TIP849: Average Returns Can Still Make You Wealthy w/ David Fagan

The Investor's Podcast (We Study Billionaires) - The Investor’s Podcast Network

The episode explores the concept of 'Total Wealth Performance,' arguing that true wealth is determined by more than just investment returns.

Key takeaways

• Total Wealth Performance includes front-end savings, the compounding engine, and back-end friction like taxes and fees.
• The 'Marshmallow Test' illustrates how delayed gratification serves as a fundamental pillar of long-term wealth creation.

Main topics

• Total Wealth Performance
• Savings Behavior

Notable quotes

Total wealth performance is whether the money got invested on and how much of the return actually made it home after taxes, fees, and friction.

Conclusion

Investors should focus on maximizing their savings rate and minimizing

Transcript preview

Speaker 1 (0:00) You're listening to TIP. In Speaker 4 (0:03) today's episode, I'm joined by my close friend and business partner, David Fagan. David is a chartered professional accountant in Nova Scotia, Canada, and for more than two decades, he has helped business owners and families build wealth. We start with a question David has been asking himself. Why can someone with average returns still build a meaningful net worth? His answer is what he calls total wealth performance. And you can think about it like this. When someone asks how your flight was, you don't just describe the plane. You also want to make sure that you make it to the airport on time and that your luggage arrived, and many other things, of course. And investing works the same way. Total wealth performance is whether the money got invested on time and how much of the return actually made it home after taxes, fees, and friction. It's the money you ultimately have at your disposal that matters. Speaker 1 (0:59) Since 2014, with more than 200 million downloads, we have interviewed the world's best investors, studied deeply the principles of value investing, and uncovered many compelling investment opportunities. We focus on understanding businesses and intrinsic value, investing accordingly, and sharing everything we learn with you. This show is not investment advice. It's intended for informational and entertainment purposes only. All opinions expressed by hosts and guests are solely their own. and they may have investments in the securities discussed. Now for your host, Stig Brodersen. Speaker 4 (1:43) Welcome to The Investor's Podcast. I'm your host, Stig Brodersen, and I'm co-hosting this episode with my friend, David Fagan. David, this is your sixth episode with us, but it feels like we're just getting started. So what is on your mind today? Thank you for the invite, Stig. Speaker 3 (2:00) We've had some beautiful weather here in the Annapolis Valley of Nova Scotia. And when the weather's super nice, I sit out in my backyard and enjoy the beauty. And I've been in a very reflective mood these days. And I've been asking myself a lot of questions. Questions like, why can someone with average returns still compound and create meaningful net worth? And is net worth even a good barometer for assessing someone's financial performance? And then here's a big one. Why do some people save and others don't? I've been thinking about all this stuff this summer. I've spent over two decades as a chartered professional accountant helping business owners and professionals and families build stronger financial futures. And the longer I do this work, the more I come back to simple things on how people can grow their net worth. And get this, it's saving, behavior, time, taxes, and structure. Is their money compounding in a way that supports the life they're trying to build? Maybe that's where I want to start today, Stig. And before we talk about investment returns and strategy and portfolio construction, first, people have to save. And I should be clear, I'm not talking about wealth preservation today. That tends to be a different ballgame. I'm talking about creating wealth from near zero. When you talk to people about creating financial independence from zero, savings is a first principle. We've talked about this. It's what I like to call an irreducible step in wealth creation. And my business partner and I, James Allen, we were talking the other day. And we were just in topic of conversation in the lunchroom. And we were asking, why is it so hard for some people to save? It was just a simple question. And it kind of spun me off in a few different directions. And then I was like, well, why do I save? And why am I wired for saving? And I really wanted to get to the root of it. So one day when I was meditating, it actually hit me. And I started smiling. I came right out of my meditation that day. It was like I was almost laughing. I mean, we talk about our lived experiences so much and how they shape us. And well, I had to go deep into the memory bank for this one. And to answer a very, very simple question, why do I save? And here it is. I'm just going to share it because it shapes so much of me and who I am and what we'll talk about today. When I was the whopping age of eight years old, back in the mid-80s, so people can do some math there, I went to the summer mecca of PEI, the land of Anna Green Gables. And we stayed in Cavendish, and I took every penny I owned with me on that trip. I think it was around $40 at the time, which was, for me, at eight years old, it was an amazing sum of money. And while in Cavendish, which is the summer... playland for families with kids in the Maritimes. We went to a toy store. And this toy store, it was just packed aisle to aisle with games, puzzles, right to the ceiling. And my brothers, they were ripping around the store looking at all the GI Joes and Hot Wheels. And for a kid, there was some amazing stuff there everywhere. And I kept wandering around looking for something to buy. And my brothers, they had no problem finding cool stuff. But I can remember not seeing anything I really wanted. And I also felt like I had to buy something too, to kind of keep up with my older brothers. And so I ended up finding a Hot Wheels racetrack for cars. And these are the old cars that would race down a track. It had a 360 loop on it and it took all of my money to buy it. In fact, I think my dad even had to cover the sales tax on it. My dad even asked me very kindly, He said, are you sure you want to buy this? And like he knew something I didn't. And of course he did. But I spent my entire net worth on that toy racetrack that day. And I was excited to get home and play with it. And of course, that's exactly what I did. We came home from the trip and I set it up and I raced the cars down the chute. And then it happened. The cars wouldn't even get around the 360 loop. and without falling at the top. And the more I played with it, the more I just got frustrated with those toys, the cars that couldn't even get to the end of the racetrack ramp and make the final jump. I had blown my entire net worth as an eight-year-old on a toy that I played with for an afternoon. And I remember just, I can remember, like when I came out of that meditation, I felt it. I could remember just how hard it was for me to save that $40 as a kid. I blew it on a thing that didn't even work. And my dad knew it with his comment, but he let me learn the lesson. And I've been saving ever since. So maybe in hindsight, it was the best purchase I ever did, Stig. Not for its utility, but for its guidance. I mean, I remember it feeling so wasteful that I spent all this money on this toy and I didn't play with it. And the ironic thing is I actually cared that it was wasteful. And I think that was the difference in this. I can't explain why my eight-year-old self kind of understood that feeling, but I did. And there it is. As innocent as that story is, that's what snapped me out of my meditation that day. And I've been saving ever since. So Stig, you can imagine, we're just all wired so differently. And I've heard you say this before so eloquently that personal finances are often more personal. than finance. So why do you think some people are able to delay gratification and consistently save while others struggle with it? And do you think it's more learning or knowledge, environment, lived experiences? Maybe I'll just throw it over to you here. Speaker 4 (7:54) Yeah. Wow. It's a big question. I mean, I could come out and say it's a combination of all of the above, but I'm certainly not a guy to avoid the whole nature versus nurture discussion. So Stig Brodersen I would typically be asking my friends like, okay, I completely understand that. It makes all sense. What about your parents? Do they have a favorite child? And without a single exception, they always like if they have siblings, they always said yes. And they always said it was the sibling, one of the siblings and not themselves. And I mean, I don't think you need to be a statistician to sort of like see there's something there that's missing. Perhaps we're not honest with ourselves, but it's also just a fun game. So anyways, you know, One topic I often discuss with friends is really how to ensure that the next generation respects money the same way they do. And I think we all want to pass down our values, for better or for worse, down to the next generation. Now, today, many of the friends that I have are first-generation financial independent. But whenever we talk about how they were raised, Most of them say that they were never taught about money by their parents, at least not like, this is how you should be thinking about money. I'm sure there've been a lot of influence in terms of watching their parents, even though they don't necessarily recall, hey, they sat me down in front of a blackboard and then they went through the eight Speaker 2 (9:47) steps of whatever. That's typically not the story that I hear. But Speaker 4 (9:52) both when you speak with first generation money, if we call it that, but also just as much second generation. you see also how they say they think about money this way, and then their siblings think about money that way. And it's typically very, very different. And to me, that's kind of interesting. I've been speaking with my parents about this multiple times, and they're always like, we gave your kids the exact same upbringing. I was like, yeah, but then if you're a therapist, which I'm not, there is also things about, are you the oldest? Are you the youngest? And I think there's probably also something to be said about if there is a big... age gap, and perhaps the oldest grew up at a time when there wasn't as much money around, and then perhaps there was more money around. So I don't know. But if you put me on the spot, I think delayed gratification, it's like speaking with people about compounding interest. It seems like either they get it or they don't, or perhaps they get it or intellectually get it, but they just can't execute on it. They would just rather buy that shiny new thing. And perhaps that is what you think whenever you're eight years old, but some people, they never grew out of it. They still want that shiny new thing whenever they're 48. So some of you have probably heard of this famous mass model test. I think it's an absolutely brilliant story. But this is this study here from the 60s, and then it was repeated in the 70s. And it's one of those experiments that almost become like folklore. Researchers invited four and five-year-old children into a room, and then they placed a marshmallow in front of them. And so they were told, hey, you can eat it now, or you can wait another 15 minutes, and then you would get two marshmallows instead. And so what do you do as a child? And lo and behold, researchers, then they followed the children years after, and those who waited to get two marshmallows. they seem to do better in life. They perform better academically, stronger social skills, and average just achieved more. And so the conclusion became pretty obvious, like successful people are simply better at delaying gratification. And that is, of course, something we as value investors understand really well. But then I saw this more recent study, and their angle was that if you really think about it, the researcher made a promise to each child. The children, through perhaps bitter experience, had learned that adults don't always keep their promises. They were far less likely to wait for the second marshmallow. So taking that marshmallow right now, actually, if you think about it, was a pretty rational decision. And so one framework I found to be incredibly effective when you meet people and typically they think about mind differently than you. And let's face it, that's more or less everyone, because it's more personal than finance. Think about what kind of experiences they had, because those financial decisions that they're making that seems odd to you are probably completely rational to them. And so let me just bring up this example. It might make complete sense for, let's say, someone in the boom generation to always be thinking real estate first. They might have lost let's say 40, 50 % in Speaker 3 (13:13) the Speaker 4 (13:13) stock market crash in 73, 74, and then they bought a home in San Francisco for like $50,000, that's worth 3 million now. Why would they go to equities today? Why wouldn't they always think the way to go is in real estate? So perhaps, David, you have experienced the same. Speaker 3 (13:32) David Collum Yeah. No, I think that's a great framework to think about. And not just for money and finances, but for life in general. I mean, you want to try to see someone's situation through their eyes, and then you can look at how they make their decisions. In so many respects, that is why you have to have compassion for people. I mean, you really have no idea what someone's been through in life and what looks odd to one person. may make complete sense to someone else based on what we call their lived experiences. I mean, I had a moment a few years ago that actually made me think about this. I was in a conversation with someone and they told me, you're so lucky to be financially independent. And the word lucky, it just kind of hit me like I didn't expect how it would hit me that day. And I believe in luck. I really do. I mean, there's serendipity and life's not a straight line. And Buffett often talks about winning the ovarian lottery. And here I am living in Canada with education and healthcare and parents that love me and lots of opportunity. And that matters just a tremendous amount. But this comment, it wasn't just about chance. And I want to be clear when this individual was talking to me, there was no envy in the person's tone at all. There was no, nothing like that. It was just the interpretation of my situation. But I just felt that... In the words, there was a subtle implication that financial independence might have just happened to me. And I had to pause. And then I had to ask myself, well, did luck prepare a budget or what I like to call a spending plan when my wife and I were 22 years old living together for the first time and not knowing where our money was going? I mean, we started preparing a spending plan and boom, it really organized our life. You know, did luck... prioritize our ability to pay off our student loans or live below our means when our income started to rise? And did luck instill delayed gratification or, you know, helping us just ignore the pressures to keep up with the Joneses? And, you know, I don't think luck was the right word. I think it was intention. And we were disciplined. My wife and I were very disciplined. And that discipline, it became a habit. So, you know, were we fortunate? 1,000%. But financial independence, it's not something that you just stumble into. It's a path and a practice. And it's the cumulative results of so many choices that you make over your lifetime. And I'll just give you an example. For the longest time, I didn't have a great answer for people when they asked, I'll be playing golf with someone and like, oh, I hear you guys are running a pretty successful accounting firm. What's your secret sauce? I would just answer it in this long-winded, very unorganized way. But then I read Richard Dawkins' book, The Blind Watchmaker, and it hit me. Our success at the firm, it didn't come from one particular thing or a lightning bolt moment. It came from just years of these small micro changes, just one step at a time. And those steps, they started to compound over time. right? We talk about compounding all the time and the cumulative results. And so it came through cumulative improvement over and over again until it became part of our edge and it got baked into our culture here at the office. And that's exactly how I see wealth creation. Again, when we start from zero, just the small habits that build in the right direction over time. I think that's just so critically important. So were we lucky for the things that we couldn't control? We were being born in Canada and having loving parents. Absolutely. But for the smaller items that contributed to our success, I'd say our journey started long before we were financially independent. And it started with consistently making decent choices with our finances and what I like to call building the muscle. The habit of wealth creation, it's like working out. You've got to consistently stay with it. So I don't know, maybe, Stig, someday I'll write a memo called, I didn't eat the marshmallow and reflect on this a little bit more. But that's the point. My wife and I, we didn't eat the marshmallow. And we were probably on our way to, well, I know we were. We were on our way to financial independence long before we probably even really knew what it meant, to be honest. You know, I guess just to switch gears a little bit, all this chatter just brings me to an idea that I want to really zone in on in today's podcast called Total Wealth Performance. And I did a mastermind community presentation on this, and it's really stayed with me because I wanted to answer a question. Why can a well-crafted average return still make a difference in someone's life? And the answer, I think, is that wealth creation, it's not just about the return on an investment statement. It's about everything around it. So total wealth performance, it's really three things. It's front-end performance, what happens before investing even starts. And then there's the compounding engine. What rate are you actually earning on your capital once it's invested? And we'll talk about that. There's many ways to invest. And then on the back end, what survives after taxes? fees, structure, and friction. Speaker 2 (18:55) And I Speaker 3 (18:55) like to equate it to when someone asks, how was your flight? So many people answer that question by saying, oh, the plane