Investing To Keep Up
Electrifying our world of investing
Rising inflation rates should push us to invest more, not less, in stocks. Consumer prices rose 3.5% in March 2024. If we keep all our money in savings, ten years from now it will lose some of its purchasing power.
Higher interest rates help fight inflation only to some extent, especially not with money we plan to leave for the next generation. Currently, the interest rates on savings accounts hover around a little over 4%. Banks pay less interest to depositors than they collect from the borrowers, to make money. Income tax is paid yearly on the interest earned, reducing savers’ returns.
Most public companies have to do better than inflation. They must pay higher wages, but also improve productivity and market share to compensate. Else their stock price will not go up with time. People instead will pick stocks in other companies, that are more likely to go up. Public companies are required to disclose their forecasts. So we have some clue of the future performance of public companies. Further, taxes on stock gains are only paid when appreciated stock is sold — and not every year. In the meantime reinvesting the unpaid tax money, can further increase returns.
But picking stocks and knowing when to buy or sell is super difficult. That is why investors like Warren Buffet are revered. His company Berkshire has delivered 19.8% compounded annual returns over nearly 55 years.
The alternative to picking stocks (not for unsophisticated investors like me) is to buy a basket of stocks such as S&P 500, where 500 large company stocks are picked by experts. The S&P 500 is the gold standard in the investing world for comparing returns.
Very few money managers beat S&P 500 returns on a long-term basis. But in any given year the fund’s returns can even be negative. Annual compounded returns on S&P 500 has been 7.8%, and most professionals are unable to beat it.
In contrast, a savings account’s money will never reduce from its original amount, but its purchasing power will keep reducing over time. The decision between investing in S&P 500 vs a bank account is that of higher risk with higher reward.
Yet I am finding investing in stocks can be fun, even though my money is at stake. It is a great learning experience for anyone. It tests our rationality. According to Gallup, 61% of Americans own stocks. Public companies get money when people invest in their stocks, and investors benefit when the stock price rises. Higher productivity of companies grows a country’s GDP. This is why capitalism works.
Almost 30000 people show up for Berkshire’s annual shareholders meeting to listen to the words of wisdom from Buffet and Munger — who passed away last November just before turning 100. In this meeting and Annual Reports — a goldmine for any investor — they share how they pick stocks:
“Price entry for buying a stock is important, because of the inherent risk in stocks, which mitigates the risk to some extent.”
“(Invest in) wonderful businesses purchased at fair prices and give up buying fair businesses at wonderful prices.” Charlie Munger advised Buffet.
“We don’t buy what we don’t understand.”
“Consistency over a long term is hard to achieve in investing, just like in the game of bridge,” Munger said.
This is how far I have gone in my playbook.
There are outliers to Warren’s investment philosophy. The biggest success story is Jim Simons’ company Renaissance Technologies. Simons, who holds a PhD in mathematics, hired the best mathematicians to design an algorithm to pick and trade stocks. “In 1979 his team studied if a severe weather pattern would affect the supply of wheat”. Many more such obscure correlated patterns, are now incorporated in their algorithms. The machine flips a stock on an average in less than 2 days, as opposed to Warren Buffet holding stocks for decades!
Renaissance Technologies Medallion Fund’s annual returns are whooping 66% against Berkeshire’s of 19.8% and S&P 500’s of 7.8%.
Simons is listed on Forbes’ list of the 100 richest. Renaissance Technologies’ secret sauce is the mathematicians who built the model and who keep improving it.
Renaissance Technologies has been so successful that it has been closed to outsiders since 1993.
In contrast, Warren’s investment philosophy is far more nuanced.
There are other success stories in both models.
For most investors, the easier choices are between letting inflation erode our purchasing power, or investing in S&P 500, like index funds. Choosing individual stocks is riskier, and mistakes can be fatal. Buying US Treasuries can be a better choice than savings accounts because the interest on them is tax-free.
Investing sensibly is not easy, but not so difficult either.
