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The Wall Street Wealth Extraction Machine

March 26, 2013

Essay. Dr. Phil DeMuth and Ben Stein in their about to be released and already famous “The Affluent Investor: Financial Advice to Grow and Protect Your Wealth” (Barron’s Educational Series, April 1, 2013) have famously coined the phrase “Avoid Wall Street’s wealth extraction machine and keep what you’ve got.” On the other hand (We have to use econo-speak from time to time, and here are no one-handed economists.), the main chapter titles© are:

Chapter One: Are You Affluent?
Chapter Two: Rules for Riches
Chapter Three: How You Invest Depends on Your Life Stage
Chapter Four: How You Invest Depends on Who You Are
Chapter Five: The Market Portfolio
Chapter Six: Beyond the Valley of the Market Portfolio
Chapter Seven: Retire the Warren Buffett Way
Chapter Eight: A Hitchhiker’s Guide to Asset Protection
Chapter Nine: Minimizing Taxes

which is a potpourri of discovering who we are, to which they have added the familiar nostrums of “investment advice” which, hopefully, anybody who might want to buy an investment already knows, but nowhere do they say “An investment is just and only the purchase of risk, and like anything else that we might want to buy, we ought to know the price of it, that is, we ought to know the price of risk (Goetze 2009)” and the “risk” is that we might not get our money back and a hopeful return above the rate of inflation (over which we have no control) and where, of course, a failure to obtain a return above the rate of inflation is just another way of losing our money.

Is that too obvious to bear speaking, or so true that one does not want to say it because it makes only we ourselves responsible for what we choose to buy?

We struggle with that distinction every day in our work and these Posts, because:

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond™
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed
With No Fees and No Loads on Capital

We can lift the veil of obscurity on “an investment is just and only the purchase of risk” by observing that anything that we buy has “risk” attached – it might not do, or be, what we reasonably expected or hoped for, and even if we can return it and get our money back, we have lost our investment of hope and time, but earned a new wisdom or understanding in return – and if we choose to buy nothing at all then we are likely to have nothing at all, and we will lose our money anyway because time will extract its “rent” through inflation or obsolescence or lost opportunity as the rest of the world grows and changes around us (excepting a disastrous scenario in which money, cash or gold, for example, would have no “value” anyway. Food, shelter, clothing and personal security would be of the essence.) Therefore, an investment is just and only the purchase of risk and the risk is that we might not get our money back and a hopeful return above the rate of inflation.

The most common purchase of risk is the purchase of a government guaranteed T-bill or bond such as $95 now to receive almost certainly $100 later and the only effective “risk” is that the rate of inflation during that time is more than 5% so that when we get our money back, it will tend to buy less of the things that we need or want. In this case, the “price of risk” is $95 which we pay now in the hope that inflation during that time thereafter will not exceed 5% and, if we don’t want to pay it now, then inflation will almost certainly be something above zero and we will still only be able to buy less of the things that we need or want then.

Of course, if there is no buying and selling under conditions of choice or free will within law, then we have only the disastrous scenario in which there is no market or honest trade at all, which we are also familiar with in time and place, even in modern times and which affects much of the world.

The capital market, and “Wall Street”, which we are defending on principle, although not necessarily its practices, is, therefore, a significant invention of enterprise and societal innovation that emerges because the people who are in the market have different views of “risk” under conditions of law, choice, and negotiation, and the “price of risk” is determined by a negotiation that occurs between “risk seekers” and “risk avoiders” and a person can be one or the other at any time and even at the same time, and it is entirely possible that, a person who sees himself as a “risk seeker” is provably “risk averse”, and vice versa, a person who believes that he (or she) is “risk averse” turns out to be a “risk seeker” because of what they don’t know. That is, they don’t know the “price of risk”.

We have discovered that there is more than one way to calculate or estimate the price of risk for an investment, although, as we noted, everything (every thing, every action or choice) has a price of risk and there might be other ways of discovering it. In the case of stocks or investments in companies, “the price of risk is the least stock price at which the company is likeable (Goetze 2009)” and “likeability” is not determined by colour or taste or “value”, for example, but by portfolios of stocks, each stock of which is deemed to be “likeable” by some criteria, and which portfolios have the property of “tending not to lose in value” and equally importantly within the same market and among the same groups of investors (which, in principle, is all of us), the contra portfolio of stocks that are deemed to be “not likeable” (by not being “likeable”) tends to not gain in value, a kind of “Occam’s Razor”. That test of “likeability” is practical and easy to verify, and we have found that most of what passes for investment advice, fails that test, and that is also true of the aforementioned book and occasion for this gentle Post, The Affluent Investor.

Another way to discover the “price of risk” is that it is the stock prices that are developed or emerge in a Nash Equilibrium (John Nash, 1950, the subject of A Beautiful Mind by Sylvia Nasar, Touchstone, New York, 1998) that is obtained between “risk seeking” and “risk averse” investors within the demonstrated societal norms of bargaining practice and “risk aversion” – we want to keep our money and obtain a hopeful return above the rate of inflation.

For more information and examples, please see almost any of our Posts and The Price of Risk, August 2012, The Nash Equilibrium & Its Stock Price, October 2012, and The Coase Theorem & The Coase Dividend, March 2013.

Finally, Dr. DeMuth does not actually give us any investments. He’s heavy on terms and concepts, but we already know what meat and potatoes and gefüllte fish are, and we can’t escape the Wall Street Market by buying what they have, that is, by buying what they want us to buy. The investors that have become famous and wealthy beyond all understanding, have never taken any risks that they did not fully understand, and to enforce their views, they almost invariably understood the price of risk and used their money, and other’s, to take commanding positions in the markets or in the companies and prospects that they were interested in, in order to enforce those views.  In these Posts, there are many examples of positions in companies and portfolios that have been vetted or crafted by the price of risk. Most recently, please see our Post, The Dow Transports, March 2013, or The Wall Street Put, March 2013, or The Risk Adjusted Dow, March 2013, or The Canada Pension Bond, February 2013, for real investments in real companies in real time.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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