Over the weekend, I came across an interview with Jeff Bezos. He discussed an interaction in which an audience member asked him what would change over the next decade. Bezos turned it around and said the rate of change is so rapid that the more interesting question is, “What will not change over the next 10 years?”
That is an interesting view of the world and one that is not too dissimilar to how we evaluate and manage investments.
Change is exciting. I can’t wait for new cars or technology. There is always something very cool being developed that may revolutionize the way we live.
However, often when faced with lots of rapid change, we cannot figure out who the winner will be. Often, the easy answer is that society will be the big beneficiary. This has certainly been true of the airplane, the automobile, the cell phone and the internet.
However, categorically, these have been pretty mediocre investments.
In assessing what won’t change, Bezos may have more in common with Warren Buffett than one would think.
In looking for investments, Buffett says he looks for predictable and consistent businesses — preferably over very long times frames. A good example has been Buffett’s holding in Coca-Cola for more than 30 years.
There are many reasons for this.
If a business model has been highly consistent for decades, there is a better indication of what the future should reasonably look like. This makes judgment calls and future assessments easier.
A highly predictable and consistent business also is easier to analyze when attempting to determine what that business is worth. If a stream of future cash flows is highly consistent, it makes it easier to know if you are getting a bargain. It is also easier to know what the range of expected outcomes should be.
As you think about business models today, it is easy to become overwhelmed by the numerous things that might happen. However, betting money on which ones will happen and accurately assessing their subsequent outcome is incredibly difficult.
When things become too difficult, remember that you hold the cards. You determine what to own and when to trade. And if things are too difficult, you can always pass on making that decision. Just throw it in the “too hard” pile.
For those of us who live in the real world, taxes are a legitimate consideration.
The capital gains tax is not a tax on gains, but rather a tax on the transaction of selling. The less you trade, the less you owe the government. Additionally, if you spend a bit of time understanding the tax code, you recognize that being a “tax-smart” investor can stretch your dollars further.
Consider three taxable investors. All three begin with a $10,000 investment 30 years ago.
The first is a hyper-trader who is constantly buying and selling. Assume he earns a fantastic 12% per year before taxes. The second investor is a bit more patient. She earns a respectable 10% per year, but turns over the portfolio each year after qualifying for long-term capital gains treatment.
The third investor is slow and boring. The investments made 30 years ago remain in his portfolio. He continues to study and observe. There has been zero turnover but he has earned a below average 8% per year.
Thirty years later, who has the most money?
The first investor pays short-term capital gains taxes of up to 40.8% on his gains. As such, his net rate of return drops to 7.1% per year. After three decades, he has more than $78,000.
The second investor has been more patient, but pays taxes up to 23.8% per year on long-term capital gains. Her net return is 7.6%, which grows her assets to more than $90,000.
The boring, consistent and predictable investor still holds the same companies. After 30 years, he has paid no capital gains taxes and his assets have grown to more than $100,000.
What can be learned from slothful investing?
Although lots of trading may conjure up the excitement of a Vegas casino, it is probably not the best strategy for your taxable portfolio. Rather, finding high quality businesses with little change are far more efficient and predictable for a long-term investor.
Taxation on wealth can be optional if you know how to best position your assets. What matters most is what you keep net of taxation.
Lastly, in a world of rapid-fire change, analyzing the things in our world that don’t change may offer the best long-term producers of wealth.