Building Wealth

Think About First Principles

Whether you want to use Aristotle or Elon Musk as your guide, now's the time to check in on a little investing wisdom...

After a long period of calm, the market woke up and slapped investors in the face last month. A huge 3% drop on August 5 and a historic spike in volatility put the markets in a tizzy... at least for a little.

For the most part, the market has rebounded. But it feels like everything people thought they knew in July about Big Tech stocks, the jobs market, and the overall economy has been upended.

Now, in a time of turmoil – especially with the election coming up – you want to turn to the "first principles."

These are the basic truths or assumptions that something is built on. If you were to break a problem down into its first principles, you would dig deeper and deeper until you're left with only the foundational truths of the issue.

Aristotle, usually credited with the original concept of first principles, called this "the first basis from which a thing is known."

He believed that to figure out a problem, you had to tear it down to the basics and then work up to what you were trying to figure out.

Aristotle explains this idea at the start of his treatise Physics – a multibook collection that discusses the way the natural world works. And you could even imagine he's talking about financial markets...

Now what is to us plain and obvious at first is rather confused masses, the elements and principles of which become known to us later by analysis. Thus we must advance from generalities to particulars; for it is a whole that is best known to sense-perception, and a generality is a kind of whole, comprehending many things within it, like parts.

More recently, Elon Musk highlighted the first principles philosophy as the key to his success...

I do think there's a good framework for thinking. It is physics. You know, the sort of first principles reasoning. [What] I mean by that is, boil things down to their fundamental truths and reason up from there, as opposed to reasoning by analogy.

Musk even explained that it was this kind of thinking that led him to see the opportunities in electric cars and rocket building.

With markets in a volatile state and assumptions being revised, it's time to check in on the first principles of investing.

Fortunately for us, storied investors like to talk about this stuff...

Always dependable for a memorable quote, Warren Buffett says, "The first rule of an investment is don't lose [money]. And the second rule of an investment is don't forget the first rule."

This focus on making sure you won't lose is a key thread from the best investors.

Noted value investor Mohnish Pabrai structures his investments similarly, "Heads I win, tails I don't lose much."

That's really just a catchier way to phrase George Soros' advice, "It is not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."

You also need to understand the moment...

David Tepper, founder of successful hedge fund Appaloosa Management (and the owner of the less successful Carolina Panthers), says, "Sometimes there's times to make money... Sometimes there's times not to lose money."

And famously, the banker and fund manager Sir John Templeton warned, "The four most dangerous words in investing are: 'This time it's different.'"

With those words of wisdom echoing through our minds, we think now is not the time for wild speculations or going "all in" on the market when valuations look very stretched today.

At the most basic level, we want to put our money into an investment... and get a little more back. Most important, you want to sleep well at night.

I've stressed many times over the past year or so that you need to be holding cash. Interest rates are set to come down, so investing in U.S. Treasuries looks like a great play.

You should also hold other assets outside of stocks... My favorite is gold, as I've talked about many times before.

The point of today's issue is just to make sure you are prepared for more volatility. Having a bit of your money in cash and in gold is a great way to be ready for just that.

And if you did want to think short term, you might want to think about trading the coming volatility – with a small portion of your money. Greg Diamond, editor of Ten Stock Trader, thinks that the next coming months will be ideal for earning quick profits as investors may act irrationally in times of volatility.

There are only a couple more days left to hear Greg's presentation, which you can listen to here.

What We're Reading...

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig and the Health & Wealth Bulletin Research Team
September 4, 2024