Investing like the rich…

While my opinion often differs from Michael James, I appreciate his perspective. I particularly enjoyed his post on investing like the rich. He makes two valid points: the rich (generally) didn’t make their money in the stock market and they aren’t necessarily successful when investing in the stock market.

This is no secret. I’ve read a number of books that have pointed this out. Think about any successful person you know. How did they make their fortune? Almost all of them made their money by owning or running a business. A single business, without diversification. That investment of time and energy, if not capital, provides an investment that is understandable and is under the control of its owner. All the information about operations and results is available, and the owner can make whatever changes he sees fit.

When the owner sells his business, the question becomes: what to do with that money now? Buying businesses makes sense and is probably comfortable for the prior business owner. Buying a share of a business is exactly what the stock market is for. The business owner is then able to put their capital to work, spread the risk across a number of ventures, and continue to collect business profits (as dividends).

The problem arises from the differences. First, ownership through shares is totally hands off. Complete information isn’t always available (although, to be fair, many companies make an effort to provide clear and complete information), and the influence of shareholders over operations is at best indirect. Once a portfolio of businesses is collected, generally more than 20, it becomes very complex to stay abreast of all the information and external conditions affecting the portfolio of businesses.

If the rich were to treat their stock investments the way they treated the businesses in which they made their fortune, they would be more successful. It would certainly go against modern portfolio theory, and the sales pitches of large financial firms. How do they hire people? They look at qualifications, experience, ability and they measure results. How do they ensure their business is on track? They are involved on a regular basis, and they set and meet targets. Finally, they don’t buy and sell their own business on a regular basis.

If we invested the way the rich run their business, I think we could expect better results. That’s why I own a small number of business, trade infrequently, read financial statements and participate in conference calls. I also don’t expect every quarter to be better than the last. The economic environment, as well as the individual company context, fluctuates over time. I expect results to deteriorate and improve over time. For this reason, it doesn’t make sense to jump in an out of a company’s shares except in response to opportunities that arise from price fluctuations.

I try to run my investment portfolio as a business, where I hire managers to function on my behalf and to be accountable to me (within reason). If I lose confidence in a company, I will sell it, and find another company I can depend on to produce results. This can be complex, since there is an interplay between the various businesses I own (they react differently and on a different timeline to external forces), as well as the impact of price movements in the marketplace.