Readers have told me after having a conversation with their Financial Advisor they usually have no idea what they were talking about. From time-to-time we all feign superior investment intelligence – somehow stirring the “Alpha” in us all, but it’s usually not as meaningful as we had hoped, and certainly not a “trip the light fantastic” moment.
As the creators of our own human capital we have a responsibility not only to ourselves, but also to our families, employees and customers to be financially literate. Not to espouse our own personal opinions, and certainly not to try and change someone else’s mind, but to at least be able to think and converse in a manner that is not only acceptable, but also absolutely necessary in today’s world of “dark pools”. A friend of mine whom I admire greatly, was an actor and playwright, his name, William Shakespeare. Willie once wrote, “The lady doth protest too much, methinks.” Today, as seen in translation on babylon.com, the phrase has come to mean that one can “insist so passionately about something not being true that people suspect the opposite of what one is saying.” By the way, Willie’s words appeared in Hamlet, Act III, Scene II. We all could use a primer of what we should consider at a minimum as being well-stocked in the basic understanding of economic theory – what it is, and why it’s important.
The classical economic theory “stresses that economiesfunction most efficiently if everyone is allowed to pursue his or her self interest, in an environment of free and opencompetition.” Based on the ideas of eighteenth and nineteenth century British economists from Adam Smith (1723-90) through to Alfred Marshall (1842-1946) - http://www.businessdictionary.com/definition. In what is considered to be the Standard Economic Model much weight is placed on the assumption that people are rational. Standard economics assumes that people are fully aware of all of the options they possess, and can always rank these options in accordance with their preferences, and always choose the option of what they like best. One should also be aware of the neo classical interpretation of economic theory as proposed by John Maynard Keynes. Keynesian economics is the view that in the short run, especially during recessions, economic output is strongly influenced by aggregate demand (total spending in the economy). In the Keynesian perspective, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host factors and sometimes behaves erratically, affecting production, employment, and inflation. Now this might seem as though we’re going from the simple to the sublime, but simply put, Capitalism is a good economic system – businesses employ and pay people to work, people earn money from their work, people can spend their money on things they want. A favorite quotation of mine by Mr. Keynes is, “Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone. “
But, when people lose their jobs , businesses close, and people who cannot work, cannot spend money. Now, we have problems in our economy – and our investment portfolios. Keynes said that this is when the government should step in and help people who do not have work - the government should spend more money when people do not have work. Without entering the political arena I should state that not every economist-professional, armchair, or otherwise-agree with Mr. Keynes’ theory.
How does all this matter to our investment portfolios?
Well, economic theory drives the policies of central banks and determines the price of money, and the price of money is fundamental to the prices of all our assets. What central banks do can be either helpful or harmful. In the short-term they can dampen volatility while intensifying pressures that distort prices, forming bubbles-which always end in significant reversals. Central banks are essentially limited to manipulating interest rates (the price of money) and flooding the market with liquidity; this is their primary function. Keep in mind though that the central banks are not the primary cause of a distorted economic policy. It’s important to look at the macroeconomic view, but please don’t get lost in the weeds.
The central banks are now winding down their extraordinary monetary policies. As for the next crisis, expect more of the same, only doled out in an environment of already low rates and more than adequate liquidity. You should understand how the theory they’re using will express itself in the economy and directly affect your investment portfolio. That depends a great deal on the relationship held with your Financial Advisor. Let’s face it, there are bad matches out there, just like there are bad matches in all phases of business and in life. My friend tells me her advisor is condescending to her. Worse, she isn’t happy with the advisor’s communication skills—he rarely gives her timely performance reports in a language a human could understand. On the other hand, there are some really great Advisors out there, and they are both passionate and sincere in seeing that your financial goals and objectives are being correctly addressed. More importantly, they will communicate with you in manner that is both intelligent and understandable. The more you understand about the economy, regardless if that’s your shtick or not, the better you’ll understand what your Advisor is telling you – for better or worse. Remember, this is the individual that you’ve selected as the steward of your investment portfolio.
So do yourself a big favor and go online with your local library and download a free eBook - The Intelligent Investor: A Book of Practical Counsel, by Benjamin Graham. This book was first published in 1949 and remains the ubër finance book of our generation. Read and re-read chapters 8 & 20 – let me know what you think. If all else fails, download a copy of Niccolò Machiavelli's The Prince. Great reading on a rainy day.
Author’s Note: Please consult with your CFP®, CPA, Registered Investment Advisor, Investment Advisor Representative, and/or Estate/Tax/Eldercare Attorney when discussing your financial needs and developing the appropriate personal/business financial plan.