You are not an investor. You might think that you are, but you are not. And that is a good thing.
Saving Versus Investing
You are, or should aim to be, a saver. If you earn more than you spend over a period of time, then you have a surplus. That excess is your savings, and you have various choices about what to do with those savings.
Investing is something different. In an economic sense, an investment is the purchase of something that is not consumed today but is used in the future to create wealth. Standard examples are starting or expanding a business, the hiring of workers or the building of a factory.
When most people talk about “investing” in stocks and bonds, they are not investing in any meaningful sense. Instead, they are allocating their savings towards the financial markets, hoping to preserve capital and maybe make a return. Despite its branding as “investment” by the financial industry, allocating savings towards the secondary market is not the same thing as providing capital for companies to grow.
In a secondary market like the NYSE or the NASDAQ, the cash does not go to the company whose share you purchased: it goes to the person who previously held that stock. When you spend $540 on a share of $APPL, that money does not go towards building factories, or hiring designers and salespeople. It goes to the person who previously owned the share. The only time that the money goes to the actual company is during IPOs and subsequent issues, which are a small proportion of overall transactions.
Why Does This Distinction Matter?
By focusing on your “savings portfolio”, rather than an “investment portfolio”, you can change the emphasis and priorities. By being clear about what you are actually trying to achieve, you can start to obtain a better result.
Cullen Roche believes that your savings portfolio should achieve two primary purposes:
1. It should protect against the potential for permanent loss.
2. It should reduce the risk of purchasing power loss.
I phrase it slightly differently, but with the same overall idea:
The goal of the individual saver should be achieving high risk-adjusted returns, net of fees, taxes and inflation.
Directing your savings towards traditional “investments” might be a suitable way to achieve those goals, but it might not be. You also have other options of what to do with your savings, and the financial industry does not have the same goals as you.
The financial industry loves to sell you the idea that you should “invest”, since that helps persuade you to buy their products. And then sell their products. And then buy slightly different products, all in the hope of a higher return.
Even better, you should hand over some of your savings to them to “invest”, so they can charge you asset management and advisory fees on top of transaction fees. This level of churning and fees is great for them, but murder for your savings.
The Bad News
Their fees might be worth paying, if you could beat the game and consistently earn high risk-adjusted returns, net of fees, taxes and inflation. The problem is you are not very well set up to do this. We might be in the golden age of the individual investor, but you are still poorly positioned relative to the news flow and order book.
Succeeding requires the right capital structure, which you are unlikely to have. One of the many things Warren Buffett got right was to recognize the importance of the right legal and operational setup. A permanent capital base, where there is little danger of sudden redemptions, is a priceless asset in taking advantages of the changing moods of Mr. Market. To be able to withstand the volatility rollercoaster without getting blown off course requires a patient and unleveraged capital base that can pick off bargains when they show up.
You are not that patient and unleveraged capital base. Any margin loans, mortgages, student loans or credit cards in your immediate family group should be viewed as leveraging your overall portfolio. Add in your unpredictable cash-flow requirements, and you are not well set up to handle the 100-year storms that hit the financial markets every seven years or so.
On top of that, we all have flawed and emotional monkey brains that let us down at the worst possible time. All of your decisions and non-decisions are influenced by your emotional and logical biases, and they will encourage you to do all the wrong things at all the wrong times. You will hold your losers, sell your winners, panic in draw-downs and seek out evidence that confirms what you already believe. You can tell yourself that you are the one person who will not act that way, but that is an emotional bias too.
You are not an investor. You are, perhaps, an over-leveraged trader with unacknowledged cognitive biases and poor risk management.
The Good News
Here is the good news. If you ignore the relentless hype of the thundering herd, then you can escape the fees and the transaction-obsession and instead focus on making good risk-adjusted decisions on the portfolio of your life.
For example, paying off your family debts is a must: often, by far the best risk and tax-adjusted return you can find is paying off your debt. Debt is an emergency, and paying it off is a far higher priority than “investing” in mutual funds.
Building up reserves is a solid idea: not just financial reserves, but real supplies of essential items as well. Investing in your skills can pay dividends at work and at home. Finding savings and negotiating discounts is as real as money made in the stock market, and a far better risk-adjusted return.
Best of all, you can get a very high rate of return by spending time on things you actually enjoy and with your family, especially your children. Children thrive under the careful attention of well-rested adults. The return you receive in helping them develop into self-confident, grounded and productive adults is likely to be higher than the return on an ETF. If you are after a solid challenge to your lifestyle choice, I suggest you go meet Mr. Money Mustache.
You are not an investor, you are a saver. And that is good, because you are not very well positioned to be a successful investor, but you are well positioned to be a great saver.
thezikomoletter 
Willem de Leeuw
/ January 5, 2013Hmmmm, I don’t agree that you’re not an investor just because you buy on the secondary market. You’re still buying into the capital structure of the firm, and it’s quite likely that the firm will reinvest earnings in new assets – money that could otherwise have been distributed to shareholders like you – and if they generate income in the future you may receive dividends direct from the firm’s bank account. If that’s not a direct relationship, I don’t know what is.
thezikomoletter
/ January 6, 2013Willem, I agree that there is a direct economic relationship between the company and the shareholder. But I do not think the behavior of the company will really change if person A pays person B $x through the secondary market and replaces them in the shareholder register.
The larger point I was trying to make was regarding intentions. Many people I have met who describe themselves as “investors” are really no such thing – they are savers who are trying to preserve their capital and earning power. It might sound like a pedantic distinction, but semantics matter and changing the description changes the emphasis and decision-making process.
Thanks for reading.