Motley Fool Money - Morgan Housel on Market History and Wild Minds

Episode Date: July 28, 2024

Every stock market valuation is a number from today multiplied by a story about tomorrow. Morgan Housel is the best-selling author of The Psychology of Money and Same as Ever. Robert Brokamp interviewed Housel at our member event FoolFest. This episode is a cut of their conversation. They discuss: - Why professional money managers often underperform the market. - The relationship between success and luck for investors. - Saving like a pessimist and investing like an optimist. - What spreadsheets can’t tell you about spending. - The benefit of losing money early in an investing journey. Companies/Tickers Mentioned: TSLA Host: Robert Brokamp Guest: Morgan Housel Producer: Ricky Mulvey Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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I've been an investor for 20 years. People here have been investing for a lot longer than that. But at every single point in the last 20 years, you could have made a very reasonable, plausible argument that we were on the cusp of a bubble, that things were unsustainable, that national debt was running out of control, that inflation was right around the corner. You could have made a very reasonable argument at every single one of those points. And over those 20 years, the S&P 500 is up fivefold. I'm Mary Long, and that's Morgan Housel, the best-selling author of the psychology of money and same as ever. Robert Brokamp recently caught up with Hausel in person at our member event, Foolfest. Today's show is a cut of that conversation. Bro and Howsell discuss

why novice investors can often beat Harvard MBAs, what it means to be a reasonable optimist, why visionary CEOs often have a dark side, and why there's always a case that the market is in a bubble. So one of the things you wrote about your book, in your book, and it's kind of the foundation of the book is that about a decade ago, you decided you're going to read more about history, read less about forecasts, and you said it was one of the most enlightening choices that you made. Tell us about that. Well, a lot of it just came from when my time as a motley full writer, just spending that much time with the financial media, whether it was CNBC or various blogs and whatnot, how bad the forecasting track record is. And it is abysmal. And I'm not talking

stock picking. I'm talking to people saying, oh, the next recession is going to start in June, or the stock market's going to go down 7% this year. That kind of forecasting, the track record over time for the last century, is as bad as you can possibly imagine. It's terrible, but we keep doing it over and over and over again. So I very quickly said, I don't want anything to do with that. If I'm going to write about finance, I do not want to do this thing that everyone else seems to gravitate towards that has such a terrible track record. But I always, as many of you are, just an amateur student of history. And what was always so interesting to me

about the history of economics and investing was, if you read about what happened in the Great Depression in the 1930s, or some of the depressions of the 1870s, people reacted exactly the same back then as they do today. The behaviors of the economy, how people respond to greed and fear and risk,

never change. It's been the same forever. And therefore, you can say, like, it's probably going to be the same in the future, too. if people responded to the financial crisis of 2008, the exact same way that they did the Great Depression in 1929, you know how they're going to respond to the next one whenever it might occur. So rather than doing the futile effort of saying,

when's the next bear market, when's the next recession, I just thought it was fun and interesting to say, well, how did people respond to it? Let's focus on that. And then whenever it comes, whenever it might come, you'll have a better understanding of what is timeless, rather than fooling yourself into thinking that you can predict the changes. So it's difficult to predict those changes, but yet we still have to make some predictions, right? Every investment, to a certain degree, I think this investment is going to be worth more than this other investment.

Whereas me as a financial planner, if I want to help someone look at their retirement planning, use a retirement calculator, I have to use some predictions about inflation, tax rates, what the stock market will return. So how do you do those types of predictions when you still have to make some sort of, sort of forecast. I think there's two ways to think about it. One is what I would call just a good enough forecast, which is, okay, so if you're thinking about recessions, rather than saying, like, oh, let's look at all the different variables in the economy and try to predict whether it's going to happen this year or next year, that's, nobody can do that. But if you said, look, historically, over the last century, there have been on average two recessions per decade,

one of which is usually pretty bad. And I expect that to be the case going forward. That's not a forecast. It's just like a baseline expectation of what you are likely to experience as a baseline. Maybe it's better, maybe it's worse than that. But as a good baseline, I think that's a good enough forecast. And so that's one way to think about it. The other is the idea that every stock market valuation is a number from today multiplied by a story about tomorrow. That's how you get every valuation, a number like earnings multiplied by a story of what the future might entail, good or bad. And I think if you think about it in those two buckets, the story about tomorrow is almost impossible for anyone to predict. And that's what makes forecasting what the stock market's

going to do so difficult. Because really what the story is, is like what kind of moods are people going to be in? Are they going to be optimistic? Are they going to be pessimistic? And if you phrased it as, look, if someone's on CNBC and they say, I think the stock market's going to go up 12% next year, that sounds reasonable. But if somebody came on and said, I think next decision, December, people are going to be in a 12% better mood than they are today. That's ridiculous, but that's what they're doing. And so I think when you are making a specific forecast, just breaking it up into buckets of what is knowable and what is clearly not. And if you're focusing on the number from today, the quality of the business, the quality of the management team,

whatnot, that's something worth paying attention to. The story about tomorrow is always going to be this nebulous factor that no one can really wrap their heads around. you talk about focusing on things that never change, but you do talk about in the book how sometimes things do change. And you have to keep an eye on that you highlight Sears, for example, that was a company that many of us remember from when we were younger, used to be on top of the world, and now it's just a shadow of itself. So how do you distinguish between looking at something and thinking,

okay, this might change versus something that, no, this is permanent, this is going to be a part of human nature for a really long time? Here's what's really interesting. Benjamin Graham, who was Warren Buffett's early mentor, he's like the godfather of value investing. And he taught Warren Buffett basically everything that he knows. He wrote the most famous investing book of all time called The Intelligent Investor, that he first published it in 1941 or thereabouts. And it still sells today hundreds of thousands of copies per year.

It's one of the best-selling investing books ever written. It's like the Bible of Value Investing. Benjamin Graham died in, I think, 1976. In the last interview that he gave, he was asked, whether he still agreed with a lot of what was put in the intelligent investor, and whether he still believed that picking individual stocks, as he laid out that you should do, was still viable. And he said, no, because the world had changed so much.

And that was in the 1970s. Like, what would he be saying today? Now, there's a lot of timeless wisdom in that book, which is why it's still worth reading. But what was so great about Graham is that he wasn't just an academic, although he was. He was a professor and one of the best, but he was actually a hedge fund manager as well. So he was very practical in what he was doing.

He was not just a theorist. And actually, I think there were six editions of the intelligent investor that were published. And every single edition, he updated the formulas that he recommend you use. So one of them would say, I'm making this up, but it would be something like, buy stocks for less than 1.5 times book value.

I'm making that. But it was a formula like that. And then in the next edition, he would say, that doesn't work anymore. Use this formula. And three years later, he would say, that doesn't work anymore. Use this one.

And so even though his book is rooted in timeless wisdom, he was practical enough to understand when the world changed. To such a degree that before he died, he said the foundation of his book wasn't even valid anymore. But I think that was why he was so successful. I think a lot of people get so wedded to their ideas and their identity is tied up in those ideas, that they become attached to a philosophy

that was very valid 10 or 20 years ago that isn't anymore because the world changed. And there are so many investing careers that get wrapped up in that. I think it's most common with value investors who, you know, there were periods in the 70s and 80s and 90s where it just worked so ridiculously well. If you just bought the cheapest basket of stock, you destroyed everybody. It was so good. And then the world changed. And it's not, you know, there are, of course, as a philosophy, you can still work.

But as a practical matter, it doesn't work nearly as well as it used to. So understanding what is timeless, which in my views are the behavior. and understand what changes, which is the technical details of the world. There's a great quote from Voltaire who said, history never repeats itself, but man always does. I think that applies to so much, to politics, to war, to investing. I think that's how I think about it. Benjamin Graham was famous for talking about a margin of safety,

mostly in terms of when you're picking a stock. And one of the quotes from your book, you mentioned that from Benjamin Graham was that the purpose of the margin of safety is to render the forecast unnecessary. But there's a personal margin of safety as well. And you quoted entrepreneur Naval Ravatnik is saying, in 1,000 parallel universes, you want to make sure you're wealthy in 99 of them. Tell us what you think that means and maybe what you've done personally to build that margin of safety into your life. I think it's impossible to know when you see someone who is very successful, like a billionaire,

how much of that was truly foresight, skill, and how much was luck? And there's a great quote from Daniel Connman, one of the greatest psychologist died not too long ago, where he said, without exception, the higher degree of success, the more that luck played a role. And it's not to say that luck played the only role, although sometimes that's the case,

but you never know what the balance is. Is it 10%, was it 50%, you have no idea. And then so when you're thinking about what to do in the future, particularly when you're looking up to, oh, how did Steve Jobs do it? How did Warren Buffett do it? Let's try to emulate what they did. Well, what can you emulate and what can you not? Buffett himself has said that, you know, most of his returns, not in dollar amount, but the percentage returns that he earned came from the 1950s to the 1970s. That's when he was literally earning like 80% per year for decades on end. And that's the bulk of his success came during this period. And he has said, that was just a very specific period in time. when the strategies that he was implementing, he was just picking up free money off the ground, but it's not like that anymore. So when you look at Buffett,

there's a lot that you can learn from him and say, I want to learn about his patience, his endurance, but I can't emulate the market conditions that he had in the 1950s. And he can't. And so it's just picking out, like, look, if you had a thousand parallel universes, what would you want to do to try to be at least decently successful in all of them,

rather than attaching to something that may have just been specific to a purest in time. Part of that gets to having a certain amount of humility about your own success, looking at other people, their circumstances, and maybe not being overconfident. You talk about overconfidence quite a bit in one of your podcasts. You said that you think one of the reasons that professional money managers underperform the market may be because of overconfidence. It tracks so many smart people, and they might be too smart for their own good. I think the line you used is that there's a fine line between intellectual rigor and believing your own bull. So which motleyful analyst do you think that describes the most? Just kidding,

although I have ideas. I think investing is one of the very few fields in life where the harder you try, it's likely the worst you will do. And there's so much evidence for that. But it's not like that in almost any other endeavor in life. If you want to be in good physical shape, you've got to work hard. You've got to sweat. And investing, there's just so much evidence that the people who do best are the ones who just leave it alone. It turned out the story is not true. This is apocryphal, but there was a great story. I wish it were true because it's so good.

And it probably would be true if they actually did it, that Fidelity ran a study, and they learned that the people who earn the highest returns of their client base were the ones who were dead. Because they stopped trading in and out. It's not a recommendation. We want you to stay alive. And look, it turned out, and I, and I, I think I told that story at a Molly Fool event a decade ago, and at the time I thought it was true. It turned out it's apocopal, but it probably would be true if they ran it, where the people who are just not pulling the levers or leaving it alone and letting it go earn the highest returns.

Here's one example of that. The Dow Jones Industrial Average is 30 stocks, but stocks come and go out of that. There's a committee that kicks this stock out, brings this one in. Jeremy Siegel, who's a professor at Wharton, he did this study years ago where he said, what if there were no committee? selecting what gets kicked out and what gets brought in. What would that hypothetical Dow that was truly just set in 1950 and they left alone? It's like two percentage points higher returns. So even in like a passive index, there's still activity.

But if you look at what would happen if there were no activity, it's better. And there are so many cases in the Dow where they kick out a company just before it's about to explode. And they bring in a company just before it's about to fall 80%. And so it's just there's so many examples. of this in investing where the less effort you put in, the better you do. And that's why investing is one of the only industries where you have novices with no financial background,

no experience, that beat the pants off of the best Harvard-trained MBAs who work at Goldman Sachs. Because when you have a PhD in physics and you go work at a hedge fund, you can't show up to the office every morning and say, I'm not going to make any changes today. You have to put your big brain to work. And so you see this.

this with individual investors too, where, and I'm sure there are people in this room, but historically there have been studies that show this, the individual investors who perform the worst, some people in this room aren't going to like this, doctors and engineers. Because those are the people who assume, and it's very natural and innocent to assume, that if you are very smart in one domain, that that will transfer over into other domains. And so you use your intelligence to try to come up with a better trading formula that almost always backfires. So I have to ask, you know, Borgon's dad is a doctor, very, very, very important.

impressive story. Went to med school later in life. Is your dad a good investor? I'm not going to tell them what you say. So my parents have dollar cost average into index funds for 40 years and never sold anything. Okay. Okay. Glad to hear that. All right. So there was a chapter in your book about how calm plants the seeds of crazy. And I've been trying to think, are we in a period of calm or crazy? So the economy is doing fine. We've had a couple of good years in the stock market. 2022 was not great at all. But really, over the span of the last 10 to 15 years, we've been pretty lucky. So maybe it's calm. But it could be creeping and crazy, especially when you factor in politics, which does affect the economy, but often not in the ways you would predict.

So what do you think? Are we calm, getting crazy? Where would you put us right now? I think it's only obvious in hindsight. I've been investor for 20 years. People here have been investing for a lot longer than that. But at every single point in the last 20 years, you could have made a very reasonable, plausible argument that we were on the cusp of a bubble, that things were unsustainable, that national

debt was running out of control, that inflation was right around the corner. You could have made a very reasonable argument at every single one of those points. And over those 20 years, the S&P 500 is up fivefold. And I think that is the course, that's the normal course of history, that over a long period of time, in any given moment, you can say, this is completely unsustainable. here are the 20 things I'm worried about. And you're all right about those things. And over a 10 or 20 year period,

despite all of that, you still end up doing phenomenal. I think that's the entire history of messy. So where it would be today? I truly think it's only obvious in hindsight. The U.S. housing market fit every characteristic of a bubble by 2002. And it kept on going for another six years. The first time Alan Greenspan used a phrase

irrational exuberance was I think 1994, and the market went up for another six years. So even when it looks crazy, it doesn't mean that things are going to change tomorrow. So you could look at things today about what's happening in venture capital, what's happening with crypto, what's happening with AI, and say, look, this checks every box of a crazy bubble. But that would have been true. That doesn't give any indication of what's going to happen even over the next five years. I would say, look, there's always a weird thing, too, where people say, oh, the market's been so good and so calm for the last couple of years. Really?

The market fell 22 percent in 2022. In 2020, it fell almost 50 percent. For in the first couple months of 2020, by almost any metric, the economy was way worse off than it was in the Great Depression. So if those are, if that's the calm market that people are used to, it's actually been pretty crazy for the last five years. Let's talk a little bit about finding the right balance between optimism and if not pessimism, realism. So the dedication for your book was for the reasonable optimists, which I kind of felt left out. because I'm an awfulizer. I'm always in the back of my mind, like,

what's the worst case scenario? I think that comes part of being a certified financial plan. We're always thinking about risks. Tom, Gardner, yesterday talked about the book and motto of Andy Grove, co-founder of Intel. Only the paranoid survive. And in your book, you highlighted a theory from a couple of psychologists called Depressive Realism,

which found that depressed people actually often are the most accurate people because they have a good appreciation for how fragile things are. So what is that balance between optimism and whatever else you want to call the other thing? There's a good story. It's very well known now. It's called the Stockdale Paradox, which was the highest ranking POW in Vietnam was a guy named Jim Stockdale. He was an admiral in the Navy, and he was a POW for several years. And when he got out, he was giving an interview, and he said,

do you know who did the worst psychologically as a POW? He said it was the optimist, because the optimist would say, when they were prisoners, they would say, we're going home by Christmas. And then Christmas would come and go, and they would be despondent. They just couldn't handle it. And he said, the people who did the best, he didn't use this phrase, but he described it as what I would consider the reasonable optimist, which was the POWs who said, we're definitely going home someday. You're going to see your wife and kids someday. This war is going to end, but we are not going home by Christmas. No way that's going to happen. Those are ones who did the best. They were very optimistic about

where they were going and very realistic about how hard it was going to be to get there. and obviously the stakes are much lower, but I think that's the same in investing. Very optimistic in where you're going and very realistic about how hard it's going to be to get there. And I think it's hard for people to distinguish between those two. In every recession, every bare market, it seems reasonable to say the market or the economy is broken. It's worked up until now and it doesn't work anymore. That's the general feeling every single time you have one of these. It's much harder to contextualize.

Like, no, this is a perfectly run-of-the-mill average thing to experience. on a very prosperous long-term journey. It's hard to do that. A lot of times in every recession, too, it seems like we're never going to get out of this. 2009, it was, look, the banking crisis might be the end of capitalism. 2020, it was, well, who knows what COVID's going to do next? It always seems like it's never going to end.

And truthly told, there have been countries that really never escaped their economic downturns. So it can happen to countries, but it's always hard to distinguish those two between, I'm very optimistic on this time period and pretty pessimistic in this time period. One way I phrased it is, save your money like a pessimist and invest your money like an optimist. If you save like a pessimist, you can be prepared for whatever it gets thrown at you.

But if you're investing like an optimist, you can stick around long enough to actually take advantage of whatever's to come. I think it's one of the tragedies of history that when you look at the life of James Stockdale, what people mostly remember is that he was Ross Pro's vice presidential candidate. And he didn't do so well in the debate. He only found out like the week ahead of time he was going to be in there. and that's what people often remember him for. But he was such an impressive figure. In prison for seven and a half years,

tortured, his legs broken twice, big into stoicism. I feel like, I've heard you reference Ryan Holliday, who's an author, talks a lot about stoicism. Have you been jumping on the stoicism bandwagon at all? I mean, the philosophies are great.

They're obviously similar to quoting Warren Buffett in investing. It's much easier to say it than it is to do it. So a lot of people are very interested in stoicism, because it seems like such a great, and it would be such a great philosophy, but it's much harder to do it in real time. I asked Ryan Holliday, who's an author, he's kind of the current Stoic writer. He spent his whole career writing about the Stoics.

And I said, do you think the Stoics were happy people? And he said, no, of course not. They weren't happy at all. And I think this gets back to depressive realism. I think they were very realistic about how fragile life could be. I mean, some of the Stoic philosophies are terrible to think about. They used to visualize their children dying so they could be prepared for it when it actually happened. A lot of these things you don't want it is not a happy life.

We're not recommending that either. We're not recommending this. But they were very realistic about how fragile life could be. So when I think about that, would I rather be that or blissfully unaware? It's probably somewhere in between about, you know, very cognizant of how fragile the world can be. But I think they were bored. They wanted to be depressed about how fragile the world was. Since you talked about happiness, I'm going to read what I think is one of my favorite quotes from your book.

was money buys happiness in the same way drugs bring pleasure. Incredible if done right, dangerous if used to mask a weakness, and disastrous when no amount is enough. So what drugs do you recommend? Because that incredible part, I'll try the incredible. Just kidding, I don't do drugs. But to that point, there's a great quote from Taleb who says, the world is split evenly between people who don't know how to start spending money

and people who don't know when to stop spending money. And so it's all just a balance of how much is too much and how much is not. There's no formula for that. But you see it a lot with people who have just entering retirement, who have saved up a really nice nest egg, and they can afford to reasonably spend a decent amount of money, and they can't do it because their identity, their financial identity, is I'm a saver.

The number will only go up. And the idea of drawing down their account is so antithetical. to everything they've ever done their entire life, that they can't do it. And I think that is the Talba quote. That's similar to a lot of things in life. Like, really, it's really difficult to find the balance between what is too much and what is not enough.

And there's no formula for that. Everyone in finance wants to go to their advisor and say, like, just show me the spread. Show me the formula. And some people might be able to do that, but I think this is all psychology. It's not something you can figure out on the spreadsheet. One of the best books that I've read over the past years,

besides yours, of course, Morgan. was a book called The Comfort Crisis by Michael Eastern. It was basically about how we as humans have really evolved to thrive under challenges. Like, we're not meant to sit on our couch and watch TV and just eat cheeotos all day. Like, we thrive physically and intellectually by engaging in something that might be hard. And you wrote in your book about the value of sometimes embracing the pain of something you have to do. One of the most fascinating stories that I've read in recent times, it was this little girl.

At the time her story came out, I think she was 10 or something like that. Her name was Gabby Gringis. And she was born with an incredibly rare genetic condition in which she was incapable of feeling pain at all. She had perfect touch. She could feel things, but she had no sense of pain whatsoever. And when you read that story at first, you think, that's like a superpower.

That's amazing. It must have been incredible. Her life was an absolute disaster because she never learned what not to do. So it's so tragic. She would put her hand on hot stoves. She chewed through her tongue. There's all these, her life.

It starts off thinking that would be amazing. She never feels pain. It's the worst life you could possibly imagine. And so I think for that for a lot of things, for business, for economies, the pain is what keeps everybody in an appropriate amount of check. It's actually like a really good thing

that once in a while you do something and say, oh, okay, I should have done that. And I think it's true in investing as well. I think so many young people, teenagers started investing in 2021, which was this unique time, the meme stock economy where you had all these 19-year-olds who thought it was completely normal to double your money every six weeks in options. And that became like their baseline measure of success. It's like how quickly can you double your money per month? And I think if there's one upside to that,

now that that is unwound and a lot of those people lost literally all their money, it's better to learn about risk when you're 19 than it is when you're 48 and trying to put your kids through college or something like that. If there's any, if you want a good path in investing, you want to start off learning about risk very quickly. And when it seems counterintuitive,

but the people who start their investing journey at the beginning of a bull market are probably going to end up with some of the worst lifetime returns because it increases your confidence more than your ability. And so dealing with that downside, hopefully early. It seems like weird. Why would you want that? But I actually think it's a very healthy thing to go through. We talk a lot about here at the Motley Fool. And when you're evaluating

a company evaluating leadership, you had a chapter in your book titled The Wild Minds, in the sense that some people who are abnormally successful are also kind of abnormal. So how do you tell the difference between like a good crazy and just crazy? I don't think so the most obvious example of this is Elon Musk. In particular, I might have thought about bringing that guy out. And I'm a Tesla shareholder. In the last couple of years, people say, I don't like his politics, I don't like how he speaks,

he's rude on. Of course he doesn't follow the rules of corporate decorum. He tried to go to Mars when he was 30. He took on General Motors. He took on NASA and succeeded. Of course he doesn't think the rules apply to him. You can't say, I want you to think out of the box and be a crazy out-of-the-box thinker

and also be a very nice, appropriate, polite person. it just usually doesn't happen that way. I think the closest that we've come to a crazy out-of-the-box thinker who also looked and dressed like a normal CEO is Bill Gates. But so many of the other, Steve Jobs, like visionary of a generation and also a monster of a boss who you would never want to work for. And Walter Isaacson, in his biography, talked about the Steve Jobs reality force-fueled, I think he called it, where Steve Jobs just didn't think any rules of the world applied to him.

And there was a part of that that we all benefit from. We all get the great technology that he created because he didn't think any of the rules applied to him. The other side was he was a jerk. Nobody wanted. He was just a terrible person to work for. He was rude to everyone. He was inconsiderate.

And I think you have to accept both of those as the same person. You can't say I like this side and I don't like that side. The part that made him crazy good also came with this crazy bat and you have to accept that as a full package. So it's like that with almost every vision. visionary CEO, visionary entrepreneur. There's going to be sides about them that you don't like or that you find inconsiderate, whatever it might be. That's part of the full package of what also makes them great. 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 Mary Long. Thanks for listening. We'll see you tomorrow.