When thinking of how to become permanently wealthy, it is important to channel Charlie Munger, who consistently instructs us to “Invert, always invert”.
What can we learn from looking at the opposite of what we should do to become and remain wealthy? Charlie suggests “alcohol, drugs and leverage” as the three main causes of wealth destruction. I think there are a few more to add to the list:
Benjamin Graham, the father of value investing, said investing is an operation which, “upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Any asset that does not have cash-flows has no reference to any rational point for analysis and is thus very likely to be a speculation. Bitcoin could be worth $1 or $1 million dollars. There is no reference.
Assets with no cash-flow reference can experience fantastic price gains. Sadly, these ‘greater fool’ run-ups in price are usually only temporary.
There are countless stories of untold non-permanent riches gained from speculation. If you want to create lasting wealth, we suggest you avoid this as it usually leads to only a temporary rise to riches.
We live in possibly the most speculative period in history. Loss-making companies, negative rate bonds, extremely low yielding property, comical crypto currencies and blank check SPACs are all in heightened speculative fever. Never have so many demanded so little of their assets due to expectations a greater fool will pay a higher price in the near future. Sadly, history is littered with failures of ‘easy riches’. If it looks too good to be true, it probably is.
If an asset has a 2 per cent return on capital, expecting it to earn meaningfully more than this over time is not rational. “Time is the friend of a wonderful company and the enemy of a poor one.” (Buffett)
Competition is more brutal than ever. The digital transformation of industries is leading to shorter periods for competitors to make a dent in established companies. Finding companies that are more resilient is a constant endeavour.
Buying a company at the top of a cycle can erode your wealth rapidly. We had a client bring us a portfolio of uranium companies after the Fukushima disaster. Those companies never recovered. Banks and miners can be more cyclical than you may realise.
Charlie Munger also notes that having the correct incentives is exceptionally important. He states, “Show me the incentives and I’ll show you the outcome.” Too many companies have perverse short-term incentives for temporary employees (CEOs) to game the system to earn large options payouts.
There are far more short-term thinkers than long-term builders. The ability to display delayed gratification for shareholders by doing the right thing by customers is less common than you think.
One of the easiest ways to destroy capital is to overpay for an asset. In a world of essentially free money and excess capital, overpaying seems like a distant memory as almost any asset looks okay compared to the paltry returns of cash.
In a world of low yields, paying too much for a low quality asset could destroy enormous sums of capital if rates start to rise, particularly if that asset is highly leveraged. Paying too much for a high return on capital, high growth asset should still have a more than acceptable result over the long-term.
Increasing your chances of permanent wealth accumulation
Becoming permanently wealthy is simple yet not easy:
1. Live a very long time.
2. Compound your wealth over extremely long periods.
3. Spend less than you earn.
4. Buy outstanding, resilient, high-quality global growth companies.
5. Buy and hold.
6. Enjoy life.
7. Give back to society.
By avoiding leverage, speculation, terrible businesses, poor management and overpaying, you naturally increase your probabilities of permanently growing your wealth.
Rob Shears is an Authorised Representative of Valor Financial Group (AFSL 405452). This advice is general and does not take into account your objectives, financial situation or needs. You should consider whether the advice is suitable for you and your personal circumstances.