To follow, without halt, one aim: there is the secret to success.
The Journal of the Lion & the Wolf
To follow, without halt, one aim: there is the secret to success.
Without great solitude no serious work is possible.
Grinding It Out: The Making of McDonald’s
by Ray Kroc, with Robert Anderson, published 1992
Reading through the stories of great entrepreneurs, business people and politicians like Cornelius Vanderbilt or Warren Buffett, it is easy to find a sentiment much like this one from Ray Kroc:
Ethel [his wife] used to complain once in a while about about the amount of time I spent away from home working. Looking back on it now, I guess it was kind of unfair. But I was driven by ambition.
I find this sentiment remarkable for a few different reasons.
The first is how common it is. It seems to suggest that achieving “great things” in a particular field of enterprise is not possible without neglecting one’s family and other personal relationships in favor of the “productive” relationships and activities.
The second is how little awareness of this tradeoff many such people seem to possess, at least until they reach the end of their life and all their glory has already been gotten. Then, as they contemplate their state of affairs, either looking back on the empire they built or ruminating regretfully now that they are deposed (violently or voluntarily), they seem to re-evaluate how they spent their time and decide they came up short in considering family time less important than it should have been. They also seem to be either disconnected from the damage they do to their children and their psyches, or else try to evade such recognition– I think Ray Kroc mentioned his daughter all of two times in this 200 page telling, and while his daughter may not have been critical to the story of building McDonald’s, you’d think she would’ve provided enough value and motivation in Kroc’s life to merit more than a couple passing mentions!
The third is how excusable such high achievers seem to find their behavior to be in retrospect. “But…” is a permission word. It negates what comes before and offers cover. Yes, Ray Kroc was unfair, but… It suggests a different moral framework for studying life or a particular circumstance, one in which the rules don’t really apply and the ends justify the means.
The fourth is what a temptation these great projects must’ve provided to these people, to ignore their family, their health or any number of other values. If I was a successful paper cup salesman but stumbled upon the idea of McDonald’s myself, could I have resisted the temptation to build it and in the process knowingly give up my family, friends, physical well-being, etc.? It is perhaps easy to sit in judgment of another person’s efforts and decisions when the attraction of my own responsibilities is relatively less compelling. It’s easy to go home to my family at the end of the day as they typically offer me more interest and excitement. But would that be the case if millions of dollars and a global business organization hung in the balance? That I don’t know for sure, and perhaps you can’t know until you’re tempted with it.
But that leads to the fifth point, which is to consider whether a story like Kroc’s and McDonald’s could be told any other way. What if in the first 27 pages of the story of this business the quote above was not to be found, nor anywhere in the 173+ pages that followed? What if Kroc didn’t get divorced (twice), didn’t have a string of health issues along the way, came home and kissed his wife and daughter on the forehead five nights a week and spent most of each month at home and around town rather than around the country? What choices would’ve needed to be made differently to support that outcome, and how would the company look different either internally or competitively if that had been the case? How big would Berkshire Hathaway be if Buffett had raised his own children and loved his first wife more considerately instead of reading so many damn books and annual reports?
To ask may be to answer, but it’s frightening (hopeful?) to think otherwise.
Besides neglecting important obligations and personal considerations, what else do stories like these seem to tell us about those who achieve outsize success?
Incredible stamina seems to be part of it. They don’t just work hard, they work all the time. But again, it’s hard to know if this is part of the person, part of the responsibility and opportunity, or both. How would a person not work hard and often at something they didn’t love to the point they were mesmerized by it? Enthralled is a good way to describe the state of mind in relation to the idea of the thing being pursued here.
Also, simplicity. Maybe it’s the bad ghostwriting designed to break the story down for a lowbrow audience but the way these people talk about what it is they did, they rarely come across as great geniuses, though they’re often wits (Buffett is a notable exception here, and Vanderbilt was clearly “sharp”, a word for cunning back then, though it wasn’t clear he was necessarily “intelligent”, while it was clear he was no buffoon). The grand strategy and complexity is often seen in hindsight, knowing how the story ends and having years and years to tell it and thus accumulate various trappings which may or may not be integral to the success. In Kroc’s own words, it was all about Quality, Service, Cleanliness and Value and then spreading it across the land. Their financing was complicated, but it’s not clear it needed to be, especially if the company was less levered and less insistent on growing as fast as it did. Being focused seems obvious, yet important enough to mention it.
Where does that leave me? If there’s a way to build a legacy that doesn’t involve neglecting one’s family and health, perhaps by being more patient, moving more slowly or being less obsessed about the outcome, that is the kind of legacy I want to build. And I have to wonder what kind of personal insecurity or individual idiosyncrasy or whatever it is, that I seem not to have, that would not allow a person to make that choice given the alternative.
But if the only way to make things great is to trash some other part of your life and leave a smoking crater behind, a crater that’s especially painful in the vulnerability of old age, then I guess I better prepare myself mentally for more humble achievements. I’m just not interested in those kinds of tradeoffs and I don’t understand how such achievements could be satisfying without a family to enjoy them with and the sound mind and body necessary to experience it all.
I am a skeptic when it comes to charity– I believe most charity efforts are inefficient ways to make the desired impact, misunderstand the nature of the problem they seek to address and are doomed to treat symptoms rather than causes or, at worst, create more problems than they solve. I believe that this is partly due to the incentivizes and mechanisms of philanthropic activities versus monetary/commercial exchange activities, and partly (mostly) due to the fact that most people interested in charity do not spend much time thinking philosophically about what they’re doing, how they’re doing it and why they’re doing it.
As I do intend to contribute to (or even create) some philanthropic entities over the course of my life and I do not wish to be a hypocrite, I have attempted to identify and outline some important tradeoffs which must be considered before engaging in charitable activities.
Spectra of tradeoffs
Short-term vision vs. Long-term vision
This tradeoff involves the consideration of looking at problems which are immediate, present or developed in nature versus looking at problems which are distant, in the future and developing or potentially could develop based on a particular trend playing out. This tradeoff also has implications for questions of fund-raising and financing methodology and the construction of a strategy to meet the problem (ie, building a strategy which is active in the coming year versus a strategy which may only become active many years from now). This tradeoff has a generational component– looking at one’s own generation or the immediately following generation, the generation of one’s grandchildren or even more distant successors, or looking at the general inheritance of mankind for all time.
Physical issues vs. World of ideas
This tradeoff involves considering problems related to things that affect the material well-being versus predominant ideas, values, culture, etc. An example would be providing books to schools, versus influencing what is in the books in schools.
Treat symptoms vs. Prevent problems
This tradeoff is one of both urgency and quantity. It implies a certain metaphysical reality for the tradeoff to exist, that is, that a smaller good can be had now at the expense of a larger good later. The tradeoff demands that we consider which is more important: ending present suffering or ending the the cause of suffering. An example is providing malaria medication, versus providing mosquito nets.
Act locally vs. Act globally
This tradeoff involves the radius of impact and the desire to improve one’s own community versus the potential to affect a more desperate community further afield. An example would be trying to end homelessness in your own city, versus trying to provide clean drinking water to everyone on the planet.
General application vs. Specific application
This tradeoff is similar to the impact radius consideration but the question asked is more precise: “Given that resources are limited, do you seek to relieve the problem as it affects one specific group, or as it affects all groups?” A person may choose a specific group far away or a specific group they know familiarly, that is why this is not a question of acting locally or globally. An example might be seeking cures for childhood cancer, versus seeking cures for all cancers.
Verifiable impact vs. Difficult to measure
This tradeoff involves considerations of the empirical measurement of philanthropic influence. You may decide only to support a cause which has a clear and objective metric to indicate the influence your contribution is making, or you may decide to support a cause where the impact is subjective, mixed up with other independent variables or is simply on too vast of a scale to easily measure. An example is delivering computers to third world classrooms, versus improving the happiness of a community.
DIY vs. Pay to fund others
This tradeoff is a question of agency and considers whether one will serve as the agent of change himself, or whether he will hire others to do the work for him. It is not just a question of leveraging the efforts of others through the division of labor– it is about whether it is personally desirable to be involved as an agent oneself or whether it is preferable to provide things like ideas, organization and money while leaving others to actually execute on the plan. An example is going on a mission trip and building houses for the poor, versus making a donation to the Bill & Melinda Gates Foundation.
Change the system vs. Work within it
This tradeoff involves an analysis of the contribution the social system (rules, laws, cultural customs, traditions, economy, etc.) makes to the existence of the problem in question. You might see the problem as a necessary outcome of the system itself, necessitating a “revolution” to resolve it, or you might see the system as largely disinterested in or detached from the problem meaning it’s possible to use the system, or channel its energy differently, to resolve the problem. An example is abolishing the tax code, versus seeking a privileged status within it such as 501(c)3 designation.
For-profit vs. Non-profit (Self-sustaining vs. Dependency)
This tradeoff examines the proper method of financing a charitable activity. It signifies an awareness of the way that the existence of a charitable resource might influence the supply or stickiness of a social problem. It also provides consideration for the likelihood of strategically resolving a social problem with a potentially uncertain, inconsistent or mismatched method of finance. It understands that the design of economic systems and the consideration of incentives is often background for the existence of certain social problems. An example is a business that purposefully hires various “at risk” demographics to keep them out of trouble, versus a charity which spends significant time and energy ensuring its continued financing by others; a corrolary example is a charity with a substantial endowment which is intelligently invested over a long-period of time allowing it to grow, versus a charity which comes hat in hand every year asking for new donations to continue its operations.
Individuals vs. Families/communities
This tradeoff involves the philosophy of “If you can change the life of just one person, you’ve made a difference” as opposed to “It takes a village” or “Only together may we truly prosper.” It asks one to focus their consideration on whether the problem is truly being solved if only some are relieved or whether a wholesale solution must be put into affect to feel a sense of accomplishment. An example is a scholarship for a talented student, versus constructing a school for an “underserved” community.
One causes vs. Many causes
This tradeoff considers whether one can do the most good by having many plates spinning and doing a little good in a lot of places, or if it’s better to dig deeply and do a lot of good on just one issue. An example is putting all your effort and resources into diabetes research, versus supporting the local children’s hospital, a charity sports league, providing scholarships to handicapped students and funding a legal defense fund.
One project vs. Many projects
This tradeoff is similar to the one immediately preceding it. The difference is simply that one could have one project at each of many causes, or many projects at one and only one cause, or some other combination of the two. It is partly a question of finishing what you started before going on to something else. An example is just feeding the poor, versus feeding the poor, providing job training for the poor and organizing community awareness seminars about the challenges of the poor.
Mankind vs. Other Organisms
This tradeoff is self-explanatory– do you seek to resolve human issues, or ecological issues (including issues related to the state of the environment, the welfare of non-human animals, the prevalence of plant species, etc.) An example is building a church, versus saving a species of river smelt from extinction.
When it comes to philanthropy, I believe the most important epistemic principle is that you should have a rational, deeply contemplated answer to the question, “How do you know you aren’t making it worse?”
Good To Great: Why some companies make the leap and others don’t
by Jim Collins, published 2001
The G2G Model
“Good To Great” seeks to answer the question, “Why do some good companies become great companies in terms of their market-beating stock performance, while competitors stagnate or decline?” After a deep dive into varied data sources with a team of tens of university researchers, Collins and his team arrived at an answer:
The first two items capture the importance of “disciplined people”, the second two items refer to “disciplined thought” and the final pair embodies “disciplined action”. The concepts are further categorized, with the first three components representing the “build up”, the ducks that must be gotten into a row before the second category holding the last three components, “breakthrough”, can take place. The entire package is wrapped up in the physical metaphor of the “flywheel”, something an organization pushes on and pushes on until suddenly it rolls forward and gains momentum on its own.
This book found its way onto my radar several times so I finally decided to read it. I’d heard it mentioned as a good business book in many places but first took the idea of reading it seriously when I saw Geoff Gannon mention it as part of an essential “Value Investing 101” reading list. I didn’t actually follow through on the initial impulse until I took a “leadership science” course recently in which this book was emphasized as worth covering.
I found G2G to be almost exactly what I expected– a rather breathless, New Age-y, pseudo-philosophical and kinda-scientific handbook to basic principles of organizational management and business success. The recommendations contained within range from the seemingly reasonable to the somewhat suspect and the author and his research team take great pains to make the case that they have built their findings on an empirical foundation but I found the “We had no theories or preconceived notions, we just looked at what the numbers said” reasoning scary. This is actually the opposite of science, you’re supposed to have some theories and then look at whether the data confirms or denies them. Data by itself can’t tell you anything and deriving theory from data patterns is the essence of fallacious pattern-fitting.
Those caveats out of the way, the book is still hard to argue with. Why would an egotistical maniac for a leader be a good thing in anything but a tyrannical political regime, for example? How would having “the wrong people on the bus” be a benefit to an organization? What would be the value in having an undisciplined culture of people who refuse to see reality for what it is?
What I found most interesting about the book is the way in which all the principles laid out essentially tend to work toward the common goal of creating a controlled decision-making structure for a business organization to protect it from the undue influence of big egos and wandering identities alike. In other words, the principles primarily address the psychological risks of business organizations connected to cult-like dependency on great leaders, tendency toward self-delusional thinking and the urge to try everything or take the easy way out rather than focus on obvious strengths. This approach has many corollaries to the value investing framework of Benjamin Graham who ultimately saw investor psychology as the biggest obstacle to investor performance.
I don’t have the time or interest to confirm this hypothesis but I did wonder how many of the market-beating performances cataloged were due primarily to financial leverage used by the organization in question, above and beyond the positive effects of their organizational structure.
A science is possible in all realms of human inquiry into the state of nature. Man and his business organizations are a part of nature and thus they fall under the rubric of potential scientific inquiry. I don’t think we’re there yet with most of what passes for business “research” and management or organizational science, but here and there the truth peeks out. “Good To Great” probably offers some clues but it’s hard to know precisely what is the wheat and what is the chaff here. Clearly if you inverted all of the recommendations of the book and tried to operate a business that way you’d meet your demise rather quickly, but that is not the same thing as saying that the recommendations as stated will lead in the other direction to greatness, or that they necessarily explain the above-average market return of these public companies.
I took a lot of notes in the margin and highlighted things that “sounded good” to me but on revisiting them I am not sure how many are as truly useful as they first seemed when I read them. I think the biggest takeaway I had from the book was the importance of questioning everything, not only as a philosophical notion but also as a practical business tool for identifying problems AND solutions.
I’d like to talk today about diversification as a strategy within the theory of portfolio management.
What is portfolio management?
In portfolio management, you have two possible extremes between which most actual portfolios lie– own one thing, or own everything.
The classic example of a person who owns one thing is the owner of a small business, of which the proprietorship makes up his entire personal equity capital in relation to the total investment universe. Most people wouldn’t even consider this person to have a portfolio because he holds nothing else. His business is his portfolio.
Consequently, portfolios imply diversification, and vice versa. The moment you take equity in more than one venture, you have created a portfolio and you are simultaneously diversified. This is the mild hypocrisy of people who warn against diversification (calling it “deworsification”) and counsel investors to maintain a concentrated portfolio. A portfolio may be concentrated to a small number of holdings (let’s say, five or less to pick an arbitrary point of distinction), but this is not a non-diversified portfolio– the very fact that it is a portfolio implies it is diversified.
The standard argument for diversification
Proponents of diversification (or, what we might term “portfolioization” to come up with an even more complicated and hard to speak/spell nomenclature for the phenomenon) argue that diversification is a way to limit risk in equity ownership. It is the “multiple egg baskets” theory, the idea being that if you drop one basket you only lose the eggs inside of the dropped basket, whereas if you carry all your eggs in one basket and drop it, there goes dinner.
But it’s a bit of trickery, because risk can’t be eliminated, only exchanged. In effect, as you diversify (portfolioize), you exchange business risk for market, or economic, risk. The larger your portfolio becomes in terms of total positions, the more it comes to resemble the total universe of equity opportunities in its performance.
With diversification, you are not limiting risk, you are exchanging it. You’re determining how much of your equity will be exposed to each kind of risk in existence, not how much risk you will be exposed to in total (that question is settled by what particular risks you do put into your portfolio).
To summarize, two risk equations:
Standard counter-arguments to diversification (or, why it’s really deworsification)
The case for diversification isn’t complicated and neither is the case against it. There are two main points to consider:
The first point is fairly self-explanatory. If you only invest X% of your portfolio in a particular risk, you ensure that your maximum loss is never greater than X%, but you also ensure that your maximum gain is never greater than X% * Y, Y being the return of the underlying investment.
So, if you invest 20% of your portfolio in ABC Company and the stock falls by half, thanks to the magic of diversification, you actually only lose 10% of your portfolio (-50% * 20% = -10%). On the other hand, if the stock rises by half, thanks to the magic of diversification you actually only make a return equal to 10% of your portfolio (50% * 20% = 10%).
There’s no free lunch. You only would get to capture the full 50% rise if you had the full 100% of your portfolio exposed. You essentially provide yourself downside insurance because, while your overall gain is capped, your overall loss is capped as well as it can never be higher than the 20% you exposed (provided you aren’t using leverage or shorting).
Perhaps more nefarious, some investment thinkers point out that by diversifying your portfolio, you spread your attention thin and could end up not understanding the individual risks your various positions hold as well as you might if you had one position (or two, or five…) and so, in a quest to limit business risk you actually enhance it because the quality of your analysis falls. Similarly, if you do poor analysis, you might be more prone to rationalize it because, “Oh well, ABC didn’t work out, but I’ve still got bets on DEF and XYZ, I’m sure they’ll turn out okay and make up for the loss– I’m diversified!”
The scarcest thing most investors have is attention they can devote to their investing, not capital.
Is one ever justified in diversifying?
Diversification by itself is not a terrible thing. As discussed above, it really doesn’t confer any advantages beyond the psychological– diversification by itself can’t improve the absolute returns of your portfolio, on net.
It also doesn’t have to be a purposeful strategy. Diversification can happen “by accident” in the following scenarios:
In the first case, imagine an investment opportunity in a company with a market cap of $100M, in which case the maximum appropriate position one could take without “bidding against oneself” is $5M, but one’s full capital represents the amount of $10M. In this situation, you would only invest half your capital in the idea because investing any more than this might destroy some of the value available. Diversification would be a natural consequence of a situation like this, whether diversification itself was desired or not.
In the second case, imagine you have $10M of total capital in period 0, which you fully invest in X. However, some time later, in period 1, you receive additional inflows of capital of $1M (perhaps you have earned a 10% dividend on your earlier investment in X). Unfortunately, the price of X has risen in the interim and no longer represents the value proposition it once did, although you’re still happy to have your earlier capital invested at the price available in period 0. In this case, you might invest the $1M in opportunity Y and, again, diversification would occur as a natural consequence of these developments whether it itself was desired or not.
In the final case, imagine you have total capital of $10M and have found an investment opportunity which could utilize your entire capital. However, you plan to accumulate in blocks because the investment is not liquid enough to take the $10M at once, and you do not want to make it obvious what you’re doing. You begin by investing $2M. Unfortunately, shortly after you do so a big-mouth blogger lets the whole world know about this great opportunity and the price of the investment opportunity rises to the stratosphere, pricing you out of any meaningful additional accumulation. You’re stuck with 80% of your capital uninvested and must look elsewhere. Again, diversification has occurred as a natural consequence even if it has not been actively sought after.
Ideal portfolio management implies no intended diversification
We’ve seen that diversification can result of two different catalysts– an investor can purposefully seek diversification in order to make a tradeoff between business risk and market risk (to self-insure his own decision-making process by giving up total return potential), or diversification can occur as the natural, unintended consequence of the general investment process.
Ideally speaking, the best situation for any investor to find themselves in is having one idea that has so much return potential relative to risk, that they are so confident about, that they are able to invest 100% of their capital in the idea, thereby avoiding diversification, or portfolioization, entirely. Ideally, one would have all their money at any given time in one idea and only one idea, and when that idea had either fruited, or a more profitable opportunity had arisen elsewhere, the investor would then sell the entire position and look to his next opportunity.
Outside of this ideal, portfolioization may occur inadvertently in pursuit of these very circumstances, in which case there is nothing to be upset over or critical about.
However, if diversification is pursued as a purposeful strategy outside the context of an individual contending with liquidity constraints (ie, perhaps investing 100% of capital in his best idea would put him in a bad position if outside demands for this capital, which are unpredictable, would require him to liquidate at an inopportune time), it stands to reason that an investor might ask himself, or be asked by another, “Why are you investing in something you’re not completely confident about in the first place?”
In other words, perfect confidence is unachievable (although it is the ideal), but it is hard to imagine why an investor would be justified in spreading his bets out across things he was less than as-confident-as-he-could-be about and consoling himself that he was doing well to mind risk thanks to diversification, when he could instead wait for an opportunity where his confidence about the risk-reward picture was as-confident-as-he-could-be and then invest all his capital in that one idea.
And of course, as almost always, I’d be wise to consider and hopefully even heed my own advice!
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