Principles of Wealth #23*

Tuesday, December 18, 2018

Delray Beach, FL.- Wall Street promotes the idea that investing in stocks and bonds is the sensible way to grow rich. But a strategy that focuses solely or even primarily on stocks and bonds is a flawed strategy. The prudent wealth builder knows this.

Pat told me about the great delivery service he’s been getting from Company A. “The other guys,” he said, “they just drop the packages over the fence. But Company A’s guy drives in and delivers my packages to the door.”

“I really like this company,” Pat said. “So I did some research. And based on what I learned, I think it’s a good investment. I’m going to buy their stock.”

It sounds smart. It reminds me of how, in One Up on Wall Street, Peter Lynch described his amazing success as the manager of Magellan Fund, which made 29.2% from 1977 to 1990, bringing the assets under management from $18 million to $14 billion.

“Invest in what you know,” was Lynch’s most popular investment rule. He attributed his success to his habit of going beyond the spreadsheets and looking under the hoods of the businesses he bought. He argued that the average investor could do the same.

He was wrong about that. And there’s a good chance that Pat will be wrong about the trade he’s about to make.

Why do I say that?

Because the average investor can’t possibly know enough about the stocks he buys to achieve a 29.2% return over a long stretch of time. The average investor, in fact, can’t even achieve the average overall market ROI of 9% to 10% over time. The average investor makes a third of that, if he’s lucky.

When Lynch talked about investing in companies you know, he meant that you should know more than you can ascertain from the public filings, from the balance sheet, the P&Ls, metrics such as P/E ratios, etc. He liked to get inside the industry a bit, get to know the players, ask questions of the execs and the frontline workers.

Lynch had the power to do that. The average investor doesn’t. At best he can do the kind of research that Pat did on Company A. But that’s not nearly enough. He’s still very much on the outside.

I’ve been “inside” the investment advisory business for more than 30 years. I have known dozens and dozens of managers and analysts. I know many of the best-known gurus. Most of them are smart. Most of them are driven. Some of them beat the market for a while. But few can match Lynch’s record. (And Lynch’s performance, let’s not forget, ended after 13 years.) So how can the average investor expect to do what even the pros can’t?

No matter what you hear from Wall Street, the stock and bond markets are not there to help the average investor get rich. They are there to provide fees and commissions to brokers, managers, and analysts.

Buying stocks and bonds is a sensible thing to do if you see it as a part, and only a part, of an overall investment strategy. What the smart investor should expect from his stocks and bonds is what the market is willing to give average investors. And that is average returns – 9% to 10%. Not 29.2%.

Now I agree with Lynch and I’ve said it a thousand times:  The smart way to build wealth is to invest in what you know. But when I say know, I mean know inside and out. I mean know with your eyes closed. I mean know the beating heart of it.

You can’t do that with stocks and bonds if you are an individual investor, like Pat, with limited access to industry, limited time to study markets and companies, and no highly paid research assistants. But you can do that with your primary job or with a side job.

If you are working for a growing company, you can earn a huge return on your time by becoming an extremely valuable employee and working your way up the corporate value chain towards CEO.

If you have a side or retirement business, you stand a good chance of getting ROIs much, much higher than you could ever expect from the stock market by acquiring true inside knowledge of the industry and using that to carve out a niche for business to ratchet up your profits.

Pat, for example, is actually doing that. When they retired a half-dozen years ago, he and his former partner went into business buying, refurbishing, and then selling inexpensive single-family homes in South Florida. It didn’t take them long to figure out that their best bet in terms of future profits was to focus on retirement communities of a certain price range. Eventually, they found a single community that is big enough to give them all the work they want but small enough where they can dominate the competition.

When they started this venture, they were making about 10% on their money with each transaction. Since then, they’ve learned exactly how much to pay for any house that comes to market, exactly how much to spend on redoing it, and how to sell it in days, not weeks or months.


Buying stocks and bonds is a sensible thing to do if you see it as a part, and only a part, of an overall investment strategy. What the smart investor should expect from his stocks and bonds is what the market is willing to give to the smartest average investors. And that is average returns. Nothing more. Hoping for more is why average investors usually make only 3% on stocks and less than that on bonds. And the difference between that 3% and the 9% that the market is willing to give? That goes into the pockets of the brokers, managers, and analysts.


Pat and his partner truly understand this business. And because they know what they are doing and can leverage their investments, they are making 25% to 30% – a whole lot more money than they will ever make in the stock market.

So do invest in stocks and bonds – but do so conservatively, happy to get average returns as an average investor. Keep the time you spend on stocks and bonds to a minimum by investing in index funds or portfolios like the Legacy Portfolio, which I’ve talked about elsewhere.

But invest in businesses, too, if you can. And in real estate. And in debt and cash and gold. Invest most in what you know best. Be safe. Be diversified. Don’t pretend you can beat the stock and bond market. You can’t.

* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years about wealth: What wealth is, what it’s not, how it can be acquired, and how it is usually lost.