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Why We Believe In Capital Efficiency And Owning Individual Stocks
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Conservative investing should not be defined by “indexing”… Charlie Munger said to invert – turn the question upside down… Owning the S&P 500 means owning lots of bad businesses… Buy high-quality, capital efficient businesses… Is Trump going to fire Powell? |
Table of Contents
Everything you’ve probably been taught about investing is wrong.
Most people have been brainwashed by Vanguard and Fidelity to believe that prudent, conservative investing is defined by “indexing” – owning a huge basket of stocks, to minimize volatility – and dollar-cost averaging. These firms produce volumes of research that “proves” this massively-diversified approach to investing is the safest and best way.
But it’s complete nonsense.
There are three massive flaws of logic inherent to index investing.
Berkshire Hathaway’s vice chair, the late Charlie Munger, always taught that good thinking happens backwards. The best way to solve difficult logical puzzles with many unknown variables was to “invert”: turn the question upside down. Start with the answer. Then work backwards. Want to figure out how to get someplace you’ve never been before? Start there on a map and then work backwards to where you are located.
What do you want to achieve as an investor? Outstanding results that compound over the long term, producing enormous wealth, without any risk of permanent loss of capital.
Can you achieve that by owning the S&P 500? Not very efficiently. And, most likely, not at all.
Since 2000, 52% of the Fortune 500 has ceased to exist – many because of bankruptcy. Notable failures include: Bear Stearns, Lehman Brothers, Merrill Lynch, Enron, Pacific Gas & Electric, Chrysler, Texaco.
If you own all of the stocks in the S&P 500, you’re guaranteed to own a lot of failing businesses.
The professors claim that index investing is safer, but they’re simply wrong. Why? Because they define risk as price volatility. Why? Because they can measure it. But is volatility actually risk? Of course not.
Over the last 25 years, Berkshire Hathaway has declined by more than 50% twice. But was its business actually at risk of failing or being permanently impaired? Absolutely not. In the real world (not the classroom) the volatility of a stock’s share price is not, in any way, fundamentally related to its actual business risk. And by focusing on avoiding volatility the professors have ignored the obvious risk to their approach: actual business failure.