Motley Fool Money - 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

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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. I'm Chris Hill and that's Morgan Housel, author of the international bestselling book, The Psychology of Money.

When I interviewed Housel in front of a live audience, we talked about investing through bare 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, 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 anger 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 it 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? Well, I think it's 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 underreporting 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 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 in what. people get so uptight about it.

Let me tee 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 $100 each way, in and out. So the barrier to entry, to make a decision was higher. You thought twice, but 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 headline seems 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 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 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 years when there was a subset of tech stocks that were just going bananas and doing so well. 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 really, realize, 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 Heibner. 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 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 gold star until you've had your, it's like, it's great to 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 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 a skill.

You thought that you're investing returns were because of your intelligence. and your skill, and then the tide goes out, and your eyes is 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 bare market and thought, oh, this is fine. It's, you know, bear markets don't last that long. I think it's next to not. I mean, but if you look at just Robin Hood, which was predominantly going after young men age 18 to 25,

that's their by far and away their core thing. 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 the 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. It's not get you to invest for the long-term in good companies which is just get you to keep pulling the lever. And that worked amazing for about a year. I remember in late 2020, someone came to me, 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. I remember being like, hey, all right. And we know what's happened to all those people in the last six or nine months. The tide

went out, so to speak. And you know, just from watching Robin Hood results, like, it's not, 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 will 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.

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 was 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 sorry, when a 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 dollar 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. I'm pretty sure. I'm not being not 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. So, 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 C.E. from other industries where like Elon Musk got $20 billion, that's now my baseline to do it. 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 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 Knox 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 worst shareholder returns ultimately. are after that. And I think the reason, really simply, it's 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 follow 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. 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 of that that particularly in the in Early stage companies venture capital where it's like it's not supposed to work like if a venture capital fund invests in a hundred businesses You know your baseline expectation is that at least half of them are gonna be bent are gonna be out of business within two years That's the baseline expectation so of course success is always very rich 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. 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, you know, the truly transcendent companies, you know, are telling

a story that is different. They're doing things in a different way. And on the flip side, there are, I mean, we can't count the number of businesses that have either said about themselves or others have said about them, you know, this is the next Apple. Yeah. 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. 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 leaders of the people, 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 and 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 had been written about him. They all go into so much detail about how Buffett thinks about MOTS 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, 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 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. 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. It's, 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. It's going to make it better. I think it's similar in investing.

And that's the part that I think's overlooked about what he's done. We 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, but... 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 100 years ago that they'll be doing 100 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 1932, 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 is, that's what I'm 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 ourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.