Much of what I write on this blog is targeted at fellow investment professionals. But it's never far from my mind that our ultimate clients are people who entrust us with the important task of safeguarding and growing their wealth. It bothers me that the asset management industry has started to refer to pension and endowment CIOs as asset owners. Most CIOs are just intermediaries. The real asset owners are the communities and members they serve. So while I don't spend an awful lot of time writing for the retail investor, I recognize that it's a worthy task, and I'm always impressed when someone does it clearly and honestly. A good friend recently asked me how he should be investing his money, and I thought a blog post would be helpful given his impending foray into the married life.
1) Understand the nature of financial assets. Financial assets provide streams of cash that are returned to investors at different points in time. We invest today, hoping to gain a return at some future time. There is a baffling array of financial instruments out there, of which stocks, bonds and real estate are the most common. But thinking about assets as streams of cash helps remove some of the poor thinking that often clouds personal finance. For example, a share of a company is a small claim on the company's future profits, not just a symbol on a stock exchange that miraculously goes up or down.
2) Understand the time value of money. A dollar today is almost always worth more than a dollar tomorrow because of the effects of inflation and the opportunity cost of postponing consumption. When thinking about future streams of cash, we must take this into account. It is the discounted cash flows we care about (i.e. cash flows measured in today's money), not the total cash flows. That said, investing for the long term allows us to harness the power of compounding, which helps small initial sums grow faster than we might expect.
3) Understand valuation. Thinking clearly about the nature of financial assets and the time value of money helps to provide a rudimentary framework for understanding how these assets are valued in a market. It's not uncommon to hear a naive investor say something like "I'm investing in Chinese equities because it's a fast growing economy" or "I'm invested in Apple shares because their iPhone sales are growing rapidly." Even if growth is strong, the market is already pricing in some expectations about future growth rates, profits etc. Always ask yourself, "What are other market participants pricing in?"
4) Understand cycles. Markets facilitate exchange between humans, so it's unsurprising that individual cognitive biases or broad social forces can move market prices to extremes, untethered from reality. We've seen this over and over in financial history. But these cycles present investors significant opportunities if they can strike a middle ground and retain a sense of equanimity.
5) Appreciate uncertainty & randomness. The world is a complex, inter-connected place. Financial markets are inherently volatile and unpredictable, reflecting investor psychology, industry dynamics and macroeconomic policy, among others. Unfortunately, charlatans are only too willing to claim special foresight and skill. Be skeptical of the stories people tell to explain events or their own performance.
6) Understand risk. Given cycles, uncertainty and randomness, outcomes can offer differ sharply from expectations. An appropriate investing framework should give due consideration to the fact that (a) interim fluctuations can be disconcerting, and (b) sometimes even the savviest investors are just plain wrong. Furthermore, all other things being equal, a riskier asset should be cheaper than a less risky one. This is an essential input into valuation, reflected by the discount rate (i.e. how much a future cash flow is valued in today's money).
7) Investing doesn't need to be a DIY process. But if you're hiring someone, do it right. Any adviser worth his or her salt should demonstrate a keen appreciation of the factors I've listed above. I've written several posts on the characteristics of good investors (see here, here and here, for starters). Also, meet several advisers to get a sense of pricing. It may be worth it to pony up for a skilled adviser or fund manager, but don't forget that small differences in expenses and fees add up to big bucks over the long term through the power of compounding.
8) Ask advisers how they invest personally. Any fund manager should have a sizable portion of his net worth in his own fund. A financial adviser should similarly broadly follow the tenets he espouses for his clients. If a financial adviser has a markedly different asset allocation than the one he's proposed for you, then you should be asking some hard questions.
9) Challenge your adviser, but don't make unrealistic demands. Randomness means that short-term performance says little about an adviser's skill. Furthermore, there are times when it is entirely appropriate for your adviser to underperform a benchmark. For example, if financial markets are entering uncomfortably overvalued territory (based on logical, rational metrics, rather than just story-telling), a courageous and ethical fund manager or adviser may well underperform. Conversely, if an adviser or fund manager is suggesting things that you simply don't understand, it's ok to walk away. Perhaps you won't maximize your returns, but you'll hopefully avoid catastrophes and outright fraud.
10) "Gain all you can, save all you can, give all you can." John D. Rockefeller was reportedly a fan of this dictum, typically attributed to John Wesley. While reasonable people can disagree about what constitutes "all you can", the pithy saying holds some hard truths. The process of saving and investing isn't rocket science, but it requires discipline and a willingness to ignore the social pressure of over-spending. A healthy attitude to money is cultivated through conversations with financial professionals, but even more importantly by developing a sensible world-view that recognizes the limits of material well-being. There's no doubt that we have long-term savings goals such as kids' college tuition and health care in old age to save for. But many of us will be fortunate enough to contribute to worthy causes such as fighting childhood malnutrition and disease, or building educational and health institutions in impoverished countries. In a classic case of obliquity, we are likely to be better investors by not focusing excessively on our material well-being, and accepting the uncertainty that investing brings.
I wish you all a healthy, happy 2015 (even if that's too short a period to accurately assess your well-being, not to mention investment performance).
No comments:
Post a Comment