There must be some people who read ‘The Lord of the Rings’ and see themselves as Gandalf, or read Harry Potter books and identify as Dumbledore.  But most of us are seeing things from the perspective of one of the children, or hobbits, placed centre stage only by the novelist’s device of Dumbledore having rushed away in response to an owl from the ministry.   And, when we look up from the novel, even if we have reached middle age, we long for childhood’s comforting illusion that there are benign, wise, grown-ups out there to whom we can leave important matters like finance, and running the country, so we can bumble along with our heads in the clouds (or is that just me?).   Unfortunately, JK Rowling and JRR Tolkein were right: it is now down to you.   Others may offer to help, but they are there to serve their own interests, not yours.

Money management is a $88 trillion industry, it attracts lots of bright people who work very hard, and are paid very well.  The average employee at Goldman Sachs makes US$ 367,564 pa (2019 figures), and that average includes all employees, the receptionists, the PAs, as well as the investment managers and sales staff.    But it does not just pay well for amazing performance.  Money management can pay very well for below average and loss-making managers.  IBM estimate that clients are overcharged US$250 billion a year by managers who underperform relative to the manager’s own stated criteria.

I am writing for those that don't want to donate to that US$250 billion a year benevolent fund for underperforming fund managers, and who want to arm themselves with the rules of the game.   The industry wants you to believe that investments are complex things best left to experts with PhDs in finance.  But you don't even need to have finished High School.  Bonds are no more complex than a mortgage (and often a lot simpler).  Shares are just bits of an underlying business, so you don't need to think about ‘the share’ so much as look at the business.  Even mysterious sounding derivatives are no more complex than deals done in a playground by children trading a weekly packet of football cards.

It is possible to find complex products, and complex models.  But they don't work reliably and are best avoided.  When times are calm, ‘tomorrow will be much like yesterday’, when they are turbulent, the models created by self-styled grown-ups: PhDs and Nobel Prize winning economists ‘lack predictive value’ (ie they are useless).  When Nobel laureates Myron Scholes and Robert Merton set up the Long Term Capital Management hedge fund, it soon blew up and needed a bailout because they believed their own complex models even when reality was screaming at them that the models were wrong.   Those that create complex structures are usually fooling someone, they probably want that someone to be their counterparties/clients, but are just as likely to prove the wisdom of Physicist Richard Feynman’s ‘The first principle is that  you  must not  fool  yourself – and  you are the easiest person to fool’.

The way most people fool themselves about money, is to think that they can leave finance to 'the professionals'.   That's all very well for civil servants with index-linked pensions, leaving matters to their friends at the Treasury.  The rest of us will pour the equivalent of eight to twenty years labour into our pensions & savings.  Over 99% of savings are managed by professionals: an industry whose interest is in persuading you not to think too deeply, or ask too many questions.  Bamboozled clients are profitable clients.  Unlike those that ask awkward questions like “Why do most funds underperform the index?”,   “Why does the average fund underperform a random bunch of stocks chosen by an ape throwing darts at a list of companies?”.  Or ‘Why should I engage you on terms that allow you to lose my money and still take home hundreds of thousands of pounds a year?’

Stuffing cash into a mattress probably makes the mattress less uncomfortable in these days of paper money, though banknotes lack the resilience of silver/gold coins against ‘moth and rust’ corrupting.  And, to the overt ‘thieves break in and steal’ risk known to the ancients, we now add the near-certainty of governments stealing its value, gradually or otherwise, through inflation.   Short of taking a vow of poverty and toddling off to a monastery (or convent), you will need to make choices about what to do with investable money.  Even if you forswear worldly goods for yourself, you may find that the holy order you join ends up putting you on a committee dealing with their finances.    You bound out of bed in the morning and have 101 things you want to do.  Making investment choices is not one of them, but here you are, joining the world of reluctant investors, because even ‘Doing nothing’ is still a choice with a risk of loss.  And, when it comes to your pension, if you ‘do nothing’ you will end up in a default fund designed with a focus on making money for those running it, rather the unlucky savers.

The ‘grown-ups’ of the financial world, are not benign, avuncular, stewards of your interests.  They are the people who have structured things so that they win, even when their clients (ie you) lose.  To have a chance of success, you need to begin by seeing that this is your problem to deal with: avoiding making the choices yourself is just too expensive.

But don’t be disheartened.  You are likely to do a rather good job.  Despite what the professionals claim, taking charge of your own finances does not require mastery of complex mathematics, or months of study.  Children learn about, squares, cubes, and X to the power Y, when they are 11 or 12 years old.  This, which explains compound interest, is the only mathematical concept you need beyond simple addition, subtraction, multiplication, and division.  Calculators (and spreadsheets) are allowed.  You don’t need trigonometry, logarithms, or calculus.

This book is not about how to be a successful investor.  [Aside from the detail that the ‘how to be a successful investor’ genre is a crowded field, even were my personal track record to date exemplary (it isn’t), writing such a book would be tempting fate.  Springing to mind is the cautionary tale lived-out by an obscure British politician who wrote a  book on ‘How to win a marginal seat’, and then promptly failed to hold his marginal seat at the next election (you don't need to feel sorry for him, his Sir Joseph Porter-esque deference to his PM ensured that, though denied the post of ‘Ruler of the Queen’s Navee’,  he found a comfortable billet on the ermine dole queue)].  Rather, it is about suspending misplaced trust in others.  The illusion that this is an area best left to the professionals, makes people think they should only make their own choices if prepared to put in the ‘hard yards’ of study, & blessed with an above average intelligence.  My aim is to make the bar much much lower, in part by showing that you don’t need to do that much study, but mostly by highlighting how badly served you are by most of the ‘grown ups’ you meet in finance sector.  Pulling away the curtain, like Toto in ‘The Wizard of Oz’ https://www.youtube.com/watch?v=YWyCCJ6B2WE , reveals a professional cohort mediocre in almost everything other than the rewards they extract for themselves.  Rather than imagining yourself playing a game against a chess grandmaster, think of the bufoon-like Oz and bear in mind his track record of being outperformed by chimpanzees throwing darts at a list of stocks: if you can do almost as well as the dart-throwing ape, you will be ahead!!

I will begin with a tour of the investment management landscape, the products, and the players, highlighting the conflicts of interest.  Rather than listen to what 'the grown ups' tell you, it helps to ask "what motivated them to say it"?     Later on, I will risk an excursion into personal discipline, a subject on which I am particularly ill-qualified to comment, but which seems unavoidable.  When I first got a dog, I took it to ‘puppy training classes’ which were actually owner training classes.  When I enrolled on a course to make me a more effective parent, I was expecting tips on how to be more effective at controlling my children, only to find that I needed to begin by controlling my own emotions and reactions.  The fight, flight, or freeze, choice hardwired into our minds as an instinct due to the survival advantage it gave our ancestors evolving on the planes of Africa, does not serve us well when it comes to connecting with an unhappy child, or when choosing investments.  It didn’t evolve for that purpose, so why should it?

But poor trading discipline is not most people's undoing,  nor is flawed analysis.  It is not bothering trying to ‘figure out’ investments, in the mistaken belief that the area is too complex.  Not bothering prompts some to neglect saving altogether: spent it all now, and hope that early death or the welfare state will step in.  Or you may be tempted to outsource the decisions to those plausible sounding ‘grown ups’ in the Financial sector.  Successful entrepreneurs who have built and sold businesses for tens of millions of pounds, become prey to the ‘wealth management’ (sales) teams of big name investment banks.  Having ‘cashed out’, the lure of retirement, and the prospect of perfecting their golf swing, makes them willing dupes.  The bank flatters them with the option of being treated as ‘sophisticated investor’: ie a rich person who has been persuaded to sign away the usual consumer protection rules.  I am not certain how ‘sophisticated’ it is to trust a youth who has not worked through a few business cycles (anyone in the sector under 30 has had a professional life comprising only the 2009-?? bull market) and whose interests and time horizons are wildly different from one’s own.   Most businesspeople would achieve rather more by applying to investing the commercial judgement that they have honed and found to work over decades building their businesses.   But you don’t need to be a millionaire businessman: stocks, bonds, and investment funds are easily understood.  Even complex derivatives & structured products are usually no more than the result of either layering one thing on top of another, or splitting things into different pieces, but you should feel free to ignore them.

One of my heroes, the physicist Richard Feynman observed “If you can't explain something in simple terms, you don't understand it”.  I have enough self knowledge to know that I will not be troubling C.S. Lewis & J.K. Rowling when it comes to being able to grab the attention of an inquiring child, but I have written this booklet to be intelligible to my 12 year old daughter, and hope that this also makes it palatable for most adults. [I remember reading and loving Rixi Markus’s books on bridge, but I didn’t learn much from them, because they presupposed an expertise I lacked.  I was used to Zia Mahmood who patiently walks his reader through each step.  Rixi Markus might show the hand, and the bidding, then simply say that the contract was successfully defeated by holding up the ten of hearts at round three. For her, the first nine cards to be played, and the consequences of that holding up, were so obvious that further comment was unnecessary.]

You probably understand human nature, at least better than many economists.  We are not always ‘utility maximizing agents’; charitable donations are not all explained as peacock-like signaling that the giver is so successful that they have surplus resources.  But, given a choice between two alternatives, someone with a job in finance is quite likely to choose the one that is best for their career / commission / bonus.

Economics is a great discipline that has helped us codify elements of common sense, and highlighted the counter-intuitive fact that trade can benefit not only the most effective producers.   Behavioral economics is fascinating, and you don't have to agree with Keynes to find him a great read [or a fun person: as an old man, on being asked if he would do anything differently if he had his life again, he answered ‘Yes, I would drink more vintage champagne’].   But, anyone with a reasonable amount of common sense does not need to study Economics in order to manage their own money.  The complex world of economic modelling, looking at whose formulae may remind us that we have forgotten our schoolboy (or girl) calculus, should hold no fears: it can be disregarded by investors because it doesn't work.   The Queen, visiting the London School of Economics in 2008, famously asked why no one had seen the credit crunch coming.  Since the crisis there has been useful introspection including The Dahlem Report (“The Financial Crisis and the Systemic Failure of Academic Economists”), but, while hindsight makes it easy to say that the models were wrong to assume markets and economies are inherently stable, it is a problem of far greater magnitude to create models that reflect the myriad factors that drive human decision making.  It may be that future generations will conquer this challenge, but, for now, we don’t have any models that work and, if one were to be created, the moment it was published, it would start influencing people’s decisions, and so it would cease being accurate.  One would need a second model that factored in the in the impact of the first.  And then that second model’s predictions would start affecting people’s choices, so one would need a third model.  Etc. [During World War II, Kenneth Arrow (who later won a Nobel prize in economics) was part of a team producing long-range weather forecasts for the Army.  In due course, they determined that their forecasts were not much better than pulling predictions out of a hat, and so wrote to the Commanding Officer, asking to be relieved of the duty, but were told “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.”.   The 'grown ups' often feel the need to consider models, not because they yield great results, but because failure to do so might make them look rash: a ‘box not ticked’ that might be held against them should things go wrong. Private individuals have the great luxury of not needing to waste any effort creating or using macroeconomic models]

Another reason for not bothering with complex economic models is that even attempting a broad brush macroeconomic analysis (ie of where we are in the asset price cycle: Boom, bust, or somewhere in between) is likely to tempt us into trying our hand at ‘market timing’.  For a retail investor this usually means holding back money as cash, waiting to ‘invest it later, when prices are better – ie cheaper’.  I’m quite a sucker for this, and would be richer had I ignored the temptation: I recognized myself when hearing it said of the late editor of The Times, Lord Rees-Mogg ‘He managed to predict seven of the last three recessions’.   Despite this awareness, as I edit the manuscript in August 2020, and see stock markets that have surged ahead while Covid lockdowns have killed the economy, corporate profitability, and employment, I must admit to hoarding some cash.

Economic history is unlikely to be your standard holiday reading, but a quick bit of online research will yield readily intelligible data.  Unhelpfully, central banks since 2008, with Quantitative Easing,  and a decade of artificially low interest rates, have entered uncharted territory [Perhaps I should say uncharted in the west.  Japan’s 1989 crash saw policymakers respond with aggressive interest rate cuts & deficit-fuelled spending.  For the 20 years since 1998 Japanese interest rates have been in the +0.5% to -0.1% range.].  Since WW2 the boom-bust cycle has lasted an average of c6 years.  Despite UK Chancellor Gordon Brown’s claim to the contrary, he did not abolish boom & bust and, even with QE, things can’t keep expanding forever.  As we enter 2021 we have had c12 years of (albeit weak) expansion, and ever-higher asset prices.  The old wisdom of ‘buy low, sell high’ has given way to ‘buy high, sell even higher’. Keynes’s observation that ‘markets can stay irrational longer than you can stay solvent’ has seldom been more relevant, but, in choosing between ‘The market is irrational’ and ‘I am wrong, probably because I am missing a key factor / new paradigm’, the odds will usually favour the latter explanation.

While you don't need to bother with economic models, don't be seduced by the idea that just doing well in your day job will cause the financial numbers to work themselves out in your favour: Paul McCartney made less money as part of The Beetles than from Wings.  By the time he formed Wings, he had wised up, lawyered up, and so got a fair deal from the record company.  The original deal made by The Beatles was so bad that the music publishing rights they gave away came to have a capital value of a billion dollars.  A single investor is not going to sign a deal that gives a billion dollars to their investment management company, but the principle is the same: lots of little investors sign up to bad deals, giving inflated fees to the fund manager, and that flow of fees can be worth billions.  This book may help you spot the investment equivalents of ‘Beatles record deals’: getting a Wings-style deal is only possible if you fight your corner, and that starts with realizing that the slick men in suits working for EMI in 1962 were not good guys looking out for the interests of John, Paul, George and Ringo.

If you ever have a moment of self doubt, or wonder if you are up to making money choices yourself, just ask if you would have signed up to the deal proposed by EMI:  LPs cost £1 12  shillings [384 old pence], and a single 6 shillings and 3 pence [75 old pence].  You might not have got them the 20% royalties [76 old pence on an LP, 15 old pence on a single] that some artists get, but I suspect that you would have insisted on more than the 1 old penny per record that EMI’s contract paid.  That’s not 1 pence each, its one pence for the whole band, so ¼ of a penny (old penny) each.   This 1/4 of an old penny each was fixed in cash terms, not adjusted for inflation, which soon toom off, and was followed by decimilaistion in 1971 whereupon each old penny became worth 0.4 New pence, so 1/4 of an old penny became 1/10th of a new penny.  That’s what the grown ups will give you if they can get away with it.  And the only way that they don’t get away with it, is if you walk away from a bad deal.

© James Wallace-Dunlop 2021