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Is It Investing Or Gambling

We are living in extraordinary times in the world of finance, and have been for a while.  With a very lethargic global economy and the uncertain but so far devastating impact of technology and globalization upon jobs and pay levels, governmental debt levels are at historical highs.  This has all led to a central bank response to manipulate interest rates down near zero.

While ultra low rates have indeed been helpful to governments seeking to manage their budgets, it has been quite the opposite for investors/savers seeking a reasonable return on their savings, with the term “reasonable” generally thought to mean something in the 6-8% range, with those numbers approximating what is needed for retirement savings to meet actuarial needs.  That is to say, without that 6-8%, retirees won’t be living too well in their retirement years.

I grew up in Yonkers, N.Y. and in my youth enjoyed plenty of time at Yonkers Raceway gambling on the trotters.  It was a lot of fun and an amazing learning experience on many levels.  Betting on horse racing involved a deep level of analysis.  I learned how to evaluate a horse’s past performances, taking into account the competition it faced, the winnings it competed for, the track it ran at, whether it had been idle for too long or raced too frequently, who its rider was, what his success had been of late, and whether that rider was new to the horse or not.  I also had to account for the weather, comparing the weather during a horse’s past performances to the prevailing weather that evening.  Some horses did very well in the rain and mud, or cold, while others did quite poorly in inclement weather.  The thing is, no matter how much analysis I or anyone ever did on past performance, the element of chance vastly overwhelmed all else.  The horse couldn’t talk and there was a serious element of randomness that led to significant and consistent losses of principal for most gamblers.

Today’s investment world reminds me a lot of Yonkers Raceway, with investors having to accept a very higher degree of principal risk in order to hope to achieve their desired rate of return.  In fact, it is difficult to find an article in the WSJ speaking about the market or a particular investment strategy without the word “bet” in it.  Investment managers use the word often to describe their activities. They “bet” that interest rates, oil, currencies, or that markets will rise or fall.  Real estate investors bet that rents or values will rise.

What is now largely missing from most investment strategies is any reasonable degree of certainty in achieving that needed return.  This was not always the case.  In decades past, high grade fixed income securities, namely bonds issued by governments or companies who were very strong and whose abilities and commitment to repay their debts were considered to be beyond reproach, or even structured bonds backed by super-senior interests in pools of loans (consumer, business, mortgage, etc), used to represent the important combination of qualities that served the essential elements of investors’ needs - namely low risk of principal loss and a certain and predictable, and acceptable current return.  Today, with too much cash chasing for yield, and a very low rate of global growth suppressing borrowing levels and thus limiting the issuance of new debt securities, the imbalance of supply and demand for high grade fixed income has produced an environment with yields in the range of 1-4%.  For a retiree, choosing to invest in high grade fixed income basically means accepting the fate of eating one square meal a day in retirement rather than the hoped for three.  Clearly this is not terribly appealing and has led to the aforementioned inclination to gamble for a higher return, and those two extra meals per day.  I believe that those fortunate few who can manufacture a desirable yield without introducing undue risks will find that their long-term outperformance versus the market will be quite extraordinary.  For the rest, the loss of purchasing power will be highly unpleasant.

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