Buy Fail-Safe Investing on Amazon
This is my new go-to book recommendation when people ask me what the first book about investing they should read is.
For one, it is only about 150 pages and it’s a light 150 pages at that so you can get through it in an afternoon.
Second, it gets two very important thing right that nearly every investing book gets wrong.
First, it tells you that you won’t get rich investing.
This is not a popular thing for an investing book to do and so few of them do it.
Browne, correctly in my view, points out that:
Think about your own occupation, for example. Could someone without your training, your skills, your experience, and your talent outperform you at your job?
Of course not.
And yet too-good-to-be-true advertisements invite you— an amateur with no particular education, training, or experience in speculation—to compete, in your spare time, with professionals who have devoted their entire careers to investing, and who continue to eat, breathe, and sleep investing every day.
Most people that get rich investing, are either professional investors or they are investing in something that they deeply understand.
If someone told me that they had built and sold two skincare brands and were making an investment into a new skincare company, I would sure listen up. It’s totally believable to me that they have some “edge” based on their extensive experience.
If they told me that they were going to start trading options on tech stocks, I would not pay you the slightest bit of attention.
Reality has a surprising amount of detail and smart people get themselves in trouble thinking that being knowledgeable in one area necessarily means they are knowledgeable in everything else (*cough* doctors *cough*).
So the first thing Browne gets very right is to focus on making money in your career, the thing which you have spent years working on and where you understand all the little details.
The second thing he gets right is that he starts from a macro framework instead of getting lost in the weeds.
Most investing books are, ultimately, stock-picking books. There is nothing wrong with stock picking books, but it’s a pretty limited toolkit. The U.S. stock market over the past century has been the best performing in the world and still, there are three ten-year periods in the U.S. where stocks were flat or down as an asset class.
Browne instead starts by looking at all possible macroeconomic environments. They fit into four general categories:
- Prosperity: A period during which living standards are rising, the economy is growing, business is thriving, interest rates usually are falling, and unemployment is declining.
- Inflation: A period when consumer prices generally are rising. They might be rising moderately (an inflation rate of 6% or so), rapidly (10% to 20% or so, as in the late 1970s), or at a runaway rate (25% or more).
- Tight money or recession: A period during which the growth of the supply of money in circulation slows down. This leaves people with less cash than they expected to have, and usually leads to a recession—a period of poor economic conditions.
- Deflation: The opposite of inflation. Consumer prices decline and the purchasing power value of money grows. In the past, deflation has sometimes triggered a depression—a prolonged period of very bad economic conditions, as in the 1930s.
Browne then identifies which asset classes perform well in each environment:
Stocks take advantage of prosperity. They tend to do poorly during periods of inflation, deflation, and tight money, but over time those periods don’t undo the gains that stocks achieve during periods of prosperity.
Bonds also take advantage of prosperity. In addition, they profit when interest rates collapse during a deflation. You should expect bonds to do poorly during times of inflation and tight money.
Gold not only does well during times of intense inflation, it does very well. In the 1970s, gold rose twenty times over as the inflation rate soared to its peak of 15% in 1980. Gold generally does poorly during times of prosperity, tight money, and deflation.
Cash is most profitable during a period of tight money. Not only is it a liquid asset that can give you purchasing power when your income and investments might be ailing, but the rise in interest rates increases the return on your dollars. Cash also becomes more valuable during a deflation as prices fall. Cash is essentially neutral during a time of prosperity, and it is a loser during times of inflation.
This came to be known as the Permanent Portfolio and is an approach that has produced “stock-like returns with bond-like risks” since the early 1970s.
There are other versions of this portfolio that people have modified over time, but the general 4-quadrant framework is both simple and powerful.
There are some quibbles I might have with a few of Browne’s details, he gets the big things right.
My Highlights and Notes
- Think about your own occupation, for example. Could someone without your training, your skills, your experience, and your talent outperform you at your job? Of course not. And yet too-good-to-be-true advertisements invite you— an amateur with no particular education, training, or experience in speculation—to compete, in your spare time, with professionals who have devoted their entire careers to investing, and who continue to eat, breathe, and sleep investing every day. (Location 114)
- Yes, you know far more now than when you started your career, but success always depends on conditions you don’t control. And those conditions are constantly changing. Markets change, technology changes, the competition changes, consumer tastes change, and laws and regulations change. You earned your wealth because your talent and effort harmonized with the circumstances in which you found yourself. But the world won’t stand still for you or repeat itself when you need it to. (Location 161)
- Note: See this with entrepreneurs whose first business does really well and they think that they are god’s gift to humanity and they aggressively redeploy all that capital, not thinking that their first biz they sold was lucky and they get to 40 and their “wage slave” friend working a steady corporate gig and maxing out retirement contributions is richer than they are. Probably better to have your 3rd business take off because you’ll know there was a significant element of luck and not squander it.
- The distinction between investing and speculating is important. Any attempt to beat the return available to others must, by definition, also involve the risk that your return will be smaller than what the market is offering effortlessly—or even that there will be no return at all. (Location 193)
- Note: I think there is something here and obviously people doing TSLA calls and the like are speculating, but even a passive investment strategy involves active decisions.There is no “average” investment. The market’s path is non-ergodic #ergodicity
- As with the rest of your life, safety doesn’t come from trying to peer into the future to eliminate uncertainty. Safety comes from devising realistic ways to deal with uncertainty. You’re violating Rule #4 if you believe a certain event has to come about—or that a given investment can’t fail—or that you have good reason to know that some apparent risk simply won’t materialize—or that someone out there knows which way the market will move next year. The truth is simply that: Anything can happen. Nothing has to happen. (Location 222)
- Note: #diversification
- But, no matter how smart or experienced he is, the Market-Beater can’t predict the future. Nor can you expect him to spot the right times to buy and sell reliably. No one can, because no one can know the motivations and intentions of hundreds of millions of different people—each of whom will have an effect on next month’s prices, and each of whom can change his mind in unpredictable ways. (Location 251)
- Note: However, what is “the market”? I think the best definition would just be the value of all the world’s assets, but hard to measure. In general, I agree with sentiment here, just think that you are always making some active decisions that involve [[basis risk]] to all the world’s assets. Certainly, you want to err more on the side of diversification.
- Investing on a cash basis doesn’t insure you against loss. But it effectively eliminates the risk of losing everything, because investment prices rarely go to zero. And if you diversify—not just among stocks, but across investment markets—even a severe loss in one market can be offset, or even overshadowed, by profits in another.2 (Location 375)
- Note: Using prudent leverage to get more return with a diversified portfolio a la risk parity is a reasonable exception to this IMO.
- For the money you’re counting on to take care of you for the rest of your life, set up a simple, balanced, diversified portfolio. 1 The portfolio should assure that your wealth will survive any event—including events that would be devastating to any one investment. In other words, this portfolio should protect you no matter what the future brings. (Location 425)
- It isn’t difficult or complicated to build a bulletproof portfolio. You can achieve a great deal of protection with a surprisingly simple mix of investments. The three absolute requirements for such a portfolio are: 1. Safety: It should protect you against every possible economic future. You should profit during times of normal prosperity, but you also should be safe (and perhaps even profit) during bad times—inflation, recession, or even depression. 2. Stability: Whatever economic climate arrives, the portfolio’s performance should be so steady that you won’t wonder whether the portfolio needs to be changed. Even in the worst possible circumstances, the portfolio’s value should drop no more than slightly—so that you won’t panic and abandon it. This stability also permits you to turn your attention away from your investments, confident that your portfolio will protect you in any circumstance. 3. Simplicity: The portfolio should be so easy to maintain, and require so little of your time, that you’ll never be tempted to look for something that seems simpler, but is less safe. (Location 428)
- Note: Cover all economic regimes, low drawdowns so you don’t panic sell and improve your CAGR, and requires little of your time.
- Your portfolio needs to respond well only to those broad movements. And they fit into four general categories: 1. Prosperity: A period during which living standards are rising, the economy is growing, business is thriving, interest rates usually are falling, and unemployment is declining. 2. Inflation: A period when consumer prices generally are rising. They might be rising moderately (an inflation rate of 6% or so), rapidly (10% to 20% or so, as in the late 1970s), or at a runaway rate (25% or more). 3. Tight money or recession: A period during which the growth of the supply of money in circulation slows down. This leaves people with less cash than they expected to have, and usually leads to a recession—a period of poor economic conditions. 4. Deflation: The opposite of inflation. Consumer prices decline and the purchasing power value of money grows. In the past, deflation has sometimes triggered a depression—a prolonged period of very bad economic conditions, as in the 1930s, (Location 445)
- To be protected in all circumstances, each economic environment must have at least one investment in the Permanent Portfolio that responds well to it. Fortunately, there are simple investments that can do that. Prosperity produces an upward market in stocks. And as prosperity causes interest rates to fall, long-term bonds go up in price. Inflation weakens faith in the U.S. dollar—the world’s most popular money. As a result, many investors around the world reduce their dollar holdings and replace them with the world’s second most popular form of money: gold. Once U.S. inflation becomes more than a minor irritant (that is, once inflation reaches 6% or so), gold usually starts moving upward—and when the inflation rate gets into double digits, gold’s rise accelerates. Deflation reduces the prices of most consumer goods and investments. As dollars become more valuable, interest rates fall dramatically. And as interest rates fall, bond prices go up. During the depression of the 1930s, for example, the interest yield on U.S. Treasury bonds fell to 2%. A drop to 2% from, say, 6% would cause long-term bonds to double in price. Tight money is usually characterized by rising interest rates, which are bad for most investments. The only attractive investment during a recession is cash. And your cash holdings may not completely offset the losses that tight money may inflict on the rest of your portfolio. But tight money is by nature a temporary condition. Unlike prosperity, inflation, or depression, it can’t go on indefinitely. Either the economy adjusts to the new level of money and returns to prosperity, or the supply of money changes— leading to inflation or a full-scale deflation. (Location 460)
- Note: Tight money is different in that it is transient and something else must happen.
- Thus four investments provide coverage for all four economic environments: Stocks take advantage of prosperity. They tend to do poorly during periods of inflation, deflation, and tight money, but over time those periods don’t undo the gains that stocks achieve during periods of prosperity. Bonds also take advantage of prosperity. In addition, they profit when interest rates collapse during a deflation. You should expect bonds to do poorly during times of inflation and tight money. Gold not only does well during times of intense inflation, it does very well. In the 1970s, gold rose twenty times over as the inflation rate soared to its peak of 15% in 1980. Gold generally does poorly during times of prosperity, tight money, and deflation. Cash is most profitable during a period of tight money. Not only is it a liquid asset that can give you purchasing power when your income and investments might be ailing, but the rise in interest rates increases the return on your dollars. Cash also becomes more valuable during a deflation as prices fall. Cash is essentially neutral during a time of prosperity, and it is a loser during times of inflation. (Location 474)
- If someone warns about the “alarming parallels” between the current decade and the 1920s, you shouldn’t wonder whether you need to sell all your stocks. You’ll know that your Permanent Portfolio will take care of you—even if next year turns out to be 1929 revisited. The deflation that could devastate stocks would push interest rates downward and bring big profits for your bonds. When someone claims the inflation rate is headed back to 15%, you shouldn’t wonder whether to dump all your bonds. You’ll know that the gain in your Permanent Portfolio’s gold would far outweigh any losses on the bonds. When someone announces that a new debt crisis is on the way, or that a bull market is about to begin in stocks, bonds, or gold, you won’t feel pressured to decide whether he’s right. You’ll know that the Permanent Portfolio will respond favorably to any eventuality. (Location 547)
- To enjoy some of your wealth while you’re earning it, budget a sum of money that you can spend each year without concern for the consequences. If you stay within that amount, you can feel free to blow the money on cars, trips, anything you want—without worry, because you’ll know you aren’t blowing your future. (Location 737)
- Some people think of real estate as an investment. And, of course, it is possible to buy a home and later resell it at a higher price. But no matter how much your home has appreciated when you sell it, it’s quite possible that you’ll replace it with another home in the same higher price range. (Location 1176)
- Note: This is an interesting point, that basically residential real estate isn’t an investment if you are living in it because any profit, you will just need to use to buy another place to live in. It’s a consumption good.
- During the 1970s bonds plummeted in price as interest rates rose. In the early 1980s, some of my newsletter customers wouldn’t buy bonds for the Permanent Portfolio— figuring they were a perpetual losing investment. They couldn’t know that bonds had actually started a long-term uptrend in 1981. By the mid-1980s some of them acknowledged that they should have bought bonds when they set up their portfolios. But, they reasoned, now bonds were higher in price—and they probably had gone about as high as they were going to. So they wanted to wait to buy at what they expected would be a lower price. But bonds continued to rise—more than doubling in price by the end of the 1980s. The lesson was clear: No matter how strong your expectations about the near future, you could easily be mistaken. And the point of the Permanent Portfolio is to ignore your own expectations and let the portfolio take care of you no matter what may come. (Location 1212)
- Note: recency bias kills returns
Last Updated on April 30, 2021 by Taylor Pearson