Where Returns Come From
When it comes to making an investment, there are three ways to earn your return:
What you pay for it;
How well you operate it;
How big you scale it.
But not all three of these areas are applicable to every investment.
For example, if you’re not an activist investor with a lot of capital behind you, you’re likely not going to be able to influence a public company as to how it operates or how it scales. So your return almost entirely depends on what you pay. This, I think, explains why “value investing,” where you buy stocks for cheap, has historically been the best-performing approach in this area even as venture investing, where investors seemingly overpay for growth but have lots of influence on the companies they fund, has done so well in the private space.
But if you’re outside of the asset allocation world and doing something tangible in the operating world like buying a new piece of production equipment or making a hire, you should arguably always overpay…particularly when it comes to people. That’s because paying more generally correlates with quality and quality tools typically last longer, perform better, and, in the case of people, level up over time. After all, isn’t the best free advice that you get what you pay for?
This is important because rarely is the payback period on any investment less than a year or two (if it is, do it!). This means that your returns are going to be generated well out in the future and then compound…the longer the better. As Einstein apocryphally pointed out, compounding is the most powerful force in the universe.
This is also why I will never purchase IKEA outdoor furniture again (and because of the allen wrenches and instructions that mock you by having no words).
So if it’s a passive investment like a stock, buy it cheap and ignore it. That’s the best route there for a good, tax-efficient return. But if you’re buying a business or expanding your production line or bringing on a teammate, pay up for quality and give it lots of TLC because the return there will not be generated by what you pay today but by how significantly that asset can improve your operations and scale into the future.
— By Tim Hanson
