Good Investors Make Money. Great Investors Create Value. | Mihir Desai | Big Think

So I’ve been concerned because finance has become demonized in the last several years and decade or two. And in part it’s for good reason, which is the practice of finance in many ways is broken. We see a lot of activity that is value extracting as opposed to value creating, and that is really disturbing. And, you know, that’s not just the financial crisis, but we see it in various parts of finance: in asset management to some degree, in banking, and so it is really worrisome that A: people have such a terrible impression of finance, and B: that we sometimes live up to it.

But the truth is that we can’t live without finance and we need to rehabilitate finance. And the reason we can’t is because it is so central to the modern economy. So I think even people who are really upset about finance have to acknowledge that it’s really central, and we have to make it better. It is the fundamental mechanism by which companies grow, we save, we allow ourselves to potentially borrow to go to college, we save for our retirement.

And innovation in general has to be funded. So finance is really central. What we have to try to figure out is how and why it's become so extractive as opposed to creating value. How do you know whether you’re creating value, and what is the recipe for creating value? So that sounds very finance-y. In fact, I use The Parable of the Talents, which is a very odd parable from the bible, a very harsh parable in the bible, which effectively captures the logic of value creation straight out of a finance textbook. By that I mean it tells the story of these three servants, two of whom actually use what they’re given well and one of whom buries his talents.

People don’t often know that the word talent is actually historically money. It is now—the modern notion is what we now think of as an ability. But the neat thing about that story is it maps to the basic recipe for value creation and finance which is, just to be a little technical, you know, you beat your cost to capital. You surpass people’s expectations. You do it for a very long period of time and you continue to grow.

So that’s how companies create value. That little recipe for value creation, I show is exactly what is in The Parable of the Talents. And, in fact, John Wesley Mitchell, who is the founder of Methodism, in his essay on The Parable of the Talents, basically says almost the exact recipe for value creation that kind of comes out of a textbook which is, you know, beat your cost to capital, which is a way of saying: give back more than you take as long as you can to as many people as you can, and so on and so forth. So it’s actually kind of neat in the sense that The Parable of the Talents, that recipe for value creation, actually maps to the recipe for a reasonably good life.

So that’s one example, but there’s like the book is littered with kind of basically examples like that. So one of the mechanisms by which finance has kind of gone wrong is they’ve made it more complex than it needs to be. And so what I try to do in the book is tell these stories from literature and philosophy and history that actually make the ideas really quite intuitive.

So ideally you take a look at the book and you kind of get a host of ideas, the core ideas of finance but just by reading stories. And I think that’s a much more powerful way for people to understand finance. And in that process of demystification what I hope will happen is people will feel empowered, you know. They’ll understand what finance is. They’ll understand what finance is doing and so they’ll A: be more appreciative of the underlying functions even if it is broken today. But also feel more empowered to talk about it and think about it and confront people when they’re faced with it.

There are a bunch of different ideas that are kind of core to finance. The most important one is risk and insurance which is just to really try to understand the omnipresence of risk and then to think about how all the kinds of things that pay off in life, really the way they’re pri...