Motley Fool Money - Making Cash vs Preserving Money

Episode Date: May 14, 2023

If you like to tinker with your investments, then it’s tough to beat the market over a long period of time. John M. Jennings is the president of St. Louis Trust & Family Office, a Professor at Washington University’s Olin Business School, and the author of “The Uncertainty Solution: How to Invest with Confidence in the Face of the Unknown.” Deidre Woollard caught up with Jennings to discuss: - Why the improbable happens all the time - 1 key attribute that some of the best-performing stocks have in common - And the business advantage that “fast followers” have over pioneers    Companies mentioned: SCHW, TJX, APPL, HUM, SHW Host: Deidre Woollard Guest: John M. Jennings Producer: Ricky Mulvey Engineers: Dan Boyd, Heather Horton Learn more about your ad choices. Visit megaphone.fm/adchoices

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If you're 45 or older and at average risk, ask your health care provider about the Coligard test. Colagard is available by prescription only. Learn more or request a prescription today at colagard.com slash screen. You know, I think that's a goal for a lot of people. They'd love to vault into the tens of millions or hundreds of millions of dollars of wealth. And what we've observed, and I've done some research on this as well, is really to get that much money, you know, you're not going to get there typically by just having a little bit of

money, you know, 10 grand or 50 grand and investing it in the stock market. The way people get that much money, you know, within a few decades of a career is, you know, With almost no exception, they are owners of a business. I'm Mary Long, and that's John M. Jennings, president of a wealth management firm that specializes in serving high net worth individuals. He's also the author of the new book, The Uncertainty Solution, How to Invest with Confidence in the Face of the Unknown. Earlier this month, Deirdre Willard caught up with Jennings to discuss why one in a million happens more often than you may think, and the difficulty of investing in trends. Quick note, this conversation was recorded on Friday, May 5th.

I love this book because you talk about uncertainty in this way that I think is really important for people to understand. And just to start off with one of the, you give mental models throughout the book, which is really helpful. You talk about accepting that the highly improbable happens all the time. I don't think most of us think of the improbable as happening every day. But if we accept that, how do you prepare your portfolio and really yourself? to handle that? Well, I'll tell you, it makes life maybe a little less fun. Because sometimes when we get coincidences, it's fun to think that, oh, wow, you know,

there really is this, you know, meaning to the world and life, you know, so for instance, like yesterday, so like I mentioned, I'm down here in Miami. Yesterday I was on, I was being interviewed on a radio program in PR up in Grand Rapids, Michigan. And then like two hours later, we're at this event for Formula One. And who do I meet? but somebody from Grand Rapids, Michigan, right? So, you know, like there's 200,000 people that live in Grand Rapids. And here I meet to somebody from Grand Rapids. And I could go, oh, wow, like, that is just,

you know, amazing. Maybe this person should have, you know, I should keep in contact with them. And we should, you know, become like email pen pals or something. But the thing to remember is that, you know, there's so many things that happen day to day and week to week that it would be surprising if things like that didn't happen. There's something I write about in my book called Littlewood's Law of Miracles, where this economist said, you know, if a miracle is a one in a million chance or one in a million occurrence, and he said we have about 30,000 things that we observe or experience every day.

So if you do the math, it means you're going to have a miracle about once a month. So, you know, 30,000 times, you know, about 30 days, it gets you close to a million. And so it would be really surprising if we didn't have these things happen. And the way to look at this from an investment standpoint is to realize that there's going to be things that we don't predict. Like I didn't predict. I'd meet somebody from Grand Rapids right after I got off a radio show from Grand Rapids, right? So there's going to be all sorts of things that are going to happen that just seemingly come out of the blue. Like, we're going to have, you know, boats stuck in, you know, important shipping canals, right?

We're going to have, you know, pandemics and terrorist attacks and wars and, you know, bank failures out of the blue. You know, we thought that the banking system, you know, after the financial crisis was good to go. We had all these stress tests. And, you know, it turns out that, you know, we have this hopefully mini banking crisis that's happened. And, you know, I don't think anybody saw it coming. So thinking about all of these inputs, you describe the, you describe the, the stock market in your book as a complex adaptive system. What does that mean?

And why does that make it so hard to figure out? I mean, as you talk about the book, economists get it wrong a lot. And right now, with everyone predicting the recession, economists seem to be getting it wrong, even more than usual. I know. So yeah, this morning we got some information about, you know, another strong month in terms of, you know, jobs created. So yeah, it seems like this recession, at least from the employment,

side of things is yet to materialize, right? Yeah, what a complex adaptive system means is that you have a lot of inputs and you cannot determine with specificity what the output is going to be. And that's because you have the actors in the system are heterogeneous agents, as they're called, and they're intelligent, and they can change their behavior and they learn from watching each other, they learn from the change in external environment and they create feedback loops. An example I talk about in my book that we all experienced just a few years ago was toilet paper hoarding in the pandemic. Right. So it was the situation, if you all remember, you'd go to Walmart or Target or your drugstore, grocery store.

And there would be no rolls of toilet paper, no package of toilet paper. And who knows why it was toilet paper that everybody started hoarding, right? So if somebody had said, oh, we're going to have this pandemic and things are going to shut down, what do you think is going to be hoarded? I would have said, you know, jugs of water or cans of beans, or I don't know, beer or, you know, wine, whatever. Like, there'd be something other than toilet paper. But once it started, it was completely rational on an individual basis to buy as much toilet paper as you could, right? So early on in the pandemic, it was about early April. I go to Walgreens to pick up a prescription. and there on the shelf was one package of toilet paper.

I couldn't believe it because every place was out of toilet paper. You tried to order on Amazon or boxed or whatever and it's like, okay, we'll get, you know, four month of delivery, right? So I bought it, even though we had plenty of toilet paper at home. And I remember I told the clerk when I was checking out. I was like, I'm so sorry. I'm being part of the problem instead of part of the solution, right? And she was just like looking at me like just like move on.

Don't, you know, like don't infect me with your COVID discussing, you know, like, complex adaptive systems. But it was completely rational once it started for everybody to buy toilet paper. But it created this system-wide effect that was bonkers. And this happens over and over again in complex social systems where, you know, because everybody's watching everybody, watch everybody else, we can't predict what the outcome is going to be. I mean, we've seen it, you know, with meme stocks. And, you know, we see it with the run up of, you know, different cryptocurrencies. It's, you know, you know, dojo coin, which was really, and probably still is a joke, you know, Elon Musk tweets about it. And people are like, oh, I think if Elon

must tweets about it, other people think it's valuable, so I'm going to buy it. And then when it goes up, it creates this feedback loop and more and more people buy it. We see it with, you know, gold and other commodities. It just happens over and over again. And, you know, the more complex to social system, the more inputs, the more actors, like an economy that has hundreds of millions of people, or global economy, which is billions of people, the less ability there is to predict what's going to happen. So this is why it's so hard to predict what's going to happen in the economy or in the stock market. It makes me wonder sometimes why we even bother to predict, but there is sort of a psychological safety idea of someone telling you what they think is going

to happen. It feels better than we have no idea what's going to happen. It absolutely does. And, you know, the premise of my book is that humans don't like uncertainty. I mean, we like a little bit. Like, that's why we like to, you know, some people like to gamble. We don't want to know the ending, you know, a novel or a movie because we get a little hit of dopamine and we feel good when uncertainty is resolved. But in general, we don't like uncertainty. It makes us feel anxious and worried.

And it's really a primary human motive. We've evolved to become these organisms that like to recognize patterns. and when we can't see a pattern, we feel antsy and worried and anxious. And one of the things that happens is if you talk to a confident expert that tells you what's going to happen in the future, to some extent, we feel like our uncertainty has been resolved. And so even if the expert isn't very good at predicting or they're wrong, we still got that hit of dopamine. And because we want to know, and we're flailing around sometimes for explanations or seeking patterns,

you know, we will continue to click on those expert opinions. And even with all my research in this area, I've written a book on this. I still find myself succumbing sometimes when I see a headline. I just saw one this morning, you know, where a bond guru was, you know, predicting, you know, what the 10-year treasury was going to be by the end of the year. And I read the headline and I almost clicked on it because I was like, oh, I want to know the shape of interest rates. You know, what's going to happen, right? I wanted to talk about something at the book that you talked about, which is,

The idea that making money and preserving money are totally different ways of thinking. And I'm wondering if you're at the stage where you're both accumulating wealth and you're trying to invest wealth, how do you hold both of the mindsets in your head at the same time? And how are they different? I was talking about really building great wealth. So our firm, we mainly work with families with $50 million and up. Our average client family has about $200-something million. Our median is more like $160.

But we're mainly, you know, working with extremely wealthy families. And, you know, I think that's a goal for a lot of people. They'd love to vault into the tens of millions or hundreds of millions of dollars of wealth. And what we've observed and I've done some research on this as well is really to get that much money, you know, you're not going to get there typically by just having a little bit of money, you know, 10 grand or 50 grand and investing it in the stock market. The way people get that much money, you know, within a few decades of a career is, with almost no exception, they are owners of a business. Either when they founded themselves or their family founded, or they were maybe in a top executive, maybe CEO in a publicly traded company. So what this means is, is that they're concentrated, so they're not diversified.

They're taking on a lot of risk. they typically put all their time and effort into it. They're obsessed, like it becomes their life to build these businesses, and they get lucky. What I love to ask is, you know, clients of ours, when they sell their companies for tens or hundreds or hundreds of millions of dollars, you know, to what do you attribute your success? And the most common answers are, I surrounded myself with great people and didn't get in their way. And number two, I got lucky, right? So that's typically how you generate, you know, great wealth.

Then there's this idea of preserving wealth, which also means growing it. Like, absolutely. It doesn't mean, oh, I'm just going to sit here. You know, I have my $100 million and I don't want it to grow. But in order to not lose it now, because remember, you know, the vast majority of companies don't make it to their 10th birthday, right? So in order to avoid losing it, you need to do things that are opposite. So instead of being concentrated, you're diversified,

Instead of being high risk, you're lower risk. Instead of you being personally involved, you're typically a passive investor, right? Which means, you know, you're investing in somebody else's company, right? So you don't have much of a say or sometimes any say over what these other businesses are doing. And often it's, you know, public stocks. And then finally, you know, definitely luck plays a role, but, you know, you're putting in a process and a discipline that is trying to smooth out the effects of luck. So it's this other mindset. And the other part of your question is, can you do both at the same time?

And absolutely. And what we talked with our clients about is, you know, once they've made all this money, you know, which bucket do you want to be on? How much of your investment assets or your wealth do you want to be trying to create more great wealth versus preserve and smartly grow? And again, smartly grow. Like if you just get a 7.2% return, it doubles every 10 years. So it's not like you can't do really well in a diversifying.

portfolio, but, you know, I think it's important to understand which category you're going to be in. And understanding in the category of creating great wealth is incredibly hard. Again, there's a big dose of luck. It's very risky. And, you know, we tell our clients, once they've done that, you know, they probably shouldn't put 100% back in there, you know, some smaller percent back into this bucket of, you know, trying to create great wealth again out of a smaller amount. That kind of brings me to the next sort of paradox, which is this idea of, you know, if you're building your own strategy, you know you have to hold on in a tough market. You know you have to trust your plan. But at the same time, how do you know if maybe you're not too overconfident? You talk a lot in the book about overconfidence, getting the best of you. How do you kind of balance that idea of trusting yourself, but not trusting yourself maybe too much? We all react emotionally, even if we don't think we are. We think we're rational, but we react emotionally.

We've all heard about all these behavioral biases that we have. And we're all overconfident. And I think that's so important. Like because of our overconfidence, we think other people are overconfident and we're not as overconfident, right? Which is an aspect of being overconfident. And part of being overconfident is not having the humility to understand that you don't really know more than other people or maybe even most people when it comes to investing. And if you're somebody that knows a lot, realizing that maybe a lot of what you know isn't helpful

when it comes to investing because the markets and the economy are complex adaptive system, and it's hard to predict. So I think it's key for us all to admit that we're overconfident. And really behavior, practicing good behavior is the most important aspect of successful investing. And what I write about in our book and what we do for our clients is really set up behavioral guardrails and, you know, in advance, and this is where you have like your investment policy statement and maybe even a statement of investment beliefs and you practice good behavior. And a lot of that is really simple but not easy to follow, right? So it's things like being inactive instead of active. It's things like focusing on being simple in your investing instead of

more complex. It's following these simple algorithms of a strategic asset allocation. And as I'm saying these things, listeners are probably going, oh my God, that's like the most boring thing I have ever heard. And really successful investing should mostly be boring. If you're doing something that is exciting or sounds great, you know, in our experience, most of the time that doesn't turn out well, right? And if you just look at over the last 20 years, some of the high highest performing stocks. I mean, Apple's like number one, but like Humana is in the top five, as is Sherwin Williams. And in the top 10 is T.J. Max. And, you know, so like there's all these great investments out there that aren't the sexy fun, you know, investments. And you're going to

get those by doing boring things like being really diversified, maybe even indexing a lot, right? So that's really a big key to successful investing is really just doing things simple and kind of being boring. But part of that is outsmarting your mind. The desire to tinker, I think we all have it. You talked to the book about simple rules to save ourselves. What do you do? Are there ways to sort of kind of stop that tinkering? Because inactive sometimes doesn't feel good. We feel the need, especially. if the market's down, we feel they need to do something, anything. Right. Yeah.

So what we found is like the desire to tinker for a lot of people is basically irresistible. And I'll tell you, I'm right there. So in writing my book, I went back, I looked at like my Schwab accounts where I can do whatever I want versus my 401k account at Vanguard. And my 401K accounts in four mutual funds. And it probably doesn't even need to be that many. But it's a bond fund, like a large cap domestic, small cap domestic, and a total international. right and I never look at it it rebalances automatically there's no reason to look at it so I went back and

looked at the returns and you know they were really you know quite solid and then I looked at how I've done and you know I was outperformed by my 401k and and I'm pretty good you know mainly you know passive I do what's known as you know factor weighted indexes you know mainly but I also tinker you know I found you know I'd get impatient and I'd sell out of some things or sometimes I buy individual stocks And so what we found is a good thing to do. And we suggest this to our clients that have a propensity to tinker and I've been doing with myself for a while is to create a play account where you can say, I'm going to give myself an amount of money.

You know, it's not going to be a huge part of my portfolio. Maybe it's 1%, 5%, 10%, whatever it is. But here's where I'm going to do my tinkering. And so, for example, with this, you know, again, hopefully it's a mini banking crisis, you know, back in March when the weekend that Silicon Valley Bank and signature, your bank failed. You know, that Monday, you know, Schwab was way down because they have a big bank. There's concerns about Schwab. And, you know, we, they're our primary custodian. We know Schwab well. I'm like, I know Schwab well. And I think they're going to come through this with flying colors.

So I bought it when it was way down. It was like, you know, like 52 bucks a share. And over the next few days, it went to like 58, 59. And I was like, oh my gosh. Like, I'm so smart. This is so great. And then it dropped back down to 50, then 52 and 50, 54. And then this week, it's like dropped to like $46 a share. And I'm like, oh my gosh, what do I do? Like, do I double down? Because I know with loss aversion, we actually become risk seeking instead of locking a loss. Do I double down?

Do I like buy more Schwab? Because if I liked it at 52, I must really like it at, you know, $47 a share. Or do I sell and say, you know, I'm just going to take the loss? Or do I say, wow, what am I doing? I am a long-term investor. I believe in Schwab long term. I'm going to stop looking at it, which is what I've decided to do. But you can see, I've written this book on all this great investment behavior and uncertainty and everything, and I still succumb to tinkering. But I know that about myself. I bought this

tiny bit of Schwab in my little play account. So I think that's a great practice for people that like to tinker. And then it's, at least for me and others that I know and looking at a lot of our clients that do this, it's humbling then to see over time how your play account with all your great ideas and your overconfidence and your smarts and your biases, how does that do versus your hopefully more simple, more diversified, more disciplined portfolio? At least in my experience for me and almost all of our clients, not well. That is my experience as well. I have a play account with some weird things that I think might happen, like, you know, flying taxis and things like that, but, you know, I'm not putting a lot of money on that, which kind of, you know, I want

to talk about AI a little bit. I know everybody talks about it, but you've got this chapter in your book. It's titled, The Trend is Not Your Friend. I feel like that's a message of people need to hear right now because everyone I know seems to be looking for how do I play AI, what do I do? Where do I go? Is it, you know, how do I make money on this? Because I'm sure there's money somewhere. I just got to find it. And really, the genesis of this chapter on trends, really it was presentations that I started giving to our client families, you know, years and years ago and then started doing an investment conferences because we'd have clients that would come to us, things like AI or, you know,

cybersecurity or genomics, you know, it's like, okay, we've mapped the genome, you know, or, you know, CRISPR, and, you know, I want to take advantage of that. I think that, you know, makes sense. You see something, you think it's a trend. You think it's going to persist and you say, how can we make money? off of it. And so really in this chapter, I hit three of the primary challenges with trends. There's more than three. But the three I hit on are it's hard to spot a trend early is number one. And that's often because, you know, really trends that make, you know, a huge impact on our lives

and business and other companies grow exponentially. And we don't really appreciate exponential growth. And we're seeing that with Chad GPT. Man, they went from, you know, the fastest of any technology in history to a million users. it took five days, right? So there's all these other things that took, you know, months and years to get to a million users. They had a million users in five days and hit 100 million users in two months. It was just, you know, unbelievable.

And that's just one, you know, AI application. So another is that, you know, once you see a trend, you don't really know how it's going to turn out and it can shift and it can change. So we don't know exactly what's going to happen with AI. But I think the most important one with respect to evaluating AI right now is the section I call it's difficult to spot a successful needle in a haystack of investors, right? And, you know, a key thing to remember is that Google was the 21st search engine. Wow, right?

So, you know, back of the day, what you do is you do a search on Alta Vista or Ask Jeeves or Dogpile or Ink Tomi or, you know, MSN search, which later became being in. Like, you'd do all these different searches because they weren't all that great. So you would do them in different things. And then along comes, you know, Google. And this has happened over and over again. There's actually a term for it, you know, early movers versus fast followers. And there was a study out of USC's business school that found that, you know, the average fast follower is really like 10, 13 years after, you know, when the pioneer went into business. But, you know, looking long term, you know, market pioneers are the early movers long term have a much higher failure rate, like,

nearly a 50% failure rate long term. And long term only have a 7% market share. Whereas the fast followers have this much lower failure rate and tend to have 40 plus percent of market share later on. So, I mean, I think that's an incredibly important mental model. To say, you know, in an early industry, there's all this creative destruction. You don't know exactly who the winner is going to be.

And it happens over and over in the automobile industry in the first 20 years of the 20th century. 775 automobile companies went into business in the U.S. and 600 went out of business. And there's only seven brands that are car brands that are in existence today that existed prior to 1920. And there have been over 500 television manufacturers. And now 10 provide 75% of all televisions in the world. And you look at smartphones. There's been hundreds of smartphones manufacturers.

Now just two, Apple and Samsung, have nearly an 80% market share in the U.S. So, again, this is what happens. You have all these companies and everybody's competing. And even if you get the trend right, yes, AI is going to be huge and people are going to find ways to make a ton of money off of it. It's really hard to know who the winner is going to be. And so the best thing to do is not try to pick these companies yourself. I mean, there's a few things to realize. You can use a specialist fund or ETF.

And again, that's risky. So you, you know, like if you wanted to do, you know, electric vehicles, which it seems to be a, you know, a burgeoning trend. I drive one myself. They're amazing to drive. But anyway, you could buy an ETF, right? Or you can buy a genomics ETF. And I'm sure I don't know if there's probably AI ETFs. You can do that.

Or you can find a specialist fund where there's actually humans saying, here's what we know and we're going to, we're going to buy. You could, if you have enough money, getting into venture capital, some of those funds are going to be able to do those things. things. Or if you just have a diversified portfolio, just realize that all these big companies, that are publicly traded companies, are looking to take advantage of trends and often buy competitors, these young startup upstarts. So, I mean, if you think about it, like Microsoft is a huge investor into OpenAI, which is, you know, the company that has Chat GPT and Dali, which is the art one. And even now if you start using Bing, we'll see how Bing does versus Google. It's using ChatGPT. in, you know, somewhat in Bing searches.

So you have all these companies that are investing in AI that you already own in your portfolio, even if you own an index fund. 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 stocks based solely on what you hear. I'm Mary Long.

Thanks for listening. We'll see you tomorrow.