Survey Finds There Is No Utopia. Markets Agree.

For pretty much all of history, humans have decried society’s shortcomings. Its failures. Its lack of perfection or utopia. This is the origin of many economic, political and sociological visions. And, perhaps unsurprisingly, it is the root of quite a few investing problems. Let me walk you through this from a few different angles.

My inspiration today is an op-ed leading The New York Times Opinion page Wednesday, “Many Americans Believe the Economy Is Rigged.” Two researchers reported the results of an American Academy of Arts and Sciences focus group survey of everyday Americans’ perceptions. Their finding, which wouldn’t even be breaking news in 1917 or the Gilded Age, never mind now: People “believe the rich and powerful have designed the economy to benefit themselves and have left others with too little or nothing at all.” They can’t reconcile amorphous things like solid GDP growth with their daily experience of rising rent and food prices. They disdain politicians from both parties campaigning as pretend champions of the working classes, then spending their time in office “awash in partisan squabbles over things that have little effect on their lives. Many believe that politicians are looking out for their political party, not the American people.”^[i]

Far be it from me to suggest everyone should feel rosy about the economy. And you may see flickers of recognition here. I do. And I could easily segue into a discourse on how these are all the fruits of our economic system’s distortions of capitalism, with too much government intervention limiting the supply of housing and health care while demand runs away unchecked. I could harp on some people’s simultaneous real estate hoarding and NIMBYism and rail about my opinion of health insurance as privatized socialism and a cabal of middlemen. But I won’t. Why? I would be committing the same basic fallacy the op-ed does, which is that perfect exists and utopia is possible to reach—something the entire arc of human history since the Garden of Eden disproves.

The desire for utopia is deeply engrained in the human psyche. It plagues communists and ultra free-market libertarians alike. Every one of us is sure beyond a doubt that if our economic worldview were implemented perfectly, there would be no privation, no poverty, no food insecurity—just happiness and perpetually rising living standards for all. Society disagrees on how but thinks the end is there, at the end of the tunnel, if only greed/politicians/fat cats/other pantomime villains weren’t mucking it all up. But because we all disagree and everyone is imperfect and wrong about something, the system will always be a mishmash of competing worldviews and interests executed by flawed human beings, which means there will be winners and losers—and people who have vested interests in perpetuating these divisions.

Therefore, the trick for us as investors isn’t to sit around navel-gazing about how to make the system better, but rather to see it clear-eyed for what it is and act accordingly. Such as: Do we like that inflation is taking a while to simmer back down to average? Heck no! But are some sectors and industries benefiting more in this environment than others? Wellll, yes, so instead of throwing our toys out of the pram, better to identify the winners and losers and let our findings guide how we invest. Furthermore, for stocks, how that reality compares to expectations is what really matters. So if negativity over inflation is pervasive while it cools—as has been the case over the past year-plus—that is bullish. You can apply both of these concepts to so many of today’s financial annoyances, from high interest rates to volatile oil and gas prices and beyond.

That is one angle. But another struck me during last month’s Australian Open, which had a lot of commercials I couldn’t fast forward. Many were from financial companies (not us!) showing friendly looking investors who just wanted simple things like steady returns, guaranteed income and no downside. And, lo, to my surprise, the actors playing brokers said they had the perfect solution! Which was clearly a pitch for deferred annuities—an idea that itself offers a vision of the impossible: simultaneous capital preservation and equity-like growth. Financial utopia!

But in this messy world, it is impossible. To achieve any rate of return, you must take risk. That is just life—there are always, always tradeoffs. Stocks offer the highest long-term returns of all major asset classes, and if you sample long rolling time horizons, those returns tend to be less variable than the competition. But in shorter periods, they often swing hard in both directions, meaning that to give yourself a chance of landing those long-term returns, you must accept the risk and high likelihood of some temporary declines. Securities that swing less in the short term, by contrast, have lower long-term returns. Cash swings least but has the lowest return, and once you factor in inflation it is basically a long-term money loser.

So if you are investing in the real world, it isn’t about finding utopia, but rather finding the mix of long-term returns and short-term volatility that matches your personal situation—your goals (meaning, the purpose for your money), needs (e.g., the amount you need to withdraw for retirement living expenses), time horizon (the length of time your money must work for you), comfort with volatility and other relevant factors. But in my experience, the vast majority of folks need some growth, which means the vast majority of folks will be exposed to temporary declines in their portfolio’s value.

There are dangers in not seeing this correctly and instead maintaining the belief that you can target capital preservation and growth at the same time. An obvious one is being vulnerable to Ponzi schemes. Bernie Madoff, for one, peddled steady-eddy, equity-like returns with zero downside. The failure to see this as too good to be true set many people up for a terrible surprise. Or, you could get trapped in expensive, illiquid products that play on the desire for capital preservation and growth while burying the truth of their inherent drawbacks in dense prospectuses. Having a clear view of how markets work—that there is and cannot be a utopia—is the antidote to both traps.

So recognize and accept that the world isn’t perfect and won’t ever be. Human history is sine waves, not a hockey stick—ups and downs, always. Politicians, business owners and you—yes, you!—will always be self-interested. But there is still wealth to be built in stocks for those who are willing to take the risk and accept setbacks in the short term. Messy and flawed, maybe, but eminently useful.