The 80/20 Principle: The Secret of Achieving More With Less (32 page)

The basic theory is very simple. Stock market performance is highly correlated with the growth of an economy as a whole. Therefore, invest in countries that have the fastest current and expected GNP growth—the emerging markets.

There are other reasons emerging markets can be very good investments. They have the lion’s share of future privatizations and these are generally good homes for money. The strange and sudden death of Communism around 1990 forced many emerging countries to adopt more free-market economic policies, which are likely to work their way through, after the inevitable initial social disruption, into higher returns for investors. And emerging-country shares are often very good value, because they tend to have quite low P/E ratios. As the market develops and matures, and individual companies become larger, the P/Es are likely to go up, boosting the share prices considerably.

But investing in emerging markets is definitely riskier than investing at home. The companies are younger and less stable, the whole country’s stock market could fall as a result of political changes or reductions in commodity prices, the currency could depreciate (and with it the value of your shares), and you may find it much more difficult to take your money out than you did to put it in. Also, the cost of investing in terms of spreads and commissions is much higher than in developed markets. The chances of getting ripped off by a market maker are much higher.

Three policies must be followed by an investor in emerging markets. One is to invest only a small part of your total portfolio, up to 20 percent, in emerging markets. The second is to invest most of your emerging market funds only when the market is relatively low and the average P/E for the countries you are investing in is under 12. The third is to invest for the long term and only pull money out when the P/Es are relatively high.

But, with these caveats, emerging markets are, over the long haul, likely to outperform and it can be wise as well as fun to have some investment in them.

Cull your loss makers

If any share falls by 15 percent (of the price you paid), sell it. Follow this rule rigorously and consistently.

If you want to buy it back later at a lower price, wait until the price has stopped falling, for at least a number of days (and preferably weeks), before you reinvest.

Apply the same 15 percent rule to the new investment: stop the loss after 15 percent.

The only acceptable exception to this commandment is if you are a very long-term investor who does not want to be bothered with the swings in markets and does not have the time to monitor investments. Those who stayed in stocks during and after the 1929–32, 1974–5, and 1987 crashes will have done well over the long term. Those who sold after the first 15 percent declines (where this was possible) and returned after the market had risen 15 percent from its lows would have done even better.

The key point about the 15 percent rule has to do with individual stocks, not with the market. If an individual stock falls by 15 percent, which is much more common than the market falling by the same amount, it should be sold. Whereas few, if any, fortunes have been lost by sticking to the stock market (or a broad portfolio of stocks) over the long term, a large number of fortunes have been lost by mistaken loyalty to one or a few declining stocks. For individual stocks, the best indication of the future trend is the current one.

Run your gains

Cut your losses, but do not cut your gains. The best long-term indicator of a great investment is a short-term gain, repeated over and over again! Resist the temptation to take profits too early. This is where many private investors make their worst mistakes: they take nice profits, but forfeit much fatter ones. Nobody ever went broke by taking a profit, but many people never got rich by following the same procedure!

There are two further 80/20 rules of investment that we have not yet explored:

• Comparing a large number of investment portfolios held over a long period of time, it is usually true that 20 percent of the portfolios contain 80 percent of the gains.

• For an individual holding a portfolio over a long period of time, 80 percent of the gains will usually come from 20 percent of the investments. In a portfolio composed exclusively of equities, 80 percent of the gains will come from 20 percent of the shares held.

The reason these rules hold true is that a few investments are usually stunningly good performers, while the majority are not. These few superstar shares can give phenomenal returns. It is absolutely crucial, therefore, to let the superstars stay within the portfolio throughout the process: to let the profits ride. In the dying words of a character from one of Anita Brookner’s novels: “never sell Glaxo.”

It would have been easy to lock in a 100 percent gain on IBM, McDonald’s, Xerox, or Marks & Spencer in the 1950s or 1960s, on Shell, GE, Lonrho, BTR, or the Swedish pharmaceuticals firm Astra in the 1970s, on American Express, Body Shop, or Cadbury Schweppes early in the 1980s, or on Microsoft later that decade. Investors who took these gains would have missed out on several times that appreciation later.

Good businesses tend to produce a virtuous cycle of consistent out-performance. Only when this momentum is reversed, which may take several decades, should you consider selling. Again, one good rule of thumb is not to sell unless the price falls by 15 percent from its recent high price.

To do this, set a “lock-gain” price at which you will sell, 15 percent below the high. A 15 percent reduction may indicate a change in the trend. Otherwise, continue to hold until circumstances force you to sell.

CONCLUSION

Money begets money. But some methods of breeding have much more prolific results. Samuel Johnson said that a man was never so innocently employed as when making money. His observation pitches the accumulation of wealth, whether through investment or a successful professional career or both, at the right moral level. Neither pursuit is to be denigrated but, equally, neither is a guaranteed passport to serving society or personal happiness. And both money making and professional success carry the dangers that they become ends in themselves.

A success hangover is quite possible. Wealth creates the need to administer it, to deal with lawyers, tax advisers, bankers, and other profoundly stimulating contacts. The logic of professional success outlined in the preceding chapter leads almost inexorably to ever-greater professional demands. To succeed, you must aim for the top. To get there, you must turn yourself into a business. To obtain maximum leverage, you must employ a large number of people. To maximize the value of your business, you must use other people’s money and exploit capital leverage—to become even larger and more profitable. Your circle of contacts expands and the time for friends and relationships contracts. On the giddy roundabout of success, it is easy to lose focus, perspective, and personal values. It is a perfectly rational response to say, at any stage, stop success: I want to get off!

This is why it is sensible to stand back from careers and money making and consider the most important subject of all: happiness.

15

THE SEVEN HABITS OF HAPPINESS

Temperament is not destiny.

D
ANIEL
G
OLEMAN
¹

Aristotle said that the goal of all human activity should be happiness. Down the ages, we haven’t listened much to Aristotle. Perhaps he should have told us how to be happier. He could usefully have started by analyzing the causes of happiness and unhappiness.

Can the 80/20 Principle really apply to happiness? I believe it can. It appears to be true for most people that the majority of perceived happiness occurs in a minority of the time. One 80/20 hypothesis would be that 80 percent of happiness occurs in 20 percent of our time. When I have tried this hypothesis on friends and asked them to divide their weeks into days and parts of days, or their months into weeks, or their years into months, or their lives into years, about two-thirds of the respondents show a marked pattern of imbalance, approximating to the 80/20 pattern.

The hypothesis does not work for everyone. About a third of my friends don’t exhibit the 80/20 pattern. Their happiness is much more equally distributed over time. What is fascinating is that this latter group seem to be markedly happier overall than the larger group whose happiness peaks in small amounts of their lives.

This fits in with common sense. Those who are happy with most of their lives are more likely to be happier overall. Those whose happiness is highly concentrated in short bursts are likely to be less happy with life overall.

It also fits in with the idea advanced throughout this book that 80/20 relationships imply waste and great scope for improvement. But, more significantly, it suggests that the 80/20 Principle might help us to be happier.

TWO WAYS TO BE HAPPIER

• Identify the times when you are happiest and expand them as much as possible.

• Identify the times when you are least happy and reduce them as much as possible.

Spend more time on the type of activities that are very effective at making you happy and less time on other activities. Start by cutting off the “valleys of unhappiness,” the things that tend to make you actively unhappy. The best way to start being more happy is to stop being unhappy. You have more control over this than you imagine simply by avoiding situations where experience suggests you are likely to become unhappy.

For activities that are very ineffective at making you happy (or effective at making you unhappy), think systematically of ways that you could enjoy them more. If this works, fine. If it doesn’t, think how to avoid these situations.

BUT AREN’T PEOPLE POWERLESS TO DEAL WITH UNHAPPINESS?

You might object, particularly if you have some experience of people who are chronically unhappy (and are often consigned to the seemingly objective, but terribly slippery and unhelpful, category of the “mentally ill,” which has perhaps brought the world more misery than most categorizations), that this analysis is far too simplistic and assumes a degree of control over our own happiness that, for deep-rooted psychological reasons, many or most or all people do not have. Isn’t our capacity to be happy largely predestined, by heredity and childhood experience? Do we really have any control over our happiness?

There is no doubt that there are people who are temperamentally more inclined to happiness than others. For some the glass is always half full, for others half empty. Psychologists and psychiatrists believe that capacity for happiness is determined by the interaction between genetics, childhood experiences, brain chemistry, and important life events. Clearly, adults can do nothing about their genes, childhood experiences, or past misfortunes in life. It is all too easy for those inclined to evade responsibility to blame their defeatism on forces outside their control, particularly if they are easily overawed by medical Jeremiahs.

Happily, common sense, observation, and the latest scientific evidence all indicate that, while everyone is dealt a different hand of cards with respect to happiness just as for every other blessing, there is a great deal that can be done to play our hand better and to improve it during the game of life. Adults are differently endowed with athletic ability, as a result of genetics and the extent of training and exercise during childhood, youth, and subsequently. Yet everyone can markedly improve their fitness by sensible, regular exercise. Similarly, we may through hereditary influences and background be thought more or less intelligent, but everyone can train their mind and develop it. We may be more or less inclined, through our genes and environment, to become overweight, but healthy eating and exercise can make most fat people considerably thinner. Why, in principle, should our ability to become happier be any different, whatever our starting point in terms of temperament?

Most of us have seen examples where the lives of acquaintances or friends have been materially changed and happiness permanently enhanced or reduced, as a result of actions freely taken by those individuals. A new partner, a new career, a new place to live, a new lifestyle, or even a conscious decision to adopt a different attitude to life: any of these can make all the difference to an individual’s happiness, and all of them are under the individual’s control. Predestination is an unconvincing hypothesis if it can be shown that only those who believe in predestination are subject to its sway. Evidence that some people can freely change their destiny ought to be persuasive and encourage us to emulate those exercising free will.

The freedom to be happy is at last supported by science

At last, the field of psychology and psychiatry (which, more than economics, has deserved the epithet of the dismal science), prodded by the findings of other scientific disciplines, is producing a more cheerful picture consistent with our common sense and observations of life. Geneticists used to be excessively deterministic, reducing complex human behavior to the whim of inherited genes. As a more enlightened geneticist, Professor Steve Jones of University College, London, points out: “There have been announcements of the discovery of single genes for manic depression, schizophrenia and alcoholism. All have been withdrawn.”
²
Now, we are told by an eminent neuropsychiatrist, “The new field of psychoneuro-immunology is telling us…that a human being acts as an integrated whole…The evidence suggests that there is a delicate balance between what we think and feel on a daily basis and our physical and mental health.”
³
In other words, within limits, you can choose to make yourself happy or unhappy and even to make yourself healthy or unhealthy.