The Albanians and the Romanians angry at being swindled in the "pyramid schemes" that swept their newly free market countries, can teach us a lesson about the dangers of oversimplification in investing.
These poor people turned the complex workings of a free market into:
"We can all be rich under capitalism!"
The current crop of mutual fund advertisements is turning the complexity of equity investment into:
"We can all become rich with AAA Funds!"
By the time investing has been reduced to a simple slogan, the prudent keep their feet firmly grounded in cashflow reality!
After the fact, investment manias seem obvious. During the heady period before the speculative collapse eventually occurs, few words of critical analysis are ever heard or even wanted. A necessary condition of overvalued assets is an iterative process of gross oversimplification.
This is a technique borrowed from the "Art of Propaganda."
1. The spreading of ideas, information, or rumor for the purpose of helping or injuring an institution, a cause, or a person.
2. Ideas, facts, or allegations spread deliberately to further one's cause or to damage an opposing cause; also: a public action having such an effect.
Judging from the huge sums that many people have invested in these schemes, most of them seem to have been eventually caught up in this investment mania.
The question is why? Why would such poor peasants flock to put their life savings into such a scheme?
Greed is the obvious motivation. As well as the delusion that accompanies mass, human activities. Without dwelling on the psychology of crowds, an easy-to-understand slogan or sales pitch is a vital ingredient.
The wartime propagandist simplifies the intricate grey complexity into the simple black and white of "THEM AGAINST US!"
The mobsters running the pyramid companies distilled capitalism into "WE CAN ALL BE RICH!" Just pass the cash for this worthless piece of paper!
So what of our late mania of "mutual" and "equity?"
A well considered investment into the securities of a good company is beyond dispute. That good money managers exist and can deliver above market returns is also persuasive. That well-run companies with rising cashflows boost their share prices is a fact. But what about this endless flow of mutual fund advertising?
Are those advertisements curing the burning itch of the "Investment Stupids?"
But to me the simple pitch is unmistakable:
"INVEST WITH US AND YOU CAN BE RICH!"
The problems with this gross oversimplification are obvious.
Economies exist primarily to distribute wealth. Not everyone can be rich!
Financial markets price the cashflows of companies and securities.
Sometimes even developed financial markets are gripped with the same valuation disability that recently possessed the citizens of Albania and Romania.
The process of regaining financial reality can be deadly for the financially promiscuous!
What of today? It is impossible to pick the peak of the market until well after the fact. When markets depart from reality there is generally widespread agreement on what seems to be persuasive rationale.
This gets reduced to simple slogans:
Mutual funds take the risk out of investing!
Let a professional money manager reduce your risk!
You underperform, so put your money in an index fund, and etc.
These slogans have some basis, but are dangerous in their oversimplified form.
A proper investment starts with consideration and research. There is no substitute for informed investing. A good investment should be simple to understand.
A mutual fund is a claim on a portfolio of stocks and bonds that an investment manager has assembled and manages.
The price that investors are willing to pay moves up and down with fundamental factors, and the emotion and sentiment in the market.
But how, you might ask, can I avoid this?
Through a well-considered, long-term, investment program! Good stocks and bonds are always good investments! Don't expect to get rich quick through risky, and speculative investments.
Jumping in with your eyes closed is not a sign of investment courage!
As the neophyte investors of Albania and Romania have found out, there's always someone with a simple slogan waiting to relieve you of your savings!