This is a bit of a different read. As much as I like my ancient authors, philosophers and science educators, occasionally one must capture the magic of not being destitute, too. I would even go so far as to say that financial security gives one the opportunity to ponder life some more… which is my favourite past time.
Or as George Bernard Shaw in Pygmalion (the basis for My Fair Lady) puts it:
HIGGINS: “Have you no morals, man?”
DOOLITTLE [unabashed]: “Cant afford them, Governor. Neither could you if you was as poor as me.”
CH. I - A Brief History of Financial Time
Bernstein starts out with a handy list of what makes a successful investor.
- Interest in the process
- The ability to do math beyond primary school level (probability and statistics)
- Knowledge of financial history
- The emotional discipline to execute your original plan
It should be noted straight away that he believes all four points are necessary for success; a bored math genius will be as unsuccessful as a historically ignorant worryguts.
I’ve personally solved my lack of math knowledge by investing together with someone I’m fully invested in. I’ll update in 40 years upon the outcome.
In the early days, consumer, farmer and merchant alike, relied on borrowing. The consumer needed food and shelter, the farmer seeds, tools and hands and the merchant pack animals, crewed ships, wares and currency.
Ancient farmers, Bernstein points out, had a 100% return rating. Supply and demand was the obvious reason. The people needed grain, the farmer harvested the grain. This did not change for a long time.
Eventually, capital became more abundant and interest fell. Interest is the cost of money. If interest falls, a consumer has an easier time to spend.
The cost of capital to a consumer is the same as the return for an investor.
We now learn about different types of financing. First, debt financing: A creditor gets the promise of debt repayment. Second, equity financing: The selling of stock shares (to raise capital) to a holder of excess capital.
Equity financing is more risky for shareholders due to the potential of losing all capital, the problem of profit prediction and the pay-back order. Bernstein explains that a business will first pay banks and bondholders before it will pay shareholders.
Historically, the first joint stock company sprung up in the medieval period. In 1150 AD, a water mill in France divided its ownership into shares. Those shares were traded until 1946.
Around 1600, the Dutch East India Company (VOC) and the English East India Company (EIC) began to sell shares.
The differences between the VOC and the EIC were stark. England was backwards, with Queen Elisabeth I. mainly making a living by charging rents on royal land and the sale of monopolies to court favourites.
Royals didn’t make good business partners, however. Lenders demanded high interest rates due to monarchs commonly defaulting on their debts. Consequently the cost of capital was high in Tudor England. The average for the lowest ventures was 10%-14%.
For the EIC that meant that they needed to offer fractional ownership for each individual expedition instead of being able to borrow capital. Luckily for them, the expeditions were hugely successful, raising the interest rates and thus, the risk.
The Netherlands on the other hand, had established markets with interest rates of about 4% p.a. for the largest borrowers. This meant that the VOC had permanent capital and thus, lower risk.
To close this chapter, Bernstein tells us briefly about the Venetian prestiti, a tax to finance the ongoing wars Venice fought with the Ottoman Empire and Genoa.
Venetians who bought prestiti at peace times for a high price made the lowest returns.
Lessons: Without dedication, maths and discipline, investing is futile. Also, know thy history!