Telarray Investment Review, Part 1: The nature of markets

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New clients at Telarray are offered a session at the beginning of our relationship to discuss the Telarray approach to investing.  It’s a lot to process in an hour or two, and we know that there may be questions as our relationship develops.

Of course, you may call your Advisor at any time with any of your questions, but we thought a multi-part series discussing our approach to investing might be helpful, too. Today we present the first part of this series.

We intend, eventually, to make the entire series available to our clients, both immediately following the initial investment session and also down the road as a resource available on demand.

At Telarray, we invest client assets in public markets via funds that invest in the stock market as well as bonds. 

Stocks represent equity, or a percentage of ownership in a company.  This ownership is for better or worse — if the company does great, the shareholders benefit proportionally, while if the company stumbles, dividends may be cut and the share price will fall.

Bonds represent a loan to the company that pays interest to bondholders in some form.  No matter how well the company does, you’ll never get more back than the predetermined amount.  When a company struggles, they are still obligated to make good on their bonds, and if they approach bankruptcy, bondholders are near the front of the line to get their money back long before owners recover anything.

In either case, the point of investing in equity OR debt is to produce a real return (i.e., a long-term return in excess of inflation).  This seems remarkably straightforward, but investable, portable, “passive” investments such as these are a relatively new development in human history and should not be taken for granted.

In fact, for thousands of years, there was no concept of a place to passively invest money and earn a return on it.  There were no real capital markets or exchanges as we think of them today until a few hundred years ago in Europe.  Even the concept of secure banking is a modern invention — the continuing discovery of troves of gold and silver coins buried all over the world is testament to that.

Exchanges and stable currencies are critical to the idea of investable stocks and bonds, but why can we count on stocks and bonds to produce a return to begin with?  The answer is economic growth, which is the magic that has caused a diversified portfolio of stock and bond funds to produce a meaningful return above inflation for the last 100+ years, and why we expect this phenomenon to continue in the long run into the future.

Before the Industrial Revolution, population was constrained by a number of factors. Widespread subsistence agriculture could only support a certain population density. Population was kept in check by disease, infant mortality, and war.  The primary path to wealth was some sort of concession from the monarch– something like land that earned rents, a special patent or license, or authority to collect taxes—and it was a zero-sum game.  There were no industries as we know them.  I don’t have a source but I once read that around the time of the American Revolution the largest companies in the world only had 200-300 employees due to the challenges of communications and scale. Indeed, for thousands of years very little happened economically.  World economic output was estimated to grow solely with population, which didn’t grow much at all.  In fact, per capita economic growth was essentially zero for all of history until about 1700, as seen in the chart below:

Then something transformational happened: the Industrial Revolution.  Technology spurred a complete change in the trajectory of civilization; suddenly economic output could grow in excess of population growth.  This spurred improvements in quality of life and quicker population growth, which further contributed to growth and started a cycle that brought world population from less than a billion to almost eight billion in just a few hundred years. Small numbers like a 1% annual growth rate may not seem like much, but over a hundred years 1% compounds to 170% growth.  Something growing at 1% for 400 years increases more than 50 times!  The numbers since 1700 are staggering.

World output increasing more than population is the fundamental reason modern capital markets work and the reason we have a long-term expectation that the ownership of productive companies will continue to create returns and increasing account balances for investors.  It’s the reason economists focus so intently on things like GDP growth, demographic trends, and economic cycles.  Productivity growth is one of the most important parts of this magic formula.  Even as population growth will peak and eventually decline, the economy can still grow as long as worker productivity continues to increase.

This is the reason that we focus on the stock market as the primary driver for long-term investment returns.  Things like gold and commodities can go up and down in price over time due to supply and demand, but ultimately, they don’t produce anything on their own and often rely on leverage to produce acceptable returns.  Their long-term expectation is not significantly different than inflation, so they can have a place in a portfolio but are unlikely to be the long-term engine of growth.  Exposure to stocks, while somewhat risky and volatile, allows us to tap into this engine of growth that has lifted us from the subsistence grind of our ancestors into the modern society we enjoy.

This might seem like a bit too much history for an investing discussion, but it’s important to challenge your assumptions and understand each step of the investing path.  Exposure to the stock market is the engine for long-term portfolio returns and is the reason that our investment portfolios allow us to retire and live off our portfolios (we hope) indefinitely without saving every dollar we will ever need before retirement.

Coming up in Part 2: We share how we get exposure to the markets in your Telarray portfolios.


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