Principal Investing

Principal Investing is the art of putting your own money where your mouth is. It occurs when a financial firm, like an investment bank or a fund, invests its own capital directly into an asset—be it a company, real estate, or stocks—rather than acting as a broker or advisor for a client. Think of it like a real estate agent who, instead of just earning a commission by helping others buy and sell houses, finds a gem of a property and buys it for herself. She bears all the risk if the property value drops, but she also reaps all the rewards if it soars. This direct financial stake is the defining feature. In principal investing, the firm isn't earning a fee for a service; it's aiming for a direct profit from the investment's performance, such as capital gains or dividends. It’s the ultimate expression of conviction, as the investor has direct skin in the game.

The core philosophy behind principal investing is the powerful alignment of interests it creates. When investors use their own money, their success is tied directly to the performance of the asset. There's no hiding behind a recommendation or a commission-based sale. This simple fact helps solve one of finance's most persistent headaches: the agency problem. An agency problem arises when an agent (like a financial advisor) is supposed to act in the best interest of a principal (the client), but is motivated by self-interest instead. For example, an advisor might push a mutual fund with high fees because it pays them a bigger commission, not because it's the best option for the client. This is a classic conflict of interest. Principal investing cuts through this noise. The investor is the principal. Their only goal is to maximize the return on their own capital. This is exactly why the value investing philosophy loves to see company executives with large personal holdings in their own stock. It’s a sign that management’s interests are aligned with those of the shareholders. They’ll think like owners because, well, they are owners.

Principal investing isn't a niche strategy; it’s the primary business model for some of the most powerful players in finance.

• Private Equity (PE) and Venture Capital (VC) Firms: This is the natural habitat of the principal investor. While private equity and venture capital firms raise the majority of their funds from outside investors (called limited partners, or LPs), the firm’s managers (the general partner, or GP) are almost always required to invest a substantial amount of their own money into the fund. This “GP commit” signals to the LPs that the managers have strong conviction in their own investment strategy.
• Investment Banks and Proprietary Trading: Historically, large investment banks operated proprietary trading desks (or “prop desks”) that traded the bank's own money for profit. This became controversial after the 2008 financial crisis, as it was seen as excessively risky. In the United States, the Volcker Rule, a key piece of the Dodd-Frank Act, was enacted to sharply curtail the ability of deposit-taking banks to engage in most forms of proprietary trading to protect the broader financial system.
• Conglomerates and Holding Companies: A company like Warren Buffett's Berkshire Hathaway is essentially a giant principal investing vehicle. It uses its own capital—and the “float” from its insurance businesses—to buy entire companies or large stakes in public stocks. Buffett isn't advising others; he's deploying Berkshire's capital directly.
• You, the Individual Investor: That's right! Every time you research a company and decide to buy its stock with your own savings, you are a principal investor. You are putting your capital at risk in the hopes of a future return, with your success or failure resting entirely on your own decisions.

For the ordinary investor, “principal investing” is more than just a definition; it's a powerful lens through which to view the entire investment world. The key takeaway is to always follow the incentives. When you consider an investment, ask yourself: who has skin in the game?

1. When evaluating a mutual fund, look up whether the fund manager personally invests a significant sum in their own fund. A manager who “eats their own cooking” is more likely to be a careful steward of your capital.
2. When analyzing a stock, check the company's proxy statement for insider ownership. Do the CEO and the board own a meaningful number of shares? If they do, their financial well-being is tied to yours as a fellow shareholder.

Principal investing embodies the spirit of accountability that is central to value investing. It's about taking ownership of your decisions, bearing the risks, and hopefully, enjoying the rewards that come from sound judgment and patient capital.