As I write this, The Masters golf tournament is getting started at Augusta National. The Masters is one of those events that transcends the sport itself. Like the Kentucky Derby and the Super Bowl, one does not need to be a fan of the sport to appreciate the event. For those who are golf fans, watching the world’s greatest live is an interesting and educational experience. One of the biggest lessons to be learned is that there is no such thing as “the right way” to swing a golf club. This is not to say that there is no such thing as fundamentals; there certainly are in golf. However, the true fundamentals are both fewer in number and more subtle than what one might hear at his local driving range.

One may hear that she can’t hit it far if she doesn’t have a big back swing, but then she sees Jon Rahm pound a ball out of sight. Perhaps she will be told that she has to keep her feet firmly planted, and then she will see Justin Thomas dancing all over as he strikes the ball beautifully. We could go on and on, but the fact is, much of what is described as absolute fundamentals are in fact just personal preferences. There is no one right way to swing a golf club.

Some will then take that observation and make yet another false conclusion, perhaps more dangerous than all the other fake fundamentals: They assume that since there is no one right way to swing a golf club, then there is no wrong way to swing a golf club. That is false. As many differences as one may observe on the fairways of Augusta National, there is a common set of fundamentals that every successful golfer must follow. There may be several “right ways,” but that does not mean there is not a wrong way. One will never see a successful golfer who has a fast back swing and slow downswing. There will never be a good golfer whose hands are behind the ball at impact. This list could also go on.

Why is this observation so important today? For the last 25 to 30, years our academic institutions have been taken over by a philosophy known as Post Modernism. The fundamental idea behind this movement is that Truth does not actually exist outside of one’s perspective. In other words, there is no absolute Truth, there is only perspective, so you have your truth and I have my truth, etc. Like all great and horrible lies – the falsehoods that have led to the most suffering in human history – there is an element of truth to this.

In the Eastern religions of Hinduism and Buddhism there is a parable of the blind men and the elephant. A wise teacher asked his students to gather four people who had been blind since birth. It was important that none of the blind individuals had ever seen an elephant. Then each blind person was led to a certain part of the elephant and told to study it with their hands. After a little while each was told to describe an elephant. Of course, their descriptions differed completely depending on what part of the elephant they had felt. One said the elephant was hairy, while another said it had no hair at all. One, who had felt the trunk, thought the elephant must slither on the ground like a great snake, while the one who felt its feet argued that it must walk.

The moral of the story is that our perspective impacts how we interpret things. This is absolutely correct. In our society we often tell a similar story of multiple people witnessing a car accident. If the police interview four witnesses, they will get four different perspectives; the stories will not match perfectly. This, however, is where Post Modernism fails: the four eyewitness accounts may vary depending on perspective, yet if one of them says, “There wasn’t an accident,” then that individual is just wrong. Just because there are multiple “right” perspectives does not mean there is no such thing as a wrong perspective.

Today there are extreme elements on the political left in our country who have embraced a concept known as Modern Monetary Policy. The idea is basically that the government can spend whatever it wants because it controls the money supply, and that it can do so without any negative consequence, i.e. inflation. The theory is wrong. In fairness, this is an oversimplified definition, but this is something academics need to understand: Their theories will always be oversimplified by the politicians who hear only what they want to hear and then use that academic theory as cover for their decisions. In other words, the oversimplified version is what is likely to actually happen in the real world.

One can certainly understand why this theory would be attractive to politicians, especially left-leaning politicians who believe that the government should have a bigger role. They can spend and spend and spend and nothing bad will happen. Why wouldn’t they want to believe this? Unfortunately for them, and for us now, this does not work so well in the real world.

Why? The basic problem with the theory is that it misunderstands what money is and how it is created. The government does not create money, it creates currency, and that is an important distinction. Currency is simply a tool which allows us to live in a society that is far simpler than it would be if we had no currency. In fact, imagining a world without currency is the best way to understand currency.

If there was no such thing as currency, we would still live in a world of barter. In other words, the plumber would do plumbing in exchange for food, shelter, etc. The doctor would be paid by giving him a chicken or a goat, or plumbing his house etc. Everyone would trade what they create for the other things they need. The obvious problem is that the plumber may need a doctor, but the doctor may already have a plumber. This is where currency comes into play. Instead of trading plumbing for medicine, we pay the plumber with money and then he can pay the doctor and she can pay the dry cleaner, etc.

Currency makes our economy work by eliminating the need to find exact trades as we would have to do in a pure barter situation. Historically precious metals were used as currency, but in the modern world we use government-issued paper currency. However, the value is sill created just as it was under the system of barter. The doctor creates value, or money, by providing us with her services. The plumber does the same and so does the butcher the baker and the candlestick maker. The private sector is what creates the value in an economy.

To put it another way, the private sector creates the supply in the concept of supply and demand. It creates the cell phones, computers, televisions, etc. It also creates the beef, fish, and chicken in our grocery stores. All of these items are created by individuals who then want to trade what they create for the other things in life they need. Currency makes that happen, but it doesn’t create the value. The value is created by the individuals who get up and go to work every day in their specific field. These individuals create the supply of goods and services we all want and need.

When government simply issues more currency, doing so does not create more value, therefore the currency begins to lose value. In other words, we experience inflation. To illustrate this, lets imagine that all the value created by the individuals who go to work each day equals 100 units. If the government issues 100 units of currency, then each unit of value equals one unit of currency. A dollar’s work equals a dollar’s pay. However, if the government issues 200 units of currency but nothing changes in the actual economy, then each unit of work now equals two units of currency: Inflation.

Another way to look at it, which is closer to what is actually happening today, is through supply and demand. Supply is the value created by all the individuals working primarily in the private sector. Supply is determined by the level of productivity – how many widgets can one person make in a day. Demand is what those individuals want to consume, and it is determined by how much currency they have in their pockets.

When the government puts more currency in the pockets of individuals while simultaneously reducing supply, they have created inflation. How does a government reduce supply when it is the private sector that creates it? Through tax and regulation. Over the last few years it has been the command to shut down, but that is short-lived and temporary. The biggest long-term issue is the over-regulation, which reduces productivity and the ability to create. The second largest threat is a tax system that penalizes the creation of excess supply.

What does it mean to be rich? It means one has created more than most. The plumber who is able to plumb the most houses will be the one who makes the most money. Of course, there will always be those who are living off money created by an ancestor and not by them. There will be examples of people who obtained money by ill-gotten means. While these are very noticeable and often unfair, the fact remains that most who achieve wealth do so by working harder and/or smarter than others around them. Therefore they create more value for all of us, and as a result get more money.

They should, as the politicians are fast to point out, pay their fair share in taxes. The problem comes from the fact that the politicians never define what “fair share” actually means. When a system is pursued that penalizes these individuals for creating more supply than anyone else, what happens is they cap the amount of supply they are willing to create. Supply is decreased, demand remains, and we all get inflation.

While this is dangerous, it is more talk than anything else. The fact is that politicians love high tax rates because they can then give out valuable loopholes. No one would pay for a loophole if it would be cheaper to pay the taxes. Did I say “give out?” Does anyone ever wonder how individuals who spend their lifetime in politics end up with so much money? I digress, but this does lead to the biggest issue with supply: government regulation. Nothing stops future supply as efficiently as regulation.

We started Iron Capital in 2003. At that time the lawyers made more money than the founders for the first three years. Today, there is no way we could have done what we did. The regulatory burden of our industry is too great and that stops others from entering into the industry. In other words, it reduces supply. That helps firms like Iron Capital as it reduces competition, and it also creates incentive for consolidation. We could sell the firm if we wanted. However, it hurts the consumer.

Where did inflation come from? It came from policymakers simultaneously stimulating demand through government handouts, while also attacking supply. Yes, they attacked supply by shutting down in response to Covid, but they are also attacking supply by increasing regulation and proposing tax regimes that even tax money that has not actually been made yet (unrealized capital gains). Inflation will not go away until this is reversed.

Some will read this and say I’m being political. That may be true in our time, but it did not used to be the case. The philosophy of limiting government interference to allow supply to be created was a guiding principle for John F. Kennedy. It was Jimmy Carter who began the deregulation credited to Reagan. It was Bill Clinton who declared the days of big government over. There is more than one right way. There is plenty of room for traditional political differences of perspective, but that doesn’t mean there is no wrong way. The current path is wrong, and the faster that is realized by people of all political perspectives, the better off we will be. +

~The Right Way

Seize the Day. This may be a strange thing for someone in my profession to say, but life is the thing you miss out on while you sit home making plans. I know: Iron Capital, like most of our competitors, does comprehensive financial planning. Our longtime readers will know that I also despise that term. I refer to the process as making financial projections, because that is what it actually is.

Projections are far less certain than plans, and there is never anything certain about the future. Did anyone plan on this never-ending reaction to a pandemic, now on its third strain? One cannot even plan on tax policy any longer because of our winner-take-all mentality with politics. Lost are the days of compromise leading to longer-term stability and the idea that winners of elections get to incrementally nudge us in the direction they wish to go. What will our tax system look like when you retire? The truth is, we don’t know.

What are we to do? These times remind me of the old legend of the tribe who lived in a cave. Every day they faced the wall at the back of the cave, and they saw shadows that scared them into not leaving the cave. Every once in a while someone would get the courage to venture out, but they never returned. The tribe, being who they were, assumed the worst. The danger outside the cave was too great. So, the tribe stayed put.

Meanwhile, those who did venture out discovered a beautiful world. They found that it was the sun rising and glowing into the cave that caused the shadows, and the figures on the wall were the shadows of the tribe itself. The outside world with all of its beauty was in fact dangerous, and some who left did indeed die. Others attempted to go back and tell the tribe that it was beautiful outside, but the tribe did not listen; fear ruled over them, and they spent their days wasting away in the cave.

Yes, there was danger outside the cave. One of the great lessons of investing, which is a universal lesson of life, is that there is no return without risk. In weightlifting they say there is no gain without pain. In the Judeo-Christian tradition of Western Civilization, the Lord told Adam and Eve that he would have to till the earth, and that she would have pain in childbearing. If one prefers Eastern philosophy, the Buddha teaches that life is suffering. To avoid risk, pain, and suffering is to avoid living.

Last year one of my cousins gave me a book entitled, “The Book of Joy.” It is written by Douglas Abrams, who records a conversation between two good friends, the Dalai Lama and Archbishop Desmond Tutu. Discussing the hardship of apartheid in South Africa, the Dalai Lama said, “You can see this in an entire generation that has experienced great difficulties like you, Archbishop. When you got your freedom, you really felt joyous. Now the new generation, who are born after, they don’t know the true joy of freedom, and complain more.” He went on to explain that it is the suffering that makes one appreciate the joy. It is the natural instinct of a parent to save their children from pain and suffering, but when we do, we rob them of their ability to grow and learn from adversity.

One of Iron Capital’s three rules of prudent investing is to be risk-averse. Are we contradicting what I just said? No. There is a huge difference between being risk-averse and being risk avoidant. Our culture today has become very black and white. We talk unthinkingly about seeing “both sides” of any issue, as if there are only two points of view – the point of view from one extreme, or that of the opposite extreme. The truth is, there is a huge area in between where most of us actually live.

Risk-avoidance means never leaving the cave: sitting there, staring at the shadows on the wall, gripped with fear. The very opposite might be jumping out of a perfectly functioning airplane, or swimming with bull and tiger sharks while a guide is feeding them. Having the courage to leave the cave and venture out in the world does not have to mean jumping off of cliffs. One could simply go for a walk in the sunshine. There are a lot more than two points of view.

We have lost our sense of balance. Seizing the day does not mean being in denial or acting carelessly. Risk should be managed – neither avoided, nor carelessly taken. This is true in investing, and it is true in life. When I was in college, I took a course to get certified to scuba dive. Scuba diving is extremely simple: breathe out of your mouth, and swim under the water. The course, however, lasted an entire semester. The reason was, we needed to learn about all the risk involved. We learned everything that could go wrong, and what to do if that happened. Then, we practiced those skills over and over in the relative safety of a deep swimming pool, while being closely monitored by instructors. By the time we made our first open-water dive, we all had good knowledge of the risks involved and how to overcome them. We did not allow the risks to stop us, nor did we simply ignore them.

We must seize the day. Life is meant to be lived, not just survived… which brings us back to planning. Planning is a very useful function: it can provide direction in life, and we need that. Wandering aimlessly with no regard for the future is not a recipe for long-term success, yet neither is frantically planning out every detail and constantly dreaming of a future while not living in the now. Just like all forms of risk, there is a balance – living today while being mindful of tomorrow. The key is flexibility.

When we help our clients with their financial projections, we always discuss flexibility. The only certainty in projecting the future is that it will never be exactly like the projection. This does not make the projection a waste of time; on the contrary, this exercise can be extremely helpful. It gives direction, and a way to measure progress. If done correctly, it can help one achieve one’s goals even if those goals change, and having done this for nearly thirty years, I can almost assure you that they will.

The real key to success, financial or otherwise, is to create positive daily habits. In other words, seize the day for today, as it is the only day that we are ever guaranteed. There are some extraordinary people who simply do this, but they are the exception. Most of us require motivation. This is where goals come into play. Goals provide motivation: they drive us to do the things today that will lead to success tomorrow. If one’s retirement goal is to buy a house in Florida and live the good life on the beach, then the picture of doing that will help ingrain the daily habits of living within one’s means and prudently investing toward that goal of living in the “Sunshine State.”

When the day finally comes and she realizes that she actually loves her home, enjoys having four seasons and wants to see the grandkids, then that new goal is easily achieved because of the habits she formed. Goals are a good thing when they provide motivation to do the right things today. Goals can, however, be dangerous, as they can become simple daydreams. Dreaming of a house in Florida while watching the snow fall outside isn’t helpful. Dreams can have us once again staring at the wall in the back of the cave. We need to get out and live today if we truly want to have a successful tomorrow.

Once we have the motivation, we need a plan of action. The hardest step is the first step. This step is, of course, dependent on where one is starting. If he is just starting out in life, then the question is, how to save? How do I create a budget and start to invest for my future? For many of our clients the question is: Now, how do I take all of these financial assets and turn them into retirement income? Every step is like leaving the cave for the first time over again.

Financial publications are full of stories about those who hesitate to get started young; less discussed are those who hesitate to enter retirement. We have multiple clients who tell us every year that they are going to retire in three years…one has been retiring “in three years” for nearly a decade now.

Leaving the cave is hard. While the existence of simply staring at the wall is mind-numbingly oppressive, it is still more comfortable than turning around and taking that first step. It is helpful to know, however, that the step does not have to mean jumping off the cliff. Many of our clients are transitioning into retirement with consulting work, or by going part-time. There are more than two points of view; in fact, there are countless points of view, and there are countless ways to imagine retirement.

But what if we leave the cave and something bad happens? We deal with it, that is what. Life is not meant to be easy. We have never lived in a world without viruses. There has never been a time on this planet when the climate wasn’t changing. Adversity is a fact of life and part of nature. It does not mean that there is some force out to get you; it is how we choose to deal with adversity that matters.

We should remember the words of the Dalai Lama, who said, “Many people think of suffering as a problem; actually it is an opportunity destiny has given you. In spite of difficulties and suffering, you can remain firm and maintain your composure.”

When we make financial projections, we run computer simulations of thousands and thousands of bad things. We do not ignore them. We are like the instructors in my scuba diving class: we think of everything that can go wrong, and we prepare for it. Then, when it happens, we can remain firm and maintain our composure.

No financial planner ever projected that we would be living through two years in which the world has allowed itself to be held hostage by a virus; nor did they foresee the Federal Reserve ignoring their own 2 percent inflation target. If they had predicted such things, they almost certainly would have assumed this meant a selloff in equity markets, not two solid years of growth. One must remain flexible and deal with life as it comes, not as we wish it to be.

If lessons have been learned over this period, one can hope we now know that shutting down completely in the face of adversity is not a productive strategy. We cannot hide in a cave waiting for there to be no more shadows on the wall. Life is meant to be lived. We will face adversity, suffering, danger; but that just grows our appreciation for the beauty. We do not ignore risk or live in denial, but instead face it and manage it. We cannot hide in our caves; we need to seize the day, precisely because life is fragile and filled with adversity. It is a New Year, let’s make the most of it. Carpe Diem!

Warm regards,

Chuck Osborne, CFA
Managing Director

~Carpe Diem

There I was, in my living room, golf club in hand, watching a relatively new program called “Golf Academy” on the Golf Channel. A young Tiger Woods was the guest along with his then-instructor, Butch Harmon. They were discussing Tiger’s swing changes and how they went through them. They had used video analysis of Tiger’s swing and Tiger said something I’ll never forget. Discussing watching his own swing on video, he said, “There is a huge difference between feel and real.”

What Tiger felt like he was doing in his swing and what he was actually doing were two very different things. Keep in mind, this was not some unathletic weekend hacker; this was Tiger Woods. He was already the greatest golfer of his generation and on his way to being, in my opinion, the second greatest golfer of all time. In all likelihood he has more body awareness than most other professional golfers, let alone us mere mortals. Yet there he was, entering the best stretch of golf in his incredible career, admitting that even he doesn’t feel what is really happening.

What a great lesson: feel isn’t real. I’m not even going to address the enormous difference between feel and real in my golf game, but this lesson from golf carries over to investing. We monitor our investment results continuously. We have both the market and our key strategies in front of us all day long when we are in the office. Every morning we review the actual results, and I can’t tell you how many times I have asked that the results be double checked because they are not what I remembered, or should I say felt, from the previous day.

There have been times, although rare, when it turned out we did have some sort of accounting glitch in our system. There is often a delay in our system for dividend payments, and that can impact the daily numbers. However, the vast majority of the time it turns out that I was just wrong, and I have been doing this for 30 years. How could that be?

The fact is that when it comes to investing there are lots of psychological traps into which investors fall. One such trap is called anchoring. The textbook example of this is when an investor looks at a company that is currently selling for $20 per share. The stock of the company then drops to $10 per share, and the investor feels that the stock is now a bargain because the stock price was cut in half. The reality may be very different; perhaps the company was never really worth $20, even if someone was once willing to pay that amount. Perhaps it should be selling for $5. Locking onto the price at one moment in time can lead to all kinds of mistakes.

I tend to fall into that trap because on most days the relative results of our actual investments compared to the market do not change. In other words, when the market opens at 9:30 a.m. Eastern Time and all stocks trade for the first time that day, I look closely at our investments. Let’s just say that on this particular day the market opens up 0.20 percent, and our investments open up 0.50 percent. In this example we are outperforming the market by 0.30 percent. That relationship usually holds for the rest of the day, no matter what the market does from there. So, if the market ends up 1 percent, I would expect our investments to be up 1.3 percent, and if the market ends up down 0.10 percent, I would expect us to be up 0.20 percent. The 0.30 difference remains the same. Unfortunately, this is also true on days we underperform.

I am conditioned to this because for the vast majority of my career this relationship has held true, but it isn’t universal. Some days the relative action will change. Our differential will grow or shrink as the day goes on, and those tend to be the days when my feelings on the portfolio do not match the reality of the portfolio.

An even larger trap is the trap of confirmation bias. I once got into an argument with someone about the wisdom of reducing the national debt. This was right after the financial crisis of 2008 and the economy was weak. While I believe we should be concerned about the size of our national dept, I also felt that it was not a good time to prioritize it. Too many people needed help. He sent me a paper written by two Harvard economists and highlighted a sentence which warned of the dangers of too much debt. The message was something along the lines of, “take that.” He had evidently failed to read the very next sentence in which the economists went on to say that now was not the time. He was not reading economic research papers in order to gain deeper understanding; he was simply looking for confirmation of his feelings.

One needs to go no further than social media to see confirmation bias in full force, as our more political friends (regardless of uniform) will cherry-pick data all day long “proving” their feelings to be correct and those other people to be not only wrong but evil. Feel is not real, and this is not a political newsletter. As investors we can fall in love with a company and when we do, we are in danger of seeing only positive data. We can also feel the market should go in a certain direction based on economics or politics or who wins the Super Bowl (don’t believe that one? Google it). Then we look only for confirming signs, even when other data may point a different direction.

This can lead to another trap known as information bias. This occurs when our feelings are driven by information that may very well be correct and complete but has no actual bearing on investment decisions. Nothing is cheaper or more prevalent today than information, but most information is useless. Understanding the difference between real news and useless noise is actually one of the most important distinctions between professional investors and lay people. My personal favorite in this category is when the financial media has “Breaking News” along the lines of, “The market today is at its lowest point since last Thursday!” Oh my, panic and run, but take your smart phone so you can keep watching.

Think I’m teasing? Watch CNBC for a week and I guarantee there will be at least two such messages. This leads to two simultaneous traps. First, this is completely useless information. The media fixates on the price level of the market because it is the easiest and fastest- changing piece of data to discuss. However, it is useless when it comes to making prudent investment decisions because we don’t invest in the market; we invest in specific companies, and while their price is certainly a factor, even then it is not usually the most important factor.

Secondly, we are once again anchoring. What was so impactful about last Thursday? Why is that the benchmark for the level of the market? Of course, the media don’t care if you fall into a psychological trap and lose money; they only care about you watching the channel or clicking on that news alert.

Perhaps the most dangerous trap is the trap of loss aversion. Investors hate taking a loss. I was once sitting in a bar in O’Hare Airport getting a quick dinner before boarding my next flight and the gentleman next to me asked what I did for a living. When I told him, as is often the case he decided to impress me with his investing acumen. He said what he did was invest in stocks and if they went down, he would simply hold on until they got back to the price he paid and then he would sell. On the other hand, if they went up, he would sell immediately locking in his gain.

That is textbook loss aversion. Loss aversion is not the same as risk aversion. The latter is a rational idea that one should avoid unnecessary risk whenever possible. Loss aversion has more to do with the psychological need to be correct. The idea here is that realizing a loss on an investment is admitting a mistake and that does not feel good. The flip side leads to realizing profits quickly so that one can prove he was correct.

While this may make an investor feel smart (the gentleman at the bar certainly felt he was brilliant), it is in reality quite dumb. By quickly selling winners and holding onto the losers this investor ends up with a portfolio full of losers. Professionals attempt to do the very opposite: cut losses rapidly and let one’s winners run. It may not feel as good, but the reality will be much better.

This year we have been exploring a theme in our Perspectives blog: If one cares about people, then one has to care about the result of policy and not just the intention of policy. In other words, one must care about real more than she cares about feel. Economically many policies feel good that in reality deliver increased suffering. There are also times when a policy that feels cold may lead to the best outcome.

So how do investors and policymakers guard against psychological traps that make us feel good while doing bad? In her book, “Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts,” professional poker player Annie Duke describes many psychological traps into which poker players fall. She admits that she falls into them herself and comes to an interesting conclusion: psychological traps cannot be avoided. We are human beings, and our brains work like everyone else’s. I have already admitted to anchoring, guilty as charged. Do you think we like telling our clients we are realizing a loss because we were wrong? Nope, we have egos just like that guy in the bar.

Confirmation bias is just human. We all do it. These traps cannot be avoided. However, as Ms. Duke points out in her book, what we can do is be aware of them. Knowing that we are human and subject to all the human psychological traps can help us remain humble and self- aware. We can’t avoid the traps, but we can recognize when we are in one and think our way out of it.

We can constantly force ourselves to face reality. As professionals we are always measuring our portfolios. We run different types of analyses that force us to be honest with ourselves. Measuring the real results puts our feelings in perspective. We also rely on process; we have an investment philosophy that governs the big picture. We create specific strategies that are consistent with that philosophy and allow us to address client needs. We then create a process by which we implement these strategies. Process is key because it takes feeling out of the equation. We know the process works because it has been tested and we trust it.

We analyze results and determine if tweaks need to be made to the process, but we do not go on feelings. Tiger Woods was also unable to will his feelings into matching reality; he simply had to accept that the correct motion did not come from what he thought was the correct feeling. Not even he could change what he felt, but he could become aware that feel and real were not the same thing. That understanding, combined with immense talent and an unrelenting work ethic, made him the second greatest golfer of all time.

Likewise, we cannot re-wire ourselves to avoid our feelings, but we can become self-aware. We can recognize a trap when we fall into it and develop a process to get ourselves back out. That is the key to having a successful investing reality.

Warm regards,

Chuck Osborne, CFA, Managing Director

~Feel vs. Real

Several weeks ago I was talking to our research director, Michael Smith. We talk all the time of course, and most of those conversations relate to the market, our clients, and the investments held in our client’s portfolios, as well as new ideas for future investment opportunities. To be more accurate, that is how most of our conversations begin; they usually end by philosophically solving one or more of our world’s problems before one of us finally says, “We have to get back to work.” These world problems could range anywhere from how Alabama will get back to playing the stiff defense for which their football team was known (Michael is a big Alabama fan), to solving the riddle that is our healthcare system, and myriad topics in between.

This particular day our conversation somehow turned to the topic of laziness. To be honest I’m not sure what turns the rabbit hole took to get us there, but it was a fruitful conversation. Sloth, after all, is one of the seven deadly sins according to Catholic teaching, and it is certainly worthy of inclusion in that list; yet it is often overshadowed by the more flashy sins like greed and wrath, which get all the glory. Nothing is more indicative of our modern society than seeing someone full of wrath over someone else’s greed.

Milton Friedman once said, “Of course, none of us are greedy, it’s only the other fellow who’s greedy.” We hear the greed thing all of the time because of our chosen profession, as investing and the accusation of greed seemingly go hand in hand. The 2008 financial crisis is a great example of this phenomenon. Books were written and movies made, and all of them had one big theme: greed was the root of the crisis. As I pointed out at the time, to believe that means that for years and years investors were not greedy and then all of a sudden became greedy, which is, of course, ridiculous. Greed could not have caused the financial crisis – not because it doesn’t exist, but because it always exists. If greedy investing decisions led to crisis, then we would always be in crisis.

The truth is that sloth had far more to do with the financial crisis than greed. Analysts got lazy. They stopped doing their jobs and were asleep at the switch. Bankers were not doing proper due diligence on mortgages they were underwriting as they figured the investors who actually provide the funds would let them know if a mortgage was too risky. Instead of thinking about what they were doing, they simply checked the box. In other words, they were slothful.

The rating agencies were slothful as well. Instead of doing real due diligence, they just assumed the bankers were doing their jobs. These securities are made up of mortgages, which are safe. They believed that a banker wouldn’t underwrite a mortgage that wasn’t safe: Check the box and rate them AAA.

Investors were slothful. Analyze the securities? Dig down into the actual mortgages themselves? The rating agencies said they are AAA, and look at the yield! What more would one need to know? Check the box, AAA security with relatively high yield: sold.

The regulators were slothful. What was there to be concerned about? They were meeting their social goal of housing for everyone: check. Banks appeared to be strong: check. After all, they had forced the banks to invest their reserves in AAA securities, so what could go wrong?

Things had been good for almost 30 years once we had gotten off the disastrous economic path of the late 1960s and 1970s and started heading in the right direction. People had gotten lazy at every level of the system. Sloth, not greed, caused the financial crisis.

Then there was the reaction: Pundits and the media all took one look and said, “This is Wall Street, it must be because they are greedy.” All they had to do for “proof” was to find a few juicy anecdotal stories of greedy idiots, and on Wall Street those stories are never hard to find. It is a low bar, but the media whose propaganda framed the narrative may very well have been the most slothful cog in the whole wheel. Why break a sweat trying to find out what actually happened when all you have to do is write the words “Wall Street Greed” to generate clicks and likes and shares?

Sloth was everywhere in 2008 and it is still with us today. Most obviously we see it with people being slow to come back to work, which has been the big story this quarter. We were undergoing a strong recovery from the reaction to the pandemic, and then we got hit by two bad jobs reports in a row. The unemployment rate actually rose at one point. People don’t want to work, and if they don’t have to because they are making more by staying on the dole, as they used to say, then they won’t. I want to be very clear: there is absolutely no judgment in that statement, it is simply a fact. It would be slothful of me to point my finger and say, “Look how lazy those folks are.” No; the reason sloth is among the Catholic deadly sins, and is a theme in every other religion and philosophy through the history of humankind, is because it is part of the human condition. It is in every single one of us. Some may be better at overcoming it than others, but we all suffer from it.

People are complicated, so an individual may show great discipline and drive in one area of her life and still be slothful about other things. I once knew a very disciplined person who competed at a high level in triathlons. She hated doing laundry and often lived out of her laundry basket to avoid having to fold her clothes when they came out of the dryer. When it came to training and competing she was extremely disciplined, but when the subject changed to laundry, one would have a hard time finding someone lazier.

Highly successful people who are frankly lazy about their own investments are Iron Capital’s bread and butter. I am thankful they exist, otherwise I would have to find another way to make a living. Many of our clients will tell us that they rely on us because they don’t have the desire or the time to do it themselves. One really can’t be disciplined in every aspect of life because there are only 24 hours in a day. Somewhere, outsourcing is necessary.

Often today that laziness manifests in how we get our news and decide what to believe. A prime example from recent history is the Wuhan virus origination story. The New York Times recently admitted that they rejected the Wuhan lab-leak theory largely out of groupthink and partisan polarization, because it was being pushed by people they did not like. To disagree with a statement or idea simply because one does not align with the person or organization offering it is the epidemy of sloth, yet we see it all the time and from people we would never describe as slothful.

This brings me back to Michael’s and my conversations. We must get back to work. Our job is to invest our clients’ money, and our own tendency toward sloth must be overcome. We believe that prudent investing has three attributes: it is done from the bottom-up, it is absolute return-oriented, and it is risk-averse. Each one of those attributes takes discipline.

However, we can also fall into the trap of just checking a box. Good investments are always found bottom-up in our opinion, yet that does not mean one can just ignore what is happening. A tobacco company may look fantastic in isolation and may very well be fantastic for an investor seeking income, but there is no growth to be had in that industry. When analyzing a company from the bottom-up one cannot be lazy and ignore the realities of what is happening in the big picture.

We believe strongly in an absolute return orientation. The grass being greener over there is the death knell for most lay investors who always chase after the highest returns. However, if one gets lazy she can use this as an excuse to ignore investing mistakes which may have caused underperformance.

Investors must be risk-averse as it is defense which wins championships, but many in our industry use this as a lazy excuse to accept lower returns in low yielding “safe” investments. They forget that market volatility is only one form of risk, and in reality the least important. The risk of outliving one’s money is far more dangerous than a simple market correction.

The greatest example of sloth is the tendency to see what one wants to see, believe what one wants to believe, and accept only facts one wants to accept. In investing this means one who believes the market is always wrong will just go counter to the market, while one who believes it is always right will go with the market. Both are forms of sloth, and both are wrong. An investor always has to do her work and think through her investments. There is never just one simple cause for everything. There is always another point of view, and prudent investors must have the discipline to see that. This means fighting their own biases. A disciplined investor is not without sloth; he is simply aware of his unique tendency toward sloth and therefore able to fight it.

It would be easy to say that the lazy investor hides in index funds, follows trends, and invests in what is popular. To a large degree this is true; however, there may be times when the index makes sense. Fighting the popular trend just to be contrarian can be just as lazy. The key to overcoming one’s own sloth is to understand it. What form does it take? A prudent investor must always be questioning himself. I used to work with a senior marketing person who loved to say that he was, “often wrong but never in doubt.” I would respond, “I’m always in doubt, which is why I’m seldom wrong.”

We would laugh and then go down some rabbit hole conversation until one of us would say, “It is time to get back to work.”

Warm regards,

Chuck Osborne
CFA, Managing Director

~Sloth

I am a proud member of the “Seinfeld” generation. We can communicate in short, seemingly meaningless phrases, and we know exactly what the other person means because of the cultural phenomenon that was the “Seinfeld” TV sitcom. One such phrase is, “No Soup for You!”

A New York City chef had opened a restaurant specializing in soup, which he served himself. The only issue was that the customer had to order the soup in a specific manner. If the customer got it wrong and upset the chef, then it was, “No soup for you!” He got away with this behavior because his soup was that good. Well, Jerry and his friends came to enjoy the soup and hilarity ensued. The bit was so funny that it went on for multiple episodes. The chef was known as the “Soup Nazi.”

At Iron Capital we are often asked, “What is your minimum?” The answer to that question is technically $1 million, but we are allowed to make exceptions, and we usually respond by telling the prospective client that we have never turned anyone away because of a lack of assets. The reason is very simple: We do not view our clients as dollar signs. This is one of my pet peeves about our business. Several years ago we tried having salespeople. We hired experienced staff from our industry. When they uncovered a promising new prospect and came to tell me about it, they would habitually started with, “She has $X in her portfolio.”

I would always tell them that I didn’t care about that; what I wanted to know is, who is this prospective client? Why is she interested in working with us, who referred her, and what is she looking for in an advisor? I wanted to know about the person, but the sales mentality went immediately to the dollars.

It was not their fault. They had all come from the industry, and this is how our industry works. In the industry people think nothing of asking, “What are your assets under management?” I understand what they mean, but the truth is Iron Capital, like every other firm out there, has no assets under management. Our clients collectively have more than $5 billion that they have entrusted to us to advise or manage, but not a dime of that belongs to Iron Capital. Those assets belong to our clients, who have largely entrusted us with the bulk of their assets, which they rely upon to provide for their various financial goals.

We tell our staff all the time: It does not matter how small a portfolio may be compared to others we manage, it is all the money in the world to that client, and he is just as important as every other client. Our responsibility to him is just as great – and perhaps even greater because he has less of a margin for error. This is our culture and it is why, for several years now, we have no salespeople. We are entirely referral-only, so people must come to us, as we have no one whose job it is to seek them out.

Once a prospective client understands that we are not concerned with their level of wealth, they usually ask the next logical question: “So have you turned people away for other reasons?” The answer is yes. If we feel that a prospective client is not a fit with us culturally, then we will politely tell them that we do not believe this is a fit, and we wish them the best of luck.

That is right – sometimes we say, “No soup for you!” (Much more kindly, to be clear.) Why would we do that? It is not because we are some form of financial advice Nazis; it actually has to do with the fact that we have no salespeople and we do not make any effort to seek out new clients in the first place.

When people from the industry hear that we don’t market ourselves to new clients, at first they often just don’t believe it because, to my knowledge, it is completely unique. They will ask, Aren’t you concerned with growth? Of course I am – people, plants and firms are all either growing or decaying. Growth is necessary for life; this is something the capitalism-haters simply do not understand, but that is a topic for another day.

Iron Capital is a living, breathing firm, and it must grow so that its employees can grow. People need raises, healthcare costs rise – everything is always going up, so we as a firm must grow as well. How do we do so if we don’t have salespeople? We rely on our clients. I have always believed that if we take care of our clients, then they will take care of us. So we focus entirely on taking care of our clients.

How do I get everyone on board with this strategy? I compare it to the Spanish conquistador Cortez, who famously burned his ships upon arriving in the New World so they had no choice but to conquer and settle the land. His men’s brutality is legendary. We don’t want brutal at Iron Capital, but I basically tell our employees that relying on a sales staff for their own raises is not an option. If they want to grow in their careers here, they will take care of our clients or go work somewhere else. Our investment professionals must grow the portfolios we actually manage, and our service professionals must take care of the clients, because we are not getting new ones.

That is not exactly true. We get more than enough new clients; they all simply come from our existing clients. This only happens because we are laser-focused on keeping and growing our existing client relationships, which is exactly why we don’t take every single client who comes our way. Don’t get me wrong, it isn’t like we turn down all that many, but it does happen.

Our clients understand that we are firm believers in what we call prudent investing. We invest from the bottom-up; we are absolute return-oriented; and we are risk-averse. Our clients understand this, and most of the time this is exactly what their friends want when clients refer them to us. However, we also will get random calls from someone who read about us or saw our name on a list of successful firms. Nine times out of ten these cold prospects start by asking questions that send up red flags, like, “What have your returns been?” And they often start by telling me how much money they have when I ask about them.

These individuals have unfortunately been conditioned by the industry to believe in competitive investing. Most of the time, this would be good for us; we know what we are doing, yet there is no investment strategy that is always successful in the short run, and there is no long-term success without a consistent strategy. I’m not saying that our way is the only way, but one has to pick a way and stick to it. These clients would be our new clients this year and someone else’s new clients next year. Why do we care? Why wouldn’t we just be happy collecting our fee for a year?

Because of you. The time spent on these kinds of clients is time that we can’t spend taking care of our real clients. Then, when they leave, their new adviser will likely sell everything we put in their portfolio, which means they will be selling many of the investments that are in your portfolio. We don’t want that.

So yes, we are selective, but it is not because we are arrogant or believe that only a certain kind of person deserves our help. We are not the investment world’s Soup Nazi; however, if we believe a new relationship will hurt our existing relationships, then it is, “No soup for you!”

Warm regards,

Chuck Osborne, CFA
Managing Director

~No Soup for You!