#30: My favourite way to think about investing, part 3

12th April, 2021

Welcome to the Idiot Money newsletter. The newsletter that has better things to do.

This week: becoming wiser with money by understanding that it pays to have a default play.

Previously on ‘my favourite way to think about investing’, we looked at the importance of focusing on odds over outcomes. This week, we go from probabilities to picking investments.

The starting point for choosing an investment strategy is to ask: ‘if all investments are gambles, what am I betting on?’

Picking investments without a strategy is of course possible, and you’re welcome to faff about with it if you enjoy that sort of thing. However, most people don’t. And if you don’t, then you should really put a value on the time spent faffing and knock it off any eventual investment return. You are human, after all, and it’s an inhuman idiocy to view investment returns in isolation from the life they serve. Your time – and indeed your energy – is as much a part of the stake as your money.

So what should you bet it on?

Let’s start simple: shares in a single company?

The internet told you opening an Etoro or Robinhood account and betting your lockdown savings on Tesla was how to wing your way to wealth. It was right, in a way. In a short time period, putting 100% into the thing that goes up the most in that period is the way to ‘maximise returns’ – the mystifyingly stupid clarion call of investment advisers everywhere.

Let’s assume you’re not that silly. Let’s also remember: it’s about odds, not winners. Amateur investment picks are often more a statement of how much someone likes the company’s products than they are a bet on that company’s future prospects being mispriced. Don’t do this.

Remember: you’re not betting on a company doing well; you’re betting on it doing better than the aggregated views of the rest of the world’s buyers and sellers think it’s going to do. And of it not turning out to be Enron. Are you happy making that bet?

Moving on from single companies, what about a fund comprising lots of shares in lots of companies (and maybe also some government or company debt)?

Here, you’re either betting on a fund manager to pick shares in a way so good it justifies the fee they charge to do so (which as-near-as-makes-no-difference doesn’t happen, and even where it does, it’s impossible to know beforehand which will, among other problems). Or you’re betting on an ‘index’ of all companies/debt in a given market, say the S&P500. You’re betting, in short, on either judgment, or a system.

What about those indices? Perhaps shares in companies from a single country? Betting on companies in one country is not a bet on that country’s economy. It’s betting on the companies publicly listed in that country. In the bigger ones (like the S&P500) most of those companies’ profits will come from overseas. A country bet is really a sector bet – for example the US is weighted towards tech stocks because Amazon, and the UK is weighted towards consumer staples and financial companies, because the people with all the disposable income in the UK are alcoholic bankers with big houses.

Picking a picker-picker

Perhaps you’d like to bet not on companies, but on the ability of a stockbroker or a fund manager to have opinions that are consistently smarter or luckier than the rest of the buyers and sellers of whatever they’re buying and selling. Perhaps you’d prefer to pick someone to pick someone to pick shares.

This is the old-school financial-advisory model. You pick an adviser, who then picks a picker for you. There’s a good reason this model evolved and endures. Because people are frightened fools, and advisers are good at sales.

The average investor patience for sparkling returns is about three years. If things go awry, and it’s the investor’s adviser doing the picking, the relationship is on the rocks after three years. If, however, the adviser in turn picks not investments, but a picker, each picker gets a separate three years, and investor patience with the adviser doesn’t run out until nearer nine. Not only do investments basically never do badly for that long, but investors are paying both adviser and picker handsomely along the way, regardless of performance. So everybody wins! Sort of.

Where to begin?

Unless you have a particular psychological aversion to investing in anything remotely American, or are especially drawn towards small stock-picking outfits because they’re based in Blackpool (both true client stories), then the starting point for everyone should be to bet on the value of the world’s companies in aggregate, through an index fund that owns bits of every country in the whole damn world.

(We’re talking publicly listed companies, of course. There’s not much you can do about the fact that some countries’ biggest companies are private, or raise money from sovereign funds, or bonds, rather than shares, so even a totally global approach arguably underweights countries like China, and Germany).

A bet on the value of the world’s companies growing in value is basically a bet on capitalism. This is a bet most people are pretty happy making, not least because if it’s a long-term loser, then you’re going to be worried about a lot more than the value of your investment account.

It’s also where I suggest everybody starts. We know this works. It’s far easier to start by justifying deviations from this bet than to wonder which of a million other bets to make.

Deviations could well be justified, depending on your personal circumstances. Circumstances that could be mathematical, e.g. when you want the money back, or non-mathematical, e.g. because you want warm and fuzzy feelings from investing in some sort of ‘ethical’ fund (a story for another day, given the scandalous extent of ‘greenwashing’).

You don’t get a choice in whether or not you’re playing this game. You already are. Inaction and ignorance are just different – and pretty damn dumb – ways to wager. So place your bets, take your chances and don’t forget to ask yourself what you mean by ‘risk’ and ‘safe’ in the first place. In the long run of your life, thoughtful investing is a safer bet than not playing; to not play at all is often the biggest risk of them all.

Next time we’ll look at the implications of this approach, including what it means for cash, property, and those kooky ‘alternative’ investments you heard about in Wolf of Wall Street.

(p.s. There’s a way-too-long-for-a-newsletter argument about what happens when the whole world goes ‘passive’. It’s an important discussion, and we’ll cover it somehow, someday. For now, important as it is, the practical implications for most people are at best unclear, so not something worth worrying about… yet.)

#34: My favourite way to think about investing, part 4: betting beyond the basics