New readers frequently ask how one can sit inactively throughout the year with all that’s happening in the market and the world. And when I’m asked at dinner parties, as a courtesy, how I invest, the questioner usually looks skeptical when I say I probably make 1-3 important investment decisions per year, either buying or selling.
“That’s not a way to invest. Didn’t you say you did this full-time?”
To people outside the world of finance—the ones who’ve outsourced that part of their life to advisers—there’s no difference between investing and trading. To them, there are no borders between investment philosophies. They look at the world of finance through fast-paced media and think that that’s how investing is supposed to look. The unfortunate reality is that lots of finance professionals think so too.
You’d think that this phenomenon is restricted to the world of finance. It’s not. The do-something syndrome is all-pervading in many disciplines where it shouldn’t be. Also called the action bias, it forces people working on the right stuff to continuously shift into doing the wrong stuff, blinding them from achieving their true objective.
As jobs get increasingly creative, getting results requires constant refinement doing the right thing over and over for improvement to surface—deliberate practice leading to occasional action when the time is right. Humans tend to act without a sensible plan because motion is mistaken for progress and results. Two false securities feed such behavior:
Movement will protect you from being accused if you fail. “Well, at least he did something. At least he didn’t just sit there.” We convince ourselves and others that we can’t be blamed if things go south as long as we’re in motion, even though just sitting there might be the best move.
Movement will protect you from explaining yourself. Because humans seek validation of others, inaction remains a cardinal sin. You get no honors or statues with your name on them if you make the right decision by waiting—for the good of your team, your company, or even society.
It’s all about appearance. In a soccer penalty, the probability of where the ball is kicked is equally distributed between the left, the right, and the center of the goal. The keeper has a good chance of saving the ball by standing still. But he jumps anyway because it’s less embarrassing than freezing on the spot if the ball flies right past him. The very optic of doing nothing would have greater consequences to his reputation even if he still didn’t save the ball.
We’ve got great flexibility and a certain discipline in terms of not doing some foolish thing just to be active—discipline in avoiding just doing any damn thing just because you can’t stand inactivity.—Charlie Munger
I used to own a jewelry company which started as a side project, quickly growing into a livelihood in a couple of years.
The business began as online DTC. We worked from home, outsourced production and logistics, and took care of the designing, strategy, content creation, branding, and promotion ourselves. We were slowly grinding every day from the comfort of the couch or by the pool on vacation.
We didn’t work extremely hard. We had fun with it, working whenever we wanted from wherever we wanted. Our marketing started to pay off and revenues and earnings from a high-margin business became larger by the month. The business required no capital reinvestment other than inventories and earnings turned immediately to free cash flows. There was no debt. Living frugally as we always had, our company savings started piling up. We could see where things were heading.
But we got ahead of ourselves.
“A young business like ours shouldn’t earn free cash flows like these and save up liquidity”, we thought. “We have to reinvest our capital.”
Working from home, we felt a sense of imposter syndrome working in the jewelry industry with no direct business relationships with anyone in the industry. We didn’t do as incumbent jewelry brands and we were affiliated with no one you were “supposed to know”. The only stakeholders in the business were ourselves, our few suppliers, and our customers which we sold directly to over the internet.
The imposter syndrome made us feel a sense of falseness. That a business like ours shouldn’t succeed so easily. And even if it did, it wouldn’t be sustainable. So we had to do something different to make it sustainable.
We started looking at the success of other brands in the industry to emulate their strategy.
We found that these other companies were hiring bunches of salespeople, agents, and distributors to get their offerings inside the doors of the thousands of little jewelry retailers that operated physical stores. They were hiring bunches of representatives that would nurture these relationships, and they would put up fancy offices into which they could invite various business relations. Many of the brands and representatives seemed to know each other, meeting up at industry conferences, and it all seemed like a club where it’s important to know the right people.
“We can’t compete with that”, we thought. “We must get in on it!”
So we rented an office at a prime location in downtown Copenhagen and spent tens of thousands of dollars making it as aesthetically pleasing as the storefront of our website. The office was 2x the size of our apartment, justified by our desire to throw evening events and expand our workforce. Frankly, and foolishly, we were also thrilled to show the success of our thriving business to the world.
We hired a full-time sales agent in Denmark and an independent agent in Sweden, and we attended conferences with expensive exhibits to attract trade relations and purchasing agents.
It worked. To our delight, some industry incumbents knew of the company already and could see that we have a good grip on online DTC. It made the break into the physical distribution channel a lot easier.
So we thought.
Our time and energy tilted ever increasingly towards our physical distribution channel and nurturing trade relationships with lower-margin customers. This stuff required loads of time. But the money we were making was not tilting that way. While our margins, of course, went down, what was once a great cash flow-generating business became a liquidity-juggling exercise. Where we once collected payments from customers before shipping orders with advantageous credit terms from suppliers, our new type of customer required ever longer credit terms on their end, worsening our cash conversion cycle.
We felt forced to make large investments in stunning store inventory as the retailers couldn’t keep up with our display requirements. Employees and traveling weren’t cheap, and our fancy office certainly wasn’t cheap. But what the hell. We were on our way to becoming a real jewelry brand. And we were busy as hell.
Yes, our size, sales volumes, and revenues were going up, but there was a second-order consequence. While our online business was partly neglected and put on automation, it became increasingly difficult to sell our offering the way we used to online. Channel conflicts appeared as retailers with their online presence started competing with our ad space, diverting the consumer from our website. And it seemed like the more success our online business had, the worse the relationships with the retailers became. While we initially sold them on the promise of our ability to persuade the online consumer, it came back to bite us. We became known as the jewelry company that prioritizes its online channel over its retailers.
We soon learned that many of the retailers were in financial trouble. It’s not like it was any big surprise. Many of them looked like they hadn’t renovated their stores in decades, which they hadn’t. We knew that liquidity was the problem and that many of them were kept alive just to cover payroll. E-commerce had slowly eaten into what was once a thriving business riding the wave of Pandora’s journey and it became worse year over year. Ever since Pandora decided to close down retailers to make the way for wholly-owned stores, franchises, and e-commerce, it had left a slump in the jewelry retail landscape with only the best turning a modest return on capital.
It didn’t take long before we felt it on our luck of payment collection. Some retailers went belly-up with us stuck in line as creditor and some simply refused to pay (in time). The administrative work became bigger and bigger.
In the end, we had turned a healthy, highly profitable business into a confused business in which we worked harder than ever before. The revenues went up, but our ability to turn a profit, let alone free cash flow, diminished as we kept patching leaking holes.
About two years into this new journey, we decided to use the cancer surgery formula in our business. We cut loose our agents and distributors, we cut the number of retailers to select few, we shut down the office, and we sold off pretty much all assets other than inventory at scrap value.
We put all our effort into rebuilding our once-thriving online business—the area in which we had a sustainable competitive advantage—and we made more money than ever, continuously slicing away everything under the topline.
All of this happened due to the urge to just do something to our business which we thought seemed too simple to be true. But simple was the holy grail. Had we understood the opportunity cost we paid from moving from the sweet spot we were in, we would have sat on our asses. I dare not think about the money lost from not focusing on the best part of the business for a couple of years. We sliced off a few years of potential compounding.
Who are you working for anyway?
We got on the wrong path with the jewelry business not just because we wanted to create a “real” jewelry company. The other half of the reason was that we wanted to show our success and ambition to the world. We couldn’t do that behind closed doors from the comfort of the couch.
But there’s a line from The Meditations of Marcus Aurelius I think about a lot:
Ambition means tying your well-being to what other people say or do…Sanity means tying it to your actions.
Ambition isn’t bad. But it’s wrong to let the contentment of your success be dependent on other people’s perceptions. For the jewelry business, the renewed strategy became: to get rich as fast as possible, as easily as possible, as freely as possible, no matter how the way there may look.
This lesson isn’t just applicable to entrepreneurs. If you’re in a job, you’re the only one who gets to decide what success is.
It’s a mindset that requires commitment to the work, as opposed to the rewards. Whenever you work on a project, it’ll will eventually leave your hands and enter the world to be judged by your peers, your boss, critics, customers, or strangers. And you can’t control other people’s validation, recognition, or jealousy. But if you let these things be your motivation in doing your best work—if ego holds sway—you’ll never fulfill your standard with pride. You’ll move around endlessly trying to satisfy this ego, thinking there’s always a better way that leaves other people content.
Another gem from The Meditations of Marcus Aurelius is:
Don’t let yourself forget how many doctors have died, furrowing their brows over how many deathbeds. How many astrologers, after pompous forecasts about others’ ends. How many philosophers, after endless disquisitions on death and immortality. How many warriors, after inflicting thousands of casualties themselves.
No matter how brilliant, none of what we do lasts. What matters in avoiding misery is living and working by your standards. It’s when you operate using an inner scorecard that you will gain independence of mind.
It’s the independence of mind that allows you to sit on your ass when you’ve got something good while allowing you to not be swayed by stagnant or destructive herding behavior. Recognition and rewards must be the extra. There’s good reason to think that the deserved rewards will come on their own.
The sit-on-your-ass-philosophy
At the beginning, I argued the way to invest is to make few important decisions per year. In some years, these decisions may scramble together, like when the market is filled with opportunities, and in others, they may never arrive.
If you’re an active trader or crave the excitement of the market, this philosophy sounds tedious. But tedious is what gives you the greatest chance of success in the long run.
The reasons are simple:
Less reinvestment risk
Getting a constant supply of new ideas is diabolically hard. I spend a lot of time getting to any single investment idea. All potential ideas go through filters in my head with the overarching one being opportunity cost. If you switch out ideas all the time for the sake of action, you won’t even know what your opportunity cost is.
Alongside opportunity cost, the other important model is your circle of competence. Selling something you know well to buy something new that seems better is a dangerous game to play. You should even be willing to sacrifice a few percentage points of your opportunity cost if the thing that’s deep within your circle of competence offers lower prospective returns than the thing that’s just outside of it.
This same principle applies to your other life activities. Anything you decide to spend your scarce time on carries an opportunity cost. So it makes sense to spend it on the things that carry the lowest to no opportunity cost. The activities that bring scores to your inner scorecard drive what you should spend time on. You’ll often find that few things will have low to no opportunity costs. In my case, reading only the best stuff and writing only the most important things are my highest-value activities. Frequently buying and selling securities is one of my lowest value activities.
Fewer transaction costs
Sit-on-your-ass investing. You’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum.—Charlie Munger
Whenever you change direction or take new action, you pay a transaction cost, even if it isn’t monetary.
When we decided to change direction in the jewelry business, we paid many transaction costs. We paid searching costs in finding the right people, we spent time every day traveling from home (our previous office) to the downtown office, and we spent time on unproductive interactions for the sake of networking. But the most important is that we lost time making a mental shift in how to conduct our business. We sacrificed sharpening our competitive advantage, keeping us from going all-in on the thing we were best at.
Beautiful compounding
The essence of compounding is time and a bunch of tiny gains lining up to massive results. To many, compounding is a thing of fairy tales (and something Einstein talked about as the eighth wonder of the world), so they never try to experience it in their own lives.
It is impossible to experience if you don’t let compounding do its thing uninterrupted on your best ideas. Many falsely tell themselves that the result of compounding is just a lucky break such as in the case of the school teacher that left a $6 million dollar legacy.
In investing, to achieve a 100-bagger, your investment would have to double six and a half times. Earning your money a hundred times over is an hard thing to fathom and it’s not easy because sitting on your ass is not easy. But it is only sit-on-your-ass investors that put themselves in a position to perhaps experience such a phenomenon.
If you do what everyone else is doing, you shouldn’t be surprised to get the same results everyone else is getting.—Peter Kaufman
Many things in life follow the laws of compounding if little improvements are present every day, such as relationships, knowledge, and fitness. But notice that the compounding halts as soon as you change these things around too much rather than sitting on what works for you.
Cultivating patience
All of humanity’s problems stem from man’s inability to sit quietly in a room alone.—Blaise Pascal
When you practice the sit-on-your-ass philosophy, you, of course, don’t expect gratification to arrive on the spot. You’ll naturally force your mind to practice delayed gratification, bringing tremendous benefits to other areas of your life. It’s an exercise in self-control. When you’re cultivating patience, you’ll over time develop skills in separating the important from the minutiae (such as short-term volatility) and you will be mindful in making sure not to spend time on the trivial. Patience is a virtue.
When acting
To live the sit-on-your-ass philosophy, the following principles are important when eventually engaging in action.
Dabble only in quality stuff
You become what you give your attention to.—Epictetus
There’s a story about one of the fathers of pragmatism, the American psychologist and philosopher William James, who were once invited to speak by the American Psychological Association at their annual conference. Many thousands attended this conference every year and there was a big buzz going around months up to the event that William James would be the big speaker.
The topic of his presentation was promoted as “Everything we’ve learned in the last 100 years of Psychological Research.”
When the big day arrived and people gathered from around the country, the presenter spoke for half an hour introducing William James.
And when William James finally arrived at the big stage, he said:
They’ve asked me to talk about the last hundred years of psychological research; it can be summed up in this statement …
People by and large become what they think of themselves.
He then left the stage and the conference.
The mind is powerful. Because the brain possesses plasticity, allowing it to adapt to experiences and thoughts, it’s up to you how those changes come about. If you’re a knowledge worker feeding your brain with irrational information, your actions will be irrational no matter the amount of information you gather.
Act with fierce decisiveness
Just as having a constant flow of good ideas is hard, the best opportunities will logically not line up often. So when the proper circumstances present themselves within your circle of competence, act with decisiveness and conviction. The game is to let opportunity meet the prepared mind.
Stay in the game
Sitting on your ass is not the equivalent of freezing when things don’t go your way. Along with acting with fierce decisiveness, you should make calculated decisions that allow keeping playing your game. No matter how much conviction you have on an idea, you have to position size your effort (or money) so that even if you suffer the maximum loss expected, you can take the loss and move on. The Kelly Criterion is a valuable lesson here.
When urging to plan ahead, stay flexible
Eschew the master plan, remain cognitively flexible, and steer the boat toward your purpose every day. In William Thorndike’s The Outsiders, Henry Singleton was quoted as follows:
I know a lot of people have very strong and definite plans that they’ve worked out on all kinds of things, but we’re subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible.
When you’ve got something good, it’s working, and you’ve spent a lot of energy getting there, it’s probably best to sit on your ass and enjoy the ride.
