David Ricard: Putting Simple Rules of Investing To Work for You

by Dr. Steve Sjuggerud, Investment U Advisory Panelist
Monday, November 11, 2002: Issue #188

I used to tell people that I had never met a rich economist. “Economists know everything about money except how to put it in their pockets,” I’d joke.

The reason I said these things was to prove a point about forecasting. I contend that financial forecasts are worthless. The reality is nobody knows if the Nasdaq will be at 500 or 5,000 next year. And nobody knows if the economy will be booming or in recession, or if inflation will be 5.0% or minus 0.5%. Economists don’t make forecasts because they believe they know the future. They simply make them because that’s what they’re paid to do

This came up in the speakers lounge backstage at the New Orleans Investment Conference over the weekend. And Mark Skousen – an economist – begged to differ. He said that history is littered with great economists who were also great investors.

He handed me a copy of his book,The Making of Modern Economics: The Lives and Ideas of the Great Thinkers, and told me about three economists in particular who both changed economic history and Made Millions speculating. I couldn’t even get past the first one – David Ricardo – without feeling the need to share with you his storyand the one simple rule that made him rich…

David Ricard: Discovering An Important Rule Of Investing

David Ricardo (1772-1823) is credited with discovering a number of economic truths. Some consider him the most important economic thinker since Adam Smith. Yet what most people don’t know is that he is credited with discovering the most important rule of investing and speculating.

His simple rule for investing made him extraordinarily rich – and it can help you as well. (More on that in a moment.) For now, just know that by understanding Ricardo’s key principles and investing based on them, you will undoubtedly improve your investing success as well.

Ricardo promoted free trade, hard money, the laws of comparative advantage, and more economic principles now widely accepted today. (Although in some cases, Ricardo’s ideas seemed outrageous at the time).

Two Historic Policy Changes That Led To The Industrial Revolution

First, as a strong advocate of ‘Sound’ Money, David Ricardo persuaded the British parliament to establish a strict anti-inflation monetary standard (which it did pass, called the Peel Act). This is the same goal Alan Greenspan and the rest of the world’s central bankers have today.

And second, on the matter of Free Trade, Ricardo sharply criticized England’s high tariffs on agricultural goods. This led to a repeal of the ‘Corn Laws,’ and ultimately led to much freer trade in the world. In another part of his ‘Corn Laws’ critique he also defined the ‘Law of Diminishing Returns,’ an economic concept that stands to this day.

These two historic policy changes (sound money and lower costs of trade) led us into the Industrial Revolution and led England to become the ‘workshop of the world,’ importing food and exporting all kinds of clothing and manufactured goods.

A Remarkable Investing Career Based On A Few Simple Rules For Investing

Ricardo didn’t just crunch numbers. He also loved to be a part of ‘the game.’ His father was a stockbroker, and by age 14 Ricardo worked with his father at the London Stock Exchange. In time, Ricardo was trading for his own account and making a market as well (kind of like a floor trader today).

Ricardo’s investing career made a huge leap forward when he began bidding as a loan contractor for the government. Ricardo’s firm held its own, competing with such big names as the Barings and the Rothschilds. The last – and biggest – loan of the Battle of Waterloo was raised on June 14, 1815. According to Mark Skousen’s book:

• ‘The price of the bonds was extremely depressed because of the size of the loan and the uncertainty of the outcome of the war. There were four bidders for the loan contract, but Ricardo’s firm won.’

• ‘Ricardo bravely held onto his position in the deeply depressed bonds, his biggest gamble ever. Other more timid investors sold early, before the Battle of Waterloo, but not Ricardo. He held on after the shocking news arrived that Wellington had won the battle against Napoleon. The government consols (bonds) skyrocketed and Ricardo became an instant millionaire. The Sunday Times reported in Ricardo’s obituary a popular rumor that during the Battle of Waterloo Ricardo had ‘netted upwards of a million sterling.’

The Golden Rule That Made It Possible

A million sterling in 1815 translates into $52 million in today’s dollars, by my math. Once Ricardo gained his fortune, he lost interest in the London Stock Exchange. He became a ‘country gentleman’ living the good life, and writing his ideas about economics in ‘On the Principles of Political Economy and Taxation,’ his economics masterwork, published in 1817.

In addition to the economic principles he created above, he also defined and explained the ‘Law of Comparative Advantage,’ one of the greatest laws in economics, according to Skousen. This law proves how free trade benefits BOTH nations, and that it pays for each nation and each individual to specialize, as it increases total output.

In my mind, Ricardo’s greatest contribution to the investing world is what I believe is the Golden Rule Of Investing. Ricardo is credited as the first to say ‘Cut short your losses’ and ‘Let your profits run on.’ This has been the most valuable piece of advice in my investing career. I believe following this advice is the single best thing you can do to improve your investing results – regardless of how you invest.

Cut your losers short, and let your winners ride. That’s about all you need to know. Thanks, David Ricardo.

Good investing,

Steve

Today’s Investment U Crib Sheet

• This idea of cutting your losers short and letting your winners ride is one that we’ve addressed before in the IU Archives. Read our Timeless Rules of Investing for more information on this classic investment concept.

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