Chapter 1The Focus of this Book
One is not likely to discern the focus and content of this book by simply noting its title. The word "investment" suggests that it will deal with investment decisions, be they "real investments" made by corporations, other businesses and governments or the purchase and sale of securities previously issued by firms and governmental agencies. The use of the word "sharing" could lead one to suspect that charitable activities will be discussed. And "outcomes" could be regarded as superfluous, if not mysterious. In fact, the title was chosen with care. We will focus on the investment choices made by individuals who place their savings and other wealth in securities -- bonds, stocks, and more exotic instruments. The creation of new securities by corporations, other businesses and governmental agencies will be addressed only tangentially. Importantly, we will emphasize that security investments should be viewed as means towards one or more ends. In the final analysis, it is the outcome of an investment that matters. A person might invest in a portfolio of stocks to finance his or her retirement. If the stocks do well, the outcome will be a comfortable standard of living after retirement. If the stocks do badly, the outcome will be less desirable. We will emphasize throughout that investments are merely instruments that provide alternative combinations of outcomes. Moreover, in many circumstances alternative combinations of investments may provide the same set of outcomes. It is thus best to consider outcomes first, and then find one or more investment strategies to achieve the desired combination of outcomes. Finally, we will note that in a market economy, individuals engage in transactions that enable those with investable wealth to share the overall outcome provided by the aggregate economy. The same can be said for sharing the future values provided by marketable securities. We will argue that an individual cannot make sensible investment decisions without explicitly considering his or her place in the set of those investing in the same overall marketplace. All of these points may seem obvious to the point of triviality. But consider two examples of the views frequently found in the press and presented by some investment advisors. "The market fell today in a wave of heavy selling." The view of "the market" as a monolith is so common that all too few question it. But there is no such thing as "the market". The indices used to measure overall market levels are computed by aggregating the prices at which transactions in many different securities among many different buyers and sellers have taken place. Moreover, for every seller there was a buyer. It would be as correct to say "the market fell today in a wave of heavy buying". "Stock XYZ is a great buy. The company's future is rosy and you can get the stock at a bargain price." If an investor going to buy shares of XYZ, he or she is going to have to buy it from someone at a price that the seller will accept. But why should the seller accept a price that is clearly too low, given the prospects for the company? Groucho Marx, a great American comedian, once said that he didn't want to join a club that would accept him as a member. Why would an investor want to buy a stock for a price at which someone else is eager to sell? We will see that there are occasions when transactions can benefit both parties, but each should seriously consider the other's possible motivations before proceeding. To see where we will be heading in this book, imagine a world governed by a benevolent and wise dictator. She cannot know how different parts of the economy will fare in the future, but has a good idea of the possibilities and the likelihood of each one. Her goal is to provide each citizen with an appropriate share of whatever the outcomes may be in the future. To some extent the best approach will depend on an assessment of the merits of each citizen. But it should also depend on their positions and preferences. We will argue that the goal of investors operating in a market environment should be to accomplish a division of future possibilities that is similar to the one a benevolent dictator would arrange. The ultimate question is this: Given the distribution of wealth, who should hold which securities? This is our subject. For ease of reading, the book is formally addressed to the individual investor. However,many individual investors need help -- human, computerized, or a combination thereof. It is hoped that professional financial advisors and those who prepare computerized systems for their use will also find the material useful, at least somewhat novel, and compelling.. |