There has been a lot written the past six months about what went wrong with our financial markets and what we need to do to correct them.
How did the financial crisis unfold? How could markets possibly be efficient in the wake extreme volatility of stock and real estate markets? Some articles have even suggested that modern portfolio theory is dead and the “buy and hold” philosophy of investing is obsolete.
For instance, recently an article appeared in The Wall Street Journal, titled, “Failure of a Fail-Safe Strategy Sends Investors Scrambling.” , criticizing this thing called “modern portfolio theory” which states that if you combine several asset classes that move dissimilar to each other in the short run, portfolio volatility can be reduced without a decrease in portfolio return.
Over the years, the financial industry started using more and more big words like covariance, correlation, and standard deviations, offering up complex equations in an effort to hype the notion that investors could get great returns with minimal amount of risk. Then they started adding important sounding investments like hedge funds, alternative investments, gold, and commodity futures to portfolios that had traditionally consisted of two primary asset classes; stocks and bonds. The Wall Street crowd was intent on making this investing thing as complicated as ever in an effort to assuage investors’ emotions of fear and greed.
As Warren Buffett famously said, “Beware of Geeks bearing formulas.”
While Wall Street stands knee-deep in complex equations of commodities and covariance, the average investor barely knows the difference between a stock and bond fund, has no concept what asset allocation means, and has absolutely no idea how to create a simple financial plan.
But before I start in on Geeks, correlations, commodities, I want to talk a little bit about the Coffeehouse Wars that have erupted in my neighborhood.
I live in a little town called Kirkland, nestled on the east side of Lake Washington, across from Seattle. You might recognize the name of my town as the same name that Costco labels all its in-house products, but that is beside the point. Downtown Kirkland is a sleepy little place, caught up in a power struggle between developers who want to bring some life to downtown Kirkland and condo dwellers who don’t want their views of Lake Washington obstructed. So far the condo dwellers are winning, which means that the downtown drag continues to be a drag, full of dowdy, dreary little businesses that can’t seem to make it past a three month lease at any location.
Except for Coffeehouses. We have a Coffeehouse War going on in downtown Kirkland, and it is getting nasty. A couple of years ago Starbucks muscled its way into a local spot to set up shop. Barely one block away, in between Starbucks and Tully’s Coffee, a popular little espresso joint, Kahili Coffee, put down roots. One year ago, just down the street and around the corner, Seattle’s hip Café Ladro opened its doors, and I just found out last week that another big-time Seattle Coffeehouse hangout, Zoka, is moving in on the corner between Café Ladro all those other Coffeehouses.
Right about now you are probably wondering where I am going with this blog.
After reading countless finance articles over the past six months that try to explain covariance, correlation, standard deviation and modern portfolio theory to investors who are more in tune with a single or double latte, it has reinforced my conviction that Wall Street just doesn’t get it. The financial industry is incredibly out of touch with the investment comprehension and concerns of the average investor.
It is not that the folks who stop in at these Coffeehouses are dumb. On the contrary, I suspect most are on their way to work in the morning, needing a jolt of java before settling in for a day’s work at successful careers.
They might not understand covariance and correlations, but as Wall Street has proven over the past eighteen months, the financial industry doesn’t either. The Coffeehouse crowd, like millions of other investors out there, is probably saving a little money in a 401k plan or IRA that has dropped in value from one year ago. All they want to know is what, if anything, they need to be doing today to get back on track of achieving their financial goals of tomorrow.
So, in the next few weeks I am going to do a little investigative reporting. I am going to go down to some of those Kirkland Coffeehouses and interview folks to get a better handle on what their questions and concerns are. I want to see if they are listening to the chatter of Wall Street, or tuning it out. I want to see how confident they are, not only of building a successful portfolio today, but reaching their financial goals tomorrow. I am putting together a list of questions, and will report back. Right now, I need your input. Post a comment and let me know what questions I should be asking to see if the reality of the working world matches the windbags on Wall Street.