The 3 (Surprisingly Simple) Secrets to Becoming and Staying Rich

This blog post is inspired by Morgan Housel’s book entitled The Psychology of Money.

Before successful investors like Buffett and Peter Lynch make an investment, there is ONE question that they always ask themselves:

“What is the worst downside that can happen, and if it happens, would I be able to live with it?”

Instead of thinking about how much money they can make with the upside, they think about the downside first.

“All I Want To Know Is Where I’m Going To Die, So I’ll Never Go There” – Charlie Munger

In Charlie Munger’s words, prevention is better than cure. And in some cases, there is no cure for wealth destruction.

So let’s explore a few thoughts that will help us gain a clearer picture of how wealth is accumulated or destroyed.

1. Knowing when “Enough” is Really Enough

“Success is a lousy teacher. It makes smart people think they can’t lose.” – Bill Gates

Some of you might be familiar with the story of Jesse Livermore. He was known to be one of the best traders in Wall Street.

In 1929, he shorted the market when the stock market lost close to 1/3 of its market value. Not knowing that he did that trade, his wife Dorothy feared that Jesse lost his entire wealth.

But when Jesse came back home, he reported that he made more than $100 million. Dorothy was relieved. Overnight, Jesse changed the quality of his life with a single trade!

But because of this success, this also encouraged him to take greater risks. He started making more risky bets, which deviated from his usual position sizing. Things were going well until one day, when the stock market he thought he knew, turned against him.

Overnight, he lost everything.

Completely broke and too embarrassed to face his family, he eventually took his own life.

You see, we tend to overestimate ourselves when the ride is good. We expect ourselves to do well so we do not see any incentive for preparing for the downside. However, in life, there are always probabilities. Some outcomes have low probabilities but when it happens, the impact can be extremely destructive.

That is the reason why in the stock market, we see very smart individuals do stupid things.

These are the people who have had more than they ever need in their own lives, who continuously put their portfolio under unnecessary risks to make that extra few percentage gains.

One of the many examples could be leveraging their own portfolios up with margins and executing several options trades without understanding the risks that they’re underwriting. Or doing a massive intra-day option trade where price movement has to go right in their direction.

What would happen to them during a sharp correction? Whatever they’ve built would be gone. In a single night.

Here’s a perfect example:

Sir Isaac Newton, who was regarded as a genius in his time, bought shares of South Sea Company in 1720. He was almost 80 years old back then.

He made a 100% return on the stock totaling about $7,000. It was considered to be a very handsome profit back then. Even so, as he saw the stock market doing so well, he felt that he wanted to be part of the ride up.

He then decided to buy back the shares at a much higher price despite knowing the risks of overvaluation.

And who could have predicted it? The shares of South Sea Company corrected quickly and Sir Isaac Newton lost a majority of his net worth.  

Here’s one more exmaple of a smart people making silly mistakes:

Jeffrey Skilling, too, was rich and smart. He did not have to commit fraud to become rich. But he did it anyway, so that he could boost Enron’s share price and his own net worth.

It’s hard to stay satisfied when you see someone else earning more money than you in the stock market or having higher stock returns. That may motivate you to risk more just to squeeze out more returns.

In the aftermath of Long-Term Capital Management’s failure, I found what Warren Buffett said to be very apt:

“But to make money they didn’t have and didn’t need, they risked what they did have and did need, and that’s foolish. That is just plain foolish. Doesn’t make any difference what your IQ is. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.”

My point is not to stop you from pursuing your potential, but a fine line has to be drawn between what is possible and what’s bordering the boundaries of tremendous risk.

What did Jeffrey, and Sir Isaac Newton lose in the end? Time with their loved ones, years of hard work, their reputation and the time to compound their money.

For Jesse, he even lost his life.

Just one big misstep for all of them was what erased years of wealth building. All in the name of squeezing out more profits each year while taking on unnecessary risk. Humans tend to be greedy and we often push ourselves into “live or die” moments, and that’s just plain stupidity.

Know what is enough for your life and how you want to get there, without doing stupid things.

2. Staying in the Game For a Long, Long Time

Earlier, I mentioned about knowing what is enough for your life.

But the funny thing is, if you live long enough and continue on doing what you’re doing, sometimes you may overshoot your own wealth target. You’re able to do this without taking on huge risks.

I will emphasize that staying in the game does not mean you are taking the kind of risk as mentioned in point 1. You can stay in the game while practicing proper stock allocations with zero margins.

So how does that work?

According to this article published in 2018, Grant Cardone mentioned that 99% of Warren Buffett’s wealth was created after his 52^nd birthday.

Honestly, I’m not surprised because that’s how compounding works.

From this table, you can see that the returns do not change. It’s 30% per year. 30% returns at year 1 is a mere $15,000 while 30% returns at year 10 is a massive $159,067.

The same percentage of growth on a bigger number will always produce a bigger return, and these returns will add on to form an even bigger number.

Because compounding is on an exponential scale, we cannot adopt a linear thinking towards it.

Kathy Xu of Capital Today, a venture capitalist, invested in Yifeng Pharmacy Chain. Her investment in Yifeng grew from $30 million to $400 million after 11 years until 2018. But in the last two years, her fund made another $600 million as Yifeng continued to compound its value.

The total gains = ($400 million – $30 million) + $600 million = $970 million.

But, 62% of the returns actually only came in during the last two years.

While these are beautiful examples, my question is…

Can you continue playing, or will you be forced out of the game because of certain risky moves?

And once you’re out, you have to start back from ground zero.

Since that is the case…why would you sabotage your own future? 

As long as you continue playing without being forced to drop out of the race, you’ll be a wealthy person in no time because of the sheer force of compounding. There isn’t a need for crazy “live or die” trades.

3. Staying in your own lane

A few days ago, a group of friends asked me whether I have bought Tesla shares.

I flatly said no without any envy.

My reasoning is very simple. We should never shy away from having a beginner’s mindset. This means we learn continuously. Every. Single. Day.

But if we do not understand something well enough, we should exercise some restraint and not jump fully into it.

I am not shy to admit that I do not understand Tesla’s valuations, and I am pretty cool with that.

Our portfolio will be different from each other and we are all in our own running lanes.

What if we are jumping into people’s lanes? We are not familiar with their paths and we may get jittery easily because we do not understand their companies as much as they do.

I think if we are jumping into people’s lanes, we are seeking self-destruction. We are just copying someone else.

The key, instead, is to observe, learn, and adapt it for your own strategy.

What about those feelings of envy when we start to see others doing better than us?

Some years, some people will do better than us. We will envy them.

Some years, we do better than some people. They will envy us.

What’s the point?

There is absolutely no end to any comparison. I can compare to you. You can compare to Warren Buffett. Warren Buffett can probably compare with Jeff Bezos.

So instead of causing yourself grief, you should set a reasonable return for yourself and stick with it.

Who says you can’t be happy when you hit your 40% returns every year although others are hitting 50 – 60% returns?

Investing is not a competition between yourself and others. It’s a competition with yourself on how you can gain more confidence in your stock-picking skills and portfolio management strategy.

Conclusion

I hope these lessons speak meaning in your investing life.

As long as you keep your head together while everyone is losing theirs, everything you need to have in this world will eventually be within your grasp.

I hope my article has benefitted you. If it has, please pay it forward by sharing it with more people!