The Financial Philosopher

What Would The Greatest Thinkers Think of the Financial Crisis?

What would Lau-tzu say about lending practices?  Would Confucius use a credit card?  Would Michel de Montaigne listen to Jim Cramer? What would Shakespeare say about spending?  And what would Ayn Rand say about government bail outs?

"The reading of all good books is indeed like a conversation with the noblest men of past centuries who were the authors of them, nay a carefully studied conversation, in which they reveal to us none but the best of their thoughts." ~ Rene Descartes

Human behavior has not changed in three-thousand years or perhaps, if at all, in the history of mankind.  The perspective I receive from reading the thoughts of the greatest thinkers who lived dozens, hundreds or even thousands of years ago is amazing.  If humans behaved the same in 600 BC as they do now, what makes us think it will ever be different -- or if the way we act will ever change?

Reading the thoughts of the greatest thinkers reminds us that human behavior never really changes -- only the circumstances and settings change -- and provides insights into how we may affect our own behavior in light of the predictability of that of others.  Our only control is of our own thoughts, desires and emotions -- and even that control is limited to the degree of our self-awareness and emotional intelligence...

"Government 'help' to business is just as disastrous as government persecution... the only way a government can be of service to national prosperity is by keeping its hands off." ~ Ayn Rand

Much of where we are today in the financial crisis is the doing of the federal government.  Of course, no one twisted the arms of consumers or forced them beyond their will to buy homes, cars, clothes and self- indulgence, but the federal government certainly made it more possible.  Historically low interest rates and an arguably over-friendly business environment gave complacency and greed just enough room and energy to manifest into the monster it inevitably would become...

And now that same government will "save us" from the monster it fed, nourished and unleashed...

"You have power over your mind -- not outside events.  Realize this, and you will find strength." ~ Marcus Aurelius

If the federal government bails out financial firms with $1 trillion of our tax dollars, what control do we have over this?  Of course, we may cast votes to elect our government representatives but those in office now are those who will make the decisions now -- not those for whom we cast votes in the next election or elections to follow.

What may we control?  Our thoughts, our emotions, our desires, our asset allocation, our attention allocation, our investment selection, our actions and our passivity are all within our control to some degree.  The actions, or lack thereof, of others and entities outside of ourselves are not within our control.  How we prepare for, or how we react to, outside events is where our strength will be established and determined.

"He who establishes his argument by noise and command shows that his reason is weak." ~ Michel de Montaigne

What would Montaigne say about Jim Cramer or any talking head that essentially sells ad time and books with noise?  Their "reason is weak" and their purpose is not founded upon altruism; therefore, we should be careful of frantically searching for answers in the media.

If anything, we could look to the noisemakers as examples of how not to actand as a proxy for the extremes of foolish behavior in financial markets and the world beyond.  In fact, the precise opposite actions and reactions of the noisemakers have proven to be prudent more times than not.

"Have more than thou showest, speak less than thou knowest." ~ William Shakespeare

The current financial crisis is a result of behavior completely opposite to these famous words from Shakespeare.  In western culture, we have both the desire and the capacity to buy now and pay later -- we wish to show more than we possess -- our display of material wealth is actually a display of our credit capacity and our desire is stronger than our will.  Because we can buy it now, we do buy it now, with little consideration of consequences.  This display is not one of financial power -- it is a display of our borrowing power -- and the lack of power over ourselves.

"Freedom from the desire for the answer is essential to the understanding of a problem." ~ Jiddu Krishnamurti

What happens now?  Where will this financial crisis lead us?  Is the worst behind us or is the worst ahead of us?  These questions in themselves are distractions from solutions to the problem.

We always look for answers from other people -- from other sources outside of ourselves.  If we stop asking questions, the silence itself allows us to listen to the real source of answers -- that which is within ourselves.

"Wealth and rank are what people desire, but unless they are obtained in the right way they may not be possessed." ~ Confucius

Our society has become a status and debt society.  If we may not possess wealth and rank then we will borrow it to inflate our egos and our economies until they become too large to contain.

I do believe that "wealth and rank" may be achieved in "the right way."  Of course there are examples to the contrary but those who begin with a passion for something other than money, then money often follows that passion; and when our altruism inspires us to give away money, it often attracts more money -- not because of the love of money -- but because of the pursuit of a passion other than money.

"There is no calamity greater than lavish desires.  There is not greater guilt than discontent.  And there is no greater disaster than greed."~ Lau-tzu

The cycle of greed is coming to an end.  Of course, the end of this cycle will not mark the end of greed -- it will only mark the end of this particular manifestation of greed. 

Do you remember Enron?  They were the ultimate symbol of the particular form of greed and hubris that ended the last market cycle.  This market cycle's poster children will likely be Bear Stearns, Lehman Brothers, and AIG -- or perhaps others loom... 

"I tell you that virtue does not come from money but from virtue comes money and every other good of man." ~ Socrates

This quote contains the core of my financial philosophy:  Money does not bring meaning -- it brings short- term rewards, which is a human and flawed pursuit.  The path to a meaningful existence is not the path of least resistance -- the shortest distance between two points is not necessarily a straight line... 

It's been said thousands of times in thousands of different ways but the truth remains that our life is a journey and our fulfillment, meaning, actualization, or whatever word you want to attach to the true source of our well-being, is about the journey itself -- it is not about the destination -- if there even is a destination.

If we pursue meaning in our lives, money may follow.  If money does not follow, it will not matter because we are already "rich" -- we find contentment in our pursuits -- and what happens outside of our control is just a production of the natural course of things.

Related Posts:

Weekend Wisdom: Going Through the Emotions

The 'Diminishing Marginal Utility' of Wealth

How Long is Your Lever?

Images: "The Wise Man" by Jim Warren

 

The Essence of Understanding

"Freedom from the desire for an answer is essential to the understanding of a problem."  Jiddu Krishnamurti (1895 - 1996)

Take a deep breath.  Now let it out slowly... Clear your mind of the clutter -- the noise from the outside world -- and begin a new day and beyond...

How important is it that we know the answers?  If our hasty desire to find the answers is great enough, that desire has the potential to overcome our better judgment and it will often settle on the first "answer" that makes sense at the time, we then cling to that answer, and set out on a course that may or may not be to our benefit...

The financial markets certainly do not have any shortage of analysts, forecasters, trend seekers, bloggers, and opinion makers that all seem to be in search of the same thing -- the answers to the prevailing questions of the day:  Where is the market headed?  How can I gain an "edge" over other investors?  How much risk should I take?  When will the volatility end?  When will it begin again? 

I try to keep my information intake to a minimum so as to overcome "the poverty of attention" and the sources I most frequently observe appear to be written, read, and commented on by intelligent people.  The knowledge of stock market history, economic terminology, corporate financial statements, and financial trends that I observe is mind-boggling, if not impressive, as I sit and read the apparent understanding of complex data (the operative word here being apparent).  At the same time, I have to remind myself that knowledge is not wisdom and, as you may relate, it is quite easy for our attention to be consumed by the overabundance of information. Wisdom, however, such as today's words from Krishnamurti, always brings me back to center...  Ah, the wonder, power, and comfort of philosophy...

Why can we not resist the temptation to find "the answers?"  I've reported on behavioral finance before.  Our brains seek out heuristics, or patterns, that "reward" us for discovering them.  The only problem is that the "patterns" almost never continue or repeat in the same way.  That's why, over time, most money managers seldom beat the market averages and, as we've recently observed, why "quant funds" run by computer programs fail miserably.

If we would only seek to know ourselves completely, both personally and as humans, we would know and understand our drive to seek out trends, which is a pattern of its own, is fundamentally flawed... 

If we will simply free ourselves from the desire to find the answers, we may discover that the problem lies, not within the search, but in the fact that we began the search in the first place...

Be free and the answers will find you...

TFPAuthor, Kent Thune, is the President and founder of Atlantic Capital Investments, LLC (ACI), a 'fee-only' Registered Investment Advisory firm located in Mt. Pleasant, SC.

How Long Is Your Lever?

"Give me a lever long enough and a fulcrum on which to place it and I shall move the world."  Archimedes (287 - 212BC)

The word, leverage, has been passed around every corner of the financial universe over the past several months.  For better or worse, it has become a "sexy" word -- one that brings that instant gratification of, "Yes, leverage is what I need.  And anyone using it must be wise."  As investors have recently learned, leverage can work for you or it can work against you.  Today, we'll start with the basics of leverage then cite a few of the many uses of the term that has been used for centuries.  Hopefully, you will discover just how long your lever is...

General Definition

First, leverage can be generally defined, in the physical sense, as an assisted advantage.  As a verb, to leverage means to gain an advantage through the use of a tool.  For example, a heavy object is more easily lifted with a lever than it is unassisted.  Think of a hinge that assists in opening a heavy door or a pulley that helps lift large objects otherwise unmovable.

Financial Leverage

More recently, leverage has become an automatic term for a business, individual or other entity utilizing borrowed money (aka "other people's money") for financial gain.  Businesses have recently used leverage to strategically change their financial structure by purchasing more company stock with low interest rate loans or by expanding their business by purchasing other businesses, in the form of "leveraged buyouts."

Financial leverage is assumed to always be intended as a wise use of resources, such as a tax advantage for the corporation and/or an increase in the return on the shareholder's investment; however, it can have negative outcomes.  Companies (and individuals, alike) that are highly leveraged increase the risk of bankruptcy; therefore risk erosion of their share price (for the individual, personal net worth) as well as their borrowing capacity (additional financing ability, bond/credit rating).

Recently, examples of leverage working against the user have shown their ugly results in the form of subprime mortgage resets, hedge fund implosions, credit market contagion, and broad stock market jitters.  I've referred to this poor usage of leverage and its messy outcome as part of the cycle of greed. 

Good Debt vs. Bad Debt

Many economic theories, most notably that of Modigliani-Miller, suggest that a highly levered firm (financed with debt) can be just as profitable as an unlevered firm (financed with equity) and the "optimal" level of debt or capital structure depends on the firm itself.  While the MM Theorum has its merits, it has much less application in the world of personal finance.  Individuals should seek prudent debt management to maintain "good debt:"

• Debt should be maintained to the degree that it keeps financial risk at a manageable level;
• The proper level of debt should serve its purpose to the individual yet ensure future financing flexibility;
• And the level of debt will allow the individual to maintain a desirable credit rating.
• General words of wisdom:  Spend less than you make; too much debt can be just as foolish as too little; a prudent debt-to income ratio level is between 20 and 36; and use debt less on depreciating assets and more on appreciating assets. 

For investors

In a financial sense, leverage can take on several meanings.  The most common application of financial leverage is applied through the time value of money, which refers to the fact that a dollar in hand today is worth more than a dollar promised at some time in the future.  Applying leverage, you must earn interest on your dollar to allow it to "work" for you until you need it later.  Ultimately, you must earn interest above the rate of inflation, not only to maintain your dollar's purchasing power but, to increase it. 

• Time and its companion, compounding interest, are the most powerful applications of financial leverage.  All other considerations being equal, the longer your investment time horizon, the longer your lever.  For example, consider two investors, both age 18:  The first investor immediately begins making an annual $4,000 IRA contribution today and stops contributing in eight years at age 26 -- the second investor waits nine years and starts at age 27, contributing the same amount and earning the same rate of return (8%) until stopping at age 65.  The first investor (using time as a lever) ends with $1,004,764 (total contributions, $36,000).  Even after more than 40 years of contributions (total, $152,000), the second investor is still behind with $951,765.
• Knowing yourself is the key to success while understanding risk is vital here.  Check a previous TFP post, "Know Thy Risk," for more specifics.  Most investors should stick to the tried, the true, and the boring-yet-prudent practices of dollar-cost averaging, balanced asset allocation, or even a life-cycle fund approach.
• Also remember, your lever's length can be shortened by imprudent investment selection or usage, inappropriate asset allocation, and any application of your emotions to investment decisions.

Levering Knowledge

As I stated above, knowing yourself is the key to financial success and has applications in every other aspect of your life as well.  Of course, there is more to knowledge than self-acquaintance.  Knowledge of your pursuit and its requirements for success is necessary to reach your destination.  If you lack the skills to do something yourself, logic says you should lever the knowledge of others.  Here are a few examples:

• Do you have the time, resources, ability, and the passion to study corporate financial statements?  If not, then you should invest in mutual funds and lever the knowledge of a professional money manager (except when index funds are appropriate).
• Would you recommend you as a financial advisor?  In my personal investment advisory practice, my best clients will agree that my primary role as their advisor is to protect them from themselves.  Generally, if you've acquired at least six figures in investable assets and your financial picture is not so simple any more, a financial planner with experience and expertise in your area (and without bias to a large firm or any proprietary investments) is wise. 
• For the individual investor who wishes to manage their own investments and possesses the aptitude and passion required for success, the active-management style of my "Socratic Model" may be a logical place to begin.  Just remember a few things to lever knowledge of others for yourself:  Education never ends; read more books than "news;" there is no such thing as original thought; understanding behavioral finance is necessary; and doubting yourself and others (critical reasoning) should remain central to your investment philosophy.

Lever or Be Levered

In the end, whether you are an individual investor, a trader, or someone simply finding their way through the maze of personal finance, the length of your lever essentially depends on your ability to minimize risk and maximize return as well as knowing what that means.  Assuming excessively high or excessively low levels of the many types of risk will potentially shorten your lever -- the highest returns typically require higher amounts of risk and the lowest levels of risk will likely result in inadequate returns.  Therefore, it is prudent to seek moderation; thereby avoiding foolish levels of risk, achieving an "acceptable" return, and freeing time to pursue your true passions -- all at the same time. 

Going back to the beginning of my post, you'll do do well to remember the broad meaning of leverage -- a means to gain advantage through the use of a tool.  You must use the "tools" of leverage for financial gain only with the ultimate objective of using money as a means for the pursuits of your life -- not for pursuing money as an end to a means.  Otherwise, you may find yourself to be "the tool" being levered...