Up like Warren Buffet
Using the right business model to invest
#65
I saw this question on Twitter: “How do I engage in legal fraud?” and someone answered “get into insurance.” I’ve always loved how the insurance industry works. Give me your money with the promise that you’ll get it back when something bad happens to you. But when this bad thing happens, I’d make it incredibly difficult for you to get your money 🙃🙃🙃. That’s why it’s the best business model and why Warren graduated to that. Check out his journey.
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First, some basic concepts that are important to understand:
What is a ___?:
Hedge fund: You give a hedge fund money and they invest it in whatever they want. The hedge fund manager makes money by charging you 2% per year of the money you put in (if you put in $1,000,000 they take $20,000 per year). They also take 20% of the profits. (If they return 10% on your $1,000,000 — a $100,000 profit — they take 20% of that, or $20,000). So a “2 and 20” fund would make $40,000 on a $1,000,000 investment that returns 10% that year. If a hedge fund has $1,000,000,000 in it then they would make $40,000,000 just on the fees. THAT is how hedge fund managers get rich. From fees.
Bank
It’s important to know how banks make money. Because it’s not very different from a hedge fund. You “Lend” the bank money when you open a checking account or savings account.
They then give you a small interest rate return on your savings account (let’s say it’s 1%, although even that is high right now). They lend out the money to people who buy homes (they do other loans but this is most common). They charge (let’s say) 7%. The difference between 7% and 1% (minus the cost of their branches and bank tellers) is what they make. (This is rough but roughly accurate). So if you put $100,000 in a savings account, you might make $1,000 a year. They lend the $100,000 out at 7% (7,000 a year) and they make $6,000. That is how a bank makes money. In one sentence: you lend them money, they invest it (by lending it to homeowners) and they take 100% of the difference each year until you take your money out. Note: hedge funds make 20% of the profits. Banks make 100% of the profits.
Insurance company:
Similar to a bank and a hedge fund: You give them money, they invest it. Small differences: You give them money, but YOU NEVER WANT THAT MONEY BACK. If you get that money back it means something bad happened to you. This is different from a bank where the bank is simply holding your money until you take it back. An insurance company tries to never give you your money back. Then they invest it in (mostly) whatever they want. And they keep 100% of the profits. You don’t keep any of that. An insurance company takes money from you every month (so you keep having insurance). Sometimes they return money each month to people who get sick. This is called “the cost of the float”. Sometimes they make money on that (they give out less than they take in). Sometimes they even lose money on the float. And then they only make money on their investments (minus the cost of the float). A bad insurance company has a high cost of float (they give out more than they take in). A good insurance company breaks even on float (they give out each month, roughly what they take in — i.e. people get sick, etc). A great insurance company makes money on BOTH the float (they only take money from people who they think won’t be sick and will never get their money back) and on their investments. (Foreshadowing: Warren Buffett runs a great insurance company). Insurance companies use statistics to see who are good risks to take money from and they use statistics to figure out how much money you should give. Extreme example: A 90 year old who wants life insurance will have to spend a lot more money than a healthy 20 year old woman. These are important things to understand to understand Warren Buffett. NOTE: Banks and insurance companies both make 100% of the profits. BUT insurance companies don’t have to give the money back when the customer wants.
To summarize:
A hedge fund takes your money for a short time, and takes 20% of the profits.
A bank takes your money for a period of time and takes 100% of the profits until you take your money back.
An insurance company takes your money FOREVER and keeps 100% of the profits.
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Warren Buffett made his first million by running a hedge fund.
Then he switched to owning small banks. Then finally he shut down his hedge fund and put all his money into running an insurance company.
An insurance company is a hedge fund that KEEPS the investors money and KEEPS 100% of the profits.
It’s the best business model in the world.
It makes FIVE TIMES what a hedge fund would make and never has to worry about anxious investors pulling money away.
Article List— What I’m reading (10 articles a day x 7 days x 4 weeks x 12 months = 3360 articles a year).
Togo, Nigeria Big Winners in Ease of Doing Business in Africa: This data is wrong. Ease of doing business has nothing to do with the daily struggles of entrepreneurs on the ground. Take a look at Sim Shagaya’s Twitter thread here.
The Oligarchs l Al Jazeera Investigations: Al Jazeera did a very good job with this. See? Africa is not the only corrupt continent.
Jumia vs Transsion Holdings: A tale of two IPOs: One’s stock price went up and came down and the other went up and up. Guess who is who.
Searching for our Medici effect: “[African] Startups should not approach wealthy Africans to make investments, they should instead think of working with them to solve problems or build legacy projects.”
A health care algorithm affecting millions is biased against black patients: Fun fact: it’s not a racially biased algorithm. Read the story and check out.
The Decline and Fall of Rudy Giuliani: Rudy, Rudy, Rudy. 🤦🏾♂ Interesting story and life in general, but his associations brought him down.
Can Africa manufacture growth?: Can we? I’ve said I don’t think Africa’s growth would mirror Asia’s but we can’t ignore manufacturing at all as a means to build up our workforce.
Platforms vs Verticals and the Next Great Unbundling: The moral of the story is this: In all but a few circumstances, the broad horizontal verticals eventually break. They become a victim of their own success. As the platforms grow, their submarkets grow too; their product gets pulled in a million different directions. Users get annoyed with an experience and business that caters to the lowest common denominator. And suddenly, what was previously too small a market to care about is a very interesting place for a standalone newco. Like clockwork, a new wave of innovation begins to swell, picking off the compelling verticals the new horizontal players cannot satisfy.
If you know which platforms are teetering on this precipice, you’ll know where to look for both opportunity and innovation.
One Man's Wild Quest to Reach the Bottom of Every Ocean: These are the kinds of things you can do when you’re really wealthy with no family commitments. He’s hit the Seven Summits and wants to hit the Five Deeps now. Amazing content.
The Fall of WeWork: How a Startup Darling Came Unglued: You’ve read about We so much on this newsletter. Might as well get the full story here.
Podcast— What I’m listening to (1 podcast episode a day x 7 days x 4 weeks x 12 months = 336 podcast episodes). Broadening my experiences through others’ stories.
Bad Batch: Do you know what stem cells are and the controversies around them? There’s different schools of thought around whether or not stem cell treatment works. These are stories about treatment going well or horribly for different individuals. A Wondery podcast— these guys are elite!
Book— 1 Chapter a day x 7 days x 4 weeks x 12 months = 336 chapters. Most books have 10-12 chapters, so 1 year = 28 to 33 books. And my book list is nearing 1000 books. Send help 🌚
Still on aunty Michelle’s book. Almost done with it and very interested to know what people’s views on her experience are. I’ve asked a couple of friends and everyone has a different perspective on whether or not she sacrificed her own career to help Barack or not.
📱📱Quote of the day
To live is to struggle.
Remember folks: “Until the lion learns to write, every story will glorify the hunter.”