Institutionalized Belief in the Greater Fool
investing1012dot0.substack.com
investing1012dot0.substack.com
The group that won third place beat us out by... not building a product that anyone could use (Their proposal was a DJ jukebox app for going to the club. Where you could pay money to have a chance to hear the song you want played at the club). I will eat my shorts if anyone has actually coded any part of that app since the competition (2016). But it didn't matter cause 3rd place walked away with like $5k, and that was the point of the competition.
Investors only want to make a return on their investment, and thus do not really care what the product is, as long as they are convinced that there is a market of appropriate size and that you can reach that market.
Here, in a nutshell, is the entire problem of misaligned incentives in modern business. The product becomes the the shares of stock. Larian's success with Baldur's Gate 3 is because they obsessed about the product and their customer. Apple's success is because Steve Jobs obsessed about the product and the customer (despite being publicly traded) and Apple continues to do so.
So many other companies are all about maximizing short-term extraction of shareholder value. They're not about the product or the customer anymore. This breaks the market mechanism, so few arguments of how the market will generate winners or fix the problem still make sense. The market is Wall Street, the stock market, not the market where customers buy goods.
How do we incentivize good product and customer service in a VC / activist investor / private equity world?
From a P/E standpoint, Wall Street is less about "short-term extraction" than at any time in history.
Yes, if you can provide a good return on investment, you can attract many investors.
But eg ESG investment is a thing. And so is Elon Musk fans essentially buying some entertainment with their shares. (The same might apply to Game Stop and cryptocurrencies.)
Go to college, regardless of tuition.
Put your money in the stock market, regardless of its health and structure.
Buy bonds, regardless of the interest rate.
Own a house, regardless of market conditions.
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Most people don't think critically about their money, which makes them easy prey for greater-fool games built on top of institions they were educated to trust.
Also, no one suggests buying bonds for the sake of it. It makes no sense and never did. Bonds are little but a balancing component for stocks.
There’s also the possibility of the market going 1917 Russian collapse or 1949 Chinese collapse, in which case you’d be left with literally nothing over night.
And not that dramatic, there’s also the chance of the Western market going October 1929, and not everyone is Lord Keynes in order to afford to ride that event out for the following 10-15 years (and I think Keynes was lucky there).
Just by virtue of being a stock market, it's not guaranteed to always keep going up (e.g. look at other stock markets like, let's say, Japan).
In fact, the US stock market has been largely unique in the amount of long term growth it's seen.
This means that the default advice of "put your money in the stock market because, long term, it will go up" is wrong. It is wrong in the sense that _even if_ the bet is positive EV, the reason for the advice is wrong.
Instead, you'd have to argue about why the US market is special, what mechanism has allowed it to go up, and why that mechanism will persist in the future.
The same is largely true for housing btw.
Capital always generates return. If it doesn't it just moves to the other place where it does. If there is no stock market, there is no way to freely move that money and it means that private property is no more, and owning capital is more of a job of "being able to milk something for profit", rather than a passive income source. That means we no longer have capitalism. Do you claim the world is really a place like that?
Or, do you claim that there are other mechanisms for that but the stock market. Which?
This is a bit of a naive viewpoint. Take your example of putting money in the stock market, regardless of its health and structure:
So I'll follow your advice and I'll think critically about it. I'm not an economist, but I'm technically and mathematically quite literate. And what I see is that historically, it's generally been a good idea to put money in the stock market. But of course that doesn't mean that will apply to the future.
Except, how can I tell whether the stock market is in good health? Even as an academic researcher, that is a really hard problem. The best I can do is look at the past, and then take a risk.
It's not my lack of critical thinking that is the problem. It's that it is a genuinely very hard problem.
Alternatively, if you want to get "fancy", you can use the 50/200 SMA crossover to determine entry and exit points. It's a much safer bet than "buy and hold" since it avoids massive drawdowns.
Wait, isn't that the wrong way round? You're waiting when it's low and buying when it's high?
So, instead of "buy low and sell high" it tends to be a lot easier to "buy into strength and sell into weakness".
I think there is a big difference between merely applying critical thinking, versus investing the necessary time into essentially becoming a semi-professional day trader.
I've been following the stock market since 1995 and have come to precisely the opposite conclusion
Why?
You have zero ability to predict the state of the market at the point that you need liquidity. So it doesn't matter if your portfolio increases for 20 years, if you need your liquidity during a crash, welp you're fucked.
But this simply means you didn't predict that you'd need the liquidity, which is easier than predicting the crash.
You have to know that as you get older, you will likely need that liquidity more. Thus, you should be swapping illiquid assets over time, as you get older, bit by bit.
Not doing it is equivalent to taking a bigger risk than you could afford to be taking.
Oh how silly of me to forget that investors have target liquidation periods and that even the most 101 level of investor knows that
Yet somehow something so basic as - predicting exactly when you are going to need your savings - eludes millions of people
Get real
it doesn't elude millions. it "eludes" those who didn't plan their financial journey, or take more risks than they should be (for example, not liquidating a chunk when planning on having a baby).
Just because people can't do it well, doesn't mean it isn't what they should be doing. Financial planning is not "put all money into the stock market and hope for the best", as the grandparent post implies.
It's good to focus on the bad outcomes as well as the good outcomes, and most people do indeed make the mistake of only considering the good outcomes. But looking at only the comparatively rare bad outcomes and then concluding that investing in the stock market is a bad idea is just availability bias.
Extending the idea of thinking critically about money, it's a safe bet that a majority of the population have no idea how money itself is issued or who issues it.
"Most investors when they buy a publicly traded stock believe that they own a part of some company. They think that somewhere there is a stock certificate or some indication of ownership that has their name on it, but this is not the case. When you buy a “stock” you are actually purchasing a security that affords certain entitlement rights related to registered stock which actual owners hold. The registered shares of a private company are directly owned by shareholders. In contrast, the registered shares of nearly all publicly traded equities are owned by Cede & Co., which is the nominee of the Depository Trust Company (DTC). (A nominee is a company whose name is given as having title to a stock, but does not receive the financial benefits of ownership.) Cede is a subsidiary of the Depository Trust Company (DTC) which is a subsidiary of the Depository Trust and Clearing Corporation (DTCC) and the DTCC is a private company owned by elite Wall Street firms and money center banks. If you need background or a refresher on DTC and DTCC, click on this link. Effectively, elite Wall Street firms and money center banks, not institutions and individual investors, own almost all of the registered shares of publicly traded companies in the US... Effectively, you are buying a financial derivative from brokers of a financial derivative they hold from Cede that is just a digital entry in your DTC account." [0]
[0] https://smithonstocks.com/part-8-illegal-naked-shorting-seri...
What does owning a stock mean, if it doesn't mean owning all entitlements, rights and obligations related to said stock?
The technical financial structure is a bit irrelevant, since this structure is created to reduce transaction costs. It made ownership of stocks much more accessible, and thus, more people could buy into it.
The idea you presented - that you don't really "own" the stock, because some other party is holding it in trust - is simply not true. After all, you do the same with the money in your bank account. Unless, of course, you're one of the few people remaining that hold out with hard cash, or even physical gold.
I would not trust the article. It reeks of the same conspiracy theory as https://wtfhappenedin1971.com/
>> What does owning a stock mean
Ownership requires property rights but you only get contractual rights. If you want to sell your stock and you both parties want to conduct that transaction under a different jurisdiction, perhaps for tax advantage, you can't choose to do that, because you don't own the property rights.
>> The technical financial structure is a bit irrelevant
That's a pretty controversial take because:
>> since this structure is created to reduce transaction costs
It also served to ensure a middleman was enshrined in all future transactions. What if you want to change the middleman, what if you don't want a middleman at all? Like I say, controversial.
>> you don't really "own" the stock, because some other party is holding it in trust - is simply not true.
History shouts loudly for us to be cautious here but presently we're blessed with a freedom to blissfully ignore those warnings.
>> you do the same with the money in your bank account
You don't. In one scenario you're a party to a private contract and in the other you're under-written to the tune of $250k (assuming USA)
>> hold out with hard cash
What does that mean in the context of a fiat currency?
It's easy to compare costs of funds: you can find them in the prospectus and the funds advertise them.
(If a fund makes it hard to find out the fees and costs, no need to sweat it: they are likely high, so you are safe avoiding that fund.)
I think that's what GP is talking about. I don't think it's unreasonable to put your money into stocks, but there are a ton of people in America that put a ton of money into the stock market without even getting to the point of doing some of the reasoning you do in your post.
If no employer match then you are giving up just the tax benefit. If you don’t really care about that then whatever you alternatively invest in for retirement planning has to already make up for what, like 30% you save in going pretax?
Anyways, you do you.
The problem with the stock market is not that its hard to tell whether you should be in or out. Its that there's so much pressure on the general population to own stock that the stock issuers can now get away with releasing essentially worthless stock (see Snapchat for an example) and still expect it to sell anyway.
When you buy US bonds at a low interest rate you are lowering your risk because those bonds are supported by F-35s, nuclear bombs, and aircraft carriers, while, in general, other countries bonds don't have that shield. This is not an investment advice but if you have money bonds should be taken into account.
Stock market? Technology advances are accelerating, that is a reality, so buying ETFs does not seem bad to have some participation. The story doesn't end in software startups.
Go to college? Well, the tuition could be insignificant if the diploma gives you the signal and network to scale after graduating. If it is not, you can study in another place with zero or minimum tuitions or skip college.
Kahneman and Tversky identified several cognitive shortcuts (heuristics) that people use to make judgments and decisions, which can lead to systematic errors (biases)... often leading to irrational decision-making. Their research explains several irrational decision-making processes that we demonstrate while investing (either in private or public markets.)
Thinking Fast and Slow is such a great book…
For people playing the game, the actual value is not the important part, what is important is that they think the hype will continue and that the price will continue to go up. Their intention is to sell just before the hype ends, to profit off the supposed "greater fools". You lose if the "greater fools" you expected are not here.
Scammers trying to outscam each others if you want, not much trust here.
I’m not convinced that this is a bad thing. The basic reason is due to broad market ETFs like VT/VTI/VXUS and similar.
The problem an individual investor has is primarily an issue of information density and information asymmetry. They don’t have the time to be an expert at the same level as institutional/professional investors, and institutional/professional investors have better sources of information.
So what can you do? Observe the behavior of institutional/professional investors as a proxy for your own analysis. What you see on even relatively short timescales is that as some investors leave the market pulling prices down, the lower prices convince other investors to enter the market (more deeply). Individual companies/stocks may flounder, but the market as a whole on a long enough timescale appreciates in equivalence to inflation + new value.
This is inclusive of crashes, which are historically the /best/ times to invest. If you aren’t trying to pick stocks you completely change the risk calculation (and the reward, you won’t get 100x multiples). There’s nothing stupid about consistently investing in a broad market fund, but I’m open to evidence to the contrary.
The average student loan debt per student is around 30k, which is easily negated by the college wage premium, and also a much lower unemployment rate for college grads. it is not even close. This holds even for low-ROI majors and low-ranking colleges.
Put your money in the stock market, regardless of its health and structure.
after factoring in dividends , S&P 500 has pretty much outperformed everything and has a 10 % annual return, which solidly beats inflation.
Own a house, regardless of market conditions.
same as above. even someone who bought a home in 2004-2008 would be ahead now. home ownership easily beats renting.
market timing has generally been shown to be futile. the best time to buy stocks is always now.
We once thought there would be such premium. Wages held stagnant as people started going to college, though, and have continued to.
If what you are trying to say is that college filters out those who are not well suited to high level careers, there is no doubt truth to that, but that is not the same as a premium. It is not like college can cure someone's disability. The same person sees no change, statistically.
But it is faulty to think that going to college will cure what ails them. Statistically, most people who are capable of graduating from college do. Everyone capable of graduating from high school does. Those who fall short, so to speak, were held back due to limitations of themselves. The same limitations that hold them back throughout life.
As before, incomes have held stagnant. There is no premium. If you're born a top performer, it doesn't really matter what exactly you do – the numbers show that you have always been a top earner. College didn't change that. If you're born with down syndrome, it again doesn't matter what you do – the numbers show that you have always been a bottom earner.
A decent programmer costs you maybe $250/y in wages, tools, office rent etc. Not counting equity grants as those don’t affect cashflow.
$20 million gets you some 80 man-years of solid senior-level programming. Where does all of that effort go? Just endless rewrites in different microservice frameworks?
Or is the money burned on something else? Google ads? AWS bills?
If stuff got to the IPO, it is usually not a complete bullshit. Very occasionally it is, but that's an exception, and someone who puts a big chunk of their nest egg into a single public stock can only blame themselves anyway.
If stuff got acquired, usually the acquiring company more or less knows what they are doing too.
But LPs are the royal bagholders indeed.
Assuming you have some saas product with a bit of traction, you raise $100M.
Why raise 100M? So you can DOMINATE growth within your vertical by hiring everyone away from their existing jobs, creating FOMO with marketing and then being acquired or doing some pump and dump like a SPAC - or maybe you can buy enough growth with other people's money to convince a friend of your Father (who is a banker) to underwrite your IPO cause your financials are slightly better than some shitcoin scam.
You can get to $1M/mo pretty easily if you get a fancy workplace with all the perks, hire 20-30 people for 250k+ each and spend $100-200k a month on ads and rent.
Remember, the whole goal of Venture and PE is to create a vehicle to dump a stock onto the public stock market at the highest delta between the IPO open price and their per-share common stock purchase price. That's it.
Doesn't matter what you make or why, or if it's fully legal, or good or bad or whatever - makes literally no difference as long as you can convince a banker that they will make 10-1000X on that specific transaction as soon as possible.
Amazon, Google, and Apple are probably the most successful examples of this.
I feel like Thiel's point about stagnation is fundamental to this problems. A lot of these startups aren't providing real value, they are repackaging existing value with an undeserved markup. They can get away with it because there really isn't a lot of innovation anymore.
Right, and not just that -- by buying those shares at that price, they played a big part in fooling others into thinking it was possible.
Anyway, great article. I think it describes exactly how the economy functioned until very recently.
This applies far beyond tech VC, which is a niche within a niche: The capital markets architecture and the financing of commercial activity is predicated on information disclosures that became common practice between ~1500-1600 AD and haven't changed much since.
While information technology will never tell the future, it can certainly change the distribution of who knows what and when about the past and present.
In terms of cost of starting a business, I think things like AWS, Stripe, Vercel, etc. have made the cost of starting a business much cheaper vs. when you were racking your own servers. I've seen lots of data indicating that the cost to START a business has gone down dramatically.
But maybe you're right that the overall cost to build a business has gone up (salaries, etc.) But my guess would be, adjusted for inflation, companies are raising more money because marketing is more expensive (your point on CPM) and the overall landscape is noisier, more competitive.
But that would lead me to believe that has driven companies to raise MORE capital rather than less.
It's very easy to forget that things could have happened differently: COVID hysteria could have been around for many years, crypto currencies could have become a major player in the world's economics, the Germans could have won...
One way to appreciate this fact is to try and predict the near future. Which of the current "hot" trends will fizzle out into (rightful) nothingness, and which will change the world? Area such as A(g)I, Quantum Computing, Self driving Cars, VR/AR/metaverse, Nuclear Fisson, Carbon Capture, etc etc.
And what percentage of your portfolio are you willing to bet on it?
unlike covid hysteria, which was/is a real thing, this had no chance of ever happening . crypto is mostly just a tool for gambling still, always was
- Self driving cars could come too late to save Uber
- Some companies have too high a burn rate for this interest environment -- but some cautious companies went under because their competitor out-raised & out spent them
- Lots of Dotcom bubble companies failed, only to have similar business models work in 2023 (Pets.com/Chewy, Streaming audio, even Cuecat style QR codes are everywhere)
In 2020 many people thought a vaccine was 5+ years away (wrong) and Covid was a permanent shift in how we worked (partially true!) and interest rates will have to be low for years because of the impending recession. If that's your worldview, what would you invest in to hedge that risk?