We Study Billionaires - The Investor’s Podcast Network - TIP226: Billionaire Charles Koch Lessons Learned (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we cover the eighth richest person on the planet, Mr. Charles Koch. Coke has been the co-owner, chairman, and CEO of Coke industry since 1967. The company was originally involved in chemicals and oil refinement, but now the company also provides products and services for pollution control equipment, polymers, fibers, minerals, fertilizers, and even ranching. Coke is a graduate of MIT and his annual compounded return since running Coke industries since 1967 is estimated to be 18% annually.

Starting point is 00:00:31 So without further delay, here's our highlights and lessons learned from Charles Koch. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, everyone. Welcome to the Investors podcast. I'm your host, Preston Pish. And as always, I'm accompanied by my co-host, Stig Broderson.

Starting point is 00:01:05 And like we said in the introduction, we're going to be covering. Charles Koch. Just as a side note before we start, Stig and I covered one of Charles Coke's books. This was episode nine a long time ago. And the name of Charles's book was The Science of Success. We thoroughly enjoyed this book. We also wrote an executive summary. So if you want to read the executive summary that Stig and I have for this book, we'll also have a link to that in the show notes. If you guys want to go back and listen to episode nine, you can hear us talk about that book, but today we're going to be covering some of the topics that Charles Cook himself has talked about. And so the first question that we're going to play here, Charles Cook was asked,

Starting point is 00:01:40 how can one be successful in business? And this was his response. I had always been a big fan of science, the philosophy of science. And so I internalize Newton's inside. If I see further, it's because I'm standing on the shoulders of giants. So I said, what I've got to do is go find these giants. Go find the principles of scientific and social progress and then figure out to how to apply them in my life to enable me to be the best me I can be. And so I started studying everything I could that was relevant for all different subjects, fields, and from all different perspectives to find those. And when I would find a principle, I would apply it in every aspect I could, or find ways to apply it. And that would be in a business with my family and my charitable

Starting point is 00:02:40 activities, my community activities, and so on. And I'll just, if I could take a minute, just give you one example here. Among the other things I learned early on is why did humanity go along for millennia, in which the common person gained almost nothing in the quality of life and standard of living. Up until the 18th century, and then in various parts of the world, quality of life exploded. So we have what's called the hockey stick. And I discovered in that that it was when the common person began to, to be given equality under the law and social dignity.

Starting point is 00:03:30 And that was brought about by a convergence of a number of changes, including the printing press. What that brought about is the common person, and I'm talking about merchants, traders, artisans, working people. But before that, people, the aristocrats and the hierarchy, they were the dignity. And people working, well, they were kind of lower and discouraged and disrespected.

Starting point is 00:04:03 This started to change in various countries at different rates. And it's because this then gave the common person the courage and incentive to better himself. And in the process, he bettered the people around. him. And we started getting innovations and progress and more open trade so people could exchange. And so that's the other part I learned that in a voluntary exchange, people enter into voluntary exchanges because they both believe they will benefit. The way I internalized all this, okay, the way to be successful in business is don't focus, first of all, on max. How do I

Starting point is 00:04:51 maximize profit. How do I get more money? It's how do I create value for others? And what capabilities do I need to be? Which customers can I create the most value for? I really like what you're saying here, and I think it's very insightful. What Charles Koch is really talking about here is what he typically refers to this as good profit. You know, it's the profit that comes from treating customers with respect and placing their values first. But I think more important, is really to understand how he wants to engage in those win-win, in those voluntary relationships. Because at the end of the day, one of the things he's really big on is that you can't sustain profit if you're not creating value for society, if you're not benefiting other people.

Starting point is 00:05:39 That is where you start. And then the profits will follow. That's his basis for the systems he's built and for the companies that he's built. I think it's really interesting how he talked about this field of philosophy of science. I remember as a graduate student myself, whenever I had introductory to philosophy of science, there's the worst cause you can ever think of. Why would you need that whenever you're doing a degree in finance or in business? What that's getting at is the reliability of scientific theories and what qualifies as a science. If there's something that we have seen here on the podcast, you can think of Charlie Monkorm, you can think of Redalio, obviously also Charles Coke is that they master so many different skills. And I think that whenever you're talking about

Starting point is 00:06:25 how do you succeed in business, which is really what this question was about, I think that it's by understanding science, understanding different fields. And whenever you put that together, it really comes down to how do you benefit society and then the profit will follow. So I really wanted to play this question as the very first one, because that is Charles Koch's framework of doing business. That is what is benefiting society and other people. The way he starts off answering this question is way more profound than I think maybe some might see at face value whenever he says the quote there standing on the shoulders of giants, kind of gave him the starting point on his journey to understanding business and how to be a

Starting point is 00:07:07 success at business. I would take that a step deeper of once you do discover a person that you admire, maybe somebody that you want to be like in business, don't just go out and read an article online about the person and stop there. Like, you really have to go a lot deeper than that. You have to try to explore what books influence that person. How can I learn everything I possibly can about this person in order to truly stand on the shoulders of giants and then just don't do it once, but then find 10 giants and then replicate that same process over and over again. And I think that if people actually take that to heart and really try to do what he just said there, I think that they'll find tremendous amounts of success and whatever they're actually trying

Starting point is 00:07:47 to go after and achieve. The other thing that I think is really important about Charles Cook, and it kind of reminded me after I'm hearing him talk from reading his book, The Science of Success, is he really does focus on what is profit? Like, whenever you start a business, why should you be allowed to have a profit on whatever product or service you're selling? And what it really comes down to is you are making other people's lives better, typically by saving them time and whatever it is that they're doing. And if you can deliver a product or a service that adds value to that other person and you're doing it in a way that's better than anybody else out there, you deserve a profit. Like you can charge a premium on that. You can collect the 10%

Starting point is 00:08:32 above and beyond what the cost is because you're making value for that other person. And I think a lot of people in business might not necessarily keep that at the forefront of their mind as they're conducting business. But the thing is, as some people in business feel like they're entitled to have that profit, when in fact they absolutely are not entitled to have the profit. And whenever you think through this framework, the thing that you ultimately come to the conclusion of is that because you're not entitled to have the profit, you're always worried that you're going to lose the customer, that maybe you're not creating value. And so then you do things to continue to protect yourself from losing that profit because you know you're not entitled to it. That's something that I think Charles Koch has in spades whenever he thinks about the way he conducts business. Hey, if I'm not adding value, well, then I'm not entitled to this process and things are going to be commoditized. And so I got to think of a way to improve or to add that value somehow,

Starting point is 00:09:31 some way. I just think that that's really profound to think that way. And I think that at the essence of business. You have to start with that framework. And if you do start with that framework, it's very profound for your long-term success. One of the things that people might not realize is that the Koch brothers, their father was a huge entrepreneur and success in his own right. If I remember right, he was a chemist. One of the questions that Charles was asked, what did you learn from your father that shaped you to become the success that you are today? And this is how he responded. My father considered work ethic, attitude toward work as critically important for developing yourself and, in fact, being healthy and happy through your life.

Starting point is 00:10:12 He believed that unless you start working in an early age, you never really develop the skills and habits and values necessary to make you productive. He told me in an early age that he didn't want no country club bums, as he facetiously put it. So there was going to be no country club in my life as a boy. He started me out digging dandy lines when I was probably six years old in most of my spare time. And I thought I'd soon get over that, but it escalated from there. We had horses and cows out there. I cleaned out the horses' stalls. I helped bail hay.

Starting point is 00:10:52 Later, when I was in high school, I milk cows before I went to school and afterwards. Then on summers I would work at various places. I worked on ranches. At one ranch, I rode line, that is, road fences to look for breaches and fix those and bring in bulls that had hoof rot. That was an interesting, very interesting experience. I bunked in an old log cabin way out in the Centennial Valley, which was tens of miles from the nearest place. I had two younger brothers, and years later, or my father didn't require them to do the same level of work that I did. And so I asked him, I said, why weren't you as tough on my brothers as you were on me? He said, son, you plumb wore me out. It was a very strong quality of my father. He was an absolute bear on integrity, both for himself and others.

Starting point is 00:11:49 And he was widely respected for that. Whatever he committed to, he would do. Absolutely. no matter what. As a part of integrity, he believed that if you said you were going to come, meet somebody at two, you were there at two before. You weren't one minute late or five minutes late. So when I was in graduate school in Boston, he had asked me to meet with him there to sit in on the meeting. He was having a business meeting. And I had an awful time getting a place to park. And so I arrived five minutes late. He was standing on the steps of the building waiting for me.

Starting point is 00:12:24 and smoke was coming out of his ears. I was never laid again with him, and I'm rarely ever laid on anything. So he taught me some great lessons. The values that were of most importance to him, I would say, were integrity, humility, work ethic, experimentation, entrepreneurship, thirst for knowledge. Those would be his,

Starting point is 00:12:50 and I would say those are all key elements in market-based management and all parts of our guiding principles. And I think the key in, and we talk a lot about mental models, and everyone has mental models to interpret reality and be able to function in the world. The key on whether they're useful or destructive is whether they fit reality. And I was blessed then to have a father whose strong metal models, as such as those I just described, fit reality.

Starting point is 00:13:20 And were very helpful to me and to work. our businesses in being successful over the years. Awesome points here. But I just want to compound on some of the ideas here quickly. So the first thing that he's talking about was work ethic. There's a really famous book out there called Grit, this idea of just working really hard and being able to achieve with you. I would ask a question, and I don't know that there's an answer to this, but how do you teach somebody to have a really hardcore work ethic? And I personally think, I think the answer to that is that you have to just get out there and do it.

Starting point is 00:13:57 And it has to be something that is bred into your own personal culture. You have to get out there and you just have to get after it. I come from a military background where you got to get up early. You got to work extremely hard. You got to work long hours nonstop. It doesn't matter what day of the week it is. Then other thing I want to talk about because I think this is so vital is integrity. So he's talking about how this was the big lesson as the father taught him.

Starting point is 00:14:25 But I want to look at it from a different vantage point. I want to talk about what does integrity enable into your life? I think that it comes down to variance and volatility. So if you're the type of person that goes around and you never lie and you're always telling the truth, because this is reciprocal stuff. So like if you go and you lie to somebody, the chances are that that person is going to come back and maybe be dishonest or maybe not even lie back. to you, but just treat you differently after they figure that out. And let's face it, folks, the truth always comes out. It's just a matter of when it comes out. They're going to treat you differently. So what you actually create whenever you don't have integrity, you create this

Starting point is 00:15:04 environment of volatility and variance in your life that is very unpredictable. And then it just kind of compounds on itself so that you have no control over what's happening to you anymore. And then you get into this blame game type mindset. When I was at the Military Academy, on at West Point. One of the things that surprised me, I just didn't quite understand this. Every time a grad would come back and they had, you know, they were 60, 70 years old and they would talk to the Corps of Cadets at the Military Academy. The one thing that they would always, always, always talk about was integrity. And I just kind of found that a little surprising that it was always brought up. But then having served in the military and got older and had these different engagements,

Starting point is 00:15:53 I really started to understand why it was so important. And a lot of it comes down to just creating this environment around yourself that's predictable, that everyone around you treat you well. And you don't have this variance in volatility in your life anymore. So just amazing points. I would love to touch more on the thirst for knowledge and the humility, but I'm going long and I want to hear Stig's comments. So Stig, I'm curious what you have to say.

Starting point is 00:16:16 Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year, bringing together activists, technologists, journalists,

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Starting point is 00:20:17 slash WSB. That's Shopify. dot com slash WSB. All right. Back to the show. I would also like to add like a personal story into the mix. There's a good chance

Starting point is 00:20:31 that have quite a few of the listeners won't like me after hearing this story, which is also why I waited more than 200 episodes into a TIP before I told it. But whenever I was a college professor, the way we measured ourselves, the college, that is, there was not only the academic credentials, but also how the companies

Starting point is 00:20:50 evaluated the graduates that we sent out, which to me was a fabulous way to do it. I mean, that is after all the end product. Now, I worked there four years, and I never heard any company come back and say that they didn't have the academic skill set that was needed to take on that job. What I often heard is that they did not have the right work ethics, which really comes back to what Preston said, like, how do you teach people to have the right work ethics? And it probably doesn't come in college. It's probably something you should have from your parents. And by the way, that's also not the way we grade in our institutions. You know, that's test and exams. It's not worth ethics.

Starting point is 00:21:27 And it was just so embarrassing to get feedback from employers that were saying, you know, he's not there on time or sometimes even checks his Facebook when facing clients. I mean, you can just imagine how you would cringe whenever you heard something like that. So one of the things I did, you know, did was whenever the class started at 820, I locked the door. I literally locked the door and students couldn't get in, which was very shocking to quite a few students. And then whenever we had break, other professors would give you five minutes or 10 minutes break. If you give a group of students five minutes break, you won't see the students anytime soon. I swear to that. But I gave them seven minutes and 43 seconds. And I just want to repeat that. Seven minutes and 43 seconds.

Starting point is 00:22:10 And then I locked the door. And I had a big timer up there so everyone could see. And there was alarm busing and I closed down the second. I had students standing outside if they were one second late because that was one second late. I didn't give them seven minutes and 44 seconds. I did give them seven minutes and 43 seconds. And there's a difference there. I know this might sound extreme.

Starting point is 00:22:29 And by the way, I did that every class throughout the year. But I really did this. Well, honestly, because it was a lot of fun. Perhaps that was one of the main reasons. But also because it really taught the students, had a lot of international students too. Lots of different backgrounds, social backgrounds, a lot of different cultures. It was really also to adapt them to the type of companies that they would typically go out in after they had a business degree. These companies, if you're there at 8, you know, it's not

Starting point is 00:22:54 801, at least not where I'm from. It's 8 o'clock. So it was really to install that worth ethic. So my two key takeaway was really, if I could say something, be there on time and do as you say and say what you do. It's just so fundamental to everything in business. So you would have done really well at West Point because in all of our classes, in all of our classrooms, we had GPS timed clocks. And there wasn't like a bell or anything like that. But if you literally showed up one second late, your teacher would give you what was called 10 hours. And what that encompassed was you had to go out on the area. You had to get in your full military like uniform. And you had to carry a rifle back and forth on a line for 10 hours during the weekend. So on Saturday,

Starting point is 00:23:40 Saturday and Sunday, you'd have to march your 10 hours back and forth in a line for being one second late to a class. This is every single class. So not only were you penalized for whatever in the class, but then you had to go walk your 10 hours after you were late. And then you're never late. And you never late. And another thing, and I know that we might be joking about this.

Starting point is 00:24:01 And some people might be like, oh, my God, Preston and steak, horrible people. And, hey, who knows, perhaps you are. But I think it's also important to know what it is that you're saying. signaling. Like, if you are late, if you don't do as you say, you know, it's a sign of disrespect, not just to yourself, which is extremely important, but to your fellow students, fellow cadets. What you're really saying is I can't even manage myself, let alone somebody else. I mean, that's really what it gets down to. Anyone who's in business who manages a bunch of people will quickly pick up on the theme of work ethic. Like, if you can't take care of yourself just to show up to

Starting point is 00:24:38 somewhere on time. How in the world are you going to manage 10 people to show up on time? He just won't. We might come from extreme backgrounds. I'm sure other people see this differently. I'm sure some people are very successful and show up late. But it's just one little facet of work ethic that I think sets an example. So let's go to the next question. On this question, Charles was asked, how do you choose among the various business opportunities you have? And this was how he responded. to believe that you can create superior value for your customers. And unless you can create more value than their alternatives for them, you're not going to succeed in that business.

Starting point is 00:25:15 And then you need to believe that it's sustainable, that it's not just you get in and they'll immediately copy you or somebody will come up with a better way of doing it, and you'll be out of business. So those are some of the things we look at, Then another piece of it is to when we're entering a new business is to do it at an experimental level. That is a small enough level that if it fails, it's not going to cripple us or destroy us. Another thing, even before we start the experiment, to have an eternal challenge process,

Starting point is 00:25:50 where we don't say, okay, we got this vision and we don't want to hear any naysaying. No, we want to hear naysay, not for people to prove they're smart or just stop us, but we want people to point out the flaws in our strategy and in our theory that we can create superior value. Because you're much better off to learn the flaws in your thinking before you plunge into it than afterwards. And I've never understood people who want to protect their ideas and not have them criticized.

Starting point is 00:26:23 Like any decision I make, when I think we ought to make an acquisition or implement a strategy, I look for, okay, what are the, key drivers in success or failure in this venture, and who is really good at each one, each aspect, whether that's operations, marketing, distribution, whatever it is, I want challenges. I want people who are going to come in and say, tell me what's wrong with this. How can this go wrong? I want to understand all the pitfalls. And every time we go through that, we come up with a better answer than I had to start with. So this idea of prototyping things or prototyping ideas, I think,

Starting point is 00:27:07 is such a smart way of doing business. And I think anybody who's run a successful business realizes how important this idea is. From an online perspective, there's an idea of prototyping where you can literally launch a digital product without really actually having the product out there. And you can run data through this, you can run traffic through it to see if the idea or product might be viable. You can also, when you look at a business that's not like an online business like I just described, and let's say you're working for a large business and you want to prototype something, maybe it's a launch in just a small town or it's a launch in one city to see whether it works. But this idea of prototyping, I think, is really important.

Starting point is 00:27:50 At the end of the day, business is about getting the maximum out of scarce resources. And that typically referred to as time and money. No one has enough time and money. And that's really the nature and guiding principle of business because we could always be investing in something else. You know, spend our time and money on another business project. So what do you do? One key thing is, yes, have it criticized as much as you possible can.

Starting point is 00:28:15 I think anyone in business quickly realize that the best investments you make are those you do not make in the first place. The next thing about the experiment that Charles Koch is talking about, And Preston gave a really good example of this in terms of the online world, you know, optimizing the relationship between effort and information. I've never met any business person who made a business plan years out and then that was exactly what happened. That's not how life works, not life, not business. You need to test it first and get all that information and make a decision based on that. Like should we continue, should we pivot, what should we do? Perhaps the best,

Starting point is 00:28:54 example of this optimizing the relationship between effort and information. It really turned out to be massively successful was Sappos. Sapo started with a guy who wanted to buy an online retail store for shoes. This was back in 1999 and you did not buy shoes in 1999 online. So what he did was he went to the local store, took pictures of the shoes, put them up on the website to see if anyone want to buy them. And if they did, he went down to the store and you bought them at retail and then shipped it to the customer, probably at a loss. Because he just wanted to check the system. How could he get the most information with the least amount of effort? He didn't have to think about investing in infrastructure and inventory. No, that was not the point. He just wanted to

Starting point is 00:29:41 see if it was a valid business model. And it was. As I'm sure some of you in the audience know, it was extremely successful. So to Amazon for a billion dollars. But it was just how it all started. If you had to make all the upfront investment, the founder Nick Sherman might not have done so in the first place. Moving on to the next question here, Mr. Koch was asked, your business is built around what you refer to as creative destruction. What is that and why is it important in business? And here's his response. That was from a great Austrian economist who ended up teaching at Harvard called Joseph Schumpeter, the way he defined creative destruction as the process of industrial mutation, incessantly revolutionizing the economic structure from within,

Starting point is 00:30:29 incessantly destroying the old one and incessantly creating the new one. And his point was, when we're competing, we think, okay, we're competing in productivity and output and price and those things. And that's true short term. But Schumpeter's point is longer term, what you're really competing in is you're competing with the new commodity, the new technology, the new sources supply, the new type of organization. So you need to not only be improving your current cost structure and how you compete on price and service, but these more revolutionary long-term changes. And you see over time, whole industries are driven out. And that's what he means by creating. destruction. We believe, and this is part of this, what we call this virtuous cycle, is

Starting point is 00:31:27 continual transformation. Since I've been with the company since 1961, five transformations, and the one we're going through now is to introduce the best technology into all our businesses. And we are just getting remarkable improvements by doing that, combining different forms of technology, whether that's electronics, connectors, sensors, and software, whether that's predictive analytics, artificial intelligence, robotics. We are using all those forms of technology to transform all our businesses, manufacturing, customer deliveries, understanding what our customers value and so forth. Created destruction is just one of the most important. factors to understand the competitive forces in business. And I would also argue as a stock investor.

Starting point is 00:32:25 As business people, we should always think of how can the marketplace make us obsolete and how can we continue to be an alarming curve that is ahead of the market, ahead of the frontier. One example that really comes to mind is the rivalry between Kroger and A&P in groceries. This was one of the famous examples that Jim Collins brought up in his book, good to grade. And it talks about how that was different than the megastores you see today. Now, it's not like you can go to your Walmart and you could, you know, get new tires and you could you pick up your drugs and everything. Like, no, it was not like that. It was these small shops and you just have multiple of them and the service is a very small area. Back then,

Starting point is 00:33:08 you know, 100% in A&P's revenue there was in these stores and it was the same with Kroger. Which was really interesting in this point in time was that even though 100% of the the revenue came from that old business model. Kroger continuously talked about, how is this going to change? How can we be out-competed? So what they did was they started building those huge stores that had everything, which is also one of the reasons why the cave became so successful. A&P instead started to compete on the prices.

Starting point is 00:33:36 But that was not what people wanted. That was not the way the development was going. It was a different lifestyle. You should be able to fix everything in one trip. You should be experienced with that trip. It was not a question of saving a few bucks. It was convenient more than anything else. By doing that, by making that gradual transition, Kroger made their own business model obsolete.

Starting point is 00:33:58 A&P did not, and by the way, also went bankrupt. And this is what Charles Koch is talking about, always questioning his own business, like who is going to out-competers. Koch Industries is right now through the six major transition since they started. They keep on evolving. They keep on to keep up with the times. And that is really what this creative destruction is all about. That's also whenever you see these stats about, you know,

Starting point is 00:34:25 which kind of companies were the biggest in Dow Jones 20 years ago and then 10 years ago and then today. Their companies are being replaced all the times if they can't keep up. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together

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Starting point is 00:37:57 Back to the show. I think this personally just goes back to the original discussion we are having about what is profit and just understanding that whenever you're creating real value for some person out there that's buying the product or service, if that value is not sustained, that's your creative destruction right there. You have to always be aware that somebody is trying to commoditize what you're doing or trying to replace what it is that you have created or what it is that you're doing. People that aren't thinking from that dynamic at all times, they're just not going to have a long-term sustainment of their business. I think as stock investors, we should think about that too. Have that framework in terms of determining what is the mode of that business.

Starting point is 00:38:37 How is it benefiting society? Can it be displaced with something else? As much as I would like to say that Warren Buffett does not invest in tech, even though it seems to have changed, I think that is one of his, one of the things he's been famous for. He does not want to invest in companies that need to reinvent themselves. It's such a hard business. Keep reinventing yourself, especially if you knew the tech field. So there's a really good book called The Innovators Dilemma, and this is by Clayton Christensen. He's out of Harvard. And the book talks about how sometimes the best way for a business to create new

Starting point is 00:39:09 products isn't necessarily inside of its own foundation, but to allow a few people to step outside of the business, start their own business, and try to launch a competing product. One of the reasons why is because it forces people to get out of the mindset of, well, this is how we've always done it. This is what works. This is what we know works. And it's just trying to look at something from a completely different vantage point. Highly recommend that book. We also have a free executive summary of that book. And Stig and I have covered that in a previous episode, which we'll have in the show notes if people want to check that out as well. All right. So that's all we have for covering some of the Charles Koch Q&A. Now what we're going to do is we're going to transition into a question from the audience. And this

Starting point is 00:39:52 question actually comes from two people, and it comes from Jonathan and Rochelle, and here's their question. Hi, Preston. Hi, Stig. This is John and Rochelle, soon to be married, and we've been on this new journey together of value investing for about two years now. One of our fundamental value is what we like to call food and time. There's no better place to enhance these values than Omaha for Stakes and the Brookshire Annual Meeting, which we will be attending for the first time in 2019. In regards to time, we've been sticking within our circle of competence and learning from investment gurus like Warren Buffett, Ray Dalio, and Jesse Felder, just to name a few, during this volatile market. With methods like the all-weather portfolio, it holds about 40% in long-term bonds,

Starting point is 00:40:33 and seven-and-a-half in gold. In a recent episode, you answered an audience question similar to this, but what are both your thoughts on setting up our security bucket versus our growth-thrust bucket going forward that caters to all the all-weather portfolio, which includes bonds in gold? We currently hold about 80% in cash, so in a way we are excited for future market opportunities of growth. Thanks again for all that you guys have done for the value investor community. See you in May. Man, I hate to say this, guys. Stig and I are not going to the Berkshire shareholders meeting this year.

Starting point is 00:41:07 I feel terrible saying that, but we both just needed a break this year. I have a bunch of stuff that's happening in May. I personally can't make it. And Stig. Yeah, my excuse is, more or less the same. I can't get my calendar to match up. And it's a bit trickier also. I had to fly in for Denmark for a weekend, which I do every two years. Unfortunately, I can't make it happen in 2019. But here's the thing. There's a lot of people that are going to this meeting.

Starting point is 00:41:34 I know Patrick O'Shaughnessy goes out there. Shane Parrish goes out there. There's tons of people you guys can hang out with and connect with. Hit us up on Twitter if you guys need any introductions to find out what some of the other people that are going out to Berkshire are doing. Before we actually are going to respond to your question, I just wanted to put it out there, then we have a guide on our website in terms of how to attend the meeting. We have that in your show notes. There's also going to be links to the forum where you can team up with other people from the community if you want to team up with them and have someone to go to a meeting with.

Starting point is 00:42:05 Before we respond to the question, I just do want to say for the record that I do plan to go in 2020 and I do plan on persuading Preston to go as well. It is a lot of fun. Oh, it is a good time. So let's try to answer this question. I don't know that I can actually provide a great response to this question because so much of it is really kind of centered around Ray Dalio's personal approach to investing, which we know is balanced across all asset classes, whether it's commodities, bonds, currencies, or equities. He has a certain distribution in this. A lot of his approach is outlined in a book by Tony Robbins called Money, Master the Game. If you're trying to understand how Ray invests, I would tell you to pick up that book. I would also tell you to pick up the hedge fund market wizards book by Jack Schwagger. Awesome profile of Ray Dalio in that book as well and to kind of tap into his mindset.

Starting point is 00:43:00 I personally have a gold position right now. This is January 2019, the beginning of January 2019. I've had that gold position on for a few months now. I think commodities are going to do well in 2019, but I think the thing that's going to be the trigger for that is whenever the Fed kind of reverses their, tightening that they're doing right now. Whenever they stop their quantitative tightening, whenever they stop doing their federal funds rate rises, I think that you're going to see actually a very strong movement in most commodities. Oil specifically, I think is going to have a

Starting point is 00:43:32 really strong upside here in 2019 by the end of 2019. So I don't know. I'm a fan of that space. As far as bonds go, I think bonds are going to have a pretty rough time in 2019. And here's my reason why. into the idea that commodities are going to do well once the Fed kind of changes course. That means that inflation is going to be much higher than it is right now at the start of 2019. If that's a true statement, that's going to absolutely get priced into the bond market. You don't want to be sitting on bonds whenever inflation, especially if this kind of goes the way I'm thinking, I think that it's going to actually be somewhat aggressive to the upside in the commodities, which is going to be a pretty drastic move for bonds.

Starting point is 00:44:17 and not in a good way for bonds. I'm not a huge fan of where that's going, but I could be wrong. Ray's a very smart guy. Ray has a substantial position. Now, one of the things I will say about bonds, especially short-duration bonds, is you know, you're not going to see too much of a price change in short-duration bonds. The long-duration bonds, you might see some pretty large and substantial price moves. But relative to equities, the price volatility is not anything like an equity.

Starting point is 00:44:47 So I think that that's important for people to understand. And I think it's also important for people to understand that commodity, volatility, and price is really high. If you're talking the volatility difference, you know, currencies, you don't have much volatility at all. Then you go to bonds. They have a little bit more. Equities have a lot more than that. And commodities are hands down the most volatile out of all of them. So you have to understand that if you are planning to invest in any one of those four asset classes, you understand that if you are wrong, the more volatility like in commodities, if you're wrong in commodities, it's going to be a very painful experience. And that's important for people to understand. And so the way that Ray weights his exposure to a lot

Starting point is 00:45:30 of those has to do with the volatility of each one of those asset classes and then trying to balance it. And then he balances it based off of leveraging some of those positions so that they cancel each other out. So I think that that's important for people to understand that approach. I don't know if I really answered your question very well, but I told you some of my thoughts for what I'm expecting here in 2019. If we look at the asset allocation in the all-weather portfolio, Redalu has 4% in long-term bonds, actually 20 years and longer. So he has a lot of interest rate risk in that, 30% in stocks, 15% intermediate long-term bonds, then 7.5% in gold and 7.5% in commodities. The reason why he refers to this as the all-weather portfolio is that he genuinely says

Starting point is 00:46:16 that are four different seasons that the economy can go through. Higher than expected inflation, lower than expected inflation, higher than expected economic growth, and lower than expected economic growth. By having this asset allocation, the idea is to have a portfolio that can go through all of these seasons. And the result should be a diversified portfolio. that can consistently earn you money while keeping your financial secure during the bear market. For instance, if there's a high unexpected inflation, it could easily hurt your bonds, but gold-tribly performs well. It's a very humble approach to investing. In the book that Preston mentioned before, Tony Robbins' book Money Master the Game, he's doing some backtesting on this

Starting point is 00:47:02 asset allocation. The All-Wither portfolio produced just under 10% annually between 1984 and 2013, which is slightly less than what you would have if you just invested in the market. What might appeal if you want to invest in your own-willa portfolio is that you would have made money in more than 86% of the time. And the average loss was just under 2%, which one of the losses being as low as 0.03%. So you do not have a ton of volatility. I think it's completely fine if you look in the asset manager and you're saying, I would like to compare your returns to the S&P 500. You know, that's the benchmark. But for a lot of people and also companies and other asset managers, they're not comparing themselves to the S&P 500. You know, it might be an

Starting point is 00:47:52 endowment. It might be a retail investor who's looking to live off his portfolio. And it might be and retail investors looking to retire and is not looking to maximize the return. Sure, maximizing return would be a great upside, but the downside of losing your principle is just so much worse. For them, something like the all-weather portfolio, I think it's a very interesting strategy, even though that you do not have it as a high return. So I got two more points based off of what Stig said there. So you heard Stig say that if you would have executed this all-weather portfolio, you would have done slightly worse than the way that the market performed, but you would only had a year, like your worst performing year would have been down 2%. So what you gain by implementing

Starting point is 00:48:37 Ray's approach that was outlined in this Tony Robbins book is that you don't have the volatility that you have if you would have just been in the S&P 500. You minimize that volatility. What it really comes down to is a personal preference and what you can stomach. If you're the type of person that you know you cannot stomach a huge loss, then implementing an approach like the one that's outlined in that book is probably a great way to look at things and to go about it because you're just not going to see those big wild swings. That's the big thing with Ray that when you study what he does is he is trying to understand what the volatility looks like. Then what he does is he designs a portfolio around something that fits that appetite or that personal preference

Starting point is 00:49:21 based on the return he would expect to get and the volatility that's associated with it. And that's the brilliance of Ray Dalio. Now, something else that I think. think's important is when you get into this risk parity strategy, because that's really what Ray invented, he also has a thing called plunge protection that's built into his strategy that is not talked about at all in Tony Robbins' book or pretty much anywhere else that you can find. I would argue this is very proprietary for what Ray does, is when does he turn off his risk parity? Because I mean, really the trigger here is he's offsetting, let me just give you an example of equities to bonds. When equities go up, typically bonds are not performing well, and when bonds are performing really well,

Starting point is 00:50:04 equities are not. So that's your risk parity. But over time, if you own both asset classes and you leverage them up so that they have equal weighting, what happens is that in aggregate of owning both of those asset classes, you make money over time. When that's not true is when you get into a systematic credit event where both asset classes, bonds and equities both go down. So this is where we get into his plunge protection on his all-weather portfolio. And this is also true for currencies and commodities that he would have this plunge protection built in. Some of the things that he's looking at with this plunge protection is he's looking at are

Starting point is 00:50:41 prices high relative to traditional measures. Our price is discounting future rapid price appreciations. Our purchases being financed by high leverage. Are buyers and companies making forward purchases? Is there a broad, bullish sentiment? And he's looking at those type of factors, is there tightening risk that's popping the current bubble? Those kind of things are what he's using to gauge whether his plund protection basically liquidates a lot of those positions. How he liquidates his positions, I don't know.

Starting point is 00:51:11 And I think that that's part of the secret sauce of Ray Dalio that's never discussed that's vital to his success and vital to his ability to navigate these markets. Like in 2009, I think he was up like eight or nine percent in the green when the rest of the market was down 50 to 60 percent. That's vital if you think you're going to just turn on an all-weather portfolio and think that you're going to have similar returns during down markets. And I think people really need to be well aware of the complexity that they're not getting by reading a book by Tony Robbins or anything else that you're reading on Ray Dalio. All right.

Starting point is 00:51:49 So John and Rochelle, that was probably way really. longer than you wanted to hear for our response, but really, really complex question there. And I don't even know that we did it any kind of justice because trying to cover Ray Dalio is not an easy task. He has a lot of writings out there. I tell you to try to read everything you can get your hands on, specifically Big Debt Crisis by Ray Dalio is a phenomenal read. And then also there's white papers that you can find out there online, various PDFs. It can help you understand his risk parity strategy. As a token of our appreciation for leaving your question, we're going to give you access to one of our free courses on the TIP Academy page on our website. The course that we're going to give you is our

Starting point is 00:52:29 intrinsic value course. And our intrinsic value course teaches people how to determine the value of an individual stock. It also teaches you how to think about the market cycle and when you're buying your stock. And it also teaches you some stuff about options trading. So we're really excited to give you this course. If anybody else out there wants to check out the course, you can go to TIP and Intrinsicvalue.com, or you can just go to our website and click on Academy, the link at the top of the page and courses right there. So if anyone else wants to leave a question on the show, go to Asktheinvestors.com, and if your question gets played on the show, you'll get a free course.

Starting point is 00:53:03 For asking your question, we're going to give you free access to one of our online courses. It's our intrinsic value course where we teach you how to calculate the value of an individual stock pick. This is a course that we normally charge for on our site, but because you ask such a great question, we're going to give it to you completely for free. For anybody else out there, if you want to get your question played on our show, go to Asktheinvestors.com. You can record your question. It's really simple to do. And if you get your question played on the show, you get access to one of our paid courses on our website. If anyone wants to check out our course on the website, go to the Academy tab and just click on that in the navigation bar.

Starting point is 00:53:38 Or you can go to tip intrinsic value.com and you can check out the course there. All right, guys. That was all the press down I had for this week's episode of The Investors Podcast. We see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to Asktheinvestors.com

Starting point is 00:54:02 and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before Cindy. or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP226: Billionaire Charles Koch Lessons Learned (Business Podcast)

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