Rich Investing
Mike Cagney
Co-Founder and CEO at Figure Markets. Views are my own and not investment advice.
Investing is a funny business. Whether you invest on your own or you use an advisor, if you own stocks or bonds you’ve probably had to answer a few questions about your investment style. Questions such as “Which portfolio would you choose?” and “How much do you know about investing?” These questions are intended to measure your risk, and, correspondingly, put you in the best portfolio for the amount of risk you are willing to take. While well intended, this approach is a ridiculous way to drive investment decisions.
Let’s consider my favorite question (as in, the one I think is most useless): “What would you do if the stock market dropped 25%?” This – or some version of it – is a stalwart of nearly every risk questionnaire (such as here and here). It has multiple problems. First, why did the market fall 25%? Earnings? Terrorist attack? These things matter to me as an investor. Second, this is a hard question to hypothesize on. Considering how I’d react – without having actually lost 25% - could yield to very different outcomes than what I would do in the real event. Lucarelli, et. all wrote of this phenomenon.
For arguments sake, assume for a moment that this is a valid question, and I answer it by saying I would sell all of my stock and run for the hills. That would suggest I’m not very risk tolerant, and my portfolio should be skewed toward shorter dated Treasuries that deliver a healthy 1% return in the current market. Now, assume I want to retire in 10 years, have saved $500,000 and need $700,000 to stop working. That’s a compounded return of 3.42%. Do I follow my risk tolerance, thereby guaranteeing I won’t reach my goal?
The inherent flaw in a risk-based approach to choosing your investments is that it ignores the very reason for which one invests: goals. Why am I foregoing consumption today for consumption in the future? Because I need money in the future for something – retirement, college tuition, etc. Shouldn’t the likelihood of reaching my goal(s) underpin my investment decisions?
Technology has the ability to dramatically transform investing. Imagine a scenario where I can define my goals – more than one – and observe the likelihood of reaching each one with different portfolios. Perhaps by being conservative, I have a 95% chance of sending my kids to college, but near certainty I’ll be dining on cat food in my twilight years. Being aggressive means the likelihood of affording college drops to 75%, but I have a good shot at leaving the cat food for the cats. Technology can give me this information real time, and let me make informed decisions about where I invest my money. This includes showing me progress toward my goals, and showing me scenario analysis of how saving (investing) more or less impacts my objectives.
We spend a considerable amount of time in tech talking about how to deliver rich experiences to our customers. “Rich” is anchored by context. Isn’t it time we made investing a rich experience (pun intended), and incorporated goals into our decisioning? Let’s support our investment choices through real, contextual outcomes that matter to us, not questions that read more like ‘cover-your-ass’ than helpful insights.
Partner | Advisor
8 年Mike Cagney Checked out the BETA. Looks like a great start. Yes, you are spot on that goals based investing, (GBI) is a must and the truth is the FinTech movement has already shifted the industry enough to make it a basic standard for the future of wealth management. Your site offers a great start to GBI, but it hasn't solved it... yet. GBI is a bit more complex then placing round numbers on your basic goals. What is your process for helping your clients define their goals properly, (e.g. how to calculate the cost for a child to attend Stanford vs. a state school while factoring in inflation)? How do you address more complicated goals like generational wealth transfer? Of course, you're currently in the business of the mass affluent so some elements of GBI won't pertain to your customer base but what happens when your "HENRY's" become the HNW? In order to truly disrupt the traditional wealth management industry, you will need a way to continue to serve this customer base as they reach their income and net worth goals won't you? Being in wealth management, I really appreciate the recent industry disruptions as they create an evolving environment so thank you for the work you're doing.
Owner
8 年Hi Mike I would like to speak you. Is there an e mail I could e mail you?
Helping Financial Institutions and Advisors create value using "Robo Investment Advisors"
8 年So much common sense..why is that not valued today Great Post!!!
Hi Mike, I'm looking forward to seeing how SoFi can drive innovation and rich customer experiences in this area.
CEO & Founder, Capital Preferences
8 年Mike Cagney - Excellent post and thanks for the contributions SoFi is making to the cause. First, I'll bring your attention to Capital Preferences, a firm I founded in 2014 with Shachar Kariv, Chair of the Economics Department at Berkeley. Our team has been addressing this head on and about to break cover in a major way. Once we do, I think you can be even more ambitious in your cry for better profiling tools and decision aids. My claim is that understanding and then forecasting someone's goals and constraints are not enough. It's not trivial, but its not where you want to start to help the masses. The missing link in improving financial well being is diagnosing a client's preferences - specifically their risk, time and distributional preferences. These preferences govern how we view and make the fundamental tradeoffs you mention in your post - the tradeoff between risk and return, consumption today and consumption tomorrow and the tradeoff between one's own well being and the well being of others. I claim that our "preferences" are the missing link to financial wellness. What would we want to know about a person, if in fact, there were no constraints of time or toolset? Its preferences - risk preferences, time preferences and social preferences: - How loss adverse is this person? - How risk adverse is this person? - How ambiguity adverse are they? - What is the decision making capability of this person? In short, who are you as a financial being? The above is what we call an Economic Fingerprint(TM) and it is only recoverable and interpreted via entirely new scientific methods based in game theory and econometrics. I must study your decisions, not your words and I must do so in a "wind tunnel" where I can identify and isolate what is actually going on. I must study how you make decisions in the "lab" and then see what that explains in the real world. At Capital Preferences, this technology now exists and it launches in Australia in a big way in 30 days and then is coming to the US. We dont want to be a new robo advisor, I was part of the first dot come revolution and know how tough customer acquisition is. We will be the pentium chip inside all credible advice processes and the toolset that enables advice firms to customize their experiences and have a robust scientific process underneath the hood. We have developed a set of scientific tools for use by all financial services firms to "diagnose" would-be investors and then "personalize" treatment. They are not an improvement on the past, they are a break from the past. Mike, you are right to call BS on the industry. I've met with many of the major global regulators and major advice givers and its universally agreed - we all can do better. No consumer would go to a doctor who tried to diagnose their cholesterol through a questionnaire? and no one should go to a bank, investment firm or advisor and pay a "customization" fee when the attempt to understand them has no scientific validity and no statistical confidence.... More to come....www.vimeopro.com/capitalposition/preferences Bernard