May 27, 2013

• Sometimes the right answer is boring.

  JDN 2456440 EDT 11:26.

   

  I found The Investment Answer by Daniel Goldie and Gordon Murray in a rack of free books, and the little softcover is only 70 pages long, so I figured I may as well read it.
  I was not disappointed; the book is a concisely written and easily accessible introduction to behavioral finance for anyone who is looking to invest in stocks and bonds. Its answers are rather banal: Buy low, sell high; don’t trust your gut, use careful analysis; invest in a diversified mix of stocks and bonds; avoid trendy new investments with unclear risks; don’t try to game the system, just ride the market.

  All of these are far less exciting than the people telling you to buy this one thing—hedge funds, gold, whatever it may be—and become a millionaire overnight. Yet, they are far more likely to actually work. Passive fundamental value investing is the one strategy that really does work consistently. It doesn’t produce enormous, exciting gains; but it also doesn’t produce enormous, painful losses either. (Warren Buffett is actually sort of a passive fundamental value investor, though the alchemy he works with markets is one that I don’t think anyone but he understands.)

  Goldie and Murray are too enamored of the so-called “efficient market hypothesis” (which, if you read its assertions carefully, is clearly just the unpredictable market hypothesis) for my taste; but they make use of it in a mainstream neoclassical way that’s hard for me to object to all that much. Their basic message is: Don’t try to be clever, don’t try to become a millionaire overnight, just buy into companies that you expect to make profits so that you can get a share of those profits.

  They try to point out the difference between investment and speculation, which is certainly important; but their explanation leaves much to be desired.
  Here’s how I would put it:

  Investment is when you buy something that makes people better at making things. You can do that indirectly through multiple steps; but ultimately it must be making someone better at making things. A crane is investment. A college education is investment. A bridge is investment. Buying stock can be an investment, if the money goes to the company and is used to finance such purchases to grow the business. Investment is nonzero-sum; it is a game that everyone can win. Buying bonds usually is an investment, because the government will spend it on things like education and infrastructure.

  Speculation is when you buy something in the hopes of selling it to someone else later for more money. Commodities, gambling, high-frequency trading, currency trading, and most hedge fund strategies are speculation. Speculation is zero-sum; someone always wins and someone else always loses.

  The problem is that most of what we call “investing” is really speculation. Those “investors” on Wall Street are really just speculators. The “trades” they make are really a sophisticated way of tricking people into giving them money. “Isn’t that just capitalism?” No. Not at all, in fact. The whole point of capitalism is investment; the goal of capitalism (which admittedly it does not always succeed at) is not to decide who gets the stuff, but to make more stuff, so that everyone can have some.

  Perhaps the easiest well to tell a true investor from a speculator is to look at the time horizon of their trades. Warren Buffett makes a few trades per year. This makes sense; over a period of months or years, a company can actually change enough that you would want to reconsider whether you’ve invested in it. Meanwhile, there are high-frequency trading algorithms on Wall Street that trade in microseconds. Stiglitz proposed the extremely reasonable idea that we limit trades to seconds, but Wall Street would not have it. I don’t think I really need to explain why a company obviously can’t have changed its real profitability in a millionth of a second. I’m sure Goldie and Murray would agree.

  There is one glaring omission from The Investment Answer however: No mention whatsoever of ethical investment. The entire book is about how to make more money in markets, and it explains quite well how to do that. But it never asks the fundamental question: How are we making money? Where is this value coming from?

  And I’ll admit, these are by no means easy questions. Sweatshops abuse their workers; but at the same time, they provide desperately-needed jobs in poor countries. Buying American goods will reduce our trade deficit; but it might also hurt everyone, if it ignores comparative advantage.

  The most die-hard neoclassical capitalists (which Goldie and Murray may well be) would say we should just act in our own self-interest and let the Invisible Hand play itself out. But this of course is easy to say for the rich White American males who have the power; yes, let it play itself out, in such a way that just so happens to benefit me enormously and allow millions of other people to suffer. There are simply too many externalities to take the Invisible Hand seriously; what I do affects you, and as such I must consider your interests as well as my own.

  Fortunately, ethical investment is something that Bill Gates and Warren Buffett do understand (and they clearly have no trouble making money either!), so I’m kind of hoping they’ll write books about it someday.

  • 11:59 am
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