Has Investing Become a Necessary Life Skill?
A Book Review of “Investment: A History”
Historians have a tough job. With so much of our past documented, analyzed and taught to us, new insights seem increasingly hard to uncover. But some still do, often finding important lessons to modern day. “Investment: A History” is just such a read.
Why would a “history of investment” be so remarkable? Because most of us, whether we recognize it or not, have become investors. Over the past century a massive shift in ownership and economic distribution has occurred. While at the same time not only has the family budget become more complex, we have also been asked to take responsibility for our retirement (e.g., the rise of 401k’s and IRA’s). Investing is no longer a hobby for the rich. Instead it is a task we must all perform. Understanding how investing evolved — how we reached this point — can help us in our new role.
In the Beginning there was professional Investment Management. Professional investment management has been with us since the early days, starting with Mesopotamia (aka the “Cradle of Civilization”). Once considered low work, and often performed by slaves, owners could delegate investment management to those with skill. A few millennia later Greek and Roman societies pursued a similar path. By the Renaissance period, when the first joint stock companies appeared, the course of history was changed and path set towards distributed ownership.
Investing became our collective destiny.
From a few hundred to now hundreds of millions of investors, stock ownership and investment is commonplace. Indeed, many of us decide to purchase tiny fractions of companies each year when we select to contribute into our employer’s retirement plan. We are part of a living history of investment.
This shift transformed a once-cottage industry. Investing is now a very big business, and growing. Only a generation ago, in the mid 1970’s, managed retirement assets totaled $370 Billon. Today that number is $24 Trillion, with $7T in individual retirement accounts (“IRA’s”) alone. With so much money flooding in, a new market for professional money management followed. Those who could invest and manage money on behalf of others stood to earn unprecedented rewards.
Economic “Master’s of the Universe.” Economies of scale are a part of all businesses, and investment management is no exception. As the industry grew to trillions of dollars, money managers who charged only a percentage or two earned increasingly larger sums. The benchmark “2 and 20” expense structure of alternative money managers (2% annual fee in addition to 20% of the profits) was an even more rewarding arrangement. Today’s top hedge fund managers can earn over a billion dollars a year.
Against this almost unimaginable level of compensation, the authors of “Investment: A History” point to a countervailing trend, namely the rise of index funds and exchange traded funds (“ETFs”). As the economic rewards to money managers attracted thousands of professionals, the market matured. The rules changed. Market inefficiencies became much harder to find, and less profit to be found. Much like the old Mad Magazine “Spy vs. Spy,” pitting one super agent against another, today’s market is one of a (highly compensated) professional investor competing against another. “Mistakes” (i.e., mis-priced assets) are now not only uncommon, but also short-lived.
The rise of the machines. As the “easy” trades of the 1960’s and ‘70’s disappeared, the strategy for “beating” the market shifted. Costs for managing, buying and selling investments became the largest determinant to success — beating a market benchmark. Many academics, researchers and investors instead focused on maximizing investment returns through minimizing expenses. Machine algorithms now manage market portfolios worth trillions of dollars, often using a tax-efficient “buy and hold” strategy, trading only to re-balance as necessary. Vanguard’s meteoric climb to become the world’s largest provider of mutual funds is a direct result of this investment strategy shift.
Around the time index funds were introduced, another financial product category was created: private equity. Commonly known as “alts,” this category typically includes hedge funds, leverage buyouts and venture capital, to name the most familiar. Similar to other financial innovation, these financial services pioneers generated significant financial returns for the “average,” early player.
However, over time the easy wins within private equity attracted more competitors. More competitors entering the market meant lower returns for everyone. In effect, the private equity industry matured. Similar to the public stock and bond markets, private equity professionals now play against one another and as a result, “the average fund is no longer outperforming [even the] basic market.”
The next phase of investment history: the individual. As the authors conclude, the financial windfalls awarded to early movers — the entrepreneurs of active trading and, later, private equity — are coming to a close. Investment manager compensation is under pressure. The rules have changed. Alternatives in particular — again, hedge funds, private equity and venture capital — are being pitched to a broader set of investors while at the same time industry returns are falling.
The authors’ prescription, no surprise, is an appeal for greater investor education. Yet modern day investing has grown more complex, while at the same time “we have yet to solve how we can properly align the incentives of investment managers and their clients, or more accurately, find an investment advisor willing and able to take on such a responsibility.”
This creates a conundrum. As the authors stress, the requirements for investing “are not yet fully understood or accepted by most of us….[and] are often too risky or too conservative at precisely the wrong times.” [Italics the authors]. Perhaps technology will enable scalable solutions through robo-advisors and chatbots, personalizing while sufficiently compensating the investment industry.
Good history tells a story. “Investment: A History” tells the story of investment as a “fundamental human enterprise.” The decision of how and where to invest resources has always been with us, and yet in today’s society is more important than ever before. Investing, the authors write, is just as necessary as “diet, health, physical health and cultural aspirations.” They hope we give it just as much of our attention.
Thanks for reading.
I’ve written on Money, Investing, Healthcare, Nutrition, Behavior, and other (mostly) related topics, more on Medium, LinkedIn, and Quora. After the HelloWallet sale to Morningstar we built a digital platform, HSA Coach, that combines this acquired book-knowledge into user-friendly financial guidance. We are particularly focused on incorporating Health Savings Accounts into a saver’s broader investment portfolio, with some personalized calculators to allocate between your HSA and 401(k). More coming. Available for free in the App Store and Google Play.
As always, comments and reading suggestions on this and other topics welcome.
