At first blush, time-honoured investment principles and the principles to be applied in getting good legal outcomes seem worlds apart. But after practicing law for eighteen years, and observing the financial markets, I have seen many parallels that run between the two.
The principles I touch on have been established by the greats, such as Warren Buffett (Berkshire Hathaway), Barbara Corcoran (real estate, and Shark Tank fame), Ray Dalio (Bridgewater Associates), George Soros (Soros Fund Management), Jim Simons (Renaissance Technologies) and others.
Although these great investors do not share the same methods, styles or work in the same markets, they do share common principles that are adaptable across a range of disciplines.
Harnessing successful principles from disciplines other than law provides an opportunity to shape better outcomes by looking through different paradigms. Rather than reinventing the wheel, adopt proven principles to make good decisions in complex situations.
Compound interest – the eighth wonder of the world
What Albert Einstein famously described as the eighth wonder of the world, compound interest is a game changer. Think about it like this, interest on interest is "free money" – an investor who earns a compounding return of 8% per year will double their capital every nine years, rather than 12.5 years for a non-compounding return. A 10% compounding return will double capital every seven years, rather than ten years for a non-compounding return.
This is a game-changer because it demonstrates how strong business decisions can have an exponential impact without added burden.
Strong businesses have strong foundations. These foundations are the product of many decisions, many small and some profound, which compound into building and maintaining a competitive advantage over time. The foundations of the business are made of steel. The same can be said about success in litigation. For example, strong underlying merits, front-end legal advice, clear well-drafted pleadings, foresight around how to prove an evidentiary case, and utilising the art of court-craft to present the evidence and law persuasively all lead to exponentially better results. While each small part may not seem important, dozens of well-executed decisions compound to generate an excellent result. If one or more of the elements is missing the results pull back to average.
Cover the downside – buy insurance
In the spirit of working smarter rather than harder, insurance is key to celebrating problems avoided rather than problems solved. Often we wonder whether insurance is really worth it, but for professional investors, it is the necessary cost of low risk business.
For example, an investor who spends $100 million on company shares betting they will go up has a lot to lose if they go down. The investor will typically "hedge" their position by shorting the same stock (essentially, a trading strategy using leverage that bets the value of the shares will go down) so that if the investor is wrong, the downside is covered at an acceptable price. This is a form of insurance bought because wise investors know the future is uncertain. However confident one is of an outcome, the opposite is always possible. An 80% chance of success still involves a 20% chance of failure, which can't be dismissed with a wave of the hand.
Smart businesses buy insurance, whether for land or buildings, the use of auditing systems or use of subject matter professionals. In litigation, well thought through offers of compromise that take into account the right reference points can be worth millions. The same goes for obtaining award and enterprise agreement audit compliance advice. The cost of obtaining advice is trivial compared to the financial and non-financial costs of making wrong assumptions or failing to stress test decisions around compliance. For example, we recently provided advice for a major employer on compliance with eight different modern awards and three separate enterprise agreements. Whilst the exercise was considered costly by some, this was a smart decision as they have six separate lines of business, thousands of staff and hundreds of different roles, meaning a wrong assumption or decision can multiply on the downside before even considering the cost of reputational damage.
Another way to think about it is the front-end insurance or advice can save many multiples of its cost. Hypothetically, say front end advice or insurance costs $20k but the cost of an underpayment issue can easily reach $5m – factoring in Regulator investigations, legal costs and penalties. That is a 24,900% return on investment (ROI). Plus, insurance (such as legal costs) is a deductible tax expense, meaning the $20k turns into $12.8k "out of pocket", lifting the ROI to 38,962%. Buying that insurance is a great decision delivering an outstanding ROI.
Ignore sunk cost
A sunk cost is one that cannot be recovered or changed, and is independent of any future costs a business may incur. If you are deciding whether to start operating a mine, the only thing that matters is whether future cash flows will exceed the costs incurred from starting to operate the mine today. Past costs incurred are irrelevant – you can't get them back whether you start operating the mine or not. The same is often true in litigation. Deciding whether to keep investing in litigation depends on the return being sought (financial and non-financial) relative to the costs incurred from today. Particularly in a limited costs jurisdiction, sunk costs can rarely, if ever, be recovered and must be discounted from analysis. This is often a mistake that plaintiffs make – to keep doubling down and incurring additional costs long after litigation has become uneconomic.
Invest in what you know
The great Charlie Munger (the less well-known business partner of Warren Buffett) said, "Knowing that you don't know is more useful than being brilliant". Many investors fall into the trap of investing in things they do not understand or letting persuasive salespeople sell them a product without understanding the product or the risks involved. Professional investors avoid risk by knowing their circle of competence and staying inside it.
When it comes to legal services, it changes from "invest in what you know" to "invest in specialists that know how to solve the problem you are confronting". In doing so, depth of expertise, track record, trust and client referrals based on personal experience are all relevant to making that decision.
Don't worry about day-to-day market movements – it's the trajectory that matters
Successful investors know that to manage capital, first you need to manage your emotions. When the market moves against you in the short term, you should not react negatively. In fact, if you are convinced the market is wrong and you are right, double down on your investment. Investors like Ray Dalio and George Soros have made billions backing themselves against the consensus view of a company, commodity or currency, which is always baked into its price.
The same is true in litigation. Typically, short term wins or losses in litigation don't end up having decisive significance to the outcome, so you should not attach emotion to them. It is the underlying merits of the case, well prosecuted, that matter. Even an ultimately negative outcome, which is not based on foundational principles, can usually be corrected on appeal. As Ray Dalio says "a system optimises for the whole". This is true for the legal system – one small part of the system may not work, or may not work on some occasions, but overall it does work well.
Judgement is the decisive skill
According to investor Naval Ravikant, no amount of glossy brochures, sophisticated sales, or talk about "smart money piling in" will ever make the underlying fundamentals of an investment any better. Neither will supposed links to successful business people as have been seen in recent scams perpetrated through social media such as Instagram. Same goes for litigation and executing legally sound commercial decisions. No amount of street smarts, technical legal expertise, hard work or court-craft will ever be able to trump the ability to triage all of that information and make a wise outcome focussed decision considering all factors. There is no substitute for good front end decisions. Judgement, above all else, is the decisive skill.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.