My Role
To Prudently Allocate Your Savings
You may believe that the role of your investment advisor is to make you wealthy, or to handily and regularly outperform market benchmarks, or to have clairvoyant views about the global economy and interest rates, or even to be able to tell the future and your fortune with a crystal ball. I believe, however - and reliable studies conclude - that an advisor cannot do these things with any consistency, and I therefore don’t believe they are appropriate for me to promise you.
I believe that the proper role of an investment advisor is to facilitate investment of a client’s savings into global capital markets in proportions appropriate for the client’s circumstances. And the returns and risks that a client can reasonably expect are the returns and risks of the capital markets themselves.
To understand why this is the case, let’s take a moment to understand the basic purpose of capitalism itself. Capitalism is a system whereby projects are undertaken through the combination of several key ingredients, including:
ü Ideas and inventions, provided by company founders and compensated through ownership. Successful ideas and inventions are very rare, and returns to founding owners of successful ventures are, on average, very high.
ü Management, provided by highly skilled workers and compensated through payroll and sometimes, fractional ownership. Management is not a commodity, and returns to managers are, on average, high.
ü Labor, provided by workers and compensated through payroll. Labor can be commodity-like, and returns to labor (especially unskilled labor) are, on average, very modest.
ü Resources, provided by suppliers and vendors and compensated through sales. Most resources are subject to competitive market supply, and returns to resource suppliers are, on average, modest.
ü Finances, provided by investors and compensated through interest payments or a share of profits. Finances are commodity-like (indeed, money is the essence of a commodity), and returns to investors range from modest to above average.
Clearly, the best way to become extraordinarily wealthy is to start a successful business. Still, over time financial investment can earn decent returns, and most importantly, it can do so without requiring your physical participation, unlike the other forms of capital. For this reason, it is the form of capital most appropriate for supporting retirement.
If you have savings – capital in excess of your basic needs - then you are well positioned to become an investor, a provider of finances to projects. Projects generally have two major ways to raise financial capital, by issuing either bonds (i.e., obtaining loans) or stock (i.e., admitting shareholders). As a bondholder, or lender of capital, you own a contract to receive regular payments and a return of your capital, and your investment is therefore generally less risky. As a shareholder, or an owner of profits, you have a right to any remaining profits from the project after other capital contributors (employees, vendors, and lenders) have been paid. Accordingly, while the potential profits to shareholders from a project may be significant, the risk of their investments not being repaid is also higher. For these reasons, the single most important financial decision that you and your advisor make is the amount of your savings devoted to cash investments and bond investments, and the amount devoted to stock investments.
The expectation of the average investor, therefore, should not be to get wealthy, or foretell the performance of the global economy, or predict the direction of interest rates, or outperform other investors. It is instead to be compensated appropriately for the level of risk assumed with investments – often an amount referred to as a project’s cost of capital. And in most cases, a bondholder can expect to be compensated, over the long term, at 5% or so on average annually, and a stockholder can expect to be compensated at 10% or so on average annually, because over time, these are average costs to raise financial capital from investors for large-scale public projects.
Notice that I say “on average”: in any given year an investment will have a return that deviates, sometimes significantly, either up or down, from its long term expected return, and for that reason, to receive the expected return from an investment requires sticking with the investment over the long term. Notice also that I say “public projects”: non-public projects, such as a brand new company with a new invention, may have higher capital costs, and therefore both greater risk of total loss of capital and higher expected returns.
Investors who expect an investment advisor to provide overall portfolio returns far in excess of these general expectations for public projects do not recognize the process of modern market capitalism and their role in it. Moreover, investors who believe the fictions told by stockbrokers, fund promoters, the financial press, “trading gurus”, and other purveyors of investment pornography may not recognize that they are targets of a process designed to win their business through a form of deception (i.e., the promise of extraordinary riches and wealth). And far too many people have bad – and sometimes catastrophic – investment experiences by following such purveyors of unreasonable expectations.
The good news is that you do not need a crystal ball to be a good investor and to have a positive investment experience. Our public financial capital markets are remarkable mechanisms for moving capital from savers to borrowers; from those with money to those with ideas; from cash to projects; and each day these markets produce – for the most part, because they are public - reasonably fair prices for the securities exchanged. As a result, you too can reasonably expect that over time your investment in a diversified class of assets will be compensated at a fair rate.
It may be enticing to be promised far more than a fair rate of return, and that is what many purveyors of financial products and advice would like you to believe. But what often ends up happening to clients who are enticed by such promises, is just the opposite: they earn far less than a fair rate of return, sometimes with disastrous consequences for an investor’s life plans.
We can allocate your savings in many different permutations of risk and reward. For example, if your savings are modest and you want them to grow, we can allocate them so that they have the potential (though not the certainty) to grow at an above-average rate, though they will incur above-average risk too. If your savings are significant, and you are wealthy by society’s standards, and you wish to remain wealthy, we can allocate them so that they can both grow at a fair rate and avoid unnecessary risk. If you have a retirement “nest egg”, we can allocate it so that a certain portion is set aside in very stable cash investments to consistently meet your living needs, almost as if you are receiving a regular paycheck from your account.
But please understand: I will not make you rich overnight, nor is that my job. Preserving and reasonably enhancing your capital, mostly through its investment in diverse public capital markets, is my job.