Cultivating the State of Flow

“Where has my day gone?”

How many times have we heard people express this frustration? For many of us, it seems like there are never enough hours in the day to accomplish all that we set out to do. The day starts off in a mad rush, proceeds through a blur of activity, and ends with a sense of dissatisfaction regarding what has actually been accomplished. Then we repeat the same process the next day, a week goes by in a blur, then a month, and then a year. How is it possible to be so busy but not achieve much at all and remain dissatisfied and pressured to always “do more”?

We might think that these problems are primarily a function of modernity and advances in technology but people have been struggling with how to best use their time for millennia. Seneca’s essay, On the Shortness of Life, was written around 49 AD, nearly two thousand years ago, yet many passages make it clear that humans suffered from precisely the same problems regarding how to effectively allocate their time.

Despite talk today of potential immortality being achievable in the not-so-distant future, for now human life is still limited to several decades with very few of us living more than a century. Human beings are probably the only species that fully understands that our earthly existence will one day end, yet Seneca points out that we do not translate this knowledge into how we live our day-to-day lives:

“You are living as if destined to live forever; your own frailty never occurs to you; you don’t notice how much time has already passed, but squander it as though you had a full and overflowing supply — though all the while that very day which you are devoting to somebody or something may be your last.”

Seneca, “On the Shortness of Life”

Seneca urges people to be as vigilant in guarding their time as they are when it comes to protecting their personal property because time is truly the one resource that is limited for everyone. There are great disparities in human talent, wealth, and income in the world but there are no exceptions, so far, when it comes to our ultimate mortality. Jeff Bezos has orders of magnitude more wealth than anyone reading these words, yet his ultimate fate a century from now is the same as for all of us. But despite the inherent limitations of our lifespan, Seneca says that “life is long if you know how to use it.”

Seneca is saying that we should strive to achieve a “state of flow” rather than being tied up in an endless treadmill of engaging in activity for the sake of activity, or being mindlessly “busy”.

“A flow state, also known colloquially as being in the zone, is the mental state of operation in which a person performing an activity is fully immersed in a feeling of energized focus, full involvement, and enjoyment in the process of the activity. In essence, flow is characterized by complete absorption in what one does, and a resulting loss in one’s sense of space and time.”


One of the ironies of achieving a flow state is that, just like the unfortunate person spinning his wheels on useless activity, it feels like the hours have flown by. However, the sense of satisfaction at the end of the process is far greater for those occupied in tasks conducive to the state of flow.

The question becomes how one can structure life in a way that results in more time in a flow state and less on useless and forgettable tasks. Clearly, the way to accomplish this is to actively remove things that are keeping us busy but achieve no useful results, an approach also known as via negativa. This is far easier said than done for people who are stuck in employment that seems to require all kinds of busy work and pointless activities such as excessive meetings, endless email, and having to maintain “face time” for purposes of career advancement.

“Many pursue no fixed goal, but are tossed about in ever-changing designs by a fickleness which is shifting, inconsistent, and never satisfied with itself.”

Seneca, “On the Shortness of Life”

Achieving a state of flow might seem like an impossible task for those who feel “stuck” in routines that make focused concentration all but impossible. The problems have become far worse in recent decades due to the increasing prevalence of technology in our lives. As a college student in the early 1990s, there were certainly opportunities to get distracted from immersion in studies, but those distractions were primarily in the physical world. With some discipline, it was still possible to disappear into the library and focus on specific topics for hours at a time, free of distraction. Cell phones were not common and “going online” was something to do for brief periods of time and only possible on a computer attached to a physical network.

Contrast the experience of the early 1990s with the temptations facing everyone today. We now are connected on a 24/7 basis by default unless we take unusual steps to isolate ourselves, and even worse, it is considered unusual or eccentric to put oneself out of reach for more than brief periods of time. We are, for the most part, “expected” to be reachable all the time in our professional and personal lives.

Electronic devices are a constant cause of context switching. Context switching is the exact opposite of the state of flow that we should aspire to. In computer science, context switching refers to switching the task of working on one process to move on to another one. One process is stored in memory, the computer switches to the other process, and then eventually it may come back to the original one. Context switching has a cost in computing. The system has to store one process in memory, switch to another one, and then reload the original process when it goes back to it. However, the cost of context switching to a computer is nothing compared to the cost of switching contexts for human beings.

When we are engaged in any task requiring in depth thinking, whether it involves reading an annual report or preparing a presentation, any chance of being in a state of flow is destroyed when we allow interruptions. Unlike computers, the cost of context switching for human beings goes far beyond the need to store one thought process in our memory, switch quickly to another, and then immediately restore our prior state of mind. In fact, this is impossible to do. A context switch breaks the state of flow.

How many times have you been in a state of flow when your cell phone makes some sort of noise – whether a text message, a phone call, notification of a new email, or countless other interruptions? Human beings are naturally curious and the temptation to check the device is overwhelming when there is any kind of notification. So, you interrupt your state of flow to check what’s happening on your phone. Maybe it was an email. But it doesn’t end there. Now that you are interacting with your phone, maybe the email requires some further action. Or, if not, maybe it is too tempting to see how many “likes” your latest Twitter post generated. Or perhaps check in on Facebook to see how outraged your virtual friends are regarding various political issues.

Just as a large amount of information does not translate into wisdom, frenzied activity and context switching does not lead to productivity or happiness. Instead, it leads to a sense of time slipping away. The state of flow also leads to a sense of time passing quickly, but in a positive way. If you come back from lunch and sit down to a state of flow, you might look up at the clock and find that it is time to go home. Time has flown by, but in a way that might have increased your wisdom or achieved some level of productivity.

When people wish for a “long life”, few wish to be bored and watch the days, months, and years slowly pass by. That’s not the kind of “long life” people aspire to achieve. Instead, humans wish for a sense of satisfaction, or a sense of a life well-lived. This desire has existed for millennia, but has become more difficult to achieve with technology that simultaneously gives up the opportunity to access a wealth of information but also tempts most of us to waste a great deal of time.

Seneca’s prescription is clear: we need to disconnect and pursue a state of flow, even if doing so is unconventional or frowned upon by others.

Ten Years

“Life is divided into three periods: past, present and future. Of these, the present is short, the future is doubtful, the past is certain.”

— Seneca

Think back to your childhood days. Many people feel like time passed by very slowly during their youth. The prospect of finally turning sixteen and getting a driver’s license seems impossibly far away to a thirteen year old. But time seems to speed up as one gets older, to the point where a few years feels like nothing at all and a decade is only a moderately long period of time.

This website was launched ten years ago, and it does not seem like that long ago even though that span accounts for about 22 percent of my life up to this point. However, much has changed. The economic climate of February 2009 was the polar opposite of the environment we find ourselves in today. The economy was in the depths of the worst recession since the 1930s and stock prices were close to reaching their nadir, although none of us knew it at the time! Morale throughout the United States was very low, consumer confidence was non-existent, and few thought conditions would improve anytime soon. No one envisioned that we were on the cusp of a decade-long bull market that, despite nearly ending at the end of 2018, continues to this day.

When I started this blog ten years ago, I did not envision that it would still be active a decade later and I did not really have much of a vision of what it would turn into. I knew that I wanted to write about investing in general and I had some work on Berkshire Hathaway that I wanted to share with others. The stock market was down sharply and my portfolio was no exception as I tried to cope with the market meltdown. But, in general, I did not have any kind of master plan for how the site would evolve over time.

What surprised me about blogging is that it became addictive quickly. I received some positive feedback from larger sites such as Guru Focus and Seeking Alpha that wanted to syndicate my work and I ended up writing nearly every day. I wrote 279 posts in 2009 and 330 posts in 2010. Although there were many book reviews and longer articles on specific companies, for the most part I was writing about “current events”. I did not initially care too much about site traffic or monetizing the site but I soon started to watch traffic statistics and felt pressure to post frequently to “keep the numbers up”. When you write about current events, your work is relevant for a short period of time. You see spikes in website traffic and then … nothing.

Nassim Taleb has written about the “Lindy Effect” which can be applied to the life expectancy of the written word. The basic premise of the Lindy Effect is that the future life expectancy of certain non-perishable things is proportional to their current age.  For example, a book that has been in print for fifty years and has retained wide readership has a much longer future life expectancy compared to a book that has been on the New York Times bestseller list for a month.  Ideas expressed in a book that has survived for 100 years will have a still longer life expectancy, and so on.  

The vast majority of my writing, whether about current news or the quarterly results of some company I was following, had a very short life expectancy. Although the content would remain accessible as long as I paid to keep the site hosting plan active, the relevance would soon dwindle and no one would read it. There is nothing wrong with sites that provide “news”, but such content will quickly lose relevancy.

Perhaps the exception to the short shelf life of my writing was the work I did on Berkshire Hathaway and published in the form of a long report. Due to the historical perspective of the report, there are still people who occasionally download it even though the information is now many years old. However, even this work is not “Lindy” in the sense that no one will have any interest in it in fifty years.

The frequency of my writing fell after early 2011 as I decided to devote more time to my own investing work, but I still posted occasional content and there were years of greater activity such as 2016 and 2017. However, for the most part, the site became an occasional endeavor after 2011. It was unsatisfying to be on a self-imposed “treadmill” of writing a large number of articles with a short shelf life.

I have great admiration for sites such as Farnam Street where nearly all of the content will be highly relevant even fifty years from now. It seems more satisfying to write about topics that have some permanence. When I have written content such as this article about Marcus Aurelius, the text remains as relevant today as when it was published. I was also very surprised when instructional articles, such as this one regarding how to read 10-Ks, proved to be very popular over longer periods of time. Providing tips on reading SEC documents isn’t going to have the staying power of Marcus Aurelius, but such articles appear to serve a useful function for many readers.

Perusing my archive, I see hundreds of articles that have no permanence and a just a few that might have a longer life expectancy. It is likely that future articles will focus more on topics that will have more permanent appeal and less on current events. A decade is a reasonably long period of time, and a writer’s interest is bound to change over that length of time. I am still interested in investment topics, and always will be, so book reviews and articles on broader investment topics are likely. In addition, I have an interest in personal finance, especially the massive problem of financial illiteracy in America, and would like to focus more in that area. Finally, Charlie Munger’s work on worldly wisdom has been an inspiration and I plan to try to add some value in that area. Life is about more than investing, narrowly defined, but the great thing about investing is that the more worldly wisdom we absorb, the better we perform as investors as a result.

I am not planning to write many articles about specific companies in the future. One of the great things about the value investing community is that investors are often generous about sharing their best ideas. However, going public with ideas has many very serious problems. Most importantly, good ideas are very rare and valuable. As an investor, if you have an actionable idea, you naturally want to act on it for your own account. When you also write about it, you are naturally biased and can fall prey to numerous cognitive biases that could sabotage your position and hurt your financial results. If you make your living from investments, that can be a serious concern.

I would like to thank readers of The Rational Walk for spending some of your valuable time on the content here. Seneca wrote that “nobody works out the value of time: men use it as lavishly as if it cost nothing.” Your time is valuable and the fact that the site has attracted nearly 1,200 email subscribers and a similar number of RSS subscribers is a great compliment. Those are small numbers in the world of online publishing but it is still satisfying to hit the “publish” button and know that a couple thousand people might decide to read what I have written.

Reaching Financial Independence

When can you give up the security of a regular paycheck?

This is a fundamental question that everyone must eventually answer in the context of their own “retirement”.  I put “retirement” in quotes because what we are really talking about is not necessarily retirement in the conventional sense. Instead, the goal might be better stated as attaining the level of financial independence that is needed to make a regular paycheck optional.  You might like your job and have great relations with your boss today, but that could always change tomorrow or next month.  A recession could result in layoffs and you might find yourself involuntarily out of work.  Illness has been the cause of many premature exits from the workforce.

At what point are you immune from having to worry about drawing a paycheck?

Nassim Nicholas Taleb should be credited with the concept of “F*** You Money” that he developed in The Black Swan and has elaborated on numerous times since the book was published.  To state the obvious, not everyone works for a pointy-headed boss and hates their job as much as Dilbert and Wally, and plenty of people actually love their job and enjoy the people they work with.  Whether or not you like the language used by Scott Adams, Nassim Taleb, or John Goodman, the point is obvious:  When can you declare independence from paid employment if you choose to do so?

At the risk of stating the obvious, there are two major factors that we need to look at:

  1. How much money is needed to fund your lifestyle every year?  The answer is not as simple as looking at what you are currently spending every year.  There will almost certainly be expenses related to work that will entirely disappear from your budget if you choose to leave paid employment.  You will no longer have to commute to work so the cost of driving or public transit will disappear.  Maybe you can even give up your car entirely.  It will be unnecessary to purchase clothing specifically for work.  If you aren’t packing a lunch for work almost every day, you are probably spending a lot of money on eating out and that could be eliminated as well.  This list isn’t exhaustive.  On the other side of the equation, you will incur new expenses in “retirement” such as the cost of health insurance, which is likely to be the largest new big ticket item.  Also, you will have more time to travel and pursue recreational activities.  You could very well end up spending more money in “retirement”!
  2. How much money have you saved?  This is obviously simpler to answer but I don’t think that it can be distilled into a single number.  Most importantly, it is critical to differentiate between assets that are accessible and assets that are locked up for an extended period of time.  If you are 40 years old and contemplating giving up your paycheck, what matters for the foreseeable future is the amount of liquid assets that you have in non-retirement accounts.  You do not want to even contemplate touching retirement funds in a 401(k) or IRA because early withdrawal penalties are significant for anyone who is younger than 59 1/2 years of age.  You also do not want to consider any form of home equity as a source of liquidity unless you are planning to downsize to a smaller home in retirement.

If you read enough personal finance articles, you probably have already come across discussions of “safe withdrawal levels”.  The idea of a safe withdrawal level is to calculate the amount of money that can be withdrawn from an investment portfolio on an inflation adjusted basis over a specific period of time without running a significant risk of depleting all of your assets.  There are usually a number of embedded assumptions that are made in studies of safe withdrawal levels, such as the percentage of assets invested in stocks versus bonds and whether the stocks are invested in an index fund.  Typically, safe withdrawal levels are contingent upon a certain stock/bond mix and broad diversification of a portfolio.

The Four Percent Rule

Over the past two decades, the idea of the “Four Percent Rule” has spread quite widely.  The idea is that one can withdraw four percent of an investment portfolio in the first year of retirement and subsequently withdraw the same amount adjusted for inflation every year.  The inverse of the four percent rule is that one needs to have savings equivalent to 25 times annual spending requirements in order to safely retire.  So, if you have calculated that you need to have $50,000 available for spending in the first year of retirement, you would need to have an investment portfolio of $1,250,000 to support that level of withdrawal in a “safe” manner.

When I first started thinking about the concept of early “retirement”, I spent quite a bit of time researching the topic of safe withdrawal rates and came upon a study that went quite a bit deeper than the four percent rule.  I am not going to link to the study because it has not been updated since 2001 and generated some subsequent controversy regarding the methodology that was used.  However, at the time it was the most comprehensive look at safe withdrawal levels that I had come across.  The study looked at financial market returns from 1871 to 2000 and projected the safe withdrawal level for various payout periods based on past history.  A reader could pick their projected payout period and find the optimal mix of stocks versus bonds that would generate a “100% safe” withdrawal level.

The payout periods ranged from ten years, which would only be appropriate for someone who is either already very old or in poor health, to sixty years which was more appropriate in my situation since I was in my thirties at the time.  I found that the safe withdrawal rate for a sixty year payout was 3.24 percent with a 85%/15% split between stocks and bonds.

The study examined 70 periods from 1871 to 2000 in order to come to the conclusion that a 3.24 percent withdrawal level could be safely sustained for sixty years, with withdrawals rising each year with inflation.  In the vast majority of cases, there would be a very substantial portfolio left at the end of the sixty years. In fact, the median result was that every $1,000 of value in the initial portfolio would end up being worth nearly $43,000 after 60 years assuming a yearly withdrawal of 3.24 percent of the initial portfolio rising each year with inflation.  The worst possible result was that the portfolio would be effectively depleted.

But the main problem with safe withdrawal level studies is that they are backward looking.

It is a major logical fallacy to assume that the next sixty years will look like the period that spanned 1871 to 2000, or anything like it at all!  This is obvious, but it is tempting to look at an overly precise number like “3.24 percent” and assign it with more certainty than it deserves.

No one has any idea what the future will bring or what investment returns will look like, but if we want to make any kind of estimate regarding financial independence, we have no choice but to at least try.  This exercise calls for a great deal of conservatism.  I am not comfortable with the four percent rule, and not really comfortable with the 3.24 percent figure that came out of the study.  Part of this is because of the fact that interest rates have been at an unusually depressed level in recent years.  In addition, the level of the stock market implies an “earnings yield” that is below average.  In a world of savings deposits earning next to nothing, a ten year treasury note yielding just 2.7 percent, and stocks trading at high valuations relative to the past, is it really conservative to look at a four percent withdrawal rate as a sure thing?  Would you bet your financial future on it?

The Three Percent Rule

I am not going to propose any specific rule for readers to follow, but I will say that I am comfortable with a three percent withdrawal rate and that is the rate that I initially used when considering my own financial independence, although my present withdrawal rate is far lower.  This rule implies that you would need to save a little bit over 33 years of annual expenses in order to consider yourself financially independent.  That’s obviously more than the 25 years that is implied by the four percent rule, but it is much more conservative.

Many people would criticize this approach as far too conservative, but is that such a bad thing?  Sure, you might have to save for a longer period of time to achieve independence, but once you do, the level of stress over withdrawal rates will be much lower.  Also, I’ve read criticism of low withdrawal rates along the lines of ending up with “too much” savings at the end of the withdrawal period.  This line of criticism is based on the idea that something big is being given up by under-spending for many years and that ending up with a large account balance in old age is a negative.  I think this is somewhat absurd for a number of reasons.  First, old age involves facing vicissitudes that younger people might not think of, especially when it comes to nursing care.  Having a pile of cash available to make life comfortable would hardly be unwelcome.  Second, most people want to leave some kind of legacy to family members and providing financial security to others in old age is hardly a negative.  Finally, you can always give away money.  There’s value in generosity and the knowledge that one’s savings can generate benefits beyond personal consumption.

The Bottom Line

The subject of safe withdrawal levels has not been a personal concern for quite some time as the level of my annual spending has declined well below any plausible “danger zone” as a percentage of my available investment assets.  I would suggest that using a three percent initial withdrawal level is far more reasonable than the much more commonly advocated four percent level and this would imply setting a target of about 33 times annual expenses as a goal for financial independence.

The other factor that should be noted here is that the lower your annual spending requirements, the sooner you can reach financial independence.  Perhaps that is obvious, but it might not be widely understood.  Too many people think about financial independence in terms of replicating their current income in retirement.  This is the wrong way to look at it.  For example, let’s say that you earn $150,000 per year but are only consuming $40,000 per year, which you expect to remain relatively constant in retirement.  You do not need to replicate a $150,000 income in retirement.  You only need to ensure that you can safely withdraw $40,000 per year from your portfolio, and that you can increase this figure each year at the rate of inflation.  Using a three percent rule, this would imply a required portfolio of a little over $1.3 million, which is less than nine times your current $150,000 annual income.

Obviously, no one want to live some horribly restrictive lifestyle either while employed or in retirement, but what is “horribly restrictive” for one person might represent luxurious living for another. Even for those who enjoy their paid employment and plan to continue working for others for decades could benefit greatly from financial independence and the peace of mind that makes work optional.

Note to readers: A version of this article originally appeared on The Spartan Spendthrift which I created a few years ago. I am planning to merge some of the existing content of The Spartan Spendthrift into The Rational Walk and to post future articles on personal finance here. It is easier to maintain only one website for all of my writing. 

Jack Bogle: Crusader for Investment Professionalism

“If you want to be trusted, be trustworthy. If you demand hard work, work hard. If you want your colleagues to level with you, level with them. It’s not very complicated!”

— John C. Bogle, Enough: True Measures of Money, Business, and Life

John C. Bogle (1929-2019)

John C. Bogle, who died on January 16, 2019 at the age of 89, was hardly universally well liked within the investment community. Visionary leaders who disrupt comfortable industries rarely escape the ire of those who have been displaced. On the other hand, Mr. Bogle was a hero to millions of investors at The Vanguard Group, the investment company he founded in 1975, as well as to the broader community of cost-conscious individual investors known as “Bogleheads“. Through Mr. Bogle’s tireless efforts to lower the cost of investing, investors have saved billions of dollars that would have otherwise gone to various “helpers” in the investment community.

Warren Buffett had the following to say about Mr. Bogle two years ago:

If a statue is ever erected to honor the person who has done the most for American investors, the hands- down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.

In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me.

Berkshire Hathaway Annual Letter, 2016

Mr. Bogle’s crowning achievement was the invention and proliferation of low cost index funds that are designed to simply match the investment results of unmanaged indexes such as the S&P 500. These funds do not attempt to beat the market through selection of securities or timing the movement of funds based on macroeconomic factors.

In exchange for giving up the prospect of beating the market, investors gain the certainty of knowing that they will at least match the market prior to investment costs. And due to the lack of a need to hire active managers and to Vanguard’s investor-owned fund structure, costs are vanishingly small. Today, the expense ratio of the Vanguard S&P 500 Index Fund (Admiral Shares) is a mere four basis points, or 0.04%, meaning that one only pays $4 annually for every $10,000 invested in the fund. In contrast, the famous Fidelity Magellan Fund, which is actively managed, has an expense ratio of 0.69%, or $69 annually for every $10,000 invested in the fund.

Over the decades, the expense ratio of Vanguard’s funds have dropped due to increasing scale and this has pressured the expense ratios prevailing throughout the mutual fund industry. Mr. Bogle also did away with fund loads, or sales charges, early in Vanguard’s history. These sales loads, which were often up to 7 percent of assets invested in a fund, have become much less common in the mutual fund industry. Between lower expense ratios and the decline of sales loads, no wonder Mr. Bogle’s popularity within the investment community wasn’t universal!

Much has been written regarding Mr. Bogle’s legacy with a focus on the massive sums he has saved for individual investors. However, anyone who has read Mr. Bogle’s book, Enough:  True Measures of Money, Business, and Life, realizes that cost savings were only one part of his overall philosophy toward business and life. One chapter of the book is entitled “Too Much Business Conduct, Not Enough Professional Conduct“. The distinction between professional conduct and business conduct may seem confusing to many people, at a surface level. After all, in our free enterprise system, isn’t a profession simply one of many means to the end when it comes to achieving business success?

Take a step back from thinking about finance, narrowly defined, and consider the field of medicine. A doctor goes through many years of education and residency prior to achieving meaningful income potential. This seems like a classic investment calculation: The prospective medical student compares the cost of his or her education (and the opportunity cost of many years of foregone wages in some other field) to the lucrative riches that can be expected once established as a fully trained physician. If the present value of the expected income earned as a doctor exceeds the costs of the education, then become a doctor. If not, enter some other more lucrative field.

But does anyone really believe that this is how a prospective medical student thinks about his or her decision to become a doctor? Of course not. The decision to enter medicine has an economic component, but it also has many completely non-economic factors. Although encounters with jaded doctors who have been in practice for many years may obscure this truth, the reality is that the vast majority of doctors almost certainly enter the field in order to help patients and save lives! They are entering a profession and a calling, not merely seeking to maximize their economic outcome.

Mr. Bogle believed that the same fundamental professionalism should exist in the field of investment management. But should it? After all, those of us who are in the investment industry aren’t here to save lives, are we? We are here to make money. So we should maximize our economic outcomes at all costs, right?

Mr. Bogle would have completely disagreed with that all-too-common sentiment, as his book makes crystal clear. Investment professionals are agents acting on behalf of owners of capital. Looking at the numbers, one can easily forget that these owners include millions of ordinary individuals who are saving for various life goals such as sending their children to college, purchasing a home, and funding retirement. Looking after the financial health of individuals should be viewed as a calling, as a profession, and not merely as a business.

In our consumer driven culture, wealth is often thought of as the ability to purchase goods and services, and this is obviously one use of money. However, what money really represents is financial freedom and independence. Money can buy control over the one thing we all have a limited supply of: Time. Poor returns, whether driven by bad investment choices or high costs, shows up as a lower balance on account statements, but the real effect is that financial freedom is deferred for those who are affected. There are very real consequences for those who have to defer retirement or find that their activities in retirement are highly constrained.

Mr. Bogle was a capitalist and acknowledged that the primary requirement for any business is to earn a profit. However, he insisted that business should operate within a context of ethical and professional conduct, and was particularly critical of the investment industry. He argues that business principles have been compromised in recent decades:

It wasn’t so many decades ago that the standards in the conduct of business were close to absolute:

There are some things that one simply doesn’t do.

But today we place our reliance on relative standards:

Everyone else is doing it, so I can do it, too.

Our society cannot and should not tolerate the substitution of moral relativism for a certain form of moral absolutism, and its debasement in the ethical standards of commerce.

Enough: True Measures of Money, Business, and Life, p. 139

Mr. Bogle was a wealthy man but he left billions of dollars on the table compared to other founders of large financial institutions. It does not seem like this bothered him very much, although he does acknowledge that he did not have any premonition regarding the massive wealth he was giving up by creating Vanguard’s structure. He comes across as a man who had more than enough in terms of financial wealth and was highly satisfied with the fulfillment of his professional calling.

The Quarterly Guidance Trap Bites Apple

“In all of our communications, we try to make sure that no single shareholder gets an edge: We do not follow the usual practice of giving earnings guidance or other information of value to analysts or large shareholders. Our goal is to have all of our owners updated at the same time.”

Warren Buffett, Berkshire Hathaway Owner’s Manual

When Warren Buffett first wrote the Berkshire Hathaway Owner’s Manual in 1983, investors had far fewer options to access corporate information in a timely manner. During the 1980s and well into the early 1990s, it was still common to research investments in a library setting. Readers over forty might even recall reviewing old magazine and newspaper articles using microfiche machines, a practice that would seem ridiculously archaic to the millennial generation. By the mid 1990s, the “information superhighway” was born and investors increasingly had access to all sorts of information online. The past two decades has seen tremendous progress in terms of the volume and velocity of data, but this progress has not necessarily been accompanied by greater understanding; in fact, it seems like market participants are as bewildered as they ever have been and increasingly value “guidance” from experts and insiders.

Apple “Misses” Guidance

The most reported financial story of the first week of 2019 involved coverage of Apple’s “missed” revenue forecast for its fiscal first quarter period which ended on December 29, 2018. Apple CEO Tim Cook kicked off the year on January 2 with a letter to investors describing various difficulties the company experienced during the holiday quarter. The number analysts immediately focused on was the revised revenue guidance which was lowered to $84 billion from a range of $89 to $93 billion given during the last earnings call on November 1. The company also lowered the gross margin estimate to 38 percent from a range of 38 to 38.5 percent.

The reaction of the market on January 3 was swift and severe with the stock price falling nearly 10 percent, although some of that decline has been reversed over the past few days. Interestingly, Berkshire Hathaway’s Class A shares declined 5.6 percent on January 3 which far exceeded the decline in the value of Berkshire’s Apple holdings and appeared to reflect Mr. Market’s skepticism regarding Warren Buffett’s ventures into technology investing.

Apple is probably the most scrutinized company in the United States, or at least in the top five, and I have little of value to add when it comes to judging the intrinsic value of the company or expressing an opinion on its future business prospects. While Tim Cook tried to frame the reduced guidance in the most benign way possible, including blaming much of the situation on macroeconomic factors in China, market participants clearly see more serious trouble ahead, particularly related to Apple’s premium pricing strategy and reports of weak demand for the iPhone XR. The fact that Apple will stop presenting unit sales data for its product lines has only added to investor angst.

The Guidance Addiction

Companies that provide quarterly guidance to the investment community are doing so because the market appears to demand it. Earnings calls typically take place a month into the subsequent quarter so analysts expect executives to not only talk about the prior period but to give a sense of how things are going during the current quarter. Typically, management will furnish either a range or a point estimate for various measures and analysts will plug these numbers into their models and then herd around a “consensus” expectation for the coming quarter.

While this might seem harmless, let’s take a step back and think about exactly what the investment community is asking for. A month into a quarter, analysts are asking management to look at the first third of the quarter and to make projections for the next sixty days. Because investors pay so much attention to guidance, managers spend significant time thinking about these estimates and deciding how aggressive or conservative they should be. Since time is finite, this means that managers are not using this time to run the actual business.

When a large company like Apple makes a prediction on November 1 and then drastically revises the prediction on January 2, a period of only 62 days, this leads investors to believe that management does not have a handle on the business or that events are spiraling out of control. After all, two months is a very short period of time.

When managers provide guidance, this effectively causes analysts to crowd around the mid-point of the range in their own models and the variation of estimates is narrower than would be the case if analysts had to do their own work. This reduces the overall quality of analyst estimates and encourages analysts to do less work and to be more reluctant to make estimates that fall far outside the consensus. When guidance later must be adjusted dramatically, the effect on the stock price is likely to be much greater than would be the case if management provided no guidance whatsoever. The irony is that managers typically give guidance in an effort to reduce volatility in the stock.

Buffett Calls for Ending Guidance

A few months ago, Warren Buffett and Jamie Dimon co-wrote an article in the Wall Street Journal calling for an end to quarterly earnings estimates. The main point of the article is that the act of providing guidance shifts management from thinking about the long term to thinking about the next quarter.

The intrinsic value of a company like Apple will depend on the quality of the decisions Tim Cook makes over the next several years. Shareholders should want Mr. Cook and other executives at Apple to focus on matters such as the optimal price points at which to offer phones for various geographic markets along with R&D that will allow the company to retain its technical and aesthetic edge over time. The last thing shareholders should want is for Mr. Cook to focus his time and energy on providing analysts with estimates of Apple’s revenue and margin over the next ninety days.

If Apple or any closely followed company stops providing all guidance, the market’s reaction is likely to be negative in the short run because it could be perceived as an attempt to hide bad news. However, over time, analysts will come up with their own estimates and a market driven consensus will emerge, probably centered around a wider range of estimates. In time, the market will get used to the lack of spoon-feeding and the actual results delivered over time will drive the value of the stock. This is as it should be and the example of Berkshire Hathaway shows that guidance is unnecessary.

Guidance vs. Disclosure

An important distinction needs to be made between guidance, or forecasts, from management and the actual disclosures that are made regarding past periods in 10-Q and 10-K reports. Apple recently announced that the company will no longer report unit sales data for its product lines starting in the current fiscal year. Changes in disclosure, as opposed to changes in guidance policy, could very well send an important message to investors. In the case of Apple, investors have reason to view the lack of unit sales disclosure with some skepticism given that it is coinciding with weak sales. A reduction in disclosure at a time of weakness does not send the most bullish signal to investors.

Berkshire Hathaway shareholders have been paying a great deal of attention to Apple in recent quarters. At the end of the third quarter of 2018, Apple represented Berkshire’s largest equity holding and Warren Buffett’s bullishness on Apple’s prospects has been a tailwind for the stock until recently. Apple’s weakness during the fourth quarter could have enticed Mr. Buffett to further increase Berkshire’s Apple holdings. On the other hand, Berkshire’s new repurchase policy opened up the ability for Mr. Buffett to make potentially large buybacks.

We will have to wait until mid-February to learn whether Berkshire’s Apple stake increased during the fourth quarter, and news of any Berkshire repurchases will have to wait until the end of February when the 2018 annual report is released. After all, Berkshire doesn’t provide guidance.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway, and by virtue of such ownership, also own shares of Apple on a “look through” basis.


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