The manifesto for action and individual investors

Woolley has the big picture right. He mocks the view that if the finance sector is flourishing, this is seen as a sign that the overall economy is necessarily well. His claim that we need to cut the finance sector down to size- otherwise we may be facing the end of capitalism as we know it, will resonate with readers of our site. In a recent commentary we criticized the proposed Canadian securities Act for not attacking the cost structure of the financial industry; see Proposed Canadian Securities Act and investor protection: a failing grade on our site.

But as interesting as Woolley’s analysis may be, is it relevant to individual investors? Yes and no. Here’s why.

Points relevant to individual investors

Four of his points are directly relevant to small investors. Here they are:

• 1 Adopt long-term investment approach (future dividend flows), rather than momentum (short-run price change) Long term investing is an approach that we believe in and promote.
• 2 Cap annual turnover of portfolios at 30%. Costs is the enemy of good long term investment returns; see Costs of investing on our site. Limiting trading is the best way of reducing costs and avoiding market timing strategies.
• 6 Not engage in alternative investments – Hedge funds, Private equity, commodities For numerous reasons, we recommend against most alternative investments ; see Alternative Investments on our site. So this is another point we agree with.
• 8 Ensure everything in the portfolio is traded on a public exchange As well, we counsel against privately placed, non-traded securities; see Venture capital (private equity) on our site.

A red flag

However, Woolley‘s approach to diversification and active vs. passive investing is in our view inappropriate for individual investors. He believes that great funds should diversify based on cash flows, not on share prices, and points out that indices can be wrong, giving the Japan and high tech bubbles as examples. He proposes a growth of GDP plus a premium for risk as a better return benchmark. These are interesting concepts, but individual investors have neither the time nor the expertise to second-guess market indices or benchmarks or to carry out cash flow analyses. In our view, until further notice, retail investors would be well advised to stay with a passive, price index approach.

Conclusion

Paul Woolley’s argument that we have an overly-expensive, destabilizing financial system is right on. And Canadians in particular should step back and smell the roses the next time one of our politicians starts cheerleading for our financial sector. And individual investors everywhere would do well to seek inspiration from Woolley’s manifesto.