Saxe Coburg November Newsletter

“All of humanities problems stem from man’s inability to sit quietly in a room alone.” – Blaise Pascal

?The Five Laws of Gold

When discussing the subject of investing with young people, I often refer them to a classic book written in 1926 by George Clason, called “The Richest Man in Babylon”.? George Clason was an enterprising fellow who, having attended university, then serving in the US army during the American Spanish war, established a publishing company and was the first to produce a road atlas of the US and Canada.

In 1926 at the age of 52 he issued the first of what became a famous series of pamphlets on thrift and financial success, using parables set in the ancient city of Babylon to make each of his points.? If you’re looking for a stocking filler for Christmas, you could do worse than a copy of this book.

In chapter 5, Clason provides readers with “The 5 laws of gold”.? Here’s my slightly abbreviated version:

1.?????? Save one tenth of your earnings

2.?????? Find profitable investments for those savings

3.?????? Gold “clings to the protection of the cautious owner” who invests it under the advice of men wise in its handling.

4.?????? Gold slips away from the man who invests it in businesses or purposes with which he is not familiar, or which are not approved by those who are skilled in its keep

5.?????? Gold flees the man who would force it to impossible earnings or who would follow the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment.

These laws contain hidden gems and almost 100 years on, seem closely aligned with our own beliefs.

The phrase “clings to the protection of the cautious owner” encapsulates the concept of capital protection.? Investing is not about shooting for the stars.? It is not first and foremost focused on the ‘gains’ but rather on avoiding what you could possibly lose.? Caution is required to be a successful investor. Look for ‘men wise in its handling’, that is investors who can demonstrate the ability and skill to invest both cautiously and profitably.

This is fundamental to our risk adjusted approach to investing.? It is all very well to be making money when markets are going up, but the true test of any investor is how they perform when markets are going down.?

Law 4 builds on this by pointing out that your selected ‘managers’ or advisors need to have a proven track record in the investments they are managing or recommending.? It’s the classic rule that you should never invest in something you don’t understand, a rule which is as relevant today as it was in 1926.?

Recent examples of widespread losses from breaking this rule occurred in the new age credit products which appeared in the lead up to the GFC.? Kerr Neilson of Platinum fame described these products as ‘financial wizardry’.? These product merchants did the rounds in New Zealand and raised 100’s of millions of dollars which evaporated when the whole pack of cards of structured credit unravelled.

More recently we have the emergence of crypto currencies, and NFT’s (non-fungible tokens), digital art and the like.? As ‘bitcoin’ breaks through to all-time highs, how many understand how and why bitcoin is worth what it is?? We don’t but I wish we did!? There are many fortunes being made by early adopters, but this has been the case in many previous financial innovations which turned out to be worthless.

Some of the world’s leading investors such as Stanley Druckenmiller said in a recent interview that he “doesn’t own any crypto currencies but he should”.? It is easy to see the logic, given how long it has lasted and how large it has become, but is probably also a clue that even he doesn’t understand it but realises it may be something.? It is conceivable that Crypto may be a real thing which becomes something which has intrinsic value, but we still can’t figure out why. Perhaps what we should do is allocate a small portion of our investments with someone like Cathy Wood who does claim to understand it, and in fact forecasts that Bitcoin will be worth between $258k and $1.48m by 2030 (a 1,400% increase on today’s value).

This is a good segway into Rule 5 which broadly references the get rich quick schemes which seem to still lure the unsuspecting, but it also points the finger at overconfidence of the individual when it comes to investing, despite a lack of experience, yet with a fanciful misconception that ‘investing’ will automatically reap rewards.

With the advent of ‘investment trading apps’ the inexperienced ‘retail’ investors’ influence has seen a massive uptick.? According to a study by Charles Schwab, 15% of US stock market investors said they began investing in 2020.? Additionally, the study shows these new investors tend to be more optimistic about their future success in the stock market.?

But how are they doing as investors?? Data from J P Morgan covering the average returns of retail investors over the 20-year period from 1998 to 2017 shows the average investor return in this period was 2.6% p.a. lagging the S&P 500 by 5.2% p.a.

Another study, Dalbar’s Quantitative Analysis of Investor Behaviour report, which covers the 30 years between January 1993 and December 2022, shows retail investors’ returns from investing in S&P500 funds was 6.8% p.a. versus the market’s 9.6% p.a.? That may not seem to be a huge difference, but when you compound this over 30 years, an investment of $100,000 yielded a return $864,138 higher in favour of the S&P500.

It makes sense that retail investors who perhaps dedicate just a few hours a week to the task of selecting investments would lag the professional fund managers and it also makes sense that the average fund manager will underperform the market after fees. But not by that much.? The underperformance of retail investors is basically due to their inexperience and propensity to chase returns when markets are high and sell to avoid the pain of further losses when markets fall.? According to Forbes (August 2023) the average holding period for retail investors in a stock has fallen from around 5 years in the 1970’s to around 10 months in 2022.? The average mutual fund is only held for 2.5 years.

As French Philosopher Blaise Pascal wrote, “All of humanities problems stem from man’s inability to sit quietly in a room alone.”

For a young investor therefore, it would not be a bad choice to entrust your hard-earned capital to a global equity index fund.? The gyrations of the market will be smoothed by your regular investment contributions, and you know that you will achieve better results than most other ‘retail’ and professional investors.? While it would perhaps not be perceived as ‘cautious’, in some ways it is.? It eliminates some of the key risks of investing, like underperforming the market and permanent loss of capital (provided you stay the course). One of the main problems is the continual threat of a bear market which can wipe 40-50% off your capital.? If this came towards the end of your journey, it could have an enormous impact on your retirement fund.

It also assigns you to the return of the market.? It certainly wasn’t a possibility when Clason penned his advice.? Rather he envisioned the concept of skill and experience to provide certainty, protection of your capital and compounding returns, building wealth over time.

In our September 2024 newsletter we described the approach of combining uncorrelated investments to build wealth and reduce risk, and this is the best approach for young investors. I think this is what Clason had in mind.? Allocating capital across different investments managed by seasoned experts, which will steadily compound your wealth and protect your capital.

The rules are simple but they’re not easy.? It’s not easy to find skilful investors with which to place your capital.? It’s not easy to compound returns in excess of the market over multi-year periods.?

This is the challenge we face and one to which we are committed.? It is a never-ending journey of learning.? You need to approach this without conflicts of interest and with an open mind.? You also have to be accountable for your decisions and keep an accurate record of your performance, both risk and return.

The beauty of the investment industry is that there is a score card, and no amount of marketing and spin can make up for poor numbers.?

Sam Brindle and Mark Houghton

Saxe-Coburg Ltd

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