There is a comforting analogy for investing.
It is a lovely image and helped me convince some investors.
Yet, although poetic, it is conceptually wrong.
Begin with a question Ludwig von Mises pondered in his magnum opus, Human Action. Why do firms employ accountants at all? If profit were a physical thing, a coin one could weigh in the hand, we would need no elaborate definitions of capital, revenue and expense, no judgement about what to capitalise and write off. We would need only counters.
That firms pay accountants for more than counting tells us something: profit is not an object. It is an abstraction, a difference between two imagined magnitudes, constructed rather than found.
Yet the abstraction is crucial. It is the signal by which an entrepreneur learns whether he has created value or destroyed it, whether his resources are worth more assembled than dispersed. A firm indifferent to that signal does not escape it. It discovers the verdict later, and less pleasantly.
The mechanism matters.
An entrepreneur buys inputs at known costs and imagines a future in which his output commands a price above them. The gap he pictures is his whole enterprise, and for now it exists only in his mind. If the future is kind, that gap materialises, embedded in a selling price that clears above cost. At no point does a separate sum change hands marked "profit." Profit is the residue of a completed transaction, not a line item paid across the counter.
Which brings us to the advice dispensed daily to savers: book your profits at regular intervals.
When a holding rises from 100 to 150, take the 50 off the table and let the 100 keep working. It sounds like prudence.
But it is a category error. There is no 50 sitting apart from the 150, waiting to be lifted clear. To realise value you must sell units, mutual fund NAVs or shares, and selling shrinks the position itself.
You may trim your exposure. You cannot prune it precisely along the seam between "gains" and "principal," because no such seam exists. The 150 and the 100 are not two objects but one, priced at two moments.
To be clear, none of this is an argument against selling.
Reducing a position can be sensible, for reasons of risk, need or price. My argument is against a metaphor that flatters the investor into believing she has harvested something while keeping her tree.
Honesty costs the adviser little. He might say what is true: not that profits are being booked, but that a smaller bet is being placed. The distinction is the difference between economics and horticulture.
Back to Writing