With the Thanksgiving holiday here in the US, I thought I’d briefly depart from the norm and offer up some “food for thought” that’s been rattling around my head for awhile.
Given my analytical/numerical nature, the topic is hopefully one you will still find interesting and relevant… and oh yeah, it’s about money, which we all like 
The Magic of Modern “Investment”
In a nutshell, here is how investing works for most people today:
- You take some money
- Set it aside in a special account
- The money grows for retirement, without much further effort
Years from now when you retire, an original $10k might have become $100k, or more. The first few times I was introduced to this concept, I wondered, in my normal questioning way, “where does the $90k come from?” But concrete answers weren’t available, so pretty soon I just started funneling money into investment accounts like everyone else.
OK, really, where DOES that extra money come from?
Questions like this are the sort of thing that I can never really put down, though, so for the past 15 years, I’ve been noodling on it, at least occasionally. I’m much closer to an answer today, and the answer is kinda… strange.
There are really only a handful of places that magical $90k can come from:
- Technological advancements that increase the total productivity of society – if we become 10 times as efficient/productive, your money can grow 10x.
- Smart investment decisions – buying dot-com stocks in 1997. Selling them in early 1999.
- Bubble-style shifts – basically, all houses in the US rose in value for ten years, and now we are well on the road back to the levels of ten years ago. But just like the dot-com boom, you can make a lot of money if you time it right.
- Competitive shifts – for instance, the United States was the only industrial power to emerge from World War Two with its manufacturing capacity intact. So investments in US companies panned out pretty well as the US became the world’s source of goods.
- Other people’s work – sounds strange but it’s true. If, for example, population booms during your investment timeline, total productivity rises just as it does when technology advances.
Strange Observation #1: Who Invited Mr. Zero Sum Game?
Notice something about numbers 2-5 above? They are all competitive. They all have winners and losers. If you sold your dot-com stock in early 1999, or your house in 2007, some poor sap had to buy it from you and suffer the subsequent decline in price. If one country advances on the world scene, that only happens relative to (and at the expense of) others. And if you gain money as the result of other people’s productivity, it stands to reason that you are gaining benefits that otherwise could have gone to them.
Only broad technological advancement raises all boats. Everything else is zero sum.
Strange Observation #2: Aren’t We All Following the Same Formula?
Anyone who’s ever worked with an investment adviser (or studied the management of their own money) knows The Formula:
- Take the desired lifestyle in retirement in terms of “money available to spend each year”
- Work backwards from that to a goal (dollar amount you need to amass)
- Given the number of years left to retirement, determine the needed annual rate of return
- Use that required rate of return to allocate stocks vs. bonds etc.
- Diversify across asset classes to offset hiccups in any one asset class
Simple! But… the zero sum nature of most growth sources (above) means that when we follow The Formula, we are betting that either 1) technology will raise all boats and The Formula’s role is just to smooth out rough spots or 2) my investment adviser can beat up your investment adviser.
The Formula promises some amazing things, too, like lifetime returns of 2000% or more. For me to get 2000% return based on skillful application of The Formula alone, well, my adviser is not only going to have to beat yours, but many other people’s advisers, too. So it’s not one winner for every loser. It’s actually many losers for every winner. Do you feel lucky?
So… CAN technology deliver?
Who knows, really? It’s certainly possible. But is it likely? Hmmm… who can predict? I don’t have an answer. I just know that my investment adviser never brought this up. His whole plan hinges essentially on a 10x or greater tech-fueled advancement in total productivity. He’s a Formula guy, through and through, not a tech futurist. I think he’s in the wrong business.
Better business intelligence tools are one component of technological growth. We better get busy
But if we all expect 10x or more return, we should be honest with ourselves – we are gambling in a big way. Nothing wrong with that of course, but it isn’t the safe green path they draw out for us on those Fidelity commercials. We are expecting something for nothing, and that sort of thing very often does not work out.
What DOES Work Out: Providing Real Benefit to Others
I don’t think the notion of investing is fundamentally flawed, I just think we’ve drifted away from what really works.
Quite simply, if you start something that benefits others, you will be rewarded with real growth on your investment. Venture Capitalists, for instance, fund companies from the beginning.
I believe our friends at Predixion, for instance, are funded by VC. If Predixion successfully brings high-powered, easy to use, and affordable predictive analytics tools to the masses, well, society will have benefited. And the money that society trades to Predixion in exchange for that benefit will be both voluntarily and well-spent.
The venture capitalists will have helped society. They will benefit accordingly because they will now own part of a valuable company. That makes fundamental sense in a way that mutual fund investing does not. Note also how they take a tangible risk when they lay out their money – not every venture works out, and when they don’t, the original venture funds often are completely lost.
Venture capitalists accept that risk. No one in the VC community kids themselves into thinking there is a Formula, or a green line to follow. One positive benefit of that risk is that they are incented to be incredibly careful about what enterprises they fund. For every company like Predixion that gets funding, there are many that do not.
So venture capitalists also end up serving a “filter” role – they sift through ideas, strategies, and, frankly, the people with those ideas and strategies to find the ones that are most likely to make money… and that tends to correlate strongly with societal benefit.
Summing Up: How Does This Impact Us?
Recapping:
- ALL investment involves a lot of risk, more than what we typically acknowledge
- Most investment gains come from competitive, zero-sum mechanisms
- The Formula is no guarantee (I can say more on this but am out of time)
- If you want to invest more soundly, accept the risk, manage it yourself, and start/expand something that benefits society
You’re probably asking, “how the heck do I do #4?” It’s true, not everyone can be a venture capitalist in the typical sense. I know I certainly don’t have the money to start something like Predixion.
But… you CAN be a venture capitalist, of sorts, on a local scale.
Here’s one of my own pet theories to illustrate what I mean: lots of people are out of work these days, and their spending habits are changing as a result. Brand new clothes, for instance, are a needless luxury, and I personally think that thrift stores are now going to be a growth business. (There’s plenty of cheap retail space available these days too).
If you took the risk and started a successful thrift store, you will have benefited a lot of people: the people who sold their old clothes got money to buy other necessities, the people who bought them got cheap clothes (saving them money to buy other necessities), and you probably employed a couple of people along the way. And hey, maybe you yourself didn’t start the store, maybe you funded someone else who had an excellent plan for the thrift store THEY wanted to start, but couldn’t afford to.
Interesting huh? That whole “think globally, act locally” hippy slogan might actually intersect with one of the best ways to become wealthy in the coming years. I really like that sort of positive irony.
Back to PowerPivot in the Next Post
Don’t worry, I will not make this off-topic thing a habit. If a subset of you find these sorts of things interesting, I may start a second blog and occasionally post there.
But “the PowerPivot remains strong in this one,” I assure you. I think I may next post about hardware planning and PowerPivot server roles.
Happy Thanksgiving, everyone.
