Austrian economist Joseph Schumpeter coined the term “creative destruction” to describe the positive impact of business failure on free market economies. It’s a simple concept. As better ideas for products or services emerge, old ones dies out. The classic example is the automobile coming on the scene and displacing horses and buggies. More recently, the internet has been a very creative destroyer. From retailers to travel agents to media companies of all types, it’s been steadily remaking just about every industry out there.
But often the companies and industries ripe for creative destruction aren’t as obvious as video rental shops or horse-drawn carriages–and they use their social and political connections to hold out far longer than they have any right to. That’s definitely the case in two sectors right now: real estate and higher education.
It’s fashionable these days, especially in my industry, to style oneself as “socially liberal but fiscally conservative.” I might be one of the only hedge fund managers out there who claims the opposite. I tend to be to the right socially, but downright Krugman-esque when it comes to many fiscal issues. I’m passionately pro-immigration. I believe we should have government-funded healthcare. And I want more public spending on infrastructure and education.
I’ll also readily admit that wealthy individualslike me are under-taxed in this country. Businesses are another matter, though. Corporations are not people, and we shouldn’t be taxing them like they are.
There’s been no shortage of criticism of “Helicopter” Ben Bernanke’s aggressive quantitative easing policies. But you have to hand it to the man. He’s nothing if not determined. Against all odds and even the laws of financial physics, he’s accomplished his primary goal—juicing stock prices.
The problem is, as usual, most average investors are behind the curve.
Year-to-date, as the NY Times pointed out Sunday, more than $85 billion has been put into bond mutual funds compared to only $73 billion for stock funds. But buying bonds is not a wise strategy going forward. Thanks to Uncle Ben’s interventions and other factors, stocks are almost surely going to outperform bonds for the next three, five, maybe even ten years.
In my last post, I talked about the enormous fees mutual funds charge their customers. There’s no doubt about it: if you’re an individual investor, your best option is index funds. But if you really want to play the market yourself, beware of stocks with too-good-to-be-true stories. They almost always have sad endings.
I’ve seen countless investors get burned by “story stocks,” businesses with little else to their names but inspiring ideas. It’s even happened–indirectly–to me.
A million years ago in the 1980s I managed a mutual fund that charged new investors something called a “front end load” fee. Just for the privilege of giving their money to my company, our customers had to pay an obscene 5.75 percent of their investment right off the bat. Thankfully, those kinds of fees are rare nowadays. But mutual funds are still fleecing their investors in a big way.
When I quit the mutual fund racket in 1990, the industry was booming. It had recently found a huge new source of revenue–retirement accounts. The old pension system was dying and everyone was hailing Wall Street’s brilliant new financial invention–the 401(k). Trust me, after four years inside that business, I can say in all confidence that people shouldn’t put a red cent into actively managed mutual funds, let alone their entire life savings. And yet 60 million Americans have now placed their nest eggs in 401(k)’s. That’s a scary thought.