There are two versions of reality in the world of investing. One is grounded in what Buddhists call ‘things-as-they-are’, or the ‘true nature’ of investing. This version of investing enables one to grow their nest egg at a rate that surpasses the so-called riskless rate, or the U. S. Treasury Bill rate, in exchange for taking on more risk. The key to successful investing in this version of reality is being able to identify and measure the amount of additional risk you are taking on, and not to overpay for that risk.
The other version of reality in the world of investing is the ‘things-as-they-appear’ version, or more to the point, the investing ‘Game.’ It’s this version that gets all the attention, and it’s this version that most participants- both the investors and the sellers of investments- buy into. I call it the greatest fraud on earth because it’s so pervasive, and so costly to so many people.
The primary goal of the investing game is not to make money for the individual investor. The primary goal is to extract as much of the investors’ capital as possible, and transfer it into the pockets of the providers of investment services.
But what makes this fraud even more interesting is that most of the perpetrators actually believe that they are selling something of value, when in fact the great majority of them simply don’t understand what value is. My favorite example of this is the story of Long Term Capital Management, a famous super-hedge fund that crashed in 1998, even though it was run by the very best and brightest minds in the world of finance. Their clients were the largest and most sophisticated institutions and wealthy individuals in the world, yet they were not able to see that what they were investing in was an illusion.
The folks who ran LTCM truly believed that they had invented a better mousetrap, and that they had found the holy grail of investing- a way to completely eliminate risk while earning outsized returns at the same time. When you think about that idea for a moment, it seems hard to believe that anyone with a modicum of common sense would fall into such an obvious trap. After all, there is no free lunch, period. It’s a truism that in order to beat the T-bill rate, you must take risk. You can’t get around this. It’s part of the first version of investing- the one that’s based in reality.
The investing game permeates every facet of the investing community, from the local broker who hangs his shingle out at the corner store, to the bank trust department who is charged with protecting the wealth of the well-to-do, to the mutual fund complex that manages the nest eggs of millions of investors from every walk of life. Most of the folks you’ve entrusted your money to actually believe that they can do the impossible… predict the future before it happens. That’s exactly what it would take in order for the investing game to match up with reality.
But no system, regardless of how sophisticated and robust it may be, can produce consistent returns over time, unless they involve placing your capital at risk. And no individual, regardless of how astute he or she may be, including the likes of Warren Buffett and Peter Lynch, can predict with anything approaching certainty, what the stock market and the stocks they pick will be worth in 6 months, 2 years, or any time horizon you like.
Warren Buffett is not a fraud. He is probably one of the most trusted and honorable people out there. But don’t forget- he’s not selling investment services. He’s a consumer of investment services. And if you listen carefully to what he says, he never claims to be able to predict the future. He simply says that he buys companies that are selling for less than they are really worth. He hasn’t amassed a fortune by predicting the future. He’s done it by being smart, hard working, and disciplined in his approach to investing. He does his homework, and he does it very thoroughly. This is not what most investors do.
Most investors leave it up to the ‘experts’ to decide what stocks to buy and when to sell. I call this phenomenon the ‘Guru Myth.’ It’s a very understandable human tendency to farm out those tasks that we don’t have time to do ourselves, and almost everyone does it. But it’s a dangerous way to invest. It’s dangerous because there is no such thing as an investment guru. There are people who are smart and disciplined, like Warren Buffett, but you can’t get access to them. That’s part of the rules of engagement in the investment game. It’s called ‘pay-to-play’ and it’s perfectly legal, moral, and ethical. Here’s how it works.