Jason Zweig on Protecting your Wealth
You write in The Little Book of Safe Money about investing in emerging markets. Do you feel these are safe bets?
One of most common things that I still hear when I talk to financial advisors is, Were overweight emerging markets because we know theyre the fastest-growing economies in the world. What most of them dont realize is that theres essentially no correlation whatsoever between GDP growth and future stock market returns. People find this absolutely shocking. Over the past 10 or 20 years, for example, the Asian emerging market economies have done far better than, say, Latin America. Their stock markets have not.
In the future, its quite likely that emerging market economies will do about as well as people expect. But the question of whether their stock markets will do as well as people expect is a much more complicated one to answer, mainly because people expect them to do so darn well. To be overweight something that is so obvious that virtually every investor in America knows about it is a very risky thing to do.
I dont think most financial advisors understand that at all. That concerns me.
Your most recent book is about keeping your money safe. You remind the reader that risk is something that you should avoid at almost all costs. What is your definition of risk? Is it exclusively the potential loss of capital, or should investors think about things like volatility?
Ive spent my whole working life trying to answer the question what is risk. For advisors, risk may have a slightly different meaning than for an investor who is working on his own without professional advice. A pretty good definition of risk a functional definition would be: you think you understand something when you dont. It could be that if we redefined risk that way, it would become a little more frightening, particularly to advisors. After all, if theres one reason your client hired you, its to understand the things he or she either cant or isnt willing to try to understand. Its really your job as an advisor to explain the way the financial world works to your client. Youd better make sure you understand the things youre explaining.
Above all else, if you ever find yourself saying the words, studies have shown that I highly recommend that you have read the studies. If, for some reason, you cant understand everything in the study, then find somebody else who can and get them to explain it to you. I cant tell you how many times financial advisors have said to me studies have shown that something-or-other and after asking a couple of questions its become evident to me that these people have not actually read the studies. Its a lot like talking about a movie when youve only read the review or seen the trailers. Youre on really dangerous ground if you havent really done the homework.
You recommend Treasury Inflation Protected Securities (TIPS). Their real yields are pretty low. Would you advocate for them as the best way to hedge against inflation?
If I had to write the book all over again, I might tone down my praise of TIPS a little because, just like anything else, in the hands of overenthusiastic people, TIPS can do some damage. TIPS arent perfect. If interest rates rise faster than inflation, somebody who holds TIPS is not going to be very happy. Theyre definitely not perfect. Are they the best way of combating inflation? I guess I would say, in general, they probably are, but there are big exceptions.
One area where advisors can play a huge role is helping people become more sophisticated in controlling the risks inflation poses to their own human capital. Im pretty critical of commodities as a general rule, but there are many people whose jobs and the health of their company depend on the price of a particular commodity.
For example, a lot of the inputs in the chemical business are petroleum-based. If you work at DuPont, you are vulnerable to higher oil prices, because when oil prices go up, the price of your companys raw materials go up. For somebody like that, whose job would be hurt by oil prices, investing in oil makes a lot of sense. While TIPS are good general way to combat inflation for the typical investor, most financial advisors would agree with me theres actually no such thing as a typical investor, because everyones situation is different.
Weve seen a recent fanaticism surrounding gold. What role should gold play in an investors portfolio?
This is an area that comes hard to a lot of people. I dont think gold is the only issue. Its commodities in general. The financial advisory community has fallen hook, line, and sinker for the Wall Street propaganda that every investor should have at least 10 percent of their assets in commodities. Thats really unfortunate.
There are a couple problems. The first problem is, in the long run, commodities have earned a negative rate of return. So its unclear to me why its a good idea for me to have a permanent long-only position in something that goes down in value. Theres a different question though, which is should I have a long-short position in something that tends to go down in value? And thats a much more complicated question.
Now we have to look at a whole bunch of other things, such as why commodities would go up in price from here. Lets remember what commodities are. Theyre all kinds of things. Some of them are man-made, like currencies. Some of them come out of the ground. Historically, whenever anything that comes out of the ground gets scarce, human ingenuity springs up and invents an artificial substitute. Its already starting to happen for oil, and down the road, it almost certainly will. Im unaware of any important natural commodity that the human race has ever run out of. If there is one, Id be willing to bet a substantial amount of money that the synthetic substitute that was created for it turned out to be better and cheaper.
Its hard to be a bull on commodity supply. You have to believe were running out of it, and when we run out of it thats just going to be tough. We might run out of oil, but if we do, will the world really grind to a halt? I dont think so, because its so important to the global economy that, once everybody agrees were running out of it, then everybodys going to try to find a substitute. The price, ultimately, is not going to go up; its going to go down. Eventually, it will go to zero.
If youre talking about things like precious metals, like gold and silver, youre dealing with an entirely different question, which is essentially the belief that when policy goes bad, gold is good. We just dont really know much about that. It may turn out to be true, but the price of gold was fixed for so long that we have a really small sample of data to base that decision on. Gold was at $35 an ounce for ages. The price has only freely floated for a couple of decades. If you had bought gold in 1980, which was the last time it was as trendy as it is now, you would have waited a quarter century to break even. I just dont see the appeal.
The entire propaganda infrastructure that has been dedicated to ramming commodities down peoples throats is very disturbing. Other than generating massive fee revenue for Wall Street, I would be very surprised if a buy-and-hold, long-only commodity position is going to do anybody any good in the long run.
Where is the empirical evidence that, in the long run, commodities are a good hedge against inflation? Theres some evidence for that in the short term, but the long-term evidence for it, in my opinion, is terrible.
It seems that mutual funds, insurance companies, banks, and other manufacturers of financial products do not have incentives that align with those of investors. Even so called fiduciary financial advisors are rewarded by growing their clients assets, which may motivate them to take on more risk than is appropriate. For the average investor, is there anyone that he or she can truly trust?
Well, sure. Most advisors really do have their clients interests at heart, certainly all good advisors.
Advisors really do need to ask themselves, Am I eating my own cooking? Would I put my money at risk the same way Im recommending that my clients do? Instead of just throwing 10 percent of every clients money into commodities, maybe advisors should ask themselves whether they would put all of their own money into commodities.
Framing the question that way might help them investigate the empirical evidence a little more closely. Reasonable minds can differ, but I personally dont see it.
So should we hold investors responsible for keeping their advisors honest?
Yes. Investors are too passive. Its partly because the nature of the fiduciary relationship is built on trust. Of course, we all tend to forget this, but doctors, in the eyes of the law, are fiduciaries for their patients. Its a term you never really hear used. When I see my doctor, I probably dont ask nearly enough questions. So its understandable why people dont do that with their financial advisors. Youve hired this person; youre comfortable with his or her level of expertise. The whole reason youre listening to this advisor is because you think he knows what hes talking about. People do tend to shut their brains down. That is unfortunate. Many advisors do get a kind of free pass from clients. And thats not good for either side.
Clients need to ask advisors a set of questions before they formalize their relationship. Advisors need to ask clients a set of questions, too. If the clients dont know the right questions to ask, then the advisors should help them. They should say, You really should have asked me for my form ADV, or, You didnt ask me how Im compensated, or, You didnt ask me how I define a conflict of interest, so let me tell you about those things. I know a lot of that does go on, but standardizing it would not be a bad idea.
Jason Zweig recommends the following resources for keeping up with trends and ideas in the field of behavioral finance: