Principles of Wealth: #21*

When the odds of a particular speculation are extremely long, we refer to it as gambling. And gambling, most sensible people would acknowledge, is a foolish financial activity. Unless, of course, the odds are in your favor.

It must have been 40 years ago. I was a young man, returning from my first trip to Las Vegas. The man next to me was an architect. His specialty was high-end hotel-casinos. His favorite part of the job, he told me, was designing the VIP suites. They were immense pleasure domes, featuring every imaginable luxury, including gilded furnishings and indoor pools.

“How much would one of those go for?” I naively asked.

“Oh, they never charge for those rooms. They give them away to high rollers for free.”

I thought about that the rest of the way back home. Casinos are about gambling. And unless you finance them the way Donald Trump did his, they can make you a huge amount of money. A typical Las Vegas casino would cost at least $300 million to build and at least $100 million a year to run. Who pays for that? As the old maxim says, it’s definitely not the winners.

Entrepreneurs are said to be risk takers. And there is no shortage of memorable stories about how some of them risked everything to finally realize their dreams. In fact, as any number of serious studies have shown, most successful entrepreneurs deplore risk and spent most of their working time bringing it down to a minimum.

I would never invest in a business – no matter how great the possible reward – unless the risk of losing my capital was less than 30%. What about a business idea where there was a 50/50 chance of making a billion? I wouldn’t be interested. And neither would most successful entrepreneurs I know.

When it comes to investing passively, in stocks or bonds or any other financial asset, my risk tolerance is less, not more. I have zero interest in putting my money into any project whose chances of success are less than 70%. Most of the time, I want the chances to be 100%. I want deals where there is no chance of losing my investment. The only question is: How large a profit am I likely to make?

What that means for me is that the only bonds I buy are triple-A rated and guaranteed municipal bonds. And the only stocks I buy are what value analyst Dan Ferris calls world-dominating companies that have a 70+% chance of growing their profits over the next 20 to 40 years.

In a similar way, I rarely buy real estate with the aim of selling it in the future. And that includes every kind of real estate, from large apartment complexes to shopping malls to single-family homes and even to tracts of land. What I do invest in are income-producing real estate deals where I am nearly guaranteed to make 15+% on my money every year.

In other words, I don’t gamble with financial assets.

Now I do – actually fairly often – invest in businesses and deals that profit from gamblers. I will invest in virtually any kind of asset so long as it gives me a risk-free profit on speculation, which means that when it comes to financial gambling, I want to be a broker or a dealer or an insurance provider. I want to own or at least work in the casino. I don’t want to play there.

And that takes us back to this principle: When the odds of a particular deal are extremely long, recognize it as a form of speculation and resist the urge to gamble on it… unless, of course, the odds are in your favor.

 * In this series of essays, I’ll be rethinking and expanding upon many of the observations I’ve made over the years about wealth: What it is, what it’s not, how it can be acquired, and how it is usually lost.