Ability to survive a calamity is the key to staying wealthy

I HAVE a collection of letters sent by fund managers to their investors when closing their fund. They are published in the throes of large bear markets, and invariably the letter starts with a version of “I could not have imagined that markets could have fallen so far so fast…”.

Often, the fund’s losses and closure are blamed on the market going through a “once in a 1,000-year storm” that no one could have foreseen. Instead of looking inwardly at their own shortcomings in terms of investment skill, blame is placed on the market for doing something “unexpected”.

This is why you rarely see very long investment track records through multiple crisis periods. Last week, I wrote about one of two lessons I learnt after three decades of managing money – that mindless pursuit of more wealth does not lead to happiness.

Here is the second lesson: Investment ability is unproven until it has survived a calamity.

If you had no training as a surgeon, your chances of successfully performing brain surgery are zero. Without extensive training, your chances of performing with a symphony orchestra are likewise zero. Investing and trading are the only professions where there is a possibility for temporary success due to pure luck. This fools many people (including some professional fund managers) into thinking that investment and trading are easier than they really are.

Over many years, I have developed a small number of questions that can separate the lucky managers from the ones that have true skill. The world is full of short investment track records that look great. They do not last. Compounding your money at 50 per cent a year for half a decade and then losing 80 per cent the following year underperforms an 8 per cent annualised return that loses 20 per cent in the final year.

Good money managers who have survived calamities understand that risk control is the most important aspect of this business. Beware of any money manager that talks about returns first and risk second. As an investor, the most important aspect of building your portfolio is having sufficient diversification.

As Warren Buffett famously said: “It is only when the tide goes out that you see who has been swimming naked.” Almost everyone is familiar with the famed investment duo and partners, Warren Buffett and Charlie Munger.

Fifty years ago however, there was a third member: Rick Guerin. Buffett said that Guerin was as smart as him and Munger, but he was in a rush to get wealthy. In the 1970s bear market he got hit with margin calls due to excessive leverage, which took him out of the game. Buffett and Munger, on the other hand, kept a healthy cash cushion that allowed them to take advantage of opportunities during deep bear markets that ensured their survival, and the uninterrupted compounding of their wealth.

Becoming wealthy and staying wealthy are two very different skills. Successful businessmen think that their skill in business is portable to the investment world. It is not.

Becoming wealthy in business involves putting your eggs in one basket, devoting all your efforts on that basket, and having an optimistic outlook on your ability to grow that basket. Staying wealthy requires the opposite: a high level of diversification and a heightened sense of paranoia about the future.

There are a million ways to get wealthy, but there is only one way to stay wealthy – and it can be summarised in one word: survival.

Cornelius Vanderbilt, the richest man who ever lived when he died in 1877, had a fortune that would be worth over US$250 billion today adjusting for inflation. Vanderbilt left most of his vast wealth to his children, and their tale confirms both the first and second lessons I learnt after three decades of managing money.

Forty-eight years after Vanderbilt’s death, one of his direct descendants died penniless. When 120 of his descendants gathered at Vanderbilt University a century later for the first family reunion, there was not a single millionaire among them.

I have unfortunately witnessed first hand too many wealthy investors lose everything in a crisis, through a combination of greed (first lesson), and highly risky and concentrated investments (second lesson). It is one thing to lose your money in your 20s and 30s; you have plenty of time to restart. It is another thing entirely for this to happen in your 70s and 80s; it should never happen at that stage of one’s life.

Can your portfolio survive a halving of stock markets worldwide, or an 80 per cent fall in the technology stocks that are today’s darlings? Can it survive escalating global conflict and wars?

Instead of focusing on achieving higher returns at all costs, once your financial goals have been achieved it is better to focus on protecting what you have – so that you will be safe during the next inevitable “once in a millennium” calamity.

The writer is head of investments for Singapore at AlTi Tiedemann Global. The views are solely his, and do not reflect the views or positions of AlTi Tiedemann Global or its subsidiaries. This content should not be considered as financial advice.