“The ultimate resource is people—especially skilled, spirited, and hopeful young people endowed with liberty—who will exert their wills and imaginations for their own benefits, and so inevitably they will benefit the rest of us as well. Human Ingenuity is the Ultimate Resource.”
– Julian Simon, Introduction for The State of Humanity
In last month’s article, we focused on “Not Being Surprised” as one of the great qualities to adopt for anyone who wants to become a great investor. This month we focus on a slightly different quality…Great Investors have Faith in the Future
Getting Paid for Uncertainty
A simple internet search for the definition of the word “invest” yields the following: To commit (money or capital) for future advantage or benefit.
In its basic form, the nature of all “investing” is the pursuit of some advantage or benefit which will accrue to us in the future. The act of investing capital is a conscious decision to defer the gratification we might experience from the current consumption of our financial capital, in hopes that that deferral might produce an even greater future utility for us. In order to invest our financial capital, we must have some belief that the future consumption of that capital will be better, more satisfying and “valuable” to us than the gratification we could derive from spending that capital now. Absent this belief, any rational human would instead opt to spend all of their capital now, in order to maximize their gratification.
Since the future is, by definition, uncertain and unpredictable, investing is really nothing more than an exercise in getting paid for taking on uncertainty about the future. If we are willing to subject our capital to the uncertainty of the future, we have an opportunity to create a future advantage from our capital. However, because of the reality of an uncertain future, this also means that we are exposing our resources to the possibility of being worth less in the future – and that the future consumption of that capital might be less “valuable” and gratifying to us than the current consumption would be.
If investing is about “getting paid” for taking on uncertainty, a related truth is that there is a direct correlation between the level of uncertainty we are willing to accept, and the amount by which we stand to “get paid”. The more uncertainty we are willing to accept, the greater our opportunity for future advantage. The less uncertainty we can take, the less we will be paid.
For example, an investor in short term Treasury Bills takes on almost no uncertainty. By making a short term loan to the US Government, the T-Bill investor can feel a high degree of confidence of being repaid their principal plus interest on time, with only a miniscule risk that the US Government will “default” on that loan. This investor also receives very little future advantage for their deferred gratification – the current one year return for T-Bills is just about 0.8%
At the other end of the spectrum, an investor in company stocks takes on a greater d