This morning’s editorial in the New York Times on new regulations proposed by the SEC for pension funds with which I’m in material agreement opens with the following seemingly bland sentence:
The nation’s public employees have a very large pool of money — about $2.2 trillion — that must be invested wisely to cover their retirement.
Is it really possible to invest wisely? Is it even possible to invest conservatively? The people who gave their money over to Bernie Madoff thought they were investing wisely and we were assured that the complex alphabet soup of derivatives that have destroyed some venerable investment banks and brought others to their knees had mitigated risk.
It seems to me that the question of what can be done so that it’s possible to invest wisely is at the heart of the still ongoing financial crisis.
I’m struck by people who think it’s possible to invest an amount of money that’s a sizeable percentage of the GDP wisely and still earn an above average rate of return (Echoes of a former president who promised an above average standard of living for all). I’d argue that you can’t – that it’s contrary to the way economics works. Investments pay because of risk/reward relationship, or because of a temporary bubble – they aren’t wise or conservative if they don’t understand those relationships.
I don’t think there’s a problem with investing conservatively or wisely, if you know what you’re investing in; it’s incompatible with banking on a huge rate of return ala Madoff, though, and I don’t think doing something wisely is the same as trusting someone else’s wisdom.
I’m not parenting wisely by hiring a nanny – I’m absolving myself of parenting. It may be that the nanny is more competent than I am, but that’s hardly to my credit as a wise parent. I’m not a good gardener because I hire a lawn service, I’m not a good programmer because I hire a consultant. I don’t invent the internet because I authorize a bill that pays Vint Cerf’s salary.
The investors who gave their money over to Bernie Madoff thought the investors were good judges of character, and that Madoff was investing wisely. If the investors conflated that with the investors investing wisely, they were mistaken on all counts.
Hmmm, the basic principals are really at the portfolio level. And there are two: diversification, and asset allocation based upon risk tolerance and yield goals. (“beta”) And these are actually disciplines rather than wisdom. After that, at the individual security or investment level, its just the best efforts of numerous money managers and their staff.
As a wise man told me 20 years ago: “despite my best intent and efforts, I simply cannot guarantee the results of any one particular investment. However, with reasonable efforts, I CAN guarantee the performance of the portfolio.”
What amazes me is how few people are able to stick to these disciplines.
Which is why I’m not sure I’d invoke Bernie Maddoff in a discussion of “wise investing.” People who put their money with him made a classic mistake. They chased the cult of personality and the notion of superior yields based upon a person or being in a club. Said another way, their animal spirits got the better of them. Warren Buffet has a fabulous record. I own some Birkshire. But I’m still diversified.
Putting it all on red is not investing, its gambling. No matter the money manager or the class of security.