Why I'm Building a Pyramid
Hello again, world wide web! It's been a while!
I've been continuing to read and learn. While doing so, an analogy popped into my head that I'd like to share.
In March 2024, I read the classic business book, Barbarians at the Gate, about the leveraged buyout of RJR Nabisco. While thinking about the authors' description of the shenanigans taking place at company headquarters and on Wall Street, something occurred to me: the whole structure was upside-down.
RJ Reynolds built the tobacco company that was named after him, and the book credits lawyer Adolphus Green as being instrumental to the early growth of Nabisco. These men (and, of course, many others) helped to build and guide these two companies in their early days, circa 1900.
But by the 1970s, the old guard had long since perished, and the executives that succeeded them had exhibited varying degrees of quality - some did well, others did not.
The same goes with the banking industry. Long a staid and profitable-but-boring industry, bankers generally did their work and went home, content to make a decent amount of money and hit the golf courses by late afternoon.
By 1975, the salesmen were coming. They weren't there yet, but they were well on their way.
And, unlike their more conservative predecessors, these guys weren't content to make decent money and then hang out on golf courses and in social clubs. The newfangled salesmen wanted to be fabulously wealthy. And patience didn't even enter into the equation.
Those impatient, free-spending salesmen had arrived by the early 1980s, led by RJR-Nabisco's newly-minted CEO, F. Ross Johnson, on the corporate side.
Interesting side note: other business books I've been reading, like The Smartest Guys in the Room [about Enron], When Genius Failed [about LTCM] and What Happened to Goldman Sachs, also discuss scandals and disastrous organizational changes that had their genesis in the early-to-mid 1980s. Also starting in the early 1980s was the worker productivity/pay gap. Obviously, somewhere in the late 1970s-early 1980s, something fundamentally changed in American business.
Anyway, for years, Johnson stood as the embodiment of corporate kleptocracy, though he has since been surpassed many times over.
While reading this book, I frequently asked myself: where were the actual barbarians? At the gates? Or inside the C-suite?...
The whole situation reminds me of a famous quote from author, educator, and management consultant, Peter Drucker (as cited in Warren Buffett's 1995 Chairman's Letter to shareholders of Berkshire Hathaway):
"Talking to Time Magazine a few years back, Peter Drucker got to the heart of things: 'I will tell you a secret: Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an enormous amount of grubby detail work . . . dealmaking is romantic, sexy. That's why you have deals that make no sense.'"
In any case, the structure of RJR Nabisco in the 1980s was like an upside-down pyramid: top-heavy and precarious. The numbers in executive management swelled under Johnson's tenure, as did the compensation and perks. But the workforce itself - the people who actually operated the machinery, who did the research, development and testing, who swept the floors and answered the phones - was relentlessly pared down.
So most of the benefits flowed to the top of the structure, like an upside-down pyramid.
And, as you'd expect from an upside-down pyramid, it can't balance on its point for very long. Such a structure is, in a word, fragile. There's only so much you can do to prop it up, especially when the environment around it gets dicey.
That's why I'm focused on building my financial house like a classic stepped pyramid of the ancient world: right-side-up. Stable. Built to endure. Here's a visual for your mind's eye:
- Layer 1/Base layer.
First, you have to have the base layer. It must be broad, flat, and stable. If you want to build a proper pyramid, this part must be laid down first. There is no alternative.
The financial pyramid's base layer must be kept securely, and preferably yields some interest or dividends. Maybe that looks like a savings account, money market account, or even a certificate of deposit in a federally insured bank or credit union; maybe it comes in the form of a fistful of high-quality savings bonds. Maybe it's a cache of physical precious metal, or a couple different major world currencies, stored in a safe.
No need to limit yourself to only one of these alternatives.
This base layer may not be terribly lucrative, but it's absolutely critical to build this layer first.
This assumes, of course, that you've found a suitable location to build your pyramid. If you try to lay the stones on a swamp, or quicksand, the strength of your first layer doesn't matter.
Of course, I'm referring in this analogy to a country with respect for property rights and the rule of law, as well as good monetary policy. If you're trying to invest wisely in a country without these advantages, you risk the government either a) seizing all your assets, or b) disastrously managing the currency in a hyperinflation scenario that may well eat up your investment gains.
I'm fortunate to live in the United States, where such possibilities are remote. Certainly not impossible, but remote nonetheless.
This blog has some international readers, however, and I would counsel them to think carefully about the jurisdictions to which their savings may be exposed.
Readers who have lived under unstable regimes will have surely thought about this already. But it's a principle of sufficient importance to bear repeating.
Primarily, at least for readers in well-developed and stable countries, I'm thinking of a savings or money market account. A local bank or credit union would be the best choice; somewhere within walking distance if possible.
This is the layer that allows you to handle unexpected problems or opportunities when they arise. Safety and availability are the name of the game here. If it pays you some interest as well, good!
I wouldn't recommend this as the only layer to your financial pyramid, but it does provide a good, stable foundation for the rest. - Layer 2.
The second layer comes next. This one can be a little more abstract; a little less easy-to-access, and maybe slightly riskier.
For this layer, I'm thinking primarily of bond mutual funds or ETFs. You may want to play it safe with only government-issued bonds, or you may want to chase a higher yield with corporate bonds. In my case, I use a total-market bond fund that holds both - however, it's strongly tilted toward U.S. government bonds (about two-thirds of the fund) and high-grade corporate bonds rated AAA, AA, or A (another ~18% of the fund).
More than 85% of this layer is in safe, or relatively safe, assets. They may drop in value - and, historically, they have at times - but they don't tend to drop as far or as fast as riskier assets. This type of asset pays regular dividends, and generally holds its value (or appreciates slowly).
Such assets are generally boring, but during difficult times, you'll wish you had more! - Layer 3.
Now for the third layer. This is where you can seek less stability and more risk, but more possible upside.
This layer is where I'd put mutual funds for stocks and/or real estate investment trusts.
Over the short run, stock or real estate funds can go up and down pretty wildly. However, the long-run annual return tends to be in the neighborhood of 10% on both types of assets.
Detail of a stock chart, from Investopedia
Note that I do not recommend using technical analysis.
You must be comfortable with looking at this sort of pattern - in your own holdings - if you're going to put your money into these sorts of assets.
I do recommend using them, but caution that you must keep a long-term perspective, and you should establish your base layer and second layer before putting money into this third layer. Otherwise, you risk panicking and doing exactly the opposite of what a wise investor should do. - Layer 4.
The fourth layer involves even riskier assets. Shares of stock in an individual company would apply to this layer, as would holdings in hedge funds, private equity investments, and collectibles (like antiques, stamps, sports cards, etc.).
Any of these assets have the possibility of a) losing 100% of their value, or b) becoming undesirable enough that you'd have problems finding a buyer at any price.
These still aren't the very riskiest assets, but there is a reasonable possibility of a crash to zero.
Think carefully about how much you'd be willing to risk in these types of assets. It might not hurt to have a few of these, as long as you've got other money in different types of assets with a lower risk level.
As for myself, as of 2024, the only assets I have in this category are some collectibles (mainly coins and precious metals, which have basically no risk of crashing to zero, so you could more properly place these holdings into the base layer, not this one).
For example, I have baseball cards and base set Pokémon cards, and I'm not intending to sell any. Since they might get burned up in a fire tomorrow, I do not include these in calculations of my net worth. Plus, it would be a hassle to look up a fair value for all of these, and I frankly don't care enough to bother.
So do I technically have some collectibles? Yes. Do I count them among my investments? No, because I didn't buy them in order to make money. (Actually, I didn't buy them at all; they were given to me when I was a child. I lack sufficient knowledge to make money from flipping such things). - Layer 5.
This the top layer of my risk pyramid. It includes things like cryptocurrency, derivatives (such as options, futures, mortgage-backed securities), leveraged ETFs or other leveraged assets, and other fancypants stuff I'm not thinking of right now.
This tier is what I'd consider highest-risk, and I wouldn't put too much in this basket. There's nothing inherently wrong with any of these assets - if you want to put 5% or less of your assets into Bitcoin AND you already have assets in the other 4 layers of the pyramid I've outlined here, then you'll have my blessing. (I'm sure everybody's waiting breathlessly for my approval 🤣)
Derivatives are for big boys and girls. Options and futures contracts and leveraged ETFs are potentially catastrophic in the hands of a novice; there's no theoretical limit to the losses you can take on such products if you fail to properly hedge your position.
Since I'm ultimately a novice and I have no desire to learn this stuff the hard way, I do not fool around with these types of assets, just as I don't fool around with a chainsaw. They're useful tools in the hands of experienced professionals who understand what they're doing. But, like a chainsaw in the hands of a novice, they can also be deadly.
The only thing I'd potentially consider from this tier is Bitcoin, but as I've noted before, I've never actually bought any, in part because the lack of regulation and the number of fraudsters in this space scare me. FTX is just the tip of the iceberg; I still don't understand the Terra/Luna disaster and definitely could not have predicted its downfall.
Thanks to such issues with crypto, my preferred currency hedge remains gold or silver. I could also see a case for other precious metals or a bit of foreign currency also.
Note: "other precious metals?" Like what, dude?
You can buy bars and coins made of metals that are even rarer than gold. Palladium, platinum, and rhodium come to mind. They're certainly interesting, and even beautiful, but unlike gold and silver, they don't have a long history as monetary metals. So in my mind, they're riskier than the classics.
I recall being in high school when I discovered that platinum was even more expensive than gold! Guess what? Gold is currently almost 3x more valuable than platinum. Caveat emptor.
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