My friend Tom is an excellent stockbroker. He often says, “The sad thing is
that nine out of ten investors do not make money.” Tom goes on to explain that
while these nine out of ten investors do not lose money, they just fail to make
money.
Rich dad said a similar thing to me: “Most people who consider themselves
investors make money one day and then give it back a week later. So they do not
lose money, they simply fail to make money. Yet they consider themselves
investors.”
Years ago, rich dad explained to me that much of what people think is
investing is really the Hollywood version of investing. The average person often
has mental images of floor traders shouting buy/sell orders at the start of the
trading day, or images of tycoons making millions of dollars in a single trade, or
images of stock prices plummeting and investors diving out of tall office buildings.
To rich dad, that was not investing.
I remember watching a program where Warren Buffet was being interviewed.
During the course of the interview, I heard him say, “The only reason I go to the
market is to see if someone is about to do something silly.” Buffet went on to
explain that he did not watch the pundits on TV or watch the ups and downs of
share prices to gain his investing advice. In fact, his investing was actually done
far away from all the noise and promotion of stock promoters and people who
make money from so-called investment news.
Investing Is Not What Most People Think
Years ago, rich dad explained to me that investing was not what most people
thought it was. He said, “Many people think investing is this exciting process
where there is a lot of drama. Many people think investing involves a lot of risk,
luck, timing, and hot tips. Some realize they know little about this mysterious
subject of investing, so they entrust their faith and money to someone they hope
knows more than they do. Many other so-called investors want to prove they know
more than other people . . . so they invest, hoping to prove that they can outsmart
the market. But while many people think this is investing, it is not what investing
is to me. To me, investing is a plan, often a dull, boring, and almost mechanical
process of getting rich.”
When I heard rich dad make that statement, I repeated it back to him several
times. “Investing is a plan, often a dull, boring, and almost mechanical process of
getting rich?” I asked. “What do you mean by a dull, boring, and almost
mechanical process of getting rich?”
“That is exactly what I said and what I mean,” said rich dad. “Investing is
simply a plan, made up of formulas and strategies, a system for getting rich . . .
almost guaranteed.”
“A plan that guarantees that you get rich?” I asked.
“I said almost guarantees,” repeated rich dad. “There is always some risk.”
“You mean investing doesn’t have to be risky, dangerous, and exciting?” I
asked hesitantly.
“That’s correct,” rich dad answered. “Unless, of course, you want it to be that
way or you think that is the way investing has to be. But for me, investing is as
simple and boring as following a recipe to bake bread. Personally, I hate risk. I just
want to be rich. So I’ll simply follow the plan, the recipe, or the formula. That is
all investing is to me.”
“So if investing is simply a matter of following a recipe, then how come so
many people don’t follow the same formula?” I asked.
“I don’t know,” said rich dad. “I’ve often asked myself the same question. I’ve
also wondered why only three out of every hundred Americans is rich. How can so
few people become rich in a country that was founded on the idea that each of us
has the opportunity to become rich? I wanted to be rich. I had no money. So to me,
it was just common sense to find a plan or recipe to be rich and follow it. Why try
and make up your own plan when someone else has already shown you the way?”
“I don’t know,” I said. “I guess I did not know that it was a recipe.”
Rich dad continued. “I now realize why it is so hard for most people to follow
a simple plan.”
“And why is that?” I asked.
“Because following a simple plan to become rich is boring,” said rich dad.
“Human beings are quickly bored and want to find something more exciting and
amusing. That is why only three out of a hundred people become rich. They start
following a plan, and soon they are bored. So they stop following the plan and
then they look for a magic way to get rich quick. They repeat the process of
boredom, amusement, and boredom again for the rest of their lives. That is why
they do not get rich. They cannot stand the boredom of following a simple,
uncomplicated plan to get rich. Most people think there is some magic to getting
rich through investing. Or they think that if it is not complicated, it cannot be a
good plan. Trust me; when it comes to investing, simple is better than complex.”
“And where did you find your formula?” I asked.
“Playing Monopoly,” said rich dad. “Most of us have played Monopoly as
children. The difference is, I did not stop playing the game once I grew up. Do you
remember that years ago, I would play Monopoly by the hours with you and
Mike?”
I nodded.
“And do you remember the formula for tremendous wealth that this simple
game teaches?”
Again I nodded.
“And what is that simple formula and strategy?” asked rich dad.
“Buy four green houses. Then exchange the four green houses for a red hotel,”
I said quietly as my childhood memories came rushing back. “You told us over
and over again while you were poor and just starting out that playing Monopoly in
real life was what you were doing.”
“And I did,” said rich dad. “Do you remember me taking you to see my green
houses and red hotels in real life?”
“I do,” I replied. “I remember how impressed I was that you actually played
the game in real life. I was only 12 years old, but I knew that for you, Monopoly
was more than a game. I just didn’t realize that this simple game was teaching you
a strategy, a recipe, or a formula to become rich. I did not see it that way.”
“Once I learned the formula, the process of buying four green houses and then
exchanging them for one red hotel, the formula became automatic. I could do it in
my sleep, and many times, it seemed like I did. I did it automatically without much
thinking. I just followed the plan for ten years, and one day I woke up and realized
I was rich.”
“Was that the only part of your plan?” I asked.
“No, it wasn’t. But that strategy was one of the simple formulas I followed. To
me, if the formula is complex, it is not worth following. If you can’t do it
automatically after you learn it, you shouldn’t follow it. That is how automatic
investing and getting rich is, if you have a simple strategy and follow it.”
A Great Book for People Who Think Investing Is
Difficult
In my investment classes, there is always the cynic or doubter to the idea that
investing is a simple and boring process of following a plan. This type of person
always wants more facts, more data, more proof from smart people. Since I am not
a technical specialist, I did not have the scholarly proof that these types of
individuals demanded—that is, until I read a great book on investing.
James P. O’Shaughnessy wrote the perfect book for people who think that
investing has to be risky, complex, and dangerous. It is also the perfect book for
those who want to think that they can outsmart the market. This book has the
academic and numerical proof that a passive or mechanical system of investing
will in most cases beat a human system of investing . . . even professional
investors such as fund managers. This book also explains why nine out of ten
investors do not make money.
O’Shaughnessy’s best-selling book is titled What Works On Wall Street: A
Guide to the Best Performing Investment Strategies of All Time. O’Shaughnessy
distinguishes between two basic types of decision-making:
The clinical or intuitive method. This method relies on knowledge,
experience, and common sense.
1.
The quantitative or actuarial method. This method relies solely on
proven relationships based on large samples of data.
2.
O’Shaughnessy found that most investors prefer the intuitive method of
investment decision-making. In most instances, the investor who used the intuitive
method was wrong or beaten by the nearly mechanical method. He quotes David
Faust, author of The Limits of Scientific Reasoning, who writes, “Human judgment
is far more limited than we think.”
O’Shaughnessy also writes, “All (speaking of money managers) of them think
they have superior insights, intelligence, and ability to pick winning stocks, yet 80
percent are routinely out performed by the S&P 500 index.” In other words, a
purely mechanical method of picking stocks out performs 80 percent of the
professional stock pickers. That means, even if you knew nothing about stock
picking, you could beat most of the so-called well-trained and educated
professionals if you followed a purely mechanical, non-intuitive method of
investing. It is exactly as rich dad said: “It’s automatic.” Or, the less you think, the
more money youmake with less risk and with a lot less worry.
Other interesting ideas that O’Shaughnessy’s book points out are:
Most investors prefer personal experience to simple basic facts or
base rates. Again, they prefer intuition to reality.
1.
Most investors prefer complex rather than simple formulas. There
seems to be this idea that if the formula is not complex and difficult,
it can’t be a good formula.
2.
Keeping it simple is the best rule for investing. He states that instead
of keeping things simple, “We make things complex, follow the
crowd, fall in love with the story of a stock, let our emotions dictate
decisions, buy and sell on tips and hunches, and approach each
investment on a case-by-case basis, with no underlying consistency
or strategy.”
3.
He also states that professional institutional investors tend to make
the same mistakes that average investors make. O’Shaughnessy
writes, “Institutional investors say they make decisions objectively
and unemotionally, but they don’t.” Here’s a quotation from the
book Fortune and Folly: “While institutional investors’ desks are
cluttered with in-depth analytical reports, the majority of pension
executives select outside managers based on gut feelings and keep
managers with consistently poor performance simply because they
have good personal relationships with them.”
4.
“The path to achieving investment success is to study long-term
results and find a strategy or group of strategies that make sense.
Then stay on the path.” He also states, “We must look at how well
strategies, not stocks, perform.”
5.
History does repeat itself. Yet people want to believe that this time,
things will be different. He writes, “People want to believe that the
present is different from the past. Markets are now computerized,
block traders dominate, individual investors are gone, and in their
place sit money managers controlling huge mutual funds to which
they have given their money. Some people think these masters of
money make decisions differently, and believe that a strategy
perfected in the 1950s and 1960s offers little insight into how it will
perform in the future.”
But not much has changed since Sir Isaac Newton, a brilliant man
6.
indeed, lost a fortune in the South Sea Trading Company bubble of
1720. Newton lamented that he could “calculate the motions of
heavenly bodies but not the madness of men.”
O’Shaughnessy was not necessarily saying to invest in the S&P 500.
He simply used that example as a comparison between intuitive
human investors and a mechanical formula. He went on to say that
investing in the S&P 500 was not necessarily the best performing
formula, although it was a good one. He explained that in the last
five to ten years, large cap stocks have done the best. Yet over the
past 46 years of data, it was actually small cap stocks, companies of
less than $25 million in capitalization, that have made the investor
the most money.
The lesson was, the longer period of time for which you had data,
the better your judgment. He looked for the formula that performed
the best over the longest amount of time.
Rich dad had a similar view. That is why his formula was to build
businesses and have his businesses buy his real estate as well as his
paper assets. That formula has been a winning formula for wealth
for at least 200 years. Rich dad said, “The formula I use, and the
formula I am teaching you, is the formula that has created the richest
individuals over a long period of time.”
Many people think the Indians who sold Manhattan Island, a.k.a.
New York City, to Peter Minuit of the Dutch West India Company
for $24 in beads and trinkets got a bad deal. Yet if the Indians had
invested that money for an 8 percent annual return, that $24 would
be worth over $27 trillion today. They could buy Manhattan back
and have plenty of money left over. The problem was not the
amount of money but the lack of a plan for their money.
7.
“There is a chasm of difference between what we think might work
and what really works.”
8.
Find a Formula That Works and Follow It
So rich dad’s simple message to me years ago was: “Find a formula that will
make you rich and follow it.” I am often disturbed when people come up to me
and start telling me about the stock they bought for $5 and how it went up to $30
and they sold it. I find myself disturbed because those kinds of stories distract
from their plan, their success.
Such stories of hot tips and quick cash often remind me of a story rich dad told
me. He said, “Many investors are like a family taking a drive in the country.
Suddenly, on the road ahead of them appear several large deer with massive horns.
The driver, usually the male of the household, shouts, ‘Look at the big bucks.’ The
bucks instinctively bolt from the road and onto the farmland alongside the road.
The driver veers the car off the road and begins chasing the big bucks across the
farm and into the trees. The ride is rough and bumpy. The family is screaming for
the driver to stop. Suddenly, the car goes over a stream embankment and crashes
into the water below. The moral of the story is that this is what happens when you
stop following your simple plan and begin chasing the big bucks.”
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