Part 6 (1/2)
Being Quiet
Hoe to Catatonia Wisely and slow; they stu ' s College, Keynes ' alma mater, is famed for its medieval chapel, considered one of the nest examples of late - Gothic architecture any-where in the world Declared the land by Henry Jalorious work of ne intelligenceWhere light and shade repose, where music dwells” It was into this place of otherworldly beauty, built by Henry VI to redound the glory of God, that Maynard Keynes strode one day in the mid - 1930s with a very specic task in hand He surveyed the chap-el ' s lofty pillars and vaulted ceilings, but not, on this occasion at least, for their aesthetic charinally was - proceeded with a rough reckoning of the cubic capac-ity of the building His purpose was to detere and i to one of his more amboyant commodity plays, Keynes was about to be encumbered with the equivalent of a dom Rather than pay the dif-ference between the spot price of wheat and the contract price - the conventionala futures contract - Keynes elected to back his judgrain, con -dent that the market rate would eventually rise beyond his contracted price In a rare victory for aesthetics over co ' s College chapel into a granary was averted - apparently the building was sin to the quality of the cargo, co that the wheat contained more than the per-rain was cleaned, the market price had risen such that the wily economist even-tually made money on the contract
Keynes ' preposterous plan to turn the hallowed chapel into one of history ' s ant barns was emblematic not only of his transfor-mation from callow aesthete to hard headed e in his invest to one of ” faithfulness ” in respect of a handful of ” pets” As an early value investor, Keynes believed that ” ' Be Quiet ' is our best nored as mere ” noise ” and the dis-ciplined investor should patiently wait for themachineThe only rational response to irrational ame players have the short term to themselves, while Keynes instead prac-ticed a policy of ” steadiness ” in respect of his select portfolio of shares
This buy - and - hold strategy was not only the natural complement to an investment philosophy that assessed stocks on the basis of future inco - ternicantly lower transaction costs, and allowed them to reap the enormous power of compound interest
Whirlpools of Speculation Speculators may do no harm as bubbles on a steady stream of enterprise But the position is serious when enterprise becomes the bubble on a whirlpool of speculationWhen the capital development of a country becomes a by - product of the activities of a casino, the job is likely to be ill - done
-Keynes, THE GENERAL THEORY Teddy Roosevelt, the trust - busting American President of the early twentieth century, once averred that ” there is noat cards or in lotteries or on the race track and gareed with this assess on the stock market was far more deleterious to a nation ' s health than the innocent pleasures of the track or the ga den In an appearance before a Royal Coareat signicance rather than be bound up with the industry and trade of the country” Keynes believed that racecourses and the like were a relatively hare ” Industrial betting ” on stock exchanges, on the other hand, could lead to ” the whole of [a nation ' s] industry beco a mere by - product of a casino”
Keynes contrasted the socially destructive effects of stock ame players with those of speculators in the commodity and currency marketsThis latter class of speculator, Keynes asserted, provided ” a use-ful, indeed al certainty in other-wise risky situations: Where risk is unavoidably present, it is much better that it should be carried by those who are qualied or are desirous to bear it, than by traders, who have neither the qualication nor the desire to do so, and whose minds it distracts from their own business
In contrast, the ” proper social purpose ” of the stock market was, as Keynes explained, ” to direct new investment into the most pro table channels in terms of future yield” The price performance of a stock will inuence not only the ability of the underlying company to raise capital on the equitycapacity, its ability to ies it seeks to i capital-ism is that the stock market should reward those businesses that are the most successful Success in the capitalist system is dened in brutally reductionist terms - the ability to earn sustainable pro ts over ti, where the investment decision is informed by an estimate of the total prospective yield of a security, facilitates this social purpose Stock ely ato decide what B, C, and D are likely to think - with B, C, and D trying to do the same ” - merely serves to distort capital ows, by potentially diverting capital and kudos away fro businesses As Keynes noted in The General Theory, ” The social object of skilled investnorance which envelop our future” In Keynes ' perfect world, the stocksecurities ” for keeps ,” based on ” long - term fore-casts of the probable yield of an investas inrust the hidden treasure frets, But gold that ' s put to use ets
-Shakespeare, VENUS AND ADONIS Keynes had a happy ability to produce economic theories that con-formed to his own personal beliefs One of the chief conclusions of The General Theory- that overn - coincided perfectly with his view that money was meant to be spent, not hoarded Keynes ' advocacy of ” a somewhat comprehensive socialization of investment ” reected his faith in state -appointed mandarins to, in certain circumstances, do a better job than the mobbish marketAnd his views on speculation in the stock market - as opposed to the currency and commodity markets - were in tune with his later incarnation as a value investor, while still allowing Keynes an occasional irtation with the co his life and posthu him of a for his theories so that they satised his personal predilections In his defense, however, socially responsible stock” of stocks acquired on the basis of anticipated yield - also happened to beter investment horizon not only allows investors to look beyond the distractions of constantly uctuating prices, but also shi+elds them from the erosion of capital inevitably produced by trans-action costs inherent in trading
Perhapsquiet ” - of li activity in the market only to those occasions when quoted prices appear to stray far from intrinsic value - allows the investor to reap the tremendous power of compound interest Compound interest works like a kind ofnancial sobll - if income from an asset is reinvested, this incoinal capital contribution grows at a geometric rateThe ” rule of 72 ” neatly illustrates the expo-nential increases available fro the number 72 by the yield earned on an investment provides a close approximation of the a capital to double in value - for exa 6 percent return per year, if re - invested, will double in twelve years, and an asset with a 9 percent per annuht years
The intelligent investor, recruiting time as his ally in the value -creation process, relies on what Keynes called the ” powerfulopera-tion of coaries of the market For the buy - and - hold value investor, it is ti - that is important
Errors of Co and selling shares in the funds
-Samuel Johnson, A DICTIONARY OF THE ENGLISH LANGUAGE Even froe, Keynes viewed brokers and investht In Indian Currency and Finance, hisrst book, Keynes asked rhetorically:how long will it be found necessary to pay City men so entirely out of proportion to what other servants of society co social services not less useful or dif cult?
Later in life, he advised his nephew - just setting out in the world of investestions Keynes hinted that a type of reverse Darwinis fraternity, a survival of the die,” one would expect brokers to be wrong If, in addi-tion to their other inside advantages, they were capable of good advice, clearly they would have retired a long tie fortune”
The Berkshi+re Hathaway duo share Keynes ' distaste for thenan-cial advisory professionWarren Buffett drolly notes that ” Wall Street is the only place that people ride to work in a Rolls Royce to get advice froer has drafted in Keynes to support his argu invest Becausearound a perpetual universe of co it just cancel each other out
As Gordon Gekko, that famous de, in aggregate, is ” a zero su another level of interate returns available to investors as a whole
But brokers and investers exert a far ame players Like sharks, appropriately, brokers and other nancial intermediaries require constant movement in order to survive The interests of investors and brokers are poorly aligned - brokers are geared toward ” churning ” trades, therebycom-missions, at the expense of the investor Not only do brokers encourage excessive trading - ” Never ask a barber if you need a haircut,” Warren Buffett quips - but coency costs can seriously erode the capital base of an active investor
Capital Punishment The avoidance of taxes is the only intellectual pursuit that still carries any reward
-Keynes (attributed) Brokers ' charges and other transaction costs do, however, possess one positive attribute - they ing stock , thereby sparing them from a potentially ains taxes ” - a levy i stocks - are not in fact taxes on capital gains; rather, they are a transaction tax An investor holding a stock that has improved in price ains - only when the security is sold will the tax liability crystallize
Buy - and - hold investors soains ” - the tax rate may, for example, be lower for invest-ments held for more than a year In addition to this explicit reduction in the tax rate, deferring a tax liability can - due to the power of conicant positive effects on the after - tax value of an investor ' s portfolio An active market player who turns his port folio over each year will incur an annual tax liability The buy - and - hold investor, on the other hand, only incurs a theoretical tax liability for as long as he holds the stocks, and therefore still has his ” before - tax ” gains working for him - in effect, the investor receives an interest - free loan fro, the buy - and - hold investor will - all other things being equal - record a signi cantly larger after - tax return
Warren Buffett and Charlie Munger are particularlyerce critics of the ” self - in icted wounds ” sustained from excessive market activ-ity Buffett cautions that a ” hyperactive stock er co ” frictional costs ” : There are huge advantages for an individual to get into a position where you reat invest less to brokers You ' re listening to less nonsense And if it works, the governe points per annum compounded
As Buffett noted in a letter to Berkshi+re stockholders,” For investors as a whole, returns decrease as motion increases”
To Have and to Hold I believe now that successful invest offairly large units through thick and thin, perhaps for several years
-Keynes to the King ' s College Estates Committee, May 8, 1938 Keynes, better thanbut intense satis-factions of the successful speculator Writing in The General Theory with the guilty knowledge of the poacher - turned - gamekeeper, he observed that ” huains are discounted by the average ical peculiarity - now pathologized as the condition of ” hyperbolic discounting ” by the behavioralnance fraternity - that Keynes laid the foundation for his tremendous stock market success in the latter part of his invest - term hori-zon consistent with an invest the latent potential of underpriced stocks, but this ” steadiness ” also protected the investor from transaction costs that can seriously erode the capital of the active investor
In The General Theory Keynes suggested that co vieould cure them of the malaise of short - terovernht[ate] the predominance of speculation over enterprise” This idea was later taken up by Warren Buffett, who argued that a 100 percent tax should be applied to prots made on stocks held for less than a year Buffett ' s refusal to effect stock splits on Berkshi+re paper - the cohest priced stock on the New York Stock Exchange, breach-ing the US100,000 per share barrier in late 2006 - is his oay of atte to curtail the liquidity of, and therefore the speculative pressure on, Berkshi+re securities
In considering the- term approach to stock market investments, Keynes opined that:to make the purchase of an investe, except by reason of death or other grave cause, ht be a useful remedy for our contemporary evils For this would force the investor to direct his- term prospects and to those only
For Keynes at least, the e metaphor was apt He had evolved fro in the n exchange and co loyal to his select group of stock market ” pets”
Warren Buffett also adopts a y, calling his stock market approach ” our ' til - death -do - us - part policy ” and re on Berkshi+re ' s ” determination to have and to hold” Jesse Livermore, a famous stock trader and market bear in the early part of the last century, once likened Wall Street to a ” giant whorehouse ” where brokers pi this adht be said that Keynes - the reformed sinner, the speculator who eventually embraced the buy - and - hold approach - perhaps wanted toa faithful and fruitful relation-shi+p with his select handful of ” stunners” As Buffett reation in one of his missives, investors are not rewarded for activity - they are rewarded for being right
Chapter 12
Eggs in One Basket
A Fugitive fro can be wonderful
-Mae West, in MY LITTLE CHICKADEE Keynes ' paternal grandfather, like his illustrious descendant, was adept at turning a pro t Exploiting England ' s enduring obsession with gardening, he accrued a s hisrst nancial killing during the ” dahlia craze ” of the 1840s Keynes senior was a shrewd businessman who resolutely focused on only the most lucrativeower strains - rst dahlias, later roses and carnations - rather than, in the words of one gardening th in dubious enterprises” Like his forebear, Maynard Keynes also believed that investing heavily in a few ” pets ” would typically deliver much better returns than an indiscriminate policy of diversi cation