The Five Laws of Gold

The Richest Man In Babylon was originally a collection of parables penned by George Clason in 1926 that focused on the judicious handling of money. Ninety years later these stories are still very applicable to our modern financial lives, with many of the lessons having been repeated numerous times in various forums. For all the time spent analyzing portfolio strategies and understanding asset class behavior there are some foundational concepts that must be in place to ensure personal financial success. Sound advice seldom, if ever, changes.

First Law

Gold cometh gladly and in increasing quantity to any man who will put by not less than one-tenth of his earnings to create an estate for his future and that of his family. [p.93]

While it sounds like a statement of the obvious, in order to be wealthy one must actually possess money. Simply having the indicators of wealth (car, house, etc.) is an illusion, and should be viewed with caution in our modern credit based economy. The ruinous outcomes that result from pursuing an image of opulence is all too often on display in the ranks of professional athletes (Mike Tyson, Allen Iverson, et al) that end up broke shortly after retirement. In some circumstances these individuals were taken advantage of, but more often than not they spent lavishly on symbols of wealth, while their real wealth was drained.

The continuous accumulation of material objects beyond one’s means can be incredibly deleterious. There’s nothing wrong with having nice things, but acquisition should be kept in check with an eye on long-term financial security. Attainment of objects requires that the owner has spent and is no longer in possession of those funds. Purchasing material objects thus represents an opportunity cost in terms of future investment returns. Savings is the necessary fuel of investment, without which future returns (in the absolute dollar sense) will likely suffer.

It never hurts to improve savings. A little more Sam Walton, a little less Russian oligarch.


Second Law

Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field. [p.94]

Compound interest, what Benjamin Franklin called the eighth wonder of the world, is perhaps one of the greatest innovations of all time, financial or otherwise, period. The idea that money can be lent out or used to fund other economic activities and concurrently increase in value for its owner is a potentially lucrative prospect.

Extra emphasis should be placed on the “wise” descriptor. It suggests that money be invested prudently, and it’s owner be willing to take on a measured level of risk corresponding with the expected return. Not all investment opportunities are created equal–some are undoubtedly more reasonable than others. The prospect of high rates of return typically bear a large amount of risk.


Third Law

Gold clingeth to the protection of the cautious owner who invests it under the advice of men wise in its handling [p.95]

One of the more direct interpretations of this passage suggests finding trustworthy advisor to handle financial affairs (I would add that they should be a fiduciary). The alternative would be self management, which isn’t for everyone. It requires time, effort and some humility. In The Four Pillars of Investing William Bernstein outlines the four key areas that individuals should master if they plan to effectively manage their own money: theory, history, psychology and business.

One of the major reasons I started this site was to hold myself accountable through an informal manner of self-education. It has allowed me to clarify my opinions (backed by factual evidence), and improve my own understanding. I’ve generally found that I learn best when I’m engaged, and provided with a controlled amount of freedom to make mistakes–that’s where real education occurs. Knowledge, like interest, has to be earned and compounds over time.

When seeking the guidance and opinion of others I’ve found especially useful to find those that disagree with my own perspective, and understand their reasoning and thought process. It’s an excellent way to defeat confirmation bias and challenge my own thoughts.


Fourth Law

Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep. [p.95]

Whether you end up working with an advisor or travel the do-it-yourself route, prime importance should be given to understanding what you own and the risks involved. Everything has a cost and a potential downside.

Charlie Munger has often quoted a famous line from Confucius: “Real knowledge is to know the extent of one’s ignorance.” Beyond knowing what you own, exercising some humility and admitting what you don’t know is far more advantageous to an investor. Mr. Market is smarter than all of us, and fluctuates up and down, sometimes violently and without notice. To expect otherwise is to disregard economic history and human behavior.


Fifth Law

Gold flees the man who would force it to impossible earnings or who followeth the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment. [p. 96]

Having an idea as to what constitutes a reasonable rate of return is an essential foundation for investment planning. Without this understanding it’s easy to be tempted into schemes that promise high rates of return. Keep in mind that it’s incredibly difficult to beat the market, some do, but the legitimate ones are few and far between. Furthermore, it’s difficult to discern if their outcome is a consequence of luck or skill. Don’t be fooled.

John Law. Charles Ponzi. Ivan Boesky. Ken Lay. Bernie Madoff. Financial history is replete with characters promising great deals that ultimately end in disaster for shareholders and investors. If something sounds too good to be true, it is.

1. Clason, George S. The Richest Man In Babylon. Signet. 1988.

NOTES – The Richest Man In Babylon.pdf

What I’m Reading
The Playbook Interview: Warren Buffett (Daniel Lippman and Jake Sherman)
The Titanic Risks of the Retirement System (Mohamed El-Erian)
A senseless subsidy (The Economist)
A Dozen Ways Michael Bloomberg Thinks Like Charlie Munger (Tren Griffin)
This Basically Anonymous Fund Manager Oversees $800 Billion (Bloomberg)
How Lending Club’s Biggest Fanboy Uncovered Shady Loans (Bloomberg)
podcast: Masters in Business With Michael Mauboussin (Barry Ritholtz)
ETFs May Actually Make Weak Players Weaker (EconomPic)