In 1900, the Michelin brothers, founders of the eponymous French tire company, created a guidebook for hotels to provide car owners in France. At the time only 3,000 French citizens owned cars, and this genius insight of the Michelin brothers helped those drivers put more mileage on their automobiles (and, of course, their tires). In 1926, Michelin began awarding stars to restaurants – one star is considered “very good in its category,” two stars is “worth a detour” while traveling, and three stars denotes the restaurant “worth a special journey.” There are currently 2,956 one-star restaurants, 489 two-stars, and an elite 147 currently hold three Michelin stars.[i] What started as an incentive to wear down tires has become the envy of restauranteurs across the globe.
Or is it?
Here is The Economist on “the curse of the Michelin star:”[ii]
A Michelin star boosts publicity: the study found that Google search intensity rose by over a third for newly starred restaurants. But that fame comes at a price. First, Mr. Sands argues, the restaurants’ customers change. Being in the limelight raises diners’ expectations and brings in tourists from farther away. Meeting guests’ greater demands piles on new costs. Second, the award puts a star-shaped target on the restaurants’ back. Businesses they deal with, such as ingredient suppliers and landlords, use the opportunity to charge more. Chefs, too, want their salaries to reflect the accolade and are more likely to be poached by competitors.
If you speak with a restauranteur about his goals, he will probably tell you all sorts of things – perhaps expanding to a new market, or creating a unique dish, or opening a new concept, or whatever else. But I suspect they all distill to a singular objective – to make money. New markets, concepts, dishes… it’s all driven by the same profit motive animating every market participant. At first glance, it seems earning a Michelin star would be a catalyst for a long and profitable future but there is some tension between making money and earning a Michelin star as catalogued in the quote from The Economist above.
I do not know why an aspiring restauranteur would seek my consultation, but if one did I would advise him to define his long-term objective at the outset and orient every decision in that direction. If his objective is profitability then shrewdly negotiating his commercial property lease or mitigating staff turnover may be more impactful (albeit less prestigious) than earning a Michelin star.
Hidden costs are everywhere.
One can use the financial markets to invest or to make bets. Tragically, many believe they are doing one when they are doing the other, but that is a story for another time. For now, we contend if you are going to use the markets to make a bet (we do not recommend doing so, but some cannot resist), you must define your objective ahead of time. If you make a bet without defining your objective and your bet pays off, you will find yourself in a pickle.* What do you do now? This is the pickle people who bought Nvidia last year find themselves in. There is little more difficult than taking profits on a position you have a financial and emotional tie to. The financial tie is obvious – you made a lot of money. Fewer acknowledge the emotional tie – though it’s always there – that winning position makes you look and feel smart. If you don’t sell and the position declines, you will forever be anchored to the high number. An example – say your $10,000 investment is a ten-bagger and grows to $100,000 then experiences a 50% decline down to $50,000. The math says you have 400% gain ($10K to $50K), but it will only ever feel like a 50% loss ($100K to $50K). You don’t feel the pleasure of a 5x gain on your original investment, you feel the pain of a 5x loss of your original investment. On the outside looking in it appears ridiculous someone would lament a 5x gain. But I am telling you this is how it works. This is a hidden cost of investing.
There is an old aphorism that goes something like there are three frogs on a lily pad and one decides to jump off. How many frogs remain on the lily pad?
The answer is three. Deciding and acting are two different things.
Here is the investor’s variation of the lily pad proverb:
There are two investors, one achieves a remarkable 100% return this year while the other achieves a pedestrian 10%. Who is richer in 30 years?
The answer is the one that earned 10% this year. His strategy is likely repeatable and probably doesn’t incur too much risk. An investor who doubles his money in one year is a speculator who loaded up on risk and will eventually get wiped out. No one earns 100% returns with any frequency or repeatability. $100K compounding at 10% for 30 years grows to ~$1,750,000. Very respectable. $100K compounding at 100% for 30 years grows to $107,374,182,400,000. That’s $107 trillion. That number is roughly double the market capitalization of the entire US stock market. So, I mean, sure. Mathematically, $107 trillion. But practically – over the long run – $0. After 30 years the investor who earned 10% in the first year is wealthier than the investor who earned 100% because:
$1,750,000 > $0.
One of the most difficult aspects of our role as financial advisors is encouraging people to take chips off the table. They made a bet on a stock or cryptocurrency, and it paid off handsomely. Now they have more money than they ever expected but are also exposed to a new set of risks. Any individual position that has experienced massive gains has the potential to experience massive losses. Note this is quite different from the risks of a diversified portfolio, which will inevitably sustain losses but not catastrophically so. There are plenty of reasons a single stock position can experience a permanent decline (loss of competitive advantage, lawsuits, regulatory changes, geopolitics, creative destruction, etc.) but only a few that could cause such a decline in a diversified portfolio (nuclear holocaust, earth destroying asteroid, resurgence of bubonic plague). A situation creating a catastrophic loss in a diversified portfolio is one in which your portfolio would be your least concern. Imagine a Tyrannosaurus Rex worrying where he’ll find his next meal as the asteroids begin impacting.
There are all sorts of risk management strategies for investors with substantially appreciated positions. You can sell the whole position, eat the taxes, and sail happily off into the sunset. That’s the easy button. You can set a limit sell order at identified prices. For instance, if you own a stock currently trading at $100/share, you can place a limit sell order at $90. This way you participate in future upside but limit your losses to 10% of the current price.** There are some options strategies you can employ, though you ought to be careful of the costs these incur. You can also do the highly technical strategy of going halfsies (sell half the position – hat tip Meb Faber for the jargon).
If you find yourself with a highly appreciated position, the bad news is you may find yourself in a pickle. You discovered the hidden cost to success in investing. You can either pay in discipline (execute your – ideally predetermined – sell discipline) or in disappointment (ride the position back down).
The cost may be hidden.
But it must be paid.
Sean Cawley, CFP®
*In a pickle is a funny phrase. It turns out the origins date back to the mid-16th century suggesting finding oneself immersed in a challenging situation much like a cucumber may find itself immersed in brine. Although Shakespeare later popularized the phrase to refer to one being inebriated in The Tempest – “how cam’st thou in a pickle.” I use it here in the non-Shakespearean sense. Come for the investing knowledge, stay for the idiom lessons.
**There is no guarantee of execution with a limit order. To guarantee execution you will need a stop order, though you may not get the price you hope for.
[i]https://guide.michelin.com/us/en/restaurants
[ii]https://www.economist.com/business/2024/09/24/the-curse-of-the-michelin-star