Nothing's Free


                                CHAPTER 15

                 Nothing's Free


Everything has a price, but not all prices appear on labels.

Everything has a price, and the key to a lot of things with money is just figuring out what that price is and being willing to pay it.

The problem is that the price of a lot of things is not obvious until you’ve experienced them firsthand, when the bill is overdue.


General Electric was the largest company in the world in 2004, worth a third of a trillion dollars. It had either been first or second each year for the previous decade, capitalism’s shining example of corporate aristocracy.

Then everything fell to pieces.

The 2008 financial crisis sent GE’s financing division—which supplied more than half the company’s profits—into chaos. It was eventually sold for scrap. Subsequent bets in oil and energy were disasters, resulting in billions in write offs. GE stock fell from $40 in 2007 to $7 by 2018.

Blame placed on CEO Jeff Immelt—who ran the company since 2001—was immediate and harsh. He was criticized for his leadership, his acquisitions, cutting the dividend, laying off workers and—of course—the plunging stock price. Rightly so: those rewarded with dynastic wealth when times are good hold the burden of responsibility when the tide goes out. He stepped down in 2017.

But Immelt said something insightful on his way out.

Responding to critics who said his actions were wrong and what he should have done was obvious, Immelt told his successor, “Every job looks easy when you’re not the one doing it.”

Every job looks easy when you’re not the one doing it because the challenges faced by someone in the arena are often invisible to those in the crowd.

Dealing with the conflicting demands of sprawling bloat, short-term investors, regulators, unions, and entrenched bureaucracy is not only hard to do, but it’s hard to even recognize the severity of the problems until you’re the one dealing with them. Immelt’s successor, who lasted 14 months, learned this as well.

Most things are harder in practice than they are in theory. Sometimes this is because we’re overconfident. More often it’s because we’re not good at identifying what the price of success is, which prevents us from being able to pay it.


The S&P 500 increased 119-fold in the 50 years ending 2018. All you had to do was sit back and let your money compound. But, of course, successful investing looks easy when you’re not the one doing it.

“Hold stocks for the long run,” you’ll hear. It’s good advice.

But do you know how hard it is to maintain a long-term outlook when stocks are collapsing?

Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret—all of which are easy to overlook until you’re dealing with them in real time.

The inability to recognize that investing has a price can tempt us to try to get something for nothing. Which, like shoplifting, rarely ends well.

Say you want a new car. It costs $30,000. You have three options: 1) Pay $30,000 for it, 2) find a cheaper used one, or 3) steal it. In this case, 99% of people know to avoid the third option, because the consequences of stealing a car outweigh the upside.

But say you want to earn an 11% annual return over the next 30 years so you can retire in peace. Does this reward come free? Of course not. The world is never that nice. There’s a price tag, a bill that must be paid. In this case it’s a never-ending taunt from the market, which gives big returns and takes them away just as fast. Including dividends the Dow Jones Industrial Average returned about 11% per year from 1950 to 2019, which is great. But the price of success during this period was dreadfully high. The shaded lines in the chart show when it was at least 5% below its previous all-time high.



This is the price of market returns. The fee. It is the cost of admission. And it hurts.

Like most products, the bigger the returns, the higher the price. Netflix stock returned more than 35,000% from 2002 to 2018, but traded below its previous all-time high on 94% of days. Monster Beverage returned 319,000% from 1995 to 2018—among the highest returns in history—but traded below its previous high 95% of the time during that period.

Now here’s the important part. Like the car, you have a few options: You can pay this price, accepting volatility and upheaval. Or you can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand-theft auto: Try to get the return while avoiding the volatility that comes along with it.

Many people in investing choose the third option. Like a car thief—though well-meaning and law-abiding—they form tricks and strategies to get the return without paying the price. They trade in and out. They attempt to sell before the next recession and buy before the next boom. Most investors with even a little experience know that volatility is real and common. Many then take what seems like the next logical step: trying to avoid it.

But the Money Gods do not look highly upon those who seek a reward without paying the price. Some car thieves will get away with it. Many more will be caught and punished.

Same thing with investing.

Morningstar once looked at the performance of tactical mutual funds, whose strategy is to switch between stocks and bonds at opportune times, capturing market returns with lower downside risk. They want the returns without paying the price. The study focused on the mid-2010 through late 2011 period, when U.S. stock markets went wild on fears of a new recession and the S&P 500 declined more than 20%. This is the exact kind of environment the tactical funds are supposed to work in. It was their moment to shine.

There were, by Morningstar’s count, 112 tactical mutual funds during this period. Only nine had better risk-adjusted returns than a simple 60/40 stock-bond fund. Less than a quarter of the tactical funds had smaller maximum drawdowns than the leave-it-alone index. Morningstar wrote: “With a few exceptions, [tactical funds] gained less, were more volatile, or were subject to just as much downside risk” as the hands-off fund.

Individual investors fall for this when making their own investments, too. The average equity fund investor underperformed the funds they invested in by half a percent per year, according to Morningstar—the result of buying and selling when they should have just bought and held.

The irony is that by trying to avoid the price, investors end up paying double.

Back to GE. One of its many faults stems from an era under former CEO Jack Welch. Welch became famous for ensuring quarterly earnings per share beat Wall Street estimates. He was the grandmaster. If Wall Street analysts expected $0.25 per share, Jack would deliver $0.26 no matter the state of business or the economy. He’d do that by massaging the numbers—that description is charitable—often pulling gains from future quarters into the current quarter to make the obedient numbers salute their master.

Forbes reported one of dozens of examples: “[General Electric] for two years in a row ‘sold’ locomotives to unnamed financial partners instead of end users in transactions that left most of the risks of ownership with GE.”

Welch never denied this game. He wrote in his book Straight From the Gut:


The response of our business leaders to the crises was typical of the GE culture. Even though the books had closed on the quarter, many immediately offered to pitch in to cover the [earnings] gap. Some said they could find an extra $10 million, $20 million, and even $30 million from their business to offset the surprise.


The result was that under Welch’s leadership, stockholders didn’t have to pay the price. They got consistency and predictability—a stock that surged year after year without the surprises of uncertainty. Then the bill came due, like it always does. GE shareholders have suffered through a decade of mammoth losses that were previously shielded by accounting maneuvers. The penny gains of Welch’s era became dime losses today.

The strangest example of this comes from failed mortgage giants Freddie Mac and Fannie Mae, which in the early 2000s were caught under-reporting current earnings by billions of dollars with the intention of spreading those gains out over future periods to give investors the illusion of smoothness and predictability. The illusion of not having to pay the price.


The question is: Why do so many people who are willing to pay the price of cars, houses, food, and vacations try so hard to avoid paying the price of good investment returns?

The answer is simple: The price of investing success is not immediately obvious. It’s not a price tag you can see, so when the bill comes due it doesn’t feel like a fee for getting something good. It feels like a fine for doing something wrong. And while people are generally fine with paying fees, fines are supposed to be avoided. You’re supposed to make decisions that preempt and avoid fines. Traffic fines and IRS fines mean you did something wrong and deserve to be punished. The natural response for anyone who watches their wealth decline and views that drop as a fine is to avoid future fines.

It sounds trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.

Few investors have the disposition to say, “I’m actually fine if I lose 20% of my money.” This is doubly true for new investors who have never experienced a 20% decline.

But if you view volatility as a fee, things look different.

Disneyland tickets cost $100. But you get an awesome day with your kids you’ll never forget. Last year more than 18 million people thought that fee was worth paying. Few felt the $100 was a punishment or a fine. The worthwhile tradeoff of fees is obvious when it’s clear you’re paying one.

Same with investing, where volatility is almost always a fee, not a fine.

Market returns are never free and never will be. They demand you pay a price, like any other product. You’re not forced to pay this fee, just like you’re not forced to go to Disneyland. You can go to the local county fair where tickets might be $10, or stay home for free. You might still have a good time. But you’ll usually get what you pay for. Same with markets. The volatility/uncertainty fee—the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds.

The trick is convincing yourself that the market’s fee is worth it. That’s the only way to properly deal with volatility and uncertainty—not just putting up with it, but realizing that it’s an admission fee worth paying.

There’s no guarantee that it will be. Sometimes it rains at Disneyland.

But if you view the admission fee as a fine, you’ll never enjoy the magic.

Find the price, then pay it.



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