Bubbles and Tailwinds

Oct 2021

 

 

““People at rest will remain at rest, and people in motion will keep moving in the same direction unless an outside enchanter acts upon them. In a tornado even a turkey can fly.”

Guy Kawasaki

“The rising tide lifts all the boats.”

John F Kennedy

 

When I was growing up, my parents said to work hard and save money as much as you could. That saving money was the path to building wealth. It wasn’t until I was older that I understood that wealth building wasn’t necessarily about how much you saved but about how much you invested. Because investing generates returns on your capital. Making your capital work for you so you don’t have to was the secret of the game that nobody explained to me.

Because the problem is that your time is finite, you only have so many hours in a day. If you’re always earning based on some increment of your time, the amount of wealth you can create will always be limited. It will be a function of your time and therefore have a natural ceiling to it. You can’t work more hours than you physically have. And you’re asleep for a lot of it too.

But if you do earn based on your time, then it also means if you want to earn more you have to work more. So the only way to earn more money in that model is to work harder. But I’m a naturally lazy person and I don’t like work for the sake of work or money, if I can help it. I like working on things that are fun and to stop when they stop being fun. So every since I became an adult, I’ve always wanted to know, could you earn more while working less?

The answer is yes. But only by disassociating yourself from your own labour. What that means is by investing, it allows your capital to effectively earn your income for you while you’re not working. That was a foundational concept and the crux of investing for me. Because it suddenly meant decoupling ones hard work from ones earning ability.

When you do that you realise a few things. 1) There’s no limit to how much wealth you can build and 2) there’s no mandate anymore on what you spend your time doing. Suddenly you realise you can build a huge fortune while spending your time doing things that are fun. It didn’t matter how hard I worked so long as I was smart and invested better. I’d probably end up in a similar or better place. But with a lot more time to do things I enjoyed.

Then as I got older still I realised that investing by itself isn’t enough. I actually have to be good at investing. Most people generate mediocre returns on their money; and investing is generally fraught with risk. People it turns out are prone to making bad investments and losing all their money on a regular basis.

Index funds are about the most widely recommended and safest investments there is where you’re unlikely to lose money and produces about 8% returns per year. That’s good but isn’t going to replace working anytime soon. Not for decades or until you already have huge amounts of money already invested. But if you were like me and didn’t have lots of money to start with, like my family didn’t have much. You have to invest in something that will grow quickly.

But how do you find something that will grow quickly that is also low risk? Remember, there’s no point investing if you lose it all. It means finding an area where there is a huge wave. You have to invest and also needed a tailwind behind you to make strong returns easier. Some huge macroeconomic force that pushes the boat upriver.

That’s when I realised that accruing significant wealth wasn’t just about investing in anything. But investing in something that had a huge tailwind and inflating bubble element to it. That’s what I think is meant when people say find a niche. They don’t just mean find an area that has few other competitors, they also mean find an area that has a huge tailwind or economic pull that will make it easier for you to do well there.

I think another word for a tailwind is an “opportunity.” I always found that word interesting. How do you know something is an opportunity when you see it as opposed to just a regular thing? It’s an opportunity if it has a tailwind. What makes something an opportunity is that it seems easy to make money in, there’s a huge overwhelming demand; and it’s only easy if there’s a tailwind behind it making it easy. A quote I read a long time ago was that you can’t create the waves, only surf them.

That was the missing ingredient. For a person to grow a lot of wealth quickly, it means finding a tailwind to make investing easier and to make each individual dollar invested compound into many more dollars than if it had been invested in something with a worse return. The problem with tailwinds is sometimes what seems like a tailwind is actually a bubble and you’re never sure if the growth is going to last or not.

People thought that Tulips or Ostriches were a tailwind but secretly they were bubbles. Internet technology has been a huge tailwind for the last 20 years, basically experiencing infinite growth as the world globalized. For Warren Buffet, he believes the greatest tailwind of the last century is the American economy – that American business will invariably keep on growing. In Australia, real estate and mining is a big tailwind because the population is growing and the country exports a lot.

What distinguishes a tailwind from a bubble? Probably need or want. A good example is that real estate can be a tailwind if a lot of people need or want to live somewhere and there are not enough houses there like in Australia. But real estate can also be a bubble like in China right now where there are something like 1 in every 5 homes is empty and there aren’t enough people to live there. But a lot of people made a lot of money in Chinese real estate as the bubble was inflating. With many equally having lost fortunes as it deflates.

So this means even bubbles make sense as investments if you can also exit the investment before it crashes. Many technology real estate investors made fortunes if they sold prior to the 2001 dot com crash or 2008 housing market crash. Famously Mark Cuban sold his shares in Yahoo making him a billionaire right before the stock dropped 99%. Shares in Evergrande, a big chinese property developer have dropped 96%. Then you have things like cryptocurrency where you’re not sure if it’s a tailwind or a bubble.

So building a fortune quickly is about investing in something that grows quickly which means finding a tailwind and then investing in that tailwind. Or finding a bubble and investing in that bubble as it is inflating and then exiting the investment before it crashes. That’s about the only way to build wealth quickly. Otherwise you’ll be building it slowly at 8% per year in an index fund.

How do you find a tailwind or bubble? That, I have no idea. Most, in hindsight, seem very obvious that something was a bubble or tailwind. But when you’re looking at one beforehand it’s not apparent that it is. If it was everyone would be investing in it. And the risk of losing everything if you pick wrong is significant. But that’s why with high risk there is high reward. It’s not actually that the thing itself may be risky, the risk is that you may have gotten it wrong to begin with and it is neither.

Anecdotally, everyone I know that has built a fortune relatively quickly has done this. They’ve picked their tailwind or bubble and then they’ve aggressively invested in it to compound their dollars as fast as possible. And each one has chosen theirs based on their own expertise or what they know. Across cryptocurrency, real estate, technology stocks, internet businesses, finance, startups et al. The only similar characteristic is that they had tailwind or bubble like qualities to them which did most of the heavy lifting of compounding capital for them.

Investing to compound capital at high rates is the way fortunes are built, not just saving money. Saving money is only step 1 that allows you to get to step 2 of investing. Step 3 is finding the tailwind to invest in to grow your money quickly. That’s what my parents forgot to explain, or more likely they never learned it themselves. But better late than never.