In Principles of Perpetual Prudence, I discussed my principles for Lifetime Investing. This article expanded on a branch first mentioned in Perpetual Prudence: The Solution To Lifetime Investing. We now add leaves to the end of that branch and conclude our discussion of this area (for now) by going into more depth on each of the principles.
We proceed chronologically, starting with our long-term framework. To repeat, life is a long game. When we think about lifetime wealth accumulation and management, the goal of Lifetime Investing, we must hold this long-term frame at all times. This is essential to realising an acceptable lifetime wealth path.
Second-order effects are unintended secondary effects of an initial action. Existence of second-order effects was the main point I raised in the previous article. I talked about 2 main ones: compounding and psychology, which I recap now.
When you think long-term you are more likely to realise the beneficial effects of compounding, a concept that is very hard for us mere mortals to understand. Secondly, thinking long-term acts as a kind of psychological buffer. Simply, you’re less likely to do stupid things when you make decisions with your whole lifetime in mind. You’re less likely to panic, selling when everyone else is or buying when everyone else is.
Finally, I mentioned mysterious “others”. Other beneficial second-order effects that I claimed I wouldn’t “bore you” with listing. As if my writing could ever bore you.
One of these is the reduced time commitment that a long-term vision is accompanied by. Let’s take my friend John. John has no plan. John does not save or invest consistently. He spends significant periods of time each week, if not each day, reading the news and analyst recommendations, “studying” financial statements and performing other seemingly-useful-but-actually-fucking-pointless activities in order to “give him an edge”. He needs to make some wonga for his trip to Milan with his annoying girlfriend in the summer so his time horizon is around 6 months.
When you have a shorter time horizon, you tend to commit more time and energy to ensure an acceptable outcome. This time could be spent more fruitfully elsewhere by going for walks, reading books about Rome, or drinking too much on first dates. Compare this to Diego. Diego isn’t really interested in a quick buck. He finds an acceptable strategy, one that will work for his lifetime (or the next 30/40/50 years, at least) and sticks with it. This requires checking once a year. So he spends probably 1/100th of what John spends in terms of time, and probably gets better results, too (1).
The long-term is underpriced
Imagine there is a market in which carrots and parsnips are sold. These items will be priced according to supply and demand. Now, let’s say that most people prefer carrots. Carrot stocks will be depleted and the price will rise as a result of this high demand and low supply. Parsnips will be cheap as the marketeer has several kgs that he needs to shift before they go off. So, if you have a preference for parsnips, besides the fact that you’re clearly a weirdo, you’ll be laughing (2).
Similarly, if you have a veeeery long-term focus (like, lifetime-long) then it stands to reason that the combination of assets and when they are purchased used to meet this end will be cheaper than a bundle used for short-term profiteering. Traders (some) look to make a profit every day. Asset managers (most) look to make a profit every year. Even those claiming to be “long-term investors” have a 10- or 20-year time frame. By rejecting these time frames and focusing on a lifetime one, you will be in the market for parsnips, not carrots.
Thinking in perpetuity
10 years isn’t long-term.
20 years isn’t long-term.
30 years isn’t long-term.
40 years isn’t long-term.
50 years isn’t long-term.
The problem with these time frames is that they are fixed. There is some end date. This makes you vulnerable to market conditions. It makes you vulnerable to timing. You’re in the market for carrots.
The only true long-term is in perpetuity.
As always, there are question marks as to how to implement these ideas in practice. How do you actually invest in perpetuity to “reduce the probability of an unacceptable outcome”?
We at least know the right questions to ask but there appears to be no immediately obvious solution.
What we can do is identify what not to do:
- Don’t look for daily profits (leave that to the traders and algorithms)
- Don’t look for annual profits (leave that to snake-oil-salesmen asset managers)
- Don’t look for decennial profits (leave that to naive “long-term” retail investors)
There is nothing wrong with profitability within these periods but it should not be our main goal. That is lifetime wealth accumulation.
(1) This was the main point, I feel, of Ramit Sethi’s excellent personal finance book I Will Teach You To Be Rich (excuse the name, please). Although he skipped through the investing section all too casually, his main point is spot on: don’t waste too much time on things financial. Good financial behaviour is mostly about the processes you have in place, these require only a few hours a month to manage. I believe the same applies to investing.
(2) This is microeconomics 101 – one of the only concepts in Economics that has applications in real life. Yes, yes, in the long run, the market will adjust such that the supply of carrots will increase depending on marginal costs of production, blah blah blah.