After the last 72 hours, it might be worth taking a few minutes to reflect on why we should even bother to risk the hazards of equity markets – because it can be easy to come up with reasons not to. We all know that neither humans nor markets are rational entities and we all know the folly of arguing with fools and knaves. Events that “cannot happen” do so with regular frequency and beg the question of, “Why bother?”
Well, though it hasn’t been so obvious recently, the most important reason is inflation. As Warren Buffett likes to point out, a dollar he earned 75 years ago only has the purchasing power of a dime today. With lifespans getting longer the value of hard-earned savings can become worth less over time, putting your lifestyle at risk. So at a bare minimum, we need to earn enough on our savings to avoid an erosion of purchasing power. Over meaningful periods of time returns on equities have proven to be one of the best ways to beat inflation. Just ask anybody who decided ten years ago to count on bonds to fund their retirement.
Now, a long time ago in a galaxy far, far away, this is what having a savings account in a bank was all about. You deposited the excess of your earnings with a bank, or that nostalgic entity, a Savings and Loan. Their job was to do due diligence identifying new and existing opportunities, mostly local, in which to invest the pooled savings of their customers. The bank’s depositors, in turn, were paid interest on the money entrusted to the bank, thereby, linking their savings to the profits of the bank and its investments (mostly loans). This was the best option for most people because it was safe, easy and much less expensive and risky than trying to trade individual stocks. And bank savings account weren’t much impacted by events like election outcomes.
As an example, the most visible use of bank deposits at one time was for home mortgages. But as reported last week in the Wall Street Journal (link below), for the first time in over 30 years, banks provided less than half of all mortgage loans. Add to this the challenges faced by banks in conforming to the many “new rules” established in the aftermath of the economic crisis in 2008-2009, and the ways in which financial institutions can invest their customer’s savings has been diminished. Today asset managers like Blackrock and Vanguard, mutual funds and exchange-traded funds are perceived as viable alternatives for individuals to invest their savings.
All of which brings us back around to the debate of active versus passive investing. Putting money in the bank is passive. And a recent Buttonwood column in The Economist (link below) demonstrates again that for most people, passive is the better option when choosing asset managers. In the on-going debate over exchange-traded funds versus mutual funds, here is another example of how the fees being charged by mutual funds can hurt the typical investor. While it has been suggested here at Invest-Notes that investing is about using your money to make money, Buttonwood offers a more nuanced definition of what long-term investing can achieve, or lose, based on something as basic as the cost of stock ownership.
So we should invest for a couple of logical reasons: to stay ahead of consumer price inflation, and to put money to work multiplying itself for our future benefit. Always remember, spend less than you make, and save the rest somewhere you will be least likely to overreact to unexpected events. Frankly, nobody has a clue what’s coming next, and knee-jerk responses to surprises, fear, politics, or the latest prognostication from pundits will only ensure you have an effective way of failing to achieve your financial goals.