Henry Ford famously expressed the sentiment that “history is bunk.”
As Ford put it, “We want to live in the present and the only history that is worth a tinker’s dam is the history we make today.”
Ford may have been one of America’s most iconic entrepreneurs – whose name still graces a Fortune 500 company more than a century after its founding – but he was dead wrong about the usefulness of history.
PIMCO co-founder Bill Gross, nicknamed the “Bond King,” once said…
The book that rests on my library coffee table is not Peter Lynch’s Beating the Street or even my own, but several books by historian Paul Johnson on the makings of the 19th and 20th centuries. There is no better teacher than history in determining the future… there are answers worth billions of dollars in a $30 history book.
As Gross’ quote suggests, in the world of investing, there is no better teacher than history in determining the future.
Whether you are Warren Buffett betting on well-established stalwarts like Coca-Cola (NYSE: KO) or Apple (Nasdaq: AAPL), or a Silicon Valley venture capitalist looking to change the world by investing in the next Facebook (Nasdaq: FB) or Alphabet (Nasdaq: GOOGL), parent company of Google, both styles of investing require an understanding of the past.
Let me explain…
The Importance of History
Whether it’s a bond investor like Gross, a value investor like Charlie Munger or a global investor like Jim Rogers, they all agree on one thing: A knowledge of history is more critical to successful investing than, say, mastering formulas from a finance textbook.
But history is hardly a hot topic at today’s top business schools. I couldn’t find a single course offered at Harvard Business School with the word history in its title.
Yet when Rogers – co-founder with George Soros of the Quantum Fund and Soros Fund Management – taught a financial history course at Columbia Business School nicknamed “Bulls and Bears,” it became one of the most popular courses on campus.
Here’s my take on why history is useful for investing…
History Teaches Patterns
Successful investing is all about recognizing patterns. And if you study financial history, you’ll learn to spot them. Now, history may not repeat itself. But it does rhyme.
So if you want to learn how a current speculative episode will end… Study the history of tulip mania in the Netherlands in 1637 or the canal mania that followed the start of the Erie Canal construction in 1817 or the dot-com boom and bust of the late 1990s.
Learn the lessons from these historic episodes, and the answers to today’s headline-grabbing speculative mania – whether regarding the prospects for Tesla or bitcoin – will reveal themselves.
History Gives You an Edge
The first question anyone who interviews at a hedge fund is asked is “What is your edge?” Today’s acceptable answer of an “edge” is some unique algorithm that will suck profits out of a market.
Well, guess what… Based on the lousy performance of hedge funds over the past decade, these algorithmic edges don’t last very long.
Contrast this kind of edge with the edge of having a historical perspective throughout a lifetime. As the Harvard economist John Kenneth Galbraith observed, “The financial memory is very short.”
Turning Galbraith’s insight into advice means this: Studying financial history – and thereby lengthening your financial memory – will give you a lifelong investment edge that will far outlast the latest whiz-bang algorithm.
Here’s my favorite story about translating historical perspective into billions…
Shark Tank star Mark Cuban is a billionaire today because he knew financial history. Cuban made his first billion by selling his stake in dot-com bubble stock Broadcast to Yahoo.
But unlike many of his dot-com billionaire peers, Cuban also knew enough about financial manias to realize that the boom would turn inevitably to bust. So he carefully structured a trade that involved 286,000 options to preserve the value of his billion-dollar stake.
Catchy, short-term predictions about a market or a stock are like intellectual junk food. They are sweet, addictive and hard to resist. But in the end, you’re left flabby, depressed and unsatisfied.
In contrast, when I read an excellent history book, it’s like gorging on intellectual superfood. Afterward, I feel like I’ve gained 20 investment IQ points.
To become a professional investor, go to the University of Chicago’s Booth School of Business and become fluent in modern financial theory’s alphabet soup of DCF (discounted cash flow), CAPM (capital asset pricing model), ROE (return on equity), ROA (return on assets) and PEG (price-to-earnings to growth) from Nobel Prize-winning professors.
But to be a successful investor, curl up with a stack of books by Paul Johnson and become fluent in history.