Motley Fool Hidden Gems Investing - Volatility = Price of Admission

Episode Date: February 20, 2022

The recent ups and downs (and more downs) of the stock market have rattled some investors, so we called on a friend to help put this volatility in context. Senior analyst Maria Gallagher talks with bestselling author Morgan Housel about: - Why time in the market is more important than your yearly return - How to think about the ups-and-downs as the cost of admission to investing - Why boring companies can make great investments Stocks discussed: FB Host: Maria Gallagher Guest: Morgan Housel Producer: Ricky Mulvey Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

I remember last summer, someone told me on Twitter, they said, if you can't double your money every year, you have no idea what you're doing as an investor. And I remember thinking, okay, this is a good sign of where we are, where expectations have come over time. I'm Chris Hill, and that was Morgan Housel, author of the international bestselling book, The Psychology of Money. At our recent Investing Essentials 2022 and Beyond event, Motley Fool senior analyst Maria Gallagher talked with Morgan about a range of topics designed to help us know ourselves better

as investors. They discussed why your yearly return is not as important as time in the market, and how boring companies can make great investments. It's Morgan Housel talking about investing at a time when a lot of investors could use some calm guidance. With that, here's Maria Gallagher. Maria Gallagher Hi, Fools. I'm Maria Gallagher, Senior Analyst on the Investing Team, and I'm joined by best-selling author and Motley Fool contributor, Morgan Housel. Morgan is a partner at the Collaborative Fund and author of the bestseller, The Psychology of Money, Timeless Lessons on Wealth, Greed, and Happiness. And as of November, he is a member of the Board of Directors at Markel. Morgan, so happy to get

a chance to chat with you. Thanks for having me, Maria. I appreciate it. So, just to start, we've seen an incredibly volatile January. What are you thinking about the markets right now as we're in the beginning of February? I think there's part of me that looks at it and just says, look, this is completely par for the course if you look at investing history, that this is what you shouldn't expect at a fairly regular basis, is for the market to decline 10% or 15% without any real significant news that you can attach to why it's doing it. That's kind of par for the course for what the market does. There is a sense that you can look at quite a few tech stocks that are not down 10% or 15% or down 50% or 70% or 80%

in the last three months. And that's something different. That requires a little bit different explanation. For a lot of those companies, the explanation of why they might be down 50% in the last three months, I think you really have to follow that up with the question, why did they rise 400% in the last year to begin with? So to answer the question, does the decline make sense? you first have to answer the question, did the hyperbolic rise before that make sense as well? For some of those companies, the answer might be yes. We'll figure that out in the long term. For a lot of companies, it's definitely no. We know beyond any reasonable doubt that a lot of what took place during the last two years, particularly in hyper growth tech stocks,

mirrored any of the crazy bubbles that we've seen in the history of the stock market, where you have these companies, some of which had no real business model that were up three, four, five hundred, a thousand percent in two years. And that, of course, is just something that we know cannot sustain. So there's probably that looks like what's happened in the last month is just saying, yeah, there's nothing that needs to be explained. This is just how markets work. And there's part of it that's like, well, this is maybe the inevitable reversion to the mean of things that had obviously gotten way extended out in front of each other. So that's an interesting point, kind of that dissonance. So where do you say, how much of

your time do you say you spend looking at that macro environment of saying, well, it's normal for the stock market to decline? And how much do you spend looking at that micro, okay, well, maybe this specific stock isn't normal? And how do you kind of balance looking at the two? Look, for me personally, I'm a fairly passive investor. I invest in index funds that I plan on holding for the next 50 years. And part of the reason that I do that is two reasons. One is all that I want to focus on for me as an investor is can I stay invested for the next 50 years? Because if you really dig into the math behind compounding, the question that you want to answer is not how can I earn the highest returns? The question that makes the biggest difference is

what are the returns that I can earn for the longest period of time, that I can sustain for the longest period of time, which are usually not the highest returns that you can earn in any given year. It's pretty much if you can earn average returns for an above average period of time, you'll achieve above average results that's how i invest personally rather than picking individual stocks but even i would say too how much time do i focus on the macro view of what's happening in the economy and pullbacks in any given year almost none because it really just comes down to what your time horizon is and if you are someone who needs this money in the next year or the next three or five years then what the market does in this year is relevant to you if you're someone

who's saying, I'm going to hold this for the next 10, 20, 30, 40, 50 years, then you look at what's happened in the last month as something that is completely inevitable that I hope to be able to achieve, or I hope to be able to experience, I would say, another 50 times over the rest of my life. A big 15% pullback that happens once a year. I hope I live long enough to experience a lot of these going forward. So when you view it at that angle, it's not necessarily fun to go through this, I don't necessarily enjoy it, but I just view it as an inevitable part of what being a long-term investor is. I know that you're a student of history of the markets. And so are there moments in history you like to think about? You said it's really typical for us to have these

types of drawdowns. Do you have moments in history that you tend to think about and tend to kind of hold on to? Because I always think things like that are very soothing and calming, saying, you know, we've been here before. We don't know what's going to happen next, but history doesn't always repeat. It rhymes, kind of things like that. I would say if you are going to be an investor for 50 years or 30 years, whatever it might be, you should expect that there's probably going to be four or five occasions that make all the difference in the world to your lifetime investing returns. Like 90% of your investing returns rely on how you behave during fewer than 10 days over the course of your entire lifetime. So October of 2008, when the stock market was

falling apart during the financial crisis, how you behave during that month was more important than what you did in the previous like 10 years combined. If you just kept your head on straight during that month, that's all you needed to do to have a good decade. And same with March of 2020. If you just didn't look at your brokerage account, didn't make any decisions, even if you didn't buy, if you just failed to panic, just avoided panic,

that's all you needed to do to do okay. So I think if you look at the last 20 years, again, March of 2020, October of 2008, March of 2000 when the dot-com bubble burst, maybe the fall of the Soviet Union, if you go back to the Kennedy assassination, World War II, the Great Depression, there's really like five or ten events over the last hundred years that account for the majority of the upheaval in what's gone on during markets. And if you just did okay during those periods, that's all you need to do to do extraordinary over a long period of time.

So what would you say to investors who are maybe newer and are thinking this is the first time they're experiencing this type of drought, and how do you keep on going if that's really what matters? To me, I think there's two things to think about here. One is that we all know you can do very well in the stock market over a long period of time. We all know that. That's the upside. That's the benefit. And like anything else in life, there is a cost to that reward. If you want that reward, there's something else that you have to give to it. And I'm not talking about investing management fees or brokerage fees. The cost to investing is putting up with and dealing with and enduring a constant chain of never-ending volatility and surprises and upheaval.

That's the cost of admission that you need to be willing to pay to get the benefit on the other side. And I think that's more than just a little, you know, just like renaming what's going on. Because once you view it as the cost of admission, then all these volatile periods take a totally different view in terms of how you experience them. And again, it's not that you say you enjoy them and you're glad that they're here. But if you view it as the cost of admission rather than just a painful period where a bunch of people made mistakes and screwed up, and you view it as, hey, I'm just paying the bills that I need to pay in order to get the reward on the other side, then going through these periods, I think, is a lot more palatable. And I think if you can use that context and rephrasing it like that in order to keep you

in the game when these things get so crazy, then I think that makes all the difference in the world to you as an investor. That's the most important thing that I would think about. The other thing I'd think about as an investor is that over a long period of time, whenever you go through a period when you have extraordinary high returns and way above average returns, you should view that as robbing from future returns. That's really what it is. Over a long period of time, you can estimate what your annual returns would be. And then whenever you have annual returns that are above that, you should expect there to be future years that are kind of repaying those. And so we've been through a period over the last two years of extraordinarily high returns. And

it's been great. And a lot of people made a lot of money. And it was a lot of fun. It was great. And that's a great thing. But I think people's expectations should be that a lot of that excess growth that we had over the last two years will be repaid. I don't know if it's already been repaid or if it'll be repaid over the next two or five years. You never know when it's going to occur or how long it will last. And by the way, the opposite of that is true as well.

So when you go through a period of five years of dismal market returns, that's usually by and large setting up something pretty good on the other side. The best period to invest in history was if you invested in the early 1930s, of course, during the peak of the Great Depression. Of course, I'm saying that with the gross advantage of hindsight, but that's always how it is. Like returns either robbed from the future or are kind of like spring loaded towards the future. Well, that's a really interesting way to think about it. And I was reading where you wrote recently about compounding effects. So you said things like a couple of ordinary things you don't notice on their own create something spectacular when they mix together at the right time and kind of having the mindset of examples that are applicable to investing.

So these type of ordinary things can compound and make things that are extraordinary and superpowers. Can you talk a little bit about what some of those examples are, which ones maybe you have that you think are really special and can really compound for an investor? I think there's this quote from Napoleon that I love where he was once asked, what is the definition of a military genius? And Napoleon said, a military genius is the man who can do the average thing when everyone else around him is losing his mind. And I love that. That's what a genius is in the military.

And I think it's the same in investing. That if you can just do the average thing when everyone else is going crazy, that is like an above average skill. It's all you need to do. And so if you're just someone who keeps their head on straight when the market's falling apart, you're in the top 10% of investors. And then if you can mix that with a low susceptibility to FOMO, the fear of missing out, I think that's one of the most important investing skills that you can have. Like it's totally fine if other people are making more money than you. I think if you're okay with

that, that's a hugely important investing skill versus always looking at whoever's making more money than you and just like throwing out your strategy and trying to chase theirs. That's a pretty dangerous mindset to have. If you can mix those two things together, that's enormous. If you can think about the next five years when everyone else is thinking about the next five months or the next five days, that puts you in the top 10% of investors. If you can manage your personal finance with as much emphasis as you put on your investments, that's another huge advantage. There are a lot of great investors who live paycheck to paycheck.

And if your goal is to maximize wealth over a long period of time, then I think the personal investing side is of equal importance of the investing side. That tends to go overlooked as well. So each of those on their own are not that big a deal, not very excited. But I think if you mix four or five of those behaviors together, you can have extraordinary results. There's this really interesting story that I like from Howard Marks, who's a billionaire investor, a great investor, who was once talking about this investing friend of his, that in

any given year was not in the top half of investors, of professional investors. He never cracked the top 50%. But over a 10-year period, he was in the top 5%. So that's why I mean that if you have average returns for an above average period of time, that's when you can achieve some of the best results possible. Yeah. And I think that's it's one of those things where it makes so much sense, but it's so hard in practice. Right. If you see somebody who's getting rich on Bitcoin and they're your neighbor and they buy this really fancy car and you it's much harder to say, OK, well, I really believe in these companies. I'm in it for 10, 15 years, and then it feels like all these other people are bragging about how they're getting rich quick, and you kind of get caught up in that mentality. Do you have any

advice for the investors who are maybe saying, I know that I'm supposed to have this long-term mindset, but also at this moment, exact moment in time, I see these other people getting rich. I see these other people who are really convincing me that this is something I should get into. How do you kind of, in actuality, keep that level-headed mindset during these moments of volatility. You're right that there's a big difference between patience and stubbornness. And a lot of times if you are sitting back and just kind of like clinging to the old way of investing while everyone else is figuring out the new stuff, it's easy to tell yourself you're being patient. But how do you know when you're not just being stubborn and just anchoring to

the past? That's a hard thing to do in real time. I think it's important. I think it's fine to update and evolve your investing beliefs. I've done that myself. Everyone should do that rather than just anchoring to one thing and never letting go of it. But I think there are a couple of iron rules in finance that will never change. And endurance and patience is one of them. So you can have patience and endurance while still updating your investing views. If you look at how Warren Buffett has invested for the last 80 years, he's completely changed his investing strategy and style and outlook four or five times. He's a completely different investor today than he was 20, 30, 40, 50 years ago. So even among someone who we think about as just doing the same thing forever

has a lot of change in their style. But there are a lot of things about Buffett as well that have never changed. Patience is, of course, one of those. So I think it's fine to update your beliefs, but you want to be able to stick with what you can for the longest period of time. That's why to get back to this idea of what really matters in investing is not what are the highest returns. It's what returns are sustainable for the longest period of time. That's what makes all the difference. That's where compounding does its magic. If you think about that equation, then it really gets down to like, I don't really care who's going to earn the highest returns this year. All I care about is how can I earn pretty good returns for

the next 50 years? Because that's going to result in 100 times more money, 100 times more wealth creation than the people who are just focused on how can I earn the highest returns over the next 12 months. That's super fascinating. So can you give an example of how you've maybe adjusted your own investing approach over time to help set yourself up for that type of success? I think I'm much less critical and judgmental of how other people invest than I used to be. I think if you went back five or 10 years ago, I had views about how other people invested and I would say, oh, this person invests like this and that's completely wrong. That's the wrong way to do it. It's never going to work. And I always have none of that anymore because I've just realized

that we're all completely different people. And your goals might be different from my goals, which are going to be different from someone else's goals. So the investing strategy that works for you might not work for me and vice versa. And it's not because we disagree with each other. It's just because we're different people. So that's really where I am today. I always have no judgmental views

about how other people are investing. I look at other people and say, I don't think the odds of success are very high from you doing that. But people invest for different reasons. And even if you were to look at a teenager who's day trading penny stocks, that's not a good investing strategy for me

because I want to do well over the next 50 years. But if you're looking at someone who's just trying investing for the first time, trying to figure out how this all works, trying to scratch an itch that is going to get them interested in investing and want them to learn more, maybe it's not a bad way for them to start and to try to find an exciting path into investing. Maybe it's not a bad idea, even if it would be a terrible idea for me and you and most of us. It might work for some people. And so thinking about kind of that new investor, do you think that a lot of people who have joined the stock market in the past two years, like you talked about in the beginning, what is abnormal? Is it the run-up or is it the type of

correction we're seeing right now? Understanding those dynamics, what would you say to a new investor? Do you think that there's a mindset coming in of seeing the returns of the past two years that isn't necessarily sustainable? Or how are you thinking about the expectations for the future based on if the person came into the stock market maybe one or two years ago? I remember last summer, someone told me on Twitter, they said, if you can't double your money every year, you have no idea what you're doing as an investor. And I remember thinking, OK, this is a good sign of where we are, where expectations have come over time.

And I think, but I also understand where that view comes from. I mean, if you look at how many new brokerage accounts have been started in the last two years on Robinhood and E-Trade and whatnot, it's literally tens of millions of people who are opening a brokerage account for the first time. and all they have ever known is a market that has been relatively easy to double your money once a year and there are stocks and industries and even the nasdaq that's up you know 100 in the last year and a half or so so i get where that mindset comes from this is where like a good historical perspective is really helpful when you look at history that you know the stock market on

average will generate 10 per year on average over the long term that's what it has done And if you can generate 11% or 12% per year over the long run, you are an extraordinary investor. And if you can deliver 15%, you're on Mount Rushmore as an investor. That's what history tells us. And that's during a period, by the way, where for the last 40 years, interest rates have declined, which is a massive tailwind for stocks. We're going forward. That's almost certainly not going to happen. Maybe we're into a rising interest rate environment now where it's even harder.

And maybe over the next 40 years, if you can grow your money by 5% or 6% per year after inflation, That's extraordinary. So when you look at that likely reality versus where expectations are, you know there's just a massive, massive disconnect. And I think a lot of why some of these stocks have declined 70% in the last three months is because that disconnect is just coming back to reality. So that's like a lot of the reason why those stocks got so expensive in the first place is because you had literally tens of millions of investors who thought it was perfectly normal for a $100 billion company to be able to double its valuation in three months on no news. And so I think that's just a lot of unwind that's happening right now in a good,

healthy way. That's what's bringing us closer to reality. Yeah, I think it's so interesting to understand kind of the mindset of the narrative around companies and the way companies can get really hyped. And you saw, I mean, last year we had so many SPACs coming public and you would have these really high valuations on companies with no revenue and no product. So kind of understanding. I think that fall back to earth and making sure things are a little bit more rational maybe and a little bit more understandable of where these numbers are coming from and the expectations baked in. And so I'd be curious if you're thinking about businesses and business models. You talked about species evolve to get bigger over time. And as companies get bigger

and more powerful, they end up moving slower. So you have a T-Rex, which is big and powerful compared to a cockroach, which as a person who lives in New York can tell you they're very hard to get rid of. They're basically never going to die ever. So how do you think about that in space of investing in companies? And are there companies that you think that kind of fit the description of bigger but still nimble? Or do you think they have to stay small to be as adaptable? Here's what's really interesting. If you look at a very long period of time, the difference between value stocks and growth stocks is almost zero. You have periods like the last 10 years where growth stocks way outperform value stocks. But over the last 50

years, 70 years, there's really no difference. Those returns are almost identical. And so why would that be that a high growth company that is innovating and coming up with new products cannot beat over a very long period of time value companies that are just old world? You know, they're making like typewriters and bleach and stuff. Why is that the case? I think one explanation for that is that if you look at value stocks like a consumer staple stock, Clorox, It makes bleach and house cleaners and stuff like that, charcoal. They make the most boring products ever. And those are not exciting, high-growth products.

But there's something unique about them, which is that they don't need to be reinvented every year, like a lot of tech products do. And when they don't need to be reinvented every year, that's like the margins that come out of that, the cash flow that comes out of that can just be extraordinary. So that's the difference. That's really the difference between those. I think a lot of those companies that don't need to reinvent themselves every year, this is obvious. those companies tend to stick around for a very long period of time. And a lot of tech companies that are hugely valuable and relevant today will be completely irrelevant five or ten years from now. That was true for AOL, which was like the absolute mammoth dominant company in the late

1990s and became completely irrelevant not too long after that. So there's a lot of stories like that. And that's going to be the case today. I'm not going to venture which company this might be, But I guarantee you that one of the top 10 biggest companies in the world right now that is a household name will be irrelevant in 10 years. And I can say that with confidence because it's always been the case. There's never been a time when that's not been the case. And if you go back 10 years ago, the biggest, most dominant companies in the world were Citigroup, AIG, General Motors, General Electric.

That's 10 years ago. That's not that long ago. And that'll definitely be the case 10 years from now. I don't know what it's going to be. but what are the biggest companies today? Apple, Amazon, Google, Microsoft, Facebook, etc. One of those, again, this is not any indictment on any of those, because I have no idea which one it will be. And maybe it's not one of those in particular. But that's always the case, like companies that need to reinvent themselves. The act of reinventing yourself creates a lot of

hype and buzz and potential growth. But if you can't repeat that over and over and over again every single year, it eventually catches up to you. Yeah, I mean, even just in my lifetime of looking at the rise of MySpace, the fall of MySpace, the rise of Facebook, the fall of Facebook, the rise of Instagram, and now TikTok. You have even just from a consumer-facing mindset, but throughout all of that time, everyone was using Raid to kill cockroaches. And so it's kind of interesting to look at those different dynamics of those companies. Before I let you go, I just wanted to ask, what is a sector or an industry or some sort of companies that you're excited to watch and excited to see evolve over the next couple of years i'm i think i'm most most interested

in what happens with facebook in in particular facebook is one is i think has been and will continue to be for the next 10 years one of the most interesting business stories in case in terms of just like the perfect example of the compounding effects of networking over time where as more people used facebook it was more of an incentive for you to use it and if you used it your friends wanted to use it, and it just kept snowballing up. And now we're kind of seeing in the last couple of months that particularly for the Facebook app, not Instagram and others, but Facebook in particular, that growth has come to a halt, if not declining in some markets. And that compounding that is amazing on the way up might be just as powerful on the way down.

And the math is if you stop using Facebook, then there's no incentive for your friends to use it. And if your friends stop using it, then their friends aren't going to use it. And it's just the same math that blew everyone away on the way up might blow them away on the way down. Now, there's a long history of companies that have that dominant a market share and that many resources might figure out how to break that cycle. But it's been, I think, the most interesting business story of the last generation just because it's such a stark example of how quickly things can compound. And I think it'll be interesting to see if that compounding actually works its way out in the other direction over the next 10 years. Yeah, that'll be fascinating to watch.

I guess last question is, do you think in the next 10 years, anyone refers to it as meta before referring to it as Facebook? No, never. Just as no one will ever call it Alphabet. The only company that I think has rebranded to an extent that kind of stuck is Altria, which used to be Marlboro. Sorry, which used to be Philip Morris, which makes Marlboro. That's one of the only rebrands that actually stuck around. But most rebrands don't stick around. Once you come up with a brand name, it's going to stick around for a while. Yeah, no one in my family refers to anything.

I think it's Citi Field. It's still Shea Stadium. And I think that was changed many, many years ago. Same with Staples Centers in Los Angeles. No one's going to call it CryptoGut. Crypto.com, it's always going to be Staples Center. That's all for today. Reminder that the market is closed on Monday for President's Day.

So we are off until Tuesday. As always, people on the program may have interests 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 on Tuesday.