A friend of mine owns a water sports business and had a few hundred thousand in savings which he gave to a financial advisor who put him in the capital markets (stock market).
After six months he was unimpressed with the returns, so he liquidated the investments and bought a new boat for his business. He makes money by chartering it.
Two years later the boat has paid itself off and everything being made now is dividend/profit. Of course, the boat could sink, but risk should be measured as a variable of our personal knowledge and expertise. My friend knows the risks well and if the boat sank he would make a plan. This is what financial planning is all about.
As a new client to a financial advisor or maybe to a Robo-advisor, we must answer a list of questions which will help in choosing our most appropriate investments. The output is usually a complex allocation of stocks and bonds with very specific percentage recommendations across all sorts of asset classes (Large Cap Core, Mid Cap Growth, Small Cap, Emerging Markets, International, Municipal Bond, Treasuries etc etc.). Very few really understand what these mean beyond their superficial definition.
Essentially these algorithms ask our age, income, and attitude toward risk. And from that the appropriate investments are chosen. I’m all for Occam’s razor, but we are complex beings.
The first failing of the traditional questionnaire is there is an investment solution in the capital markets for anyone who has some extra money in the bank, or for anyone thinking forward to retirement.
Capital markets is one option, but not the only option
The era of pensions is all but gone. During that era, it was safe to say that someone would work at one job for their entire career. By doing so, people were effectively investing in their ability to show up at work 2,000 hours a year (plus or minues overtime and sick days). And investing in their ability to climb the corporate ladder.
Now that pensions have gone the way of the Dodo, we have to figure out our retirement plans ourselves and, if we follow the success of previous generations, we must invest in ourselves.
This is what the financial services process needs to be more considerate of—investing in ourselves is our best opportunity for prosperous investment.
The capital markets should be a last resort of sorts and once it becomes an option, then Occam’s razor becomes relevant. The one with the fewest assumptions should be selected.
Invest in an index.
For the last 20 years, the S&P 500 (a representation of roughly the 500 largest publicly traded companies in the U.S.) has returned eight percent per year. The average investor has returned two percent on their investments per year. More on this later, but it shows that eight percent per year is our opportunity over the long term in the capital markets. So if you invest $50,000 in the market, that’s $4,000 per year before compounding the calculation.
Say I took $5,000 and paid for a yoga teacher training course after which I taught yoga twice a week. Assuming I enjoyed it and it was sustainable, that could be $3,000 a year and something I could do for the rest of my life. Also something I could enjoy outside of a nine-to-five job.
Maybe you have a nine-to-five job, but love retro cars. You use $50,000 to buy a few old broken down Broncos and VW buses and hire a mechanic to rebuild them for re-sale. These retro cars are going for $30,000-$50,000 a piece these days. A passion project with a much higher return opportunity than eight percent.
What the questionnaire should be asking us—or what we should be asking ourselves—is how we want to make the money we plan to invest and what the reinvestment opportunities are. We don’t have to own a business to reinvest, but we do have to be active. And we are active. We are always looking for something constructive to do. Even those who stop working after making huge amounts of money, after a sabbatical, start to do something again—and those that don’t tend to be miserable.
So our first opportunity at reinvestment is to continue to optimize what we are doing—or will do—to earn money. Our second opportunity is to become more knowledgeable.
A good investor is one who has knowledge about their investment. If we invest in something we don’t really understand, then it is a bad investment. So a questionnaire should ask questions that will lead to an output of knowledge, an output of a solution that makes sense.
Financial advisors not only should not be managing our money but should not be recommending investments; they should be educating us. Teaching us how to pick investments. Teaching us how the financial system works. They should be our business partners, getting paid for their time and expertise. A previously agreed upon amount of money for services rendered…not an asset based fee.
“Conversation is the heart of human life and the heart of commerce” ~ David Whyte
The conversation about our personal commerce should help us get better, not get sedentary and scared.
The conversation should be how money can work for us.
Author: Tim Thomas
Image: Money Pit–Movie Still
Editor: Travis May