get completely, all the assets get reallocated into very conservative hands that have a low time preference. And they put those things to use in a conservative type way that’s not out there trying to run a race.

Preston Pysh (00:39:18):

Because that’s the ultimate thing here is that should be happening in a free and open market, is this give take between aggressive competitiveness and then a reset into the people who are being fiscally responsible with the way that they’re managing their assets and retained earnings and everything else. But in a system where you have a fiat currency that’s dominated for, what are we up to 50 years? And then you get this idea of “too big to fail” with the banks. You’re effectively holding a gun up to the market’s head that says, all right, go ahead. Let me fail. Because if you do this entire scheme is going down. If you let me fail the bank right next to me is going to fail. And this is what we saw in 2008, 2009. And they let Bear Sterns, they, they let a few of them fail.

Preston Pysh (00:40:08):

And then they realized, holy hell, if we let this keep going, the whole thing’s going to come melding down. And so I think that was a big advantage that I had was experiencing that in 2008, I was an active participant in the market. And I saw how quickly everything just evaporated. People will say it was fear. It wasn’t fear. It was credit units blowing up. The units were missing out of the market. And you had all this counterparty risk that had to sell, had to sell their assets to adjudicate the promises that were broken. And that’s why people sell. It’s not because it’s just fear it’s because they had promises that they failed to uphold and they had to sell the only things that were still valuable. And so you get into this for selling event and that’s what a credit event does is it creates this, and here’s the word, deflationary event where everything goes down in price. And then the central banks have to come in and add more monetary baseline units to make up for all those promises and credit that contract it.

Clay Finck (00:41:10):

With all this talk of the Fed raising rates, tightening the monetary supply, some of you may be wondering if them raising rates is actually sustainable. Can our economy actually handle rates being higher than where they’re at today, even with inflation running hot? This is the question I propose to Joe Brown.

Clay Finck (00:41:31):

As you know, there’s a lot of talk that the Federal Reserve can’t afford to materially raise rates. It makes me look back to the ’70s and early ’80s where the ten-year Treasury rose all the way to 15%, which is pretty insane to think about. Is it just the high debt levels that we have today that prevent them from raising rates materially or what makes this period so much different than that time period?

Joe Brown (00:41:56):

Yeah, and it’s not even just the total debt amount in terms of dollars. It’s the total debt amount in terms of percent, however you want to measure it compared to anything else. And so whether you’re looking at total corporate debt, whether you’re looking at debt to GDP, whether you’re looking at the total national debt, whether you’re looking at the cost of the federal government, servicing its debt load, as a percent of what it brings in from tax income, we are nowhere near where we were in the ’70s. It is not even close.

Joe Brown (00:42:27):

When you look at the fact that the federal funds rate got up to 19% in ’79 or ’80, we probably couldn’t even get the federal funds rate up to 4 or 5% before the government is insolvent. That would be if the average interest rate of government debt got up to like 4 or 5%, it would cost more to service that debt than the government brings in taxes. That’s insolvent. Now, far before we get to that point, I think there will be other problems that will cause them to reverse course. But the fact of the matter is we have no capability to fix this through austerity or raising interest rates. The crash is baked into the cake already.

Clay Finck (00:43:05):

Given that the macro environment is pretty crazy and seems unsustainable, this has led me to exploring other asset classes outside of just individual stocks or index funds. While I’m not a huge fan of gold, I can see its merit and benefits in the current environment, especially for those wanting to preserve their buying power. Here is Tavi Costa’s take on why gold is positioned to perform well in this environment specifically.

Clay Finck (00:43:34):

Many of our listeners fall under the Warren Buffett school of thought and will operate under the assumption that a portfolio of high quality businesses will outperform gold over the long run. However, there are periods historically where gold has performed exceptionally well. Why do you believe that now specifically is a good time to own gold?

Tavi Costa (00:43:56):

I think there are a lot of reasons why I believe in that. And by the way, I do think that Warren Buffett is correct on his statements about gold in general and tangible assets. I think there are times when you want to own tangible assets. Those times they begin with the difficulty of finding a yield, a general nominal yield in alternatives of investments as the whole. And I think we are in one of those times. We saw that in the 1970s, the 1940s, and the 1910s. All those times were inflationary periods. Some of them were more sporadic in inflationary times like the ’40s, and some others are more sticky, like the 10s in the ’70s, but all the three had one thing in common, which was negative real rates during those times. And the other thing in common was that commodities or tangible assets did better than things like financial assets at those times.

Tavi Costa (00:44:43):

And so I think we’re entering something similar to that in terms of the inflation problem. I think we have the wages and salaries growth. That’s number one, which we saw back in the ’70s. I think we have the supply constraints, this chronic underinvestment in not natural resources that will drive prices higher, continue to drive prices higher, something you cannot fix in a short term. We’ve got this reckless fiscal spending. Now we can get into that, but it’s certainly something I’ve been watching very closely and matches with other inflationary times.

Tavi Costa (00:45:12):

And the third one is in my view, this end of a globalized world where we’re seeing geopolitical tensions. And that is indeed a very also inflationary pillar to the global economy. So I am extremely focused on owning tangible assets today at a time when you have debt, valuation, and inflation playing out in the US, which we haven’t seen those three imbalances really unfolding all at once. We’ve seen them independently happen throughout history but not all at once. And so I think this is very unique from a political constraint standpoint, and it’s the time to be allocating capital towards gold and other tangible assets too.

Clay Finck (00:45:51):

Another one of the highlights of my year was having the opportunity to chat with Dan Rasmussen. If you haven’t listened to my episode with Dan, this was episode 161. I recommend checking it out. Dan is a brilliant mind, and he actually interned at Ray Dalio’s hedge fund, Bridgewater Associates. Here’s a clip of him explaining what he learned from that experience.

Clay Finck (00:46:15):

Now, Dan, we bring a lot of different types of investors on the show, and many of them follow something similar to the Warren Buffett school of thought. That approach includes pretty much avoiding anything macro, as the belief is that there are just too many moving pieces and it’s very difficult to predict what could happen in various scenarios. However, you’re not really in that school of thought. You started your investment career interning at Bridgewater Associates, which is the largest hedge fund in the world founded by Ray Dalio. Could you talk a little bit about Dalio’s impact on you and your development as an investor?

Dan Rasmussen (00:46:54):

Absolutely. I studied history and literature in college. I actually wrote a book about a slave revolt in New Orleans. So my first introduction to business and investing and having any job at all was actually interning at Bridgewater my summer of my junior year. And it had a huge influence on me. I’d say, first it showed me that investing, they used to say investing is the intellectual Olympics, right? You’ve got all of these really smart people trying to compete to generate alpha, and it’s really hard and it’s really scarce. But ultimately it’s this competition, right? Who has the best ideas? That had a big influence on me.

Dan Rasmussen (00:47:27):

And I think that the next thing that had a big influence me was the general framework through which Bridgewater seemed to approach investing, which was to say investment strategies should be logical, they should follow a logic, and they should back test well, right? You should be able to prove that they work empirically. So there’s a burden of proof. If someone says, “Hey, gee, stocks do well when interest rates go down,” you don’t just say, “Okay, great interest rates are going down. So stocks should go up, right?” You say, “Well, gee, let’s pull all the data, take a look at that. Is that true over all of time? Or just recently? What about in other markets?”

Dan Rasmussen (00:48:01):

And that really turned me onto this idea, which led me down the path eventually to quantitative or quantamental investing of taking a look at the data and seeing what the data says, as opposed to relying on stories or memes or theories. And I think if you compare and contrast that approach with Buffett’s approach, right? Buffett is not necessarily back testing his strategies or using a lot of quantitative tools. He has a simple formula, however, that has worked for him for a long time. And I think there are a lot of quants that have tried to diagnose what that formula is and replicate it.

Dan Rasmussen (00:48:37):

But I think at its heart, it’s started out doing deep value and then transitioned into doing large high-quality value. And I think that’s sort of the story of Buffett. And I think the final question that you asked was about the relationship of macro to the buy-and-hold equity approach. And I’d say that they’re not contradictory, right? A large empirical understanding of the world would lead you to say that most investors should have the majority of their money in low cost, passive equity index funds or the equivalent, right? If you said, I want to choose, choose 10 stocks or whatever, but broadly that’s the conclusion, right? Active management doesn’t seem to work by and large. Diversification out of equities tends to reduce your long-term returns.

Dan Rasmussen (00:49:20):

And so for most people, the right answer is to have the vast majority of your money in long, only in essentially low cost passive index funds that charge next to nothing and provide you with broad equity exposure. But I think then there’s the temptation or desire to do something around that, right? To change your return patterns. And I think there are a few things that people often are interested in achieving. I think the first thing they’re often interested in achieving is saying, “Hey, can I achieve higher returns?” Right? What’s going to beat an all equity portfolio? That’s hard but possible, maybe. The next thing is reducing risk. And I think, I think about risk as drawdown reduction, right? So the peak to trough draw down on an all equity portfolio could be 50 or 60%. Right? So if you say, “Gee, I spent my entire life and I’m 65 and I’ve got 10 million.”

Dan Rasmussen (00:50:09):

And then in the year that you turn 66, there’s a 50% drawdown, now you got 5 million, you ain’t going to be too happy. So drawdown mitigation is another worthwhile goal. And I think some people pursue that through diversification or through asset allocation. And I think that’s another reasonable goal. So I think I’m very interested in these questions, these problems of “Gee, within equities, what has over the long term, beaten a broad market index?” And are there times that it’s easier or harder to beat an equity index? And then the second question is thinking about asset allocation and diversification. What else do I need to complement my equity portfolio? To diversify it, to reduce risk and enhance the returns of my total portfolio? Assuming that I still have a large portion of my wealth in low cost, passive index funds, then those are the intellectual questions I’ve been grappling with one way or the other since I started my career, whether that’s at Bridgewater or Bain Capital or now Verdad.

Clay Finck (00:51:11):

For those who want to diversify within the stock market in particular, I asked Dan about his thoughts on diversifying into small cap value to try and enhance returns. Here’s what he had to say on this particular manner.

Clay Finck (00:51:28):

I like how you take this very contrarian approach and you hear over and over how growth has outperformed value over the past decade. And we’ve also been hearing talks of a potentially lost decade for the overall stock market with interest rates as historical lows and inflation on the rise. Do you think that small cap value might be something that someone that has that buy-and-hold approach? You know, small cap value could be a diversifier for them to try and enhance their returns?

Dan Rasmussen (00:52:03):

Yeah. I think if you look at really any large empirical study of what works in the equity markets, you’re going to come to value. And where small comes into play is that if you think there are 500 large caps and 2000 small caps, just to round the numbers out. If you then say, “Well, how many stocks trade it less than five times EBITDA or trade it less than five times PE or have a greater than 5% dividend deal.” Right? Some pick some extreme value metric. You’ll find that like nine out of 10 are small caps, right? Small cap value is just pure value essentially, right? Whereas if you constrain it to large, you’re not getting the real value hit, because all the really cheap stuff is in small cap. Now the thing to note about small caps is that their riskier, and bankruptcy risk is higher than in large caps. So you get much bigger swings, especially during recessionary periods where small cap is going to sell off a lot worse than large cap.

Dan Rasmussen (00:53:00):

Conversely, it’s going to come back a lot more when the recessions ends and the recovery begins, but you have to, if you’re thinking about moving from large cap to small cap, that increase in volatility and drawdowns is meaningful. On the other hand, again, almost any large scale long-term empirical study across markets is going to find that value works and the more extreme value exposure you can take, the better it works. And so I think that absolutely small cap value deserves a place, an outsize place, in people’s portfolio. If you think small caps are 10% of the market and small cap value, therefore is roughly 5%, right? I think people shove at least 10% of their money in small cap value, right? At least a two X overweight, given the robustness of the empirical findings about its out-performance potential.

Dan Rasmussen (00:53:43):

Now more than that, you’ve got to have some real fortitude to take on the ups and the downs. But I think as much as you can handle within reason is probably good. Now I think we’ve lived through a period where this style, small cap value, has just had atrocious performance, especially 2018 through 2020, right? If you’re saying, “Well, the reason I want to own small cap value is because it outperforms,” and someone says, “Oh, it outperforms? Not in the last five years, not in the last 10 years.” Right? Were you asleep during 2018 to 2020? Right? small cap value sucks. It’s the worst performing part of the market. What are you talking about? And that’s true too, right? We have to grapple with that. There are long periods where it doesn’t work. And I think sticking with it requires a lot of conviction, and I think a lot of grounding in the data, because again, the data is very, very strongly supportive of this and the logic of it is very strong.

Dan Rasmussen (00:54:32):

It hasn’t, small cap value has not crowned itself in glory in the years leading up to COVID. Now since COVID, it’s done quite well. And I think people are starting to see the reasons that you have it. And I’d say one of the things that I would note about small cap value is that periods of volatility, especially in the more economic recoveries you have, the better small cap value does. Whereas when you have protracted bull markets, those tend to favor the types of risk taking that often reward people going further and further out in the valuation spectrum. And so you tend to see growth bubbles occur at the end of long bull markets. I don’t think those are the conditions that we have today, and I think growth is selling off for that reason. So I think it’s a very good time for people to think about small cap value, adding it to the portfolio, adding exposure, especially given how well small cap value did during the last lost decades during the ’70s and during the 2000s.

Clay Finck (00:55:23):

Another popular way to diversify a portfolio is to expand to international markets, emerging markets and China. So I couldn’t help but ask Dan his thoughts on this investing approach. And I think his response might surprise you.

Clay Finck (00:55:40):

Yeah. That’s why I mentioned that you take this contrarian approach. A lot of people want to put more money in the NASDAQ while the small cap value underperformed up through 2020. And you know, when you buy something that’s cheap, that’s when you can get that out-performance. And another way to potentially diversify a portfolio full of equities is to expand in international stocks or emerging markets. I’m curious what your thoughts are on this approach.

Dan Rasmussen (00:56:08):

International markets are another area, which has not been crowned with roses over the past few years. So it’s understandable that I think people are skeptical about international diversification and why do I own international stocks? They seem pretty correlated with us stocks. They just perform worse. And then they say, “Well, all the best companies are in the US. So why do I need to go to the international markets?” Right? I think that all seems right when the US is winning.

Dan Rasmussen (00:56:32):

But the US has been winning for a long time. I don’t know that there’s a reason why great Japanese companies or great European companies or great companies in the United Kingdom shouldn’t do just as well, if not better, starting from much lower valuations today than US companies. We just don’t know. And so I think you start from saying, “Hey, from behind the veil of ignorance of not knowing economic conditions, why take such a disproportionate of bet on the US, right?”

Dan Rasmussen (00:56:58):

I mean, it just seems crazy. Especially given how much cheaper international markets are and the potential for diversification. I think international investing is deeply attractive, but it also it’s correlated with value, right? I mean, I think that the growth names that have been winning are disproportionately in the US. International markets are disproportionately value markets. So a lot of this stuff it’s the same trade or the same logic that when one of them works, the other one doesn’t work as well.

Dan Rasmussen (00:57:24):

Emerging markets, Clay, I have a contrarian view on. I am a perma-bear on emerging markets. I think emerging markets stay emerging. And I think if you look at people that make money in emerging markets, watch what they do. They make their money in Brazil, what do they do? They buy a condo in Miami, they get the money the hell out of Brazil as fast as possible, because what they know about their own countries, they know how corrupt these countries are. They know how risky the political systems, fragile the political systems are. These countries, most of them are one socialist away from complete economic devastation. They’re one stupid invasion away from being locked out of the economic system. They’re one firing of a central bank governor away from complete monetary collapse, right?

Dan Rasmussen (00:58:10):

The line between stability and complete devastation is so quick in these emerging economies. In our research, what we found is that the defining attribute of emerging markets is the frequency and severity of economic crises that happen three to five times as often as in developed markets and are more severe and you’re less likely to recover. I think that emerging markets are sort of the original ESG, right? So in the 2000s, we all wanted to help close the gap, the income gap between poor countries and rich countries by spreading democracy and capitalism. And the way to do that was to invest your dollars in building bridges in Vietnam or factories in Thailand or helping make China less communist by building up their tech entrepreneur scene.

Dan Rasmussen (00:58:57):

Right. And it all sounded good. And it was a disaster for investors who put their money. There might have been good for the emerging markets but it certainly wasn’t good for the investors. And I think there was a conflation of a political goal with an economic outcome. And I think frankly, neither the political goal nor the economic outcome were achieved, I’d say probably ESG investing, which is as so invoked today is probably a doom for a similar dual failure on both political and economic outcomes. But I think that investors are suited to broadly avoid emerging markets. I think there are rare, interesting times in the EM, so generally after major crises, that can be of interest, right? Because things just get so bombed out and disastrous, but you’ve got to again, have a lot of fortitude to take advantage of those.

Clay Finck (00:59:41):

So I’d assume China and Chinese stocks fall into that emerging market bucket for you where it’s just something you won’t even touch.

Dan Rasmussen (00:59:49):

Yeah. I mean, what is an equity in a communist country? I mean, who owns it? What rights do you have? I don’t know. I mean, I don’t understand. It boggles my mind of how much money has flown into China. And then you think of what’s even more crazy is the fad among college endowments for Chinese VC. And you’re just like, not only are you investing in a communist country or who knows, you’re already get your money back and who knows, who controls it and who knows, who owns the thing? Now you want to do that in an illiquid way. So there’s not even a market you can buy and sell it. You just want to give it to somebody. I mean, it just seems totally, totally nuts to me. And I know some people have made a lot of money there, but it just seems not worth the risk to me.

Clay Finck (01:00:29):

Another asset we talk about quite a bit here at TIP is Bitcoin. One of my favorite interviews of the year was having Chris Kuiper and Jack Neureuter on the show from Fidelity Digital Assets. They wrote this brilliant piece for research called Bitcoin First. They are bringing top tier research when it comes to Bitcoin and digital assets. And I hear over and over and over again that some better cryptocurrency is going to come along and eventually overtake Bitcoin. And I just don’t think that is likely at all. Could it happen? Sure. But I just don’t think it’s likely. Here’s their take on the argument and why they agree.

Clay Finck (01:01:10):

You two wrote this brilliant paper titled Bitcoin First Whitepaper. Why investors need to consider Bitcoin separately from other digital assets? I can’t tell you the number of people that have asked me, “What’s going to be the next Bitcoin?” or tell me, “This is going to be the next Bitcoin.” Why does Fidelity consider Bitcoin to be in a league of its own relative to all of the other cryptos?

Chris Kuiper (01:01:36):

Going back to how everyone goes along that journey, you’ve pointed out a very common one we hear, which is, “Okay, I’m beginning to understand this technology, I want some exposure, but which one do I invest in? Obviously I know Bitcoin.” And they bring along that technological lens that prior. And I did this too, when I first started. Remember, I was a tech investor or tech analyst, and you bring along the tech lens, which usually in the technology world, the pioneer blazes the trail, but it’s the other people that come along and make some incremental improvements or, or take over, right?

Chris Kuiper (01:02:06):

So it’s the classic Facebook placing MySpace or Google replacing all these search engines no one’s heard of anymore, Alta Vista, Ask Jeeves, whatever. So I get that. I made the same assumption. So that was one of things we wanted to tackle in this paper, that if you’re going to look at these other things, you need to realize there’s inherent trade offs.

Chris Kuiper (01:02:26):

And so we actually start the paper first by saying, “What do we view Bitcoin as?” And we view it as a monetary good. It fulfills the role of money because it has all these characteristics of good money. And we go through them. It’s divisible, it’s portable, it’s scarce, and finite. You can make sure it’s genuine. All of these things make for really good money over history. And there’s a lot of research to back that up. If you think of Bitcoin as a monetary, good, then the next question is okay, could something out-compete it, right? And so if you have a free market for, for monetary goods, you want the one that has fulfills all these things, the best will win, right? It’s a good question to ask, it’s theoretically possible, but when you start to dig into it, you realize this is likely not going to happen at all because Bitcoin is the most decentralized and the most secure of all of the other things out there.

Chris Kuiper (01:03:19):

So at the very best someone can come along and completely copy Bitcoin’s code. It’s open source, right? So they’ve made another Bitcoin that’s just as decentralized or secure, or in theory could be right. But in practice, it’s not because of network effects. And so it’s the example that we give. I could copy Wikipedia code, but my Wikipedia wouldn’t be nearly as successful because why would people have an incentive to jump to mine when it’s exactly the same? We use the example of reinventing the wheel in the paper. And we actually say, this is such a cliche, but here it’s actually true. Like you would just be reinventing the wheel. Once you see Bitcoin, you can’t unsee it. You can’t make a better one, right? If people are already with Bitcoin, it was the first mover. It’s the most decentralized. It’s the most secure.

Chris Kuiper (01:04:02):

We think this one is going to have the dominant network effects. And if you think network effects are strong for things like Facebook, which has half the globe on its networks, wait till you see the network effects for money, because the incentive is so much higher to choose the right monetary network. You are literally going to lose money if you don’t choose the right one. And so we don’t see anything usurping that, because again, if you want money, are you going to choose one that’s the most decentralized or secure? Or are you going to choose something else?

Chris Kuiper (01:04:31):

Now like you said, that’s why we see it in a league of its own. We think you have to start with Bitcoin in its own bucket in that way. Now other things of course have come along, they’ve copied the code and they changed it. And that’s fine. We’re not disparaging those things in the paper. We’re simply pointing out that once you do that, whether you want to realize it or not, you’re making a trade off. So if you’re going to say, “Oh, this is better than Bitcoin, because it’s more scalable. It’s faster. It’s got more programmability.” That may be true. But then you’ve sacrificed something else. Usually in the realm of decentralization or security. And again, those are the things you want for a money. So we think Bitcoin fulfills the role of money. These other things can fulfill other use cases.

Clay Finck (01:05:11):

William Green provided such a good episode for our audience that I wanted to pull one more clip from my episode with him, where he talks about the importance of the idea of compounding and taking it seriously. This is an idea I strongly believe in and I try to apply it to many areas of my life. And I just think it’s such a powerful concept that William explains here. I figured this was a really good clip to end the episode for you guys. Hope you enjoy it.

Clay Finck (01:05:41):

For listeners of the Millennial Investing podcast, what is one simple idea that you’d like to share with them that they should consider implementing into their own lives?

William Green (01:05:52):

I think if you take really seriously the idea of compounding in multiple areas of your life, it’s a very profoundly important and powerful concept. So think of, think of compounding first in the most obvious way, which is investing. If you look at compound interest tables, and you think about what happens when you make 10% a year without catastrophe over many, many decades, the results are so astonishing that you start to realize, “Well, actually, I don’t need to be gunning the engine and trying to make 30% and risking going bankrupt.” You just want to stay in the game, have steady returns for a long period of time. So compounding money over a long period of time is very powerful and also your expenses are compounding against you. So if you keep the expenses low, your trading expenses, your transaction costs, your tax bills. If you keep those low and you live within your means and you compound money steadily over many years, you become extraordinarily rich.

William Green (01:06:56):

And so compounding money over time without disaster is an incredibly powerful idea. But then think about the different ways in which you can also apply the concept of compounding. So think about the importance of compounding knowledge over many years, compounding skills over many years, actually over decades. So, so one of the things that Charlie Munger says about Buffett, who’s a relatively young man compared to Charlie Munger. I think buffet is only 90 or 91, so he’s a mere stripling, a youth. One of the things that Munger says about Buffett is he’s a continuous learning machine. So think about why Buffett has been so immensely successful. One of the reasons is that he’s been learning like crazy for the last 90 years. So he’s changed the way he invests over, over decades. He started off buying busted companies. What he would call cigar butts, things that were discarded that were incredibly cheap.

William Green (01:07:57):

Then he, under Munger’s influence, ends up buying better companies, then becomes more international, stops just buying companies in the US. He becomes international. Then goes into industries that he never believed in investing in like railroads sort of becomes hugely profitable. And then always said you shouldn’t invest in technology, and ends up in his ages making investment in Apple. That turns out to have been in dollar terms, the most lucrative investment of his entire career. And so there’s a guy who’s a continuous learning machine who just keeps compounding his knowledge. So that’s a really important idea. You want to be constantly compounding your knowledge over many, many years, over decades.

William Green (01:08:39):

Then you think of compounding with your habits. So think about, I wrote about this in a chapter on high performance habits. If you do simple things in life, whether it’s, whether it’s reading consistently or exercising consistently or eating well, they seem like nothing on the day. If you, if you meditate for say 12 minutes on the day, it doesn’t really have a huge impact. I mean, maybe it calms you down. Maybe it settles you a bit. But if you meditate for 10, 12 minutes a day for 10, 20, 30 years, the impact is astonishing.

William Green (01:09:14):

And then think finally of another form of compounding, but maybe the most important of all, which comes from a friend of mine, Guy Spier, who’s been a guest of Investors Podcast multiple times, Guy talks about the compounding of goodwill. And so what Guy does is he’s constantly trying to be generous to people, to be helpful to people, to be kind to people. And what I realized in writing this book is that there’s a tremendous compounding effect in your own life when you try over many years to be decent and kind ethical, do the right thing, help people, that there’s this kind of compounding effect there as well.

William Green (01:09:53):

So that I think we probably discussed about four different types of compounding there, and I’m sure there are more, but compounding money, compounding knowledge and learning, compounding good habits, compounding goodwill and kindness. If you just harness that one simple idea of compounding, you really take it seriously. You make it an operating principle. It’s immensely powerful. It changes your whole life. And, and actually when I think about it, when I think about the reason we are here together Clay talking today, it’s literally, I think it’s because about seven years ago, I published a book called The Great Minds of Investing and Guy Spier who has been a friend of mine for 20-something years and has always been kind to me, always been doing me favors, introduced me to Stig and Preston, who then had just founded We Study Billionaires, which then was called The Investors Podcast.

William Green (01:10:43):

And, and so they were just starting out and they had interviewed him and they interviewed me over two episodes and then Stig wrote an incredibly kind review of my book on LinkedIn. I think that I didn’t ask him to do just cause he’s a kind bloke. And then over the years we’ve just remained really friendly, and I ended up when this book “Richer, Wiser, Happier” came out, I wrote to Stig about it, I think the very first interview that I did about the book, I think probably the first podcast I did was with We Study Billionaires was with Stig. We’ve continued to talk, become better and better friends. And now as a result, I met you because now I’m going to be doing a podcast where I’ll be, co-hosting a podcast for the Ambassadors Podcast Network.

William Green (01:11:29):

And you came to my office because Stig sent you to help set me up with the equipment. And you got a wonderful trip out of New York and we all got to become friends too. And so you think of the series of events that have happened because of Guy’s kindness seven or eight years ago, and introducing it to Stig and Preston. And all of these good things in our lives have happened because of that. And that’s all unknowable. You couldn’t have predicted any of that, but this is happening in Guy’s life and my life in so many different ways. And wherever I go, I see people who Guy has helped over the years. And it’s something that’s very easy to underestimate. If your behaving in that way, in countless little ways, in all areas of your life, you’re just constantly helping people. The impact of the compounding of goodwill over decades is actually pretty much overwhelming, because your relationships ultimately is what matters most.

William Green (01:12:23):

And so if, if people feel good about you, because you’ve tried to be decent and kind it has an immense impact. And you see it with Buffett and Munger right? Why do 40,000 people want to go to Omaha each year to see Buffett and Munger talk? It’s because of the way they behave, and their relationship is built on kindness and honesty and integrity and fairness. And, and so these values, the way that you behave, creates this kind of knock-on effect that it reverberates in all these different ways. So, so just knowing that good behavior has a long shelf life, that it, that it has these, this, this compounding effect that’s, that’s really profoundly important, I think.

Clay Finck (01:13:08):

All right. I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app. So you can get these episodes delivered automatically. If you’ve been enjoying the podcast, we would really appreciate it if you left us a rating or review on the podcast app you’re on. This will really help us in the search algorithm so others can discover the show as well. And if you haven’t already done so, be sure to check out our website, theinvestorspodcast.com. There you’ll find all of our episodes, some educational resources, as well as our TIP finance tool that Robert and I use to manage our own stock portfolios. And with that, we’ll see you again next time.

Outro (01:13:44):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investors Podcast Network. Every Wednesday, we teach you about Bitcoin, and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts, or courses go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional. This show is copyrighted by the Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.