Motley Fool Hidden Gems Investing - Morgan Housel on Inflation, Incentives, and Investing through Bear Markets

Episode Date: September 24, 2022

“No one's success is proven until they've survived a calamity.” You can’t join the NBA with a few good shots, but you can join the ranks of “great” investors. Luck and skill are much harder to separate in the financial world and making that distinction can take a few decades. Chris Hill talked with best-selling author Morgan Housel in front of a live audience about: - Why inflation is so personal and variable - Elon Musk’s best product (hint: it’s not a car) - The power of incentives - The secret to 99% of Warren Buffet’s success - Investing through bear markets Companies mentioned: BRK.A, BRK.B, HOOD, TSLA If you're a member of any Motley Fool service you can access the video for the full interview here: https://www.fool.com/premium/coverage/4056/coverage/2022/08/31/wealth-greed-and-happiness-with-best-selling-autho   Host: Chris Hill Guest: Morgan Housel Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Volvo is leaving the chaos of rush hour outside. Start by settling into your saddle-stitched Nappa leather seats. Notice the open space around you. Uncluttered, elegant, intentional, warm ambient light, and natural wood details to ground you. This is Volvo's Scandinavian sanctuary for every journey. Learn more at volvocars.ca. Optional features mentioned. The vast vast majority of his net worth came in his elderly years and the takeaway from that for me is that look if Buffett had retired at age 60 like a

normal person might no one in this room would have ever heard of him all of his success came in his 70s 80s and early 90s and that's really important because we spend all this time talking about how he values companies but the whole secret to his success is not that he's good at picking companies it's not even that a good investor it's that he's been a good investor for 80 years i'm chris hill and that's morgan housel author of the international best-selling book the psychology of money when i interviewed housel in front of a live audience we talked about investing through bear markets the power of incentives and what he's working on for his next book but i kicked

off the conversation by asking about what he's encountered since writing the psychology of money I know that the number of copies that your book sold is surprising to you, so let's just put that aside. In terms of reaction to the book, whether it's from financial media, institutions, people you've met, what has surprised you the most in terms of the reaction? One thing I think is interesting is a big theme of the book is that everyone's different and has different goals and different risk tolerances and different aspirations, different incomes, family situations. And because of that, no two people, even if you are the same age,

same education, same information, are going to come to the same conclusion about what you should do with your money. How to invest your money, how to spend your money. There's no one right answer. It's not like math where two plus two equals four for everybody, no matter who you are. Investing is like, it's a very individual pursuit. That's a big theme of the book. Now, the last chapter of the book is called Confessions, and I lay out exactly how my wife and I what we do with our money. There's no numbers in there, but it's here's how we spend, here's how we save, here's how we invest, here's what our goals are. And despite the book up to that point saying everyone's different, there's no one, people were, so many people were so offended

by how I invest my money. And I really do think that there's this quote that I love, I'm going to butcher it, but it's when people spend more time on the internet being exposed to other opinions, the angrier they get that other opinions exist. And I think it's true for investing, too, that even if you accept and know that everyone is different and comes to different conclusions, if somebody else is investing their money different from you are, it's very easy to view that as a slight on your own strategy.

And the number of readers who reached out and said, I like the book until that chapter, and now I can't take you seriously anymore, I thought was pretty interesting. So I think that, but it's pretty telling, too, that people take offense to when others manage their money, spend their money, invest their money different than they do because they view it as like a threat.

Or I think they view it as maybe an indication that maybe they're doing it wrong and that makes them anxious about it. I want to get to some things you've written recently. But first, a huge topic of conversation, including on this stage yesterday, is inflation. And I'm curious about sort of like, what is the piece of the inflation conversation

that you find most interesting? What I think is most interesting, I mean, the first thing is that there's no other variable in the economy that gets people as fired up, as angry as inflation. And the number one thing you hear that a lot of you will agree with, I'm sure, is that the inflation number that is published every month

does not reflect reality. That is a big narrative that's out there among millions and millions of people. What I think is interesting about how that could be true is because normally people will say that and then they will say, because the number is not calculated properly, they're intentionally under-reporting what it is. But what I think is really interesting is that everyone spends their money differently. So no two people have the same inflation rate. There is no such thing as

the inflation rate. It's just your own individual household. If you have a hundred-mile daily commute, then of course you are more sensitive to gas prices to someone who just works from home all the time. Or if you or your children are in college, then tuition prices mean everything to you. If you are not in college, you couldn't care less about what tuition prices are doing. So since everyone spends their money differently, everyone has a different, their own individual inflation rate. I think right now, the published inflation rate is 8.5%, something like that, 8.7, whatever it is. I'm sure there are people whose personal inflation rate is zero, and there are people whose personal inflation rate is 30, 40 percent and everything in between. So I think

that's what's most interesting is that there's no the inflation rate. And that's not true for other data. Like there is one price of Apple stock for everybody. But inflation, there's such a huge variance of outcomes. And that's why I think it's so controversial and why people get so uptight about it. Let me tee you up with a couple of things that you had written recently that I found particularly interesting and I think apply to investing and in particular looking at different stocks. But just from an investing standpoint, you recently wrote, sitting still feels reckless in a fast-moving world, which I immediately identified with because there have certainly been times when the market is dropping where my gut instinct is, what do I do? I really

should do something. Yeah. I think, you know, one of the biggest innovations in the last 20 or 30 years, even just the last 10 years, is that it's so much easier and cheaper to make a financial transaction, to buy and sell securities. It used to be not that long ago, and definitely 20, 30 years ago, that to buy or sell a stock might cost you, it was a phone call to your broker, and it cost you a hundred bucks each way, in and out. So the barrier to entry to make a decision was higher. You thought twice about whether you need to do it, and it's not like that anymore. It's free. You go on your phone, boom, click, click, and you're done. And so I think it's just made it easier to pull the levers and twist the knobs. And when the world is falling apart, and things

are uncertain, and the headlines seem scary, it's so easy to pull those levers these days, even if you know it's the wrong thing to do. But it often feels like the right thing to do, because if you see everything falling apart around you, and your reaction is to shrug your shoulders and say, oh, well, I'm just going to see what happens here, that probably is the right thing to do, but it feels reckless. There's no other situation in your life where you think there is a big existential threat to your well-being, and the right thing to do is nothing. If your house is on fire, you should do something about it. There's actions you should take. So I think that's just a quirk about investing, is that since it is a long-term game that should be measured in years, if not

decades, we know that the right thing to do the huge majority of the time is nothing. But it feels reckless. It feels like you are just being ignorant of the risks that are out there if you do nothing, even if it's the right thing no one's success is proven until they've survived a calamity which i'm assuming you wrote that about you know individual accomplishments and possibly businesses as well sort of having to deal with their own crisis but i'm wondering if you think that applies to individual investors particularly when they're starting out i think it's mostly investors there is there are many other fields where you have the potential to not only do well but very well based off of dumb luck.

There are not many other fields like that. You can't be a top NBA player based off of luck. It's just impossible. But in investing, you can. There exists the possibility that your success is due to luck. I'm not saying everyone's is, but the possibility exists. And for a subset of investors, that's definitely what it has been, particularly over the last couple of years

when there was a subset of tech stocks that were just going bananas and doing so well. And because of that, I think the only way that you can really separate luck from skill is surviving a calamity and seeing who's around after that. Not just individual investors, but there are every single cycle. There are hedge fund managers, private equity fund managers, businesses, CEOs, who are the shining stars. And then the tide goes out and you realize there was, you know, their skill was good

for that particular moment. But there was no sense of endurance or longevity attached to it. And I think if you were to look at someone like Warren Buffett or George Soros or someone like that, people who've been investing for 50, 60 years and have succeeded in every possible climate, have survived every possible calamity that they've been through, that's when you know that there's actual real skill there. And the hard part about it is that sometimes the economic cycles take a decade. This is not something, it might take a while.

You can be crowned as the star fund manager of the decade, and then the tide goes out and it's all washed away. And there were a lot of people like that. I mean, not, you know, who was it? The fund manager of the decade in the early 2000s was a guy named Ken Huebner. Amazing returns from like 2000 to 2008. And then the tide went out

and like that was effectively it. And so if you view investing as like, I want to stick around for decades, I'm thinking about like building generational money, then you need to be able to survive and thrive in multiple different cycles. I think it's just the only way to separate skill from luck.

So taking that one step further, because you know part of what we've talked about including David Gardner yesterday his work with the full foundation and really trying to encourage younger people to invest all that sort of thing it almost seems like we need to prepare people for the inevitable downfall or just bear market that sort of thing because it's almost like hey we're not going to give you a a gold star until you've had your first, it's like, it's great to, you know, succeed in investing, but we're not giving you, you know, we're not really considering you an investor until you

can show us the scars of you've invested through a bear market. Yeah, I think that's right. And since it might only happen, I mean, what were the big bear markets of the last generation? It was 2000, 2008, and maybe March of 2020, but that lasted a month before it was basically over. So There's really only been two real cycles in the last 25 years, even 30 years, only two big cycles. So even in your entire investing lifetime, you might only go through two or three of these cycles. Maybe you'll go through more, but they don't, since they happen so infrequently, it's easy

to become lulled into the idea that they don't exist or that you are immune to them or that your skill was actually just kind of serendipity masquerading as skill. thought that you're investing returns were because of your intelligence and your skill and then the tide goes out and your eyes, it's very different. The Warren Buffett quote is, you only realize who's swimming naked when the tide goes out. What are the odds that there were people who started investing in early 2020, made it through that bear market and thought, oh, this is fine. It's, you know, bear markets don't last that long.

I think it's next to none. I mean, but if you look at just Robinhood, which was predominantly going after young men age 18 to 25 that's their by far and away their core thing they added like 10 million new accounts in 2020 like incredible like so many of these people came into the market and by and large because it was in robin hood they were being incentivized they were being led to trade and trade the most obnoxious bankrupt penny stocks you can think of that was the whole game that's robin hood's business model is to not get you to invest for the long term in good companies it was get you to keep pulling the lever. And that worked amazing for about a year. I remember in

late 2020, someone came to me, a young guy came to me and said, if you can't double your money every year, you have no idea what you're doing as an investor. And I remember being like, all right. And we know what's happened to all those people over the last six or nine months. The tide went out, so to speak. And you know, just from watching Robinhood results, like it's not pretty. In one way, I think it's almost a benefit if you learn what risk is when you're 19 versus 45 and putting your kids through college. Maybe it's good that you learn that lesson early on,

but it's also tough to watch a whole generation of investors being pushed into the gambling quarter of investing, because now it leaves a taste in their mouth of like now that everything's kind of washed out, like, oh, the odds are stacked against me, it's all gambling, it's kind of a joke. And will that stick with them? for the next 10 or 20 years,

and they don't become good investors, I think that's a risk too. One other thing you wrote recently, incentives are the strongest force in the world, which that's a pretty absolute type of statement. And when I read it, it immediately got me in the mindset of using incentives as a lens through which to view businesses.

Yeah. Is that how you intended it? And should we be doing that? I started really thinking about this after the financial crisis of 2008 when there was so much criticism, rightful criticism, of the greedy Wall Street bankers, accurate criticism. The part that I disagreed with is people who don't understand that if they were a 25-year-old who was told,

package these subprime mortgages and we'll give you a $3 million bonus, you would have done it too. And people really underestimated what they would be capable of if the incentives were correct. It's not to absolve anyone who did terrible things, but people underestimate what they are willing to do if the incentives are appropriate. And I think you see this at the CEO level,

you see it at the company level, you see it among fund managers. I think there is a tremendous amount of misbehavior in the investing industry, but the huge majority of those people are good, honest, well-meaning people. They just exist in an industry where the incentives can be so twisted

and the incentives can be so enormous and people who can make millions of dollars a year if they're willing to close their eyes and look the other way, the number of people who are willing to do it that I've seen in the industry is pretty high. So I think that's where that came from. Well, let's stick with the CEOs for a second

because there are CEOs who are paid tens of millions of dollars a year just in their salary. And then there are CEOs who do the whole, well, I'm just going to take a dollar and I'm going to take it in stock options. But of course, then their incentive is tied to the price of the stock.

Do you view one as being better than the other? I'll tell you a story. When Collaborative Fund was founded in 2010, I was not there, but when Craig Shapiro started it, when he's starting a brand new venture capital fund, he thought it would be great to tell investors, hey, I'm not going to charge you a management fee. This is my first fund.

I need to prove myself. No fee. And he thought that would be great, that the investors would be like, oh, amazing, we love this. Every single investor to a T told him, We cannot invest in your fund if you don't have a management fee, because you don't have any, it's just not a viable, enduring organization that can work. And I think there is some, I mean, most of the CEOs who take a $1 salary are deca-billionaires, so whatever salary you're going to give them makes no difference.

Jeff Bezos, Mark Zuckerberg, the Google guys, whatnot, makes no difference to them whatsoever. I do think there are, it's an interesting situation when you have a CEO compensation structure like Elon Musk had, where, I forget when it was granted, maybe 2016, 2017, where it was, basically it was, if you turn Tesla into a trillion dollar company, we will give you like 20 billion dollars. I'm pretty sure, I'm not being 100% accurate, but it was something like, it was close to that. And he did. He turned it into a trillion dollar company, and I think he was paid something like $20 billion as his compensation. That's not like his original investment when he founded the company. That was just his paycheck, was $20 billion. And I think it's always the case in CEO compensation that it just ratchets to wherever the next guy was. So now you're going to have all these other CEOs from other industries who are like, Elon Musk got $20 billion. That's

now my baseline to do and it just keeps ratcheting up and up and up and up and so many of the compensation structures too are not really they're not tied to results they're tied to share price which is by and large outside of the ceo's control and so now you it's just there are a lot of really twisted incentives and it's all tied to um your competitors and it's almost similar to like in the real estate market when it's based the price is based off of comps well the prices keep going up because your sales price, it wants to be 5% from higher than whatever the last guy. It just keeps going up and up. And I think it's really similar for CEO comp too. So there are a handful of CEOs now who make over $100 million a year. Every single one of those people, I think almost

to a T, the share price performance does not back it up. And there have been some studies actually that there's a negative correlation between CEO comp and shareholder return. It's a negative correlation. The higher it gets, the worse shareholder returns ultimately are after that. And I think the reason, really simply, is just because you have a CEO in that situation whose only goal is to enrich themselves. It's not to build the business for the long term. It's not to take care of customers. The whole goal, what they wake up in the morning is, like, how can I meet my targets to get my bonus? I'm following you on Twitter, like a lot of people.

And I appreciate that you don't tweet very often. So thank you. If people are just, like, mass tweeting, I just, yeah, it's like. Too much. It's too much. You tweeted something recently. Every great investment was once mocked by the crowd. The crowd is usually right.

Would you care to unpack that? Well, of course, to have a standout company or to be a standout investor, it's rare. Of course, it's rare. It has to be rare. It has to be a one in a hundred, one in a thousand kind of thing. And so it's always the case whenever there's a new technology, a new up-and-coming business, a new investing strategy, that the crowd mocks them. Always the case.

has always been the case, always will be the case. But the crowd is usually right. They're usually right to be mocked. It usually ends up not working. And so, you know, I think a lot about that, particularly in early stage companies, venture capital, where it's like, it's not supposed to work.

Like if a venture capital fund invests in 100 businesses, you know your baseline expectation is that at least half of them are gonna be out of business within two years. That's the baseline expectation. So of course, success is always very rare. So I brought it up because there's always a case with new investments and new companies where there is a lot of criticism of those companies. And a lot of times the investors will say, oh, you also criticize Google.

You also criticize Facebook. And they use the criticism of the crowd as an indication that they are right. But most contrarianism, like to be successful, you need to be a contrarian. But most contrarianism is just cynicism. cynicism. It's not actually real contrarianism. So that's the core to it. I think a lot of investing is like, it's supposed to be hard. It's not supposed to be easy. And there should exist no world when every company or every investor who is trying to be better than everyone else is successful at doing it. It's always going to be the case that 90% of companies and 90%

of investors do not meet the objectives that they set out to. Well, and part of that process ties into something else you've talked about in terms of the story that companies tell and the idea that the best story wins because the truly transcendent companies are telling a story that is different. They're doing things in a different way. And on the flip side,

we can't count the number of businesses that have either said about themselves or others have said about them, this is the next Apple. This is the next Google. Yeah. You know, in terms of like telling stories and whatnot, someone brought up this point recently that I really liked.

And they said, Elon Musk's best product is not a car. It's not a spaceship. It's Tesla stock that is most amazing. Because he's told such a good story and got so many people to nod their heads to that story that, you know, Ford is multiple times the size of Tesla in terms of the cars they produce and revenue and profits. And Tesla's worth 50 times as much, 20 times as much, whatever it is.

All that is just because Musk has done such a good job telling the story. And I think any successful company that you look at, the leader's ability to tell a story about that company exceeds even the success of that company's products. You mentioned Warren Buffett earlier. Today is his birthday. He is 92 years old. I don't know how many books have been written about him

or how many articles, but among, if not the most examined life in the world of investing. Is there any part of Buffett and his investing that you think gets less attention than other parts? What I think is interesting is that of the God knows how many books that have been written about him, they all go into so much detail about how Buffett thinks about moats and business models and valuation

and management teams, like how does he analyze companies. That's 99% of the analysis of his success. And those are all really important. That's an important topic. But if you look at the trajectory of his life, 99% of his net worth was accumulated after his 50th birthday. And like 98% came after his 65th birthday. The vast, vast majority of his net worth came in his elderly years.

And the takeaway from that for me is that, well, look, if Buffett had retired at age 60, like a normal person might, no one in this room would have ever heard of him. All of his success came in his 70s, 80s, and early 90s. And that's really important because we spend all this time talking about how he values companies, But the whole secret to his success is not that he's good at picking companies. It's not even that he's a good investor. It's that he's been a good investor for 80 years.

That makes all the difference in the world. That's 99% of the success. So if you want to, like, what is the takeaway from Buffett's success? It's not how he values companies. It's not how he thinks about management. It's his endurance and longevity that is 99% of that success.

And that is very often overlooked. And I think that answer that all of his success is just the fact that he's been investing full-time since he was 11 years old, and now he's 92. do. It's too simple for people to take seriously. It's too boring. They want to dig deep into how he digs into balance sheets and income statements. And it's also, it seems too hard. Like if the answer is, oh, just wait another half century and you'll accumulate some wealth too. No one wants to hear that answer. They want the answer that you can put to use today.

They want the pill, so to speak. It's similar in medicine. Like the doctor says like, oh, you need to sleep more and diet and exercise. People are like, no, I want the pill. Just give me the pill, it's going to make it better. I think it's similar in investing. And that's the part that I think is overlooked about what he's done. We've got a minute left. Let me close with a question that I know is on the minds of a lot of people, particularly those who have read your book, which is, is there another book in the works? The question is, are you going to do the audio book version of it again? I mean, that's my follow-up question. So yeah, I'm writing another book right now. I think it'll probably be out in the spring or summer, next spring or

summer and it's about the behaviors that never change over time in business and investing but also like other areas of life what were people doing a hundred years ago that they'll be doing a hundred years from now and i think there's so much focus on emphasis and emphasis on what's going to change what industries are going to change how are what technology is going to change which is cool and important but it's the things that never change that i think move the needle the most the behaviors of greed and fear and how people respond to surprise those things never change. You read the history from, I'll tell you a quick story where we got this, where I got this from. There's a book called The Great Depression, A Diary. It was written by a lawyer named Benjamin

Roth, who was a lawyer during the Great Depression. He kept a very intricate diary of what was going on in the economy. His son published it in 2010, and I think it's the best economic book ever written, because there's no hindsight bias in the book. He was writing all this in real time in the 1930s. And he wrote, there's an entry in there where I was reading it, and I thought, this is exactly verbatim what somebody would have said in 2008 during the financial crisis. When he was writing in 1932, it's exactly what you would have said in 2008. His next entry, he's writing and he says, what's going on in 1932 reminds me exactly of what happened in 1907. And what happened in 1907 is exactly what happened in 1876. These things never ever change. It's the same story

over and over again. So I think just understanding those behaviors that never change, that's what digging into in this book. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow. Thank you.