Thursday, August 25, 2011

The New Investing Paradigm

Different Process; Different Result
Have you ever stopped to think why home-made bread tastes better than store-bought?  After all, it is the same basic recipe, so why the difference?  We know the ingredients are not exactly the same.  Store bread usually contains cheaper, lesser quality ingredients to save money, as well as preservatives to keep the bread from spoiling, and perhaps other ingredients to speed the bread-making process.  The process, itself, is different.  Most of us at home do not bake hundreds of loaves at a time.  While most kitchens have what is required to bake a loaf of bread, few vendors have the equipment to make all of the bread they sell.  There are good reasons their ingredients, and their processes are different from those we would follow at home.

Viva la Difference
Is institutional investing different from personal investing?  Should it be?  We are subject to so much marketing done by the industry that few people, I have met, see any difference.  The common questions I get are, "Why not give your money to the professionals?  How do you expect to do better when they have so much more in resources at their disposal?"

One thing I know for sure, I am going to take a lot better care of my stuff than anybody else will, period.  That is especially true of my money.  We hear so many stories of people who have lost their whole life savings because of this person, or another.  Would it have happened if they could have taken a more active role in the process?  If made aware, most of us are going to put a stop to our losses at a point which is well before everything being gone. 

The Sales Game
Have you ever been to a new car dealership and hung around the smallest car on the showroom floor?  I can tell you there are few sales people who want to spend time with you since most are hoping to land the next big deal on the "super whatever" with all of the toys.  A financial plan tailor-made for us little people is basically the same one made just for everyone else like you and me.  Let's face it, you and I get to speak to the sales people, not the decision-makers.  The sales people are compensated for how much of our money they get us to hand over, not how much they, in turn, make for us.   

Size Matters
Does a multi-million dollar corporation use different financial controls than we would use for our family finances?  I would hope so.  Most of us can see that hiring a corporate accountant to manage our household books is more than just a little over-kill.  Does a whale have different feeding habits than a minnow?  Of course.  The mistake too many people make is in thinking that personal investing should follow the rules of the institutional investors.  Large institutions follow a "buy and hold" approach because they are at the mercy of their own size.  The bottom line is the sales people in the financial services industry promote buy and hold as the only alternative because they want the sale.  I know few sales people who are going to sell one thing, and promote something entirely different.

Setting Expectations
Institutional and personal investors seek a decent return on investment.  Until they lump a whole lot of smaller accounts into larger accounts, the big institutions can't afford us.  It is not cost-effective for them to treat every investment, and every account differently.  They want to make a good return, and earn a revenue stream from charging fees to cover as many of their expenses as they can.  They want us to believe normal returns are in the mid-single digits, that the game is terribly complicated, and also, that a huge investment of time and resources is necessary (to justify their fees).

A New Paradigm
I believe the investing paradigm is changing.  In the beginning, the game was entirely broker-centric.  The broker controlled the flow of information and money.  Everything was done through them.  Then, when the internet provided unprecedented access to information, the process became somewhat automated by the application of computer and networking technology.  The problem with today's model is bigger is less effective than smaller.  Too big to fail is an invention of the owners of the means of finance, meant to serve themselves and their wealthy clients.  Large industrial companies, and technology companies that grow too large in physical size can't withstand the pressure brought about by the application of technology to global markets.  You may be reading it here first, but I am saying a new future of personal investing is beginning with you and I, today.  We can outperform the large institutions if we don't try to beat them at their own game, and if we don't continue to blindly follow the rules they create for us.  We have the technology, we have control of our own money, we have access to all the tools, and we can learn to use and improve our own ability.  The last thing we should do is to want to be just like them.

"Buy and Hold" hasn't worked in the last decade.  I can't predict if market conditions are going to favour a buy and hold approach over the next couple of decades.  Are you willing to risk your future and take that chance?

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