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The Friend of My Friend Igor
Fool HQ once had a summer investing intern named Igor. Igor was a very talented Russian American who brought along his own investing smarts. I wish every 19-to-20-year-old was as thoughtful, as energized, and as wise beyond his years about money.
I asked him, “How’d you get started, Igor?”
“I had a mentor who got me started investing. He was a guy a year ahead of me at college… The funny thing is, he’s no longer investing!”
His friend had exhibited two distinctive tendencies with his investing, Igor conveyed: The first was he loved to find very early, so-called “development-stage companies.” These are companies that not only don’t have profits, but in some cases they don’t even have revenues. His friend’s passion about these kinds of companies had inspired him to teach others — like Igor — about investing.
The second was he loved to go almost all in when he invested. He was a so-called focused investor. He had very few companies. When he found something that he liked and he believed in, he would pile what you and I might think of as an alarmingly high percentage of his money into those few ideas.
I replied, “I’m not surprised that your mentor is no longer still in the game.”
Play that approach forward a bit — that system — and it doesn’t take too long to see what happens. Highly focused development-stage investors might get it right a few times… but when they get it wrong, they lose a lot of money. And when they’re specifically targeting early-stage, development-stage companies, it’s highly likely that a few of those aren’t going to play out so very well. Which means: They’re no longer investing.
Which is a shame! Because you have to love the passion. Young people are so advantaged in that the wealth they’re building will compound their whole lives long.
Picture a four-quadrant matrix where the vertical Y axis labeled “Company” goes from “development-stage” to “mature.” The X axis, labeled “Investor” goes from “all-in” to “diversified.”
Where is Igor’s mentor plotted?
Ah, but now we’re talking STYLE-BOXING. That deserves its own blog.
Style-Boxing
So, back to that 2×2 style-box explicated in the story of Igor’s friend: Its Y axis (labeled “Company”) goes upward from “development-stage” to “mature,” and its X axis (labeled “Investor”) goes rightward from “focused” to “diversified”…
Igor’s friend was a “focused investor” investing in “development-stage companies,” otherwise known as a recipe for disaster. There are other choices in that matrix. For instance, there’s a ton of money in big index funds today that track indices like the S&P 500. Those are obviously “diversified” investors — highly so — concentrating their capital in “mature” companies. That’s the very opposite of the matrix from Igor’s friend. On the other hand, venture capitalists invest in development-stage (or at least, earlier-stage) companies, but they diversify. That’s the box I identify with.
But that’s just one type of style-box.
You can invent your own. Morningstar did, and became a billion-dollar enterprise, in part, because of that. Famously, Morningstar created a 3×3 matrix for stock funds, gauging the size of market cap on one axis (small, midsize, large) and what it terms a fund’s “investment style” on the other (“value,” “blend,” or “growth”). While I often inveigh against “value vs. growth,” we certainly can’t argue with the overall helpfulness of Morningstar’s innovation. It’s ubiquitous, and has made the whole complicated world of investment choices a lot more intelligible.
As I say, you can invent your own style box. An entire industry of business consultants has done it, and the cliché is that often you want to be in the upper-right box, “the good one.” The Myers-Briggs women did it, building an industry of their own premised on 16 personality types.
And in my own way I have done it too, a simple 2×2 matrix that explains simply and clearly what makes the Rule Breaker investing approach tick, and why it wins. Creating simple style boxes is a worthy and illuminating exercise! So put on your Morningstar; summon your inner Myers-Briggs. And tune in next time for the secret style box of Rule Breaker Investing!
(Any guesses, dear reader, as to how my two axes are labeled?)
The Rule Breaker’s Lonely Style Box
Last time I teased the style box that helps explain why Rule Breaker investing wins. Remember that style boxes oversimplify; they’re cartoonish views of the world. But when we make things as simple as we can (Einstein: “But no simpler”), we give ourselves a clarity that many others lack.
Here’s the style box I use to explain why Rule Breaker Investing works:
The Y axis, labeled “Timeframe,” goes upward from “short-term” to “long-term.” This is the holding period of your investing, with traders at the bottom and investors at the top.
The X axis, labeled “Company Type,” goes rightward from “predictable” to “innovative.” “Predictable” companies predominate the world of business, whether they’re operating oil fields or selling Dunkin Donuts. These companies stay within the defined lines of their industries and their core businesses. The “innovators” are the rare Rule Breakers.
For “Timeframe,” well more than half the financial world operates in a short-term timeframe. So if you’re fishing in the “long-term” pond, you’re already feeling lonely. For “Company Type,” well more than half the corporate world is not only predictable, most of it strives to be even more so! Businesses at scale that challenge the status quo, or completely unravel it, are few and far between.
Thus, if you’re investing in the quadrant of “long-term” and “innovative,” you are among a tiny subset of investors. Most of the long-term capital out there (e.g., the Buffett crowd) has been actively coached and reinforced to avoid innovation. Meantime, most of the “innovator” company stocks are highly volatile, “overpriced.” “Make your money fast before they blow up,” short-termers say, treating them as a “trade.”
Malcolm Gladwell has shown: The best way for David (here, individual investors) to beat Goliath (institutional investors) is by playing the game completely differently. Rule Breaker investors ironically serve as lonely fishers at the market’s most stocked pond. The fish swimming here are the world’s great innovators who’ll provide the most market-crushing long-term returns.
I love this pond, this style box! It’s enriched me, so much, in part because so few find their way here… to our quadrant.