No investment comes without some risk and 100% certainty.
However, people like Warren Buffett, Charlie Munger, and their idol Benjamin Graham, have adopted a strategy known as “Value Investing.”
This “value investing” strategy allows them to be near certain of their investments.
The most certain of investments usually included these five characteristics:
- You have control over the asset. You have the ability to increase the asset’s income and/or the ability to decrease the asset’s expenses.
- The asset is always in demand. Necessities are always in demand because they’re required for day-to-day living.
- The asset must pay you for owning it (generates income).
- You can buy the asset significantly below intrinsic value. Intrinsic value is in part determined by the income paid by the asset. The more income paid by the asset, the higher the intrinsic value.
- You have the ability to increase demand for the asset through effective marketing and management.
You can likely improve your investment results by allocating more money to assets meeting all five of these requirements. This shift in allocation would obviously force you to allocate less money to any asset not meeting these five requirements. Such a formula might be:
Allocate 80% (or more) to certain investments
Allocate 20% (or less) to uncertain investments
The average person usually invests mainly into index funds through their company’s retirement plan. Do index funds meet all five of the above criteria? No, they don’t, which means average people are allocating the majority of their investment portfolio into uncertain investments. In other words, this is the average person’s formula:
100% Allocation to Uncertain Investments
0% Allocation to Assets Offering Certainty
Unfortunately, this strategy increases their investment risk significantly. Certainty is what reduces risk.
If you study stock trading and/or trade individual stocks on your own, you might be familiar with a “system” of sorts that some investors use to invest safely. The approach is to invest in stocks with a price-to-earning ratio of 7 or below and a dividend yield of 7 or above. This combination usually results in a stock that’s both undervalued and pays income – two factors that increase your margin of safety.
Sometimes, investors take the strategy a step further by examining how many shares of stocks with these attributes have been recently acquired by company insiders.
As much certainty as such an approach adds to an investment, the problem with this system is two-fold:
You still don’t have any control over the stocks, and you don’t have the ability to increase demand for these assets. That means that even with a “system” for investing in stocks that increases the margin of safety, you only meet two of the five criteria of investment certainty:
- Have control over the asset. (NO)
- Asset is in demand. (YES)
- Asset pays us for owning it. (YES)
- Asset could be purchased significantly below value. (YES)
- Have the ability to increase demand. (NO)
With that little certainty, then, it would be wise to NOT allocate a large percentage of your portfolio to these types of assets. Remember Warren Buffett’s No. 1 rule of investing:
Never lose money
The best way to not lose money when investing is to focus more of your resources (time and money) into assets that offer certainty (meet the five certainty criteria).
“Time” has been included the allocation analysis because you can apply this same approach to how you invest your time. Allocate most of your time into opportunities that offer more certainty and less time into opportunities offering less certainty.
Take a minute and make a list of things you invest your time into from day to day.
Consider the following questions for each activity on your list:
- Do you enjoy the activity?
- Do you control the outcome of the activity?
- Can you improve the benefits extracted from the activity?
- Can you leverage the benefits into other opportunities?
Try to allocate more of your time to the activities that you’ve answered “yes” to each question because these activities offer you the highest return on the time you invest.
There are investment opportunities that allow you to allocate both resources – time and money – that can be very profitable. Owning your own business, or partnering in a business, is a way to invest both your funds and your time into something that could be profitable. An individual business that you have a 50-percent-or-more stake in might certainly meet the five criteria of certainty.
- You control it.
- It could provide goods or services that are in demand.
- It pays you for owning it.
- It could be purchased (or launched) below market value.
- You have the ability to increase demand (marketing).
The five criteria of certainty give you a margin of safety for the financial portion of your investment in a business, and it probably shouldn’t be difficult to figure out if it’s worth the time investment. Simply ask the four time-allocation questions in the context of your own business:
- Is it an activity you enjoy?
- Do you have control over the outcome of the activity?
- Can you improve the benefit extracted from the activity?
- Can you leverage the benefits into other activities?
One of the commonalities among the world’s greatest investors of all time – and of wealth-builders in general – is that they own their own business. Graham’s and Buffet’s businesses were investors themselves, yes, but Buffet bought Berkshire Hathaway when it was a failing textile company. And through the years, Berkshire Hathaway has become one of the largest companies in the world and owns controlling interest in many large companies.
In other words, even when Buffett makes investments into shares of stocks, he invests into assets (companies) that, ultimately, he controls.
One of our near certain investments is our build-to-rent real estate investing strategy, where we build a 15-20% cushion in our investment by building rental properties on our own.
Because of this cushion, this minimizes our risk in a market correction. It is near certain to us.
Hopefully, you can use the ideas in this article to invest with a little more certainty and slowly inch ever closer to that glorious position of FU.
Vince & Mike