Thursday, June 15, 2006

John Burley's 7 Levels of Investor

George S. Clason, author of The Richest Man in Babylon, had a couple very basic financial lessons to convey:

  • A part [10%+] of all you earn is yours to keep
  • Pay yourself first
The profound wisdom and simplicity of those precepts is undoubtedly why Clason’s 1926 book continues to sell so well today. It’s also, I believe, why today’s financial “gurus” have, at best, only succeeded in repackaging Clason’s maxims, without really improving on them.

Robert Kiyosaki’s take on it—his “hook,” if you will—comes in the form of his “Cashflow Quadrant.” While this has certainly proved a lucrative idea for him—one that undeniably resonates with his readers—does it really add anything substantial to Clason’s dictums? Has the Cashflow Quadrant ever been a demonstrable part of making anyone—aside from Kiyosaki, that is—financially better off? I really wonder if it’s going to still be around in 80 years.

Burton G. Malkiel, Princeton economist and author of A Random Walk Down Wall Street, expands Clason’s advice to ten rules. Among them are Start saving now; Diversity reduces adversity; Pay yourself, not the piper; and Bow to the wisdom of the market. What Professor Malkiel gains for his readers in clarity, realism, and specificity, he unfortunately seems to lose in allure. Excepting the whole “random walk” notion (which is certainly his “hook”), Malkiel’s avoidance of aphorism and platitude, as well as his presumed distaste for painting pictures of imminent riches in the minds of his readers, is probably the better part of an explanation for his relative obscurity—at least when compared with Clason, Kiyosaki, and John Burley, I mean.

I bring up John Burley, of course, because it’s Burley’s own contribution to the field, the “Seven Levels of Investor,” that I’d like to focus on here. My intent is to argue that, while Burley certainly wants you to believe that his particular exercise in abstraction really presents a unique and illuminating perspective on wealth creation, it really just boils down to obscurantism.

What are the 7 levels, anyway? Burley provides his definitions in a free report downloadable from his web page, here. In summary:

Level 0 – The Non-existent
Level 1 – The Borrower
Level 2 – The Saver
Level 3 – The Passive Investor
Level 4 – The Automatic Investor
Level 5 – The Active Investor
Level 6 – The Capitalist Investor

Note immediately that, in a way analogous to Kiyosaki’s abuse of the terms “asset” and “liability,” Burley has taken the word “investor” and pummeled it beyond recognition. The first three levels aren’t “investors” at all! Neither are levels 5 or 6, as I’ll be arguing in a moment—at least not in any sense relevant to Burley’s concept of “financial freedom.” Furthermore, Burley’s overly broad definition nonetheless fails to include one of the more important types of “investor”: the college student. This omission is characteristic of the get-rich-quick “gurus,” who all pooh-pooh education, and seem to have no concept whatever of basic economic concepts such as the time-value of money, comparative advantage, and opportunity cost (or, if they do, they keep this knowledge to themselves).

But what about Levels 3 and 4? Well, at least you can say that they actually fit the colloquial meaning of the term “investor.” I’ll also admit that, while I disagree with a number of things, on net I think Burley has some good advice for Level 4 Investors. But his good advice makes my point: He doesn’t manage to say anything that Clason and Malkiel didn’t already cover—and cover better.

In his discussion of Level 3, Burley obviously intends to inoculate his dupes against the inevitable criticisms that will be made by people like me. Standing the skeptics up as straw men and calling us the “It Can’t Be Done” Passive Investors, Burley makes a big show of knocking us down:

The “It Can’t Be Done” Passive Investor has determined that all investments involving more than the most basic research by the investor, that promise much more than bank interest rates of return are beyond them. They believe that higher rates of return “can’t be done” by other than the most “gifted,” “lucky” or “connected” business people, “corporate highfliers” or “shady wheeler dealers.” They truly believe that high rates of return on investments are either impossible, probably illegal or available only to the chosen few. They believe that the knowledge and skills required to even recognize such investments are beyond THEM, in their present circumstances.
Bla bla bla bla bla! Seriously, who believes that high rates of return are illegal or impossible, except maybe Fidel Castro? Burley continues with the baseless insults and vacuous “arguments” for quite a while after that. What he says amounts to a gross distortion and oversimplification of the efficient markets hypothesis (EMH). The EMH, a concept I have previously gone over, is not just something spouted by broke, envious “cowards” who are intent on sabotaging your future. It happens to be backed by mountains of empirical evidence collected over decades. Don’t take my word for it. Read Burton Malkiel’s book on it, for example. Or, surprisingly, you can just take Burley’s word! Burley reveals his own implicit belief in the EMH on page 15 of his report. Counseling the Level 4 Investor, Burley, in a fit of rare clarity, says:

Stick to owning solid stocks and proven growth Mutual Funds. Do not attempt to outsmart the market. Use a fund like the US Vanguard Index 500 fund that closely ‘mirrors’ the S & P 500 Index. This index outperforms two-thirds of all Mutual Funds, year in and year out. Over 10 years this will historically provide you a return that will exceed 90%+ of the “professional” Mutual Fund managers. [My emphasis]
An ironic little twist in all this: Guess who serves on the board of directors for the Vanguard Funds... Burton G. Malkiel!

So much for Levels 3 and 4!

As far as Levels 5 and 6 are concerned, I believe Burley consciously avoided using a term that would have fit them much more nicely: the entrepreneur. Burley is clearly not stupid. He’s gotta know that the use of this word will strike fear in the hearts of those on the quest for easy money, because following on the heels of “entrepreneur,” invariably, is a four-letter word that the Kiyosakis and the Burleys of the world despise: Risk.

It is particularly important to understand this: risk is not simply inextricably intertwined with the entrepreneur; the assumption of risk is the role of the entrepreneur in the free market economy. Risk is the entrepreneur’s function! You’ll, of course, never hear this from Kiyosaki or Burley. They want you to believe exactly the opposite: that it’s really your job that’s the risky thing, and the entrepreneur, the one who hired you and has agreed to pay you for your time—pay you whether the company is in the red or in the black this year—is really the “secure” one. This is pure, unmitigated, utter bullshit!

I’ll take a look at some of the particulars of Burley’s Level 5, but before I do, let me just touch on Level 6 briefly, to get it out of the way. Level 6 is the rarified air of the true innovators of the world—the Gates’s, the Winfrey’s, the Stewart’s, the Trump’s… Innovators are those who, throughout history, have been responsible for most of the improvements to the human condition (Hmmm, well… with the possible exception of Bill Gates, maybe the names I listed above don’t quite fit into that category…). Burley mentions Level 6 pretty much as an afterthought, I think because he recognizes that it’s unrealistic to consciously strive for this level. Stellar entrepreneurial success is not called “making a fortune” for no reason.

So, back to Level 5. This is Burley’s “sweet spot.” Burley and his acolytes love to concoct all sorts of mythology about the Level 5 Investor. Level Fives have “principles and rules” for investing… They’re “visionaries who use lateral thinking to develop ideas and methods no one else has thought of”… They brag “about how many vacations and three-day weekends they’re able to take”… They “don’t want to wait until they’re 60 to be financially secure”…and on and on and on. Who wouldn’t want to be Level 5? Where’s my credit card so I can pay Burley to tell me all the secrets of the Level 5 Investor?

As I said before, the Level 5 Investor isn’t an investor in the sense that Burley wants you to take it—i.e., a person who sticks his money someplace and then waits for the big checks to roll in. Burley is careful to pick a positive yet very generic label for this level. To call the “Active Investor” what it really is—the sole proprietor, the franchisee, the small-business owner—doesn’t fit well with the image Burley needs to convey in order to keep his dupes interested. He can’t afford to give his “students” the impression that being at Level 5 takes real work. 14-hour days 7 days a week for a couple years or more—the reality of the typical start-up, run by someone interested in making it successful—doesn’t quite jibe with the notion of “financial freedom” envisioned by Burley’s target market. These are the sort of people, you realize, who respond positively when Kiyosaki remarks, “I’m lazy. I’m also incompetent. The trouble with being competent: People call you up [to ask you to do things for them]… I keep myself incompetent...” So, Burley, quite rationally, dances around this issue. He keeps the description of the Active Investor in his report fairly brief. Among other things,
[Level Fives] consistently strive to optimize performance while minimizing risk. It is normal for this type of investor to have long-term annual rates of return of 20%-100%+. They intimately understand money and how it works. Level Five Active Investors become very wealthy. Their main working focus is on increasing their assets and thus their cash flow.
What’s annoying about the above characteristics is that, aside from being arbitrary, they’re entirely descriptive in nature—meaning that you won’t know you’re a Level 5 Investor until it’s too late for you to give a crap about it. Didn’t become wealthy? Well, you obviously weren’t really a Level 5. Didn’t earn 20%+ on your money? Sorry, you just didn’t have what it takes to be Level 5. Did you get filthy rich without any appreciable understanding of the “money game”? Clearly you're a Level 3 PIG who got lucky. Anyway, you get the idea…

In the final analysis, though, Burley’s descriptions of the 7 Levels of Investor aren’t meant to instruct or illuminate. Instead, Burley intends to inspire in his readers a burning desire to learn the Secrets of Professional Investors so that they can Win the Money Game, obtain the Blueprint for Success and The Keys to the Vault. Attend the Boot Camp and your status as a Level 5 Investor will undoubtedly be assured! Awareness, Attitude, and Action—i.e., pulling out that credit card and lining Burley’s pockets.

“But einzige,” I can hear you interjecting, “your argument seems to imply that becoming rich is an impossibility. The fact that rich people actually exist is a clear refutation of this notion. Ha!”

Here’s something that seems lost on all get-rich-quick scammers out there—let’s call it my “hook”, my aphorism:
Einzige’s Get-Rich-Quick Secret

Do something that others value

You never seem to hear this from the likes of Burley and Kiyosaki. The idea that an entrepreneur is beholden to the whims and tastes of the consuming public is an afterthought—if it is even mentioned at all. This idea, however, is central to the creation of wealth. Zalmon Gilbert Simmons did it with mattresses… Daniel Gray Reid did it with tin plates… Jeremiah Milbank did it with condensed milk… Henry O. Havemeyer did it with sugar… Rockefeller did it with kerosene… Ray Kroc did it with hamburgers… Andrew Carnegie did it with steel… John Sperling did it with an online private University… The list is endless! It has always irked me that the real estate gurus push the bullshit myth that all the wealthy got that way via real estate.

If you can put my Secret to work in combination with what I’ll call “Einzige’s Corollary” –

Do your thing better and/or cheaper than the next guy

– then you’ll really be off and running. If you can corner the market, even better! This is a little more difficult, though, because keeping competitors and imitators from biting at your heels is almost always impossible. There are still examples out there, though. Howard Stern is wealthy because his “product” is Howard Stern—though he has competition in the broader market for “shock jocks.” Michael Jordan is a similar case. He’s the only one capable of selling Michael Jordan, but there are others out there selling the product called “talented athlete.”

I can hear you now saying, “But einzige, your ‘secret’ isn’t helpful at all! Being an innovator isn’t easy!”

Ahhhh! Now you’re getting it. On the other hand, maybe it’s time to defer to the greater wisdom of überBurleyist Robyn Grinter on this one: “If you think you can, you’re right. If you think you can’t, you’re still right.”

Now, maybe there’s an improvement on Clason!


Solan said...

Malkiel ... but what's a REIT?

Einzige said...

Stands for Real Estate Investment Trust. It's sorta like a mutual fund for real estate.

Solan said...

On a similar note: My office neighbour says he's seeing all the signs from the 70ies stagflation returning. People pay insane prices for gold and property because those prices may soon not be insane anymore. Hmmmm ... but maybe the interest rates will take a real hike this time, rather than inflation?

Einzige said...

I suppose this is why all eyes are on the Fed, lately.

Goodhart's Law (among other things) make's me uncomfortable trying to guess where the economy is going to go.

Solan said...

Another thing is that a hike in interest rates probably can't stop long-term inflation if the underlying case is (for instance) a rampant monetary press.

Dikkii said...

I really hate the straw man that Burley uses where he says that if you believe in the Efficient Market Hypothesis, you cannot outsmart the market.

The EMH does not say this, it just says your chances of doing so are unlikely.

Great post.

Einzige said...

Thanks, Dikii!

I've got another Burley post in the works - should be my last, I hope - where I make a concerted effort to tackle Burley's ROI claims head-on. It's difficult, of course, to be definitive, since I don't have access to Burley's financial records, but my goal is to take what evidence there is and make some educated guesses. I hope to at least give pause to those who would otherwise be inclined to take Burley at his word.


It's been a while since I studied monetary policy, but I seem to remember that the Fed's only "tools" for affecting the economy were

1) Setting the discount rate (and Federal Funds rate???),
2) Setting the reserve requirements for banks and S&Ls, and
3) Buying and selling Treasury securities.

So, you're right. A hike in the interest rate won't necessarily affect inflation if they are at the same time buying T-bills like crazy. Unfortunately, I can't remember enough the class to know exactly how to tell if that's what's currently happening. I'm sure it's a fairly simple thing. Hopefully someone will come along and enlighten us.