Keynes may be the most famous name in all of economics. The term “Keynesian Economics” still fills headlines today as global financiers look for ways to restart economic growth.
But what you may not have known is that the same Keynes that created Keynesian Economics, is also responsible for some of the earliest thoughts on value investing, diversification and behavioral finance.
I was lucky enough to get a recommendation to read the book Keynes’s Way to Wealth
Not having the highest of expectations I sat down to read the book while on vacation recently and was pleasantly surprised to be sucked in almost immediately.
I was obviously naive, but I never looked in Keynes’s work or history much, thinking him much more of an academic and creator of policy than practical investor . But nothing could be further from the truth. In fact, Keynes has an incredible investing track record and provided some of the groundwork for what became value investing and the study of behavior finance today. His investing ideas influenced some of the most famous investors in history; Benjamin Graham, Warren Buffett, Charlie Munger and John Bogle to name a few.
Like many of us, Keynes did not start off with a brilliant investing mind. It took him a few decades to learn some painful investing lessons.
Keynes’s First Attempts
Keynes started professionally investing by forming an investment syndicate in 1920. In fact, this syndicate was one of the world’s first hedge funds. He bet heavily on currencies and by April 1920 had made $80,000 (Roughly $1.3 million adjusted for inflation today). But being highly leveraged, his luck did not last long:
“Suddenly, in the space of four weeks, a spasm of optimism about Germany briefly drove the declining European currencies back up, wiping out [The Syndicate’s] entire capital.”
Within 5 months, Keynes was already out of money.
But he didn’t stay out of the market for long. By June 1921 he had created another fund. This one called A.D. Investment Trust Ltd.
This time, instead of currencies Keynes focused on commodities. In researching his trades, Keynes developed the early basis that would become his work on behavior finance. Keynes Identified a few “behavioral factors” that he believed influenced commodity prices (and as he would come to the conclusion of later, stock prices as well):
- High prices may be brought about by general confidence or overconfidence in business prospects.
- There may also be famine high prices, due to a shortage of commodities in relation to purchasing power.
- High prices may indicate poverty as well as confidence.
- Curtailment of world production also can lead to high prices.
But Keynes was still a speculator at heart, and despite doing well enough to amass a fortune worth more than $3.5 million in today’s dollars, he would lose over 80% of it in the 1929 crash.
A New Investor Emerges
This lead the arrogant Keynes to rethink his investing philosophy. His commodity investments that usually were uncorrelated to stocks and bonds, dropped just as fast as his equity investments. This lead Keynes to begin thinking about the behavior effects of investors and their impacts on the market (what he would later refer to as “animal instincts”).
Some of this is evident as early as 1931 when he sends the following memo to the directors of National Mutual Insurance Company, where he was managing money:
- If we get out, our mentality being what it is, we shall never get back in again until much too late and will assuredly be left behind when the recovery does come. If the recovery never comes, nothing matters.
- Some of the things which I vaguely apprehend are, like the end of the world, uninsurable risks and it is useless to worry about them.
- I hesitate before the consequences of the doctrine that institutions should aggregate the bear tendency by hurrying each to be in front of the other in clearing out, when a general clearing out by the nature of things is impossible… And would bring the whole system down. I believe that there are times when one has to remain in the procession and not tried to cut in.
The former cycle following, rapid trading speculator had now morphed into a “sit-on-your-hands” contrarian. Keynes’s primary investment vehicle also changed, now to equities, where instead of speculating on companies he would buy and hold based on the company’s “intrinsic value”. And he had to defend his beliefs strongly after a portfolio he managed posted big losses in 1938 where he stated:
I believe now that successful investment depends upon three principals:
- A careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time;
- A steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until they have fulfilled their promise or it is evident that they were purchased on a mistake;
- A balanced investment position, i. e., A variety of risks in spite of individual holdings being large, and if possible opposed risks (e.g., a holding of gold shares amongst other equities, since they are likely to move in opposite directions it when there are general fluctuations).
And by no coincidence, this is precisely the time that Keynes’s performance began to separate him from the average:
(This slide comes from here: https://www.cfasociety.org/westmichigan/Past%20Event%20Presentations/Jeff%20Pantages%20-%206.19.2013.pdf) The book also contains numerous tables of Keynes’s returns.
The book is a quick, easy read, only about 150 pages – And it is well worth your time.
The book goes on to sum up Keynes’s thoughts on behavior finance in Chapter 6, his investment criteria in chapter 7 and concludes with his “10 Keys to Wealth” – The last of which is the only non-investment related, and a fitting way to end:
“10. Drink more Champagne!
This is said to have been Keynes’s one regret (and last words) – that he had not enjoyed life more and drunk more bubbly. The object of investing is to ensure prosperity, not to become obsessed with making money. Prosperity isn’t necessarily having a four car garage filled with toys or a closet stuffed with close and shoes. It’s the hope for a secure and comfortable future… So put your investing on autopilot with the sound plan that meets your goals and monitor it once a year. Then go out and live. “