We have already stated that becoming wealthy is desirable, feasible, and even necessary; that the first fundamental prerequisite for this is to live within one’s means; and that the next step is to build our wealth by trading our intellectual or labor capital for financial capital, while steadily increasing the quality of the assets acquired.
We already learned you should spend less than you earn. How should you invest the rest? That is the subject of this chapter. This is so enormously popular a topic that you could never exhaust the articles pumped out daily by journalists, asset managers and traders via books, magazines and internet investing sites. They have so much to say, and as we’ll see, our Torah sources have very little to say. But the Torah’s advice is worth more than its weight in gold, and isn’t burdened with a sales motive.
Before we hear the Torah’s stance on investing, it would be worthwhile to gain some insight into the approach of the multi-billion-dollar asset management industry. These companies try to project an image of quantitative rigor. One may even get the idea that their portfolio managers might have gone on to careers in rocket science had they not been waylaid by Wall Street’s impressive salaries. And yet there are significant differences between the hard sciences and investing.
A physicist, given all relevant forces, will be able to predict an object’s trajectory. But scroll down to the bottom of any asset management company’s website and you’ll see something like this (usually in very small print): “Mutual fund investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.”
The reason statements of this kind are necessary is because investing is not a science, and not even the most quantitatively rigorous asset manager will guarantee their returns.
Take as an example asset manager Dimensional Fund Advisors (DFA), chosen because the firm’s marketing literature is replete with references to “financial science” or “the science of capital markets” and the firm’s ties to the academic community.
In an interview several years ago with Sensible Investing TV, DFA co-founder David Booth had a lot to say about data, testing and academic research, but he gave his game away when he let a softer word slip out of his mouth: “Our philosophy is a philosophy that people can stick with” – that is, keeping money in the market and not bailing out in difficult periods. As Booth intuited, what investors really need, more than a science, is a philosophy – a financial plan – that they “can stick with.” Wall Street offers many such plans competing for the consumers’ attention. But the Talmud’s advice is less commonly proffered.
We’ll get to that shortly, but let’s take a step back again to gain a broad overview of our subject. Simply put, investing means putting your capital at risk over a period of time in a fashion that is calculated to reap a gain, but which could generate a loss.
Given all this inherent uncertainty amid fluctuating asset values, the investment industry is required to warn of its products that “past performance is no guarantee of future results.” And that is why asset managers do not guarantee their products. If the risk were small, the cost of the guarantee would be commensurately small. But the risk is large and so even large multinational firms with trillions of dollars in assets make sure that their Mom and Pop clients assume all the risk.
This is why investing is so scary. We work hard to save and invest our hard-earned wealth with no clear picture of the future (yet often via asset managers that hint they have some sort of crystal ball). At some level we understand that unforeseen shocks will occur, putting our portfolios at risk of loss, while at the same time we know that not taking this risk may prevent us from achieving our financial goals: “Nothing ventured, nothing gained,” as the saying goes.
And so the investment industry’s goal is to gain your trust, to come off as wise, experienced portfolio managers who have seen it all and have conviction about their investment decisions: “We believe history can help provide reassurance that our portfolios remain well positioned to weather the storm.” Or: “We remain focused on taking advantage of the pricing opportunities that present themselves in uncertain market environments like the one at hand.” (Note that there has never yet been a certain market environment!)
While all asset managers make similar statements and share a propensity for verbosity, their actual strategies vary greatly. In contrast, the Talmud says very little, but what it says is useful for every market environment, be that bullish, bearish, sideways, topsy-turvy, or any other descriptor you can think of. Here Rabbi Yitzchak offers, in a mere dozen words (in the original Hebrew) what in the financial industry lexicon is termed an asset-allocation model:
A person should always divide his money into three: a third in land, a third in business, and a third at hand.Bava Metzia 42a
Asset allocation is, as the term suggests, how one apportions his assets into broad asset classes, such as stocks, bonds or cash. Wall Street’s default asset allocation model is 60 percent stocks and 40 percent bonds. Rabbi Yitzchak disagrees with this approach. His recommendation is that a third of your net worth should derive from productive land, a third from business income and/or shares in equity investments; and a third in liquid reserves, i.e., cash or cash equivalents such as gold.
By today’s common industry standards, the Talmudic portfolio looks quite conservative with its call for one-third in cash. The financial services industry usually frowns on cash, preferring somewhat higher-returning bonds.
Unlike Wall Street, which wants to make a sale to a client based on what will have immediate appeal and eschews cash because it is not a fee generator, the Talmud takes an exceedingly long-term view of how each investor can achieve solvency. A story will help illustrate this point.
Some years ago a member of a shul in Los Angeles gave a farewell speech as he set off for a new life in Dallas, noting that there he would be able to afford a home that would suit his growing family. By appearance and of his own admission, he was a person of mere ordinary wealth. He noted in passing that a century earlier his forebears had owned vast tracts of land in Jerusalem. If he owned even a portion of that land today, he would be a multi-billionaire. But when calamity struck, his family was forced to sell its land holdings, and its progeny today was a humble guy with a modest income.
Despite its deceptive simplicity, the Talmud’s pithy statement on asset allocation yields an insight of depth and power: You don’t attain wealth without ownership of assets such as real estate and stocks. But you don’t preserve that wealth from the blows that time and chance deliver without a large dose of liquidity.
No one has perfect clarity about the future, including the high-salaried portfolio managers who boldly interpret bank officials’ policy decisions. The investment industry always presents itself as acutely aware of the inner workings of the global economy. But the beauty of the Talmud’s investment advice is that you don’t need this clarity – rather, you simply assume that as life takes its natural course you will need liquidity to deal with calamity.
But this “conservatism” is more than compensated for by the aggressive footing of investing in risk-based assets such as real estate and businesses. So unlike the schizophrenic market commentators who are always telling you to buy or to sell, the ingenious Talmudic portfolio counsels us to simultaneously take risk and seek safety, and further suggests we diversify our sources of risk.
Wall Street generally only has stocks to sell, so its verbose commentators don’t normally explain that real estate ownership will further cushion your risk, as your land may hold its value while your stocks are falling. So in essence, the Talmudic portfolio is more venturesome because it is two-thirds invested in risk-based assets, albeit in a more diversified manner than the classic Wall Street 60% in stocks.
Meanwhile, the conservative side of the Talmudic portfolio is simultaneously simpler and superior. Bonds may nominally offer higher returns than cash, but they lose their value over time. Bonds are essentially a loan to government or corporate borrowers. In return for your money, you get interest payments until the loan matures, when you get your principal back. As the years go by and the cost of living rises, you are paid back with less valuable money than you initially offered. One might argue that the Talmudic portfolio’s cash would fare even worse, but that is not so, because cash offers optionality. When land values plummet or businesses plunge, you now have an investment fund at the ready with which to purchase risk-based assets cheaply.
What the Talmudic portfolio makes possible, uniquely, is the ability to both increase your wealth and genuinely sleep well at night. In short, this is a plan you “can stick with.”
Relating this to the financial foundation of “spend less than you earn, keep a stash of cash and invest the rest,” the key here is to fund your future income through current income. What that implies is that your future lifestyle bears a relationship to your current lifestyle. If you can live within your means at whatever your current income is, while saving for the purchase of land or business assets, you will then be accumulating capital while paving the way to achieve financial independence, the ability to support yourself one day without working. That, in contemporary terms, is termed retirement, the subject of a future chapter.
One more critical point about the Talmudic portfolio: While its equal weighing among three asset classes is theoretically elegant, it is difficult in practice to maintain. One’s balance sheet is constantly shifting. Your home may be going up in value while your business interests decline, and so on. Our economic lives are dynamic, and everyone’s finances differ according to his unique journey in life and lifecycle stage. Think of the Talmudic tripod rather as an ideal to which we rebalance periodically, even over a period of years, as best we can.