“Enough” helps to discover the real diamonds of life and separate them from false ones. It is simply a informing that in an absolute pursuit of success – frequently illusory – it is easy to miss real diamonds by inviting into your life, household or killing company, fast-split weeds of infidelity, greed and dishonesty. “Enough” teaches economics and spectacularly shows how dangerous the consequences of ignoring its rules are. Anyone who wants to live better and smarter should read the book.
We thank Maklerska.pl for sharing a part for publication. We encourage you to read the full book.
Chapter 1
Too much cost, besides small value[25]
Let me begin by recalling this magnificent old epigram from the nineteenth century United Kingdom:
Some people make a surviving utilizing nature and drawing on their hands — we call it work. Others gain a surviving utilizing those who gain a living, utilizing nature and drawing on their hands — that is what we call commerce. inactive others make a surviving utilizing those who gain a living, utilizing those who gain a living, utilizing nature and drawing on their hands — that is what we call finances.[26]
Today, these strong statements proceed to describe well the realities of the dependence between the financial strategy (with which my full career was connected) and the economy as such. The principles under which this strategy operates — after Justice Louis Brandeis — are indeed iron principles. The gross profit generated by financial markets minus the costs of the financial strategy equals the net profit to the investors.
Thus, as long as the financial strategy brings to investors (aggregated) the profits which they generously give to the stock and bond markets — but the profits only (i.e. always) after deducting financial intermediation costs — so long the anticipation for citizens to rise savings during retirement will proceed to be severely undermined by the immense costs of the strategy itself.
The more the financial strategy takes for itself, the little the investor earns.
The investor is the base ‘nutrient’ of the current, highly costly investment ‘food chain’.
The bare truth, which we can so sum up each of these undisputed statements, is this: by balancing everything together, it appears that the current financial strategy is diminishing the value that society can produce. These are the modern realities of our financial system. These realities developed over the years as the financial sector expanded into the largest single section of the American economy over decades.
Not adequate value
We live in a planet where besides many of us don't seem to be producing anything anymore.
We only trade pieces of paper, exchanging shares and bonds among ourselves, while paying our financial dealers real fortunes. As part of this trend, costs automatically increase with the creation of very complex derivatives (derivatives), which have built into the financial strategy immense and unfathomable risks.
Warren Buffett’s wise business partner, Charlie Munger, is very open - minded, stating that “most operations aimed at making money produce profoundly antisocial effects. The high-cost investment instruments are now becoming increasingly popular... and the operations carried out through them are increasingly reinforcing the harmful trend in which the intellectual and ethical possible of young people in this country is increasingly attracted to the lucrative business of money management. This possible is corroded by the tensions presently inscribed in this kind of career, as opposed to the possible of a career involving work, the consequence of which is the creation of much greater value."
I share Charles Munger's concern about the situation in which we face an avalanche of young talent in the manufacture that clearly depletes the value of our society. I frequently talk about this in speeches addressed to students. But I never advise them straight not to enter the money management business. Words alone don't scare anyone away. Instead, I ask these young graduates to consider 3 issues before they decide to enter the field.
I would ask you, no substance what profession you may be doing, to consider these issues. Think about how they can relate to your life. Consider, in their context, how you realize the message that in our worldly life in pursuit of satisfaction and happiness we transcend the limits set by “enough” and take action that goes far beyond what is adequate and good for our fellowmen.
Prophetic Prophecy
Here's what I had to say at the highest of the boom in the financial sector, during the inaugural lecture at Georgetown University in May 2007:
First, if you enter the financial sector, enter it with your eyes wide open, knowing that any action that defrauds value from customers may, in a period more anxious than the present, prove to be an action leading to you falling into your own snares. It is rightly said on Wall Street that "money has no conscience," but do not let this truism make you ignore your consciences, or that your conduct and your character will change. Secondly, erstwhile you start investing in order to have adequate to pay for your pensions, you request only in a fewer decades, invest in specified a way as to minimize the costs generated by the financial environment, which reduce the profits generated by the economy. These words — I am not hiding — are a kind of self-promotional advice to invest in low-cost indexed American and global stock funds (as Vanguard). specified a strategy will give you the only warrant of a fair[28] share of the profits that can be obtained on our financial markets. Thirdly, no substance what career you choose, effort your best to keep advanced standards traditionally associated with professionalism, even though they are now rapidly eroded,
and according to these standards, the highest precedence is always the thought of responsibility, caring for the good entrusted to us and guarding the client's interests. Do not underestimate the greater good of your local community, your country and the world. As William Penn utilized to say, “We go through this planet only once, so all the good deeds we can do must be done here and now, and now we should besides show all the kindness that we can afford, for we will never walk the same way again.”
The informing given in this talk, which speaks of the request to realize that any action that defrauds value from customers may, in a period more anxious than the present, turn out to be an action that leads us to fall into our own snares, proved not only prophetic, but besides amazingly timely. The manufacture blew up due to its own production dynamite. Without a shadow of a uncertainty in July 2007, only 2 months after my lecture on the financial sector, the leaders of which were (not to mention, not to mention) Citigroup and investment banks Merrill Lynch and Bear Stearns, began to collapse simply due to the fact that the risky, recklessly unprotected, complex and costly credit instruments created by these companies began to match the overly voracious beer that had to be drank with 1 gust on the spot. This was followed by immense losses in the financial statements. By mid-2008, they had reached a full staggering amount of $975 billion, with even more in the future.
Life from Finance
During the lecture at Georgetown University, I stressed that in 2006, only the financial sector itself was liable for 215 out of $711 billion of profits achieved by 500 companies consisting of S & P 500 Stock Index, which accounted for 30 percent of the full profits generated this year by companies listed in this index (or possibly 35 percent or more if it included the financial income of large industrial companies specified as General Electric). The dominance of financial companies in our economy and on the stock markets is extraordinary. The combined profits of these companies outweigh the combined profits of very profitable American energy and technology companies, and are about 3 times higher than the revenues of the thriving wellness care manufacture or the American gigant companies operating in the industry.
By the end of 2007, however, the profits of the financial sector rapidly decreased by almost half, shrinking that year to $132 billion. However, it is not only that the share of the sector's income decreased from 30 to 17 percent in the $600 billion pool of full profits generated by companies listed by the S & P 500 index. The sector was besides liable for the full 90 percent drop in profits from this index in that year 2007. The slaughter continued in 2008.
At this point, it could be said that proverbial justice has been done. But is it true? The clients of financial companies and banks lost hundreds of billions of dollars in the risk-bearing credit derivatives created by these banks[29], followed by a wave of redundancies in the manufacture — over 200,000 people lost their jobs in finance.
However, most investment bank heads proceed to receive outstanding salaries.
I was reminded of a communicative here, possibly just an anecdote I was reading recently. She tells of an investment banker who says this to his colleagues after the securities marketplace is broken and covered by bank bonds: “I have good news and bad news. The bad news is we fucked quite a few money. The good news is that there was not a penny of our own money."
This communicative one more time reminds us that in most cases what is good for the financial manufacture is bad for us as its customers.* Oh, my God *
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Fortunes broken in defeat
Take, for example, the briefings of 3 well-known CEOs in the finance sector, who failed both their customers and shareholders during the fresh marketplace turmoil. Charles Prince, head of Citigroup, took his position in October 2003, erstwhile the shares of this group sold at $47. For respective years, utilizing the economical situation, the bank created a highly risky investment portfolio, which in 5 years completely disintegrated, and the losses incurred reached around $21 billion (as yet). Citigroup profits fell from $4.5 paid for a share in 2006 to $0.72 in 2007, and as I compose these words, 1 share of Citigroup costs $20. Mr. Prince was paid $138 million for his efforts at a good time.
For the disaster that followed, he suffered no punishment (he resigned from his post on November 4, 2007).
The case of Stanley O’Neal, the CEO of Merrill Lynch, was similar. The hazard taken by this company erstwhile creating a advanced hazard investment portfolio exploded in late 2007, bringing losses of $19 billion (it is rather likely that they will be higher). Merrill reported net losses for the same year of $10.73 per share, and the price of his stock on the stock marketplace went to his head, per neck from $95 per part to below $20. Nevertheless, the financial compensation for Mr O' Neal's work, amounting to $161 million for the period 2002-2007, has not been affected. He was besides full paid by the board a bonus package including a pension plan, which he was awarded erstwhile he resigned in October 2007 — another 160 million (i.e. a full of $321 million).
The biggest insolence, however, was the payment to James E. Cayne, CEO (CEO) at Bear Stearns, about $232 million for the period 1993–2006, erstwhile the stock exchange price of this “tanker” among investment banks rose from $12 per share to $165. Meanwhile, a risky and mostly liquidated investment portfolio combined with very advanced leverage (the assets nearly 35 times the value of capital),30 led Bear to the bankruptcy threshold. The national Reserve had to give him a warrant on the value of most of this portfolio before JPMorgan pursuit agreed to buy the company at a price of $2 per share (finally the price increased to $10) — a failure of about $25 billion, which simply evaporated from shareholder capital. Nevertheless, millions of dollars in wages for Mr. Cayne have been paid in full. (The investments he made at Bear, erstwhile valued for a billion dollars, were nevertheless worth only 60 million at the time he sold his shares in March 2008. Most of us most likely think that $60 million is inactive a immense amount of money, especially if we compare it with the disaster of capital failure by another shareholders and the failure of work by thousands of Bear employees having nothing to do with the bankruptcy of this company.)
To paraphrase Winston Churchill's statement, 1 might say that: never so much has been paid so much for so fewer achievements.
Eagle — I win, tails — you lose
The wealth that our financial vouchers have gained over the past fewer decades — and the unwarranted costs they have put on investors — pales in comparison to the wealth accumulated by the most successful hedge fund managers. In 2007 alone, 50 top-paid managers of these funds earned a full of 29 billion
dollars (yes, billions). If you didn't make $360 million in 1 year, you couldn't even break through to the top twenty-five on that list. Yes, gambling at advanced stakes — either on Wall Street, on a racetrack or at Las Vegas casinos — can bring a cut of profits.
According to the fresh York Times, in 2007, the best-paid hedge fund manager was John Paulson, who picked up a circular $3.7 billion. It is said that his Paulson & Company has made more than 20 billion for its customers, betting on the breakdown of the rates of any mortgage-protected securities (I will describe these papers more accurately in a moment).
Who could regret Mr Paulson's large reward for the profits his company has made for its customers thanks to specified highly successful speculation?** Not me!
My problem with the stunning salaries earned by hedge fund managers is, on the another hand, about asymmetrics — the deficiency of a fundamental balance. erstwhile speculation is profitable, managers receive immense rewards, but erstwhile it is loss-making, they do not lose the same amount as investors. For example, since Paulson actually made money from the transactions he had made, as if the value of securities secured by liens (so-called mortgage bonds)[31] were going to collapse — in another words, the consequence of speculations made under the name of default swaps in the repayment of the loan[32] — another company had to lose on these transactions, assuming that there would be an increase in the value of credit derivatives (and the price of their swaps). It follows, therefore, that the another organization containing this "establishment" lost on it the $20 billion profit collected by Paulson.
However, as we all know, the managers of the company that lost this bet did not return 20 billion to their customers.
In this way, the excruciating costs generated by the financial strategy have increased even more, at the same time bringing large benefits to those who are well seated in the mediate of it and gain even erstwhile their customers are (indecently speaking) impoverished alternatively than rich. A hypothetical example will make it even clearer. Let's say you've invested in 1 of the hedge funds, which is operated by 2 managers. They each have the same number of shares. 1 of them bets 1 side of the bet described above, the another side of the bet. 1 earns 30 percent and the another loses 30 percent, so your account balances to zero... but only seemingly. For this winning one, you pay, say, 20 percent of the “wins” for you 30 percent — or 6 percent of the full capital plus 2 percent in the management fee, which is 8 percent. But besides to the 1 who lost, you besides pay his base wage in the form of 2 percent, and in the cost of your full investment account, that is on average 5 percent. And then you pay another 2 percent to the multi-fund manager of the fund. In this way, even though your investment portfolio generated a zero return on investment (because before deducting costs you are zero), you lost 7 percent of your capital.
Again, the sector wins, the investor loses.
Brain drain
The massive revenues late generated by hedge fund managers and the stunning salaries and bonuses paid to investment bankers clearly ignite the imagination of many business school graduates in America, making Wall Street the preferred destination for their career. Despite the alarming statements of Charlie Munger and akin individuals, a full wave of capable young people proceed to flow a wide stream into the finance sector, gaining momentum even erstwhile they lost their financial markets. The number of licensed financial advisors[33] reached a evidence level of 82,000 and the letter “Barron’s” late reported that “not little than 140,000 fresh candidates — record-breakingly many — from all corners of the globe are lining up for an exam, whose passage guarantees the successful so desired entry on the licensing list.”
Maybe I should be happy to hear the news. It's a profession I've devoted my full career to. I fear, however, that the motivation of besides many of those rushing into the financial planet has more to do with what they can draw from society than what they can contribute to society.
It is simply a mathematical certainty that the costs of the services provided by their employees — taken as a aggregate — will exceed their value.
I want us to focus on this issue now: the deficiency of a link between costs and values in the financial system.
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Join us!Drainage through costs and taxes
Let's start with the cost, due to the fact that in this case, it's easier to see things in the fog. For the last 50 years (nominal) the gross profit on shares was on average 11 percent per year. Therefore, the $1,000 invested at the beginning of this period in shares, present would be $14,4600 worth. Not bad, huh? But having shares costs: commissions for brokers, salaries for managers, acquisition fees, consulting fees, advertising costs, lawyer fees and so on. It would be right to estimation these costs at least 2 percent per year.
When we subtract these assumed investment expenditures, even at the level of 2 percent, the long-term net return will fall to 9 percent, and the final value of our investment will fall to just $74,400. If we presume that a minimum of 1.5 percent of this will be paid by the obliged investors for income taxation and profit taxation on the stock exchange, the profit after taxation deduction will fall to 7.5 percent, and the final capital increase will shrink again by half — to $37,000.
It is clear that the miraculous magic of accumulated profits is inevitably subjected to a powerful tyranny of cumulative costs.
About 80 percent of the earnings we can anticipate just vanish into thin air.
And let us not forget that if we number in dollars, our profit from the first investment in the amount of
$1,000 will be reduced by inflation, which, at a 4.1% inflation rate over the last half century and after deducting costs and taxes, gives us — alternatively of 184,600 nominal “pre-cost” and “pre-tax” dollars — just $5,300!
Magic Unfriendly
The costs of the financial strategy are now so advanced primarily due to the fact that we have given up conventional (and favorable) investment standards, aptly characterized in the statements of legendary Benjamin Graham, published in the "Financial Analysts Journal" (May-June 1963 edition):
My basic thesis, which applies both to the future and to the past, says that an intelligent and well - trained financial advisor can execute useful work for many different clients, as the guardian of an investment portfolio, thus justifying more than the convincing request for his existence. I besides claim that he can do his occupation by following a fewer comparatively simple principles relating to reasonable investment, for example by keeping the right balance between bonds and shares; decently diversified by forging a portfolio; preferring investments from typical indices; advising against speculative operations that are inappropriate from the point of view of the client's financial situation or incompatible with his temperament. In order to put these principles into practice, a financial advisor does not request to be a magician who, with the aid of a magic wand, prefers winners in the list of listed shares or a psychic predicting movements in the markets.
No 1 who is acquainted with the ideas promoted by me during my long career will be amazed to see that with both hands I sign up to these simple principles of balance, diversification and long-term investment, not to mention the skeptical attitude towards expectations that the stock exchanges of magicians and prophets predicting trends on the marketplace are able (in full and in the long run) to produce any added value.
As far as the accuracy is concerned, erstwhile I entered the open investment fund manufacture fifty-seven long years ago, money managers invested in it, so to speak, rather in line with Graham's recommendations. The portfolios of the main equity funds at the time consisted primarily of diversified investments in blue chips shares[34], and managers of these portfolios invested in the long term. They refrained from speculation on shares, directed their funds at costs that were (compared to today's standards) ridiculously low, and made profits for their investors akin to those generated by markets.
These managers were not the magicians of the top-ranking winners, as evidenced by reports showing the course of their actions over the long term.
Costs — hideous, multiheaded Hydra
Today, if fund managers can consider themselves magicians in any field, this is the art of pulling money out of investors' pockets. In 2007, the direct costs of the open fund strategy (FIO) in America (mainly management fees and operating and marketing expenses) amounted to a full of over $100 billion. In addition, funds lose tens of billions of dollars going to transaction fees to brokerage houses and investment banks, and, indirectly, to remuneration to depository banks serving them
and any another “facilitators”[35].
Investmentrs in funds besides pay another (estimated) $10 billion all year in the form of salaries for financial advisors.
In their defense, open funds alone are liable for only part — alternatively tiny — of the full cost of the US financial brokering strategy to investors. In addition to the 100 billion costs generated by FIO, additional costs related to investment banking and brokerage activities and all those charges that go to the accounts of hedge fund managers and pension funds, trust departments in banks, financial advisors, and fees for lawyers and accountants — then the bill issued is about $620 billion a year.
Nobody knows the exact amount. I'm certain there's only 1 thing you can say: either way, these billions are coming out of the pockets of investors. And we must not forget that these are costs incurred year after year. If the current pace continues, and I say it will increase rather, the aggregate cost of financial intermediation will scope an unimaginable $6 trillion in the next 10 years. At this point, it is worth referring to these cumulative costs to the amount of $15 trillion, which reflects the value of the US stock marketplace and to the amount of $30 trillion that represents the value of the US debt market.
Investors get precisely what they don't pay for.
The fact that due to the imposition of the cost of financial intermediation, investor profits are lower than the profits generated by the marketplace is indisputable and, however, it is frequently said that the financial strategy is for
society is simply a origin of added value due to another benefits it brings to investors. These kinds of thesis lie the image of the reality of this system, which does not work in theoretically perfect (classical) conditions of the free market. It is highly burdened with information asymmetry (favouring sellers alternatively than buyers), far from free competition and irrational decisions that are made more under the influence of emotion than reason.
Of course, this does not mean that our financial strategy only generates costs, due to the fact that from the point of view of society it is indeed a origin of any concrete benefits.
It facilitates the optimal allocation of capital among all its users; it enables effective interactions between buyers and sellers; it provides extraordinary liquidity; it strengthens the ability of any investors to rise capital to discount future cash flows and others to get rights to these streams; it creates financial instruments (often involving alleged derivatives, i.e. instruments of complexity frequently not understood for the human head and value derived from another financial instruments) allowing investors to take additional risks or dispose of them (by passing it on to others).
No, it's not that this strategy can't do anything to make benefits. Rather, the question is whether, in general, the cost of gaining these benefits does not scope the ceiling at which they begin to exceed the value of these benefits. The answer to this question seems to me, at least to me, rather obvious: the financial sector is not only the largest sector of our economy; it is besides the only sector in which customers do not receive even the most about what they pay for. Given these inexorable rules of simple arithmetic, investors — treated together — get precisely what they do not pay for. (Paradoxically, if they had not paid anything, they would have got everything!)
A Issue of Extraordinary Importance
Over the past 2 centuries, America has moved from an agricultural-based economy to an industrial-based economy, then a service-based economy and now an economy based mainly on financial operations. However, this finance-based economy by definition reduces the value generated by real (productive) companies[36]. Just think: if, thanks to the opportunities offered by American capitalism, owners and shareholders of real-life, productive enterprises will make profits from dividends and higher incomes, people playing in financial markets will capture these profits from investing in business and return them to investors after the financial intermediation costs have been deducted.
It follows that while investing in American business is simply a game of winnings providing profits higher than stock gains on the stock market, after deducting costs becomes a game of zero total.
In keeping with specified brokering costs, racing the marketplace — from the position of all of us as a group — becomes a game of losers to warrant our failure.
Despite the tremendous and late rapidly increasing dominance of the financial sector in our full economical life, I have not heard of any technological work that the author would undertake to systematically calculate to what degree the financial strategy has depleted investors' profits. There was besides not a single article (except for my own) that dealt with this issue in professional publications: neither in "Journal of Finance", nor in "Journal of Financial Economics", nor in "Journal of Portfolio Management" or "Financial Analysts Journal". The first article I encountered — Kenneth R. Frencha The Cost of Active Investing — was not written until mid-2008 and was shortly to be published in "Journal of Finance".
However, this veil of ignorance[37] must be removed. We must find a way to bring about a extremist improvement in the American capital accumulation system, utilizing tools specified as education, public information, regulation and structural and legislative reforms. If my book contributes to this goal, it will mean that the time I utilized to compose it was well used. The thing is, it just should be done. Until it is, the finance-based economy will proceed to unduly deplete the value produced by real productive companies, and in the hard times ahead of us, this means losses that we cannot afford.
In June 2007, a master of economics, speaking on behalf of this year of alumni[38] at Princeton University, Glen Weyl (now Dr. Weyl, due to the fact that he obtained a PhD in economics just a year later), so characterized his passion for intellectual research: “There are issues of specified large importance that it is hard or should be hard to think about anything else.”
There are issues so crucial that it is hard or should be hard to think about anything else. The efficient functioning of a defective financial intermediation strategy in our country is 1 of these issues. It is time not only to start reasoning about this issue, but to examine it in depth, to calculate its costs and to mention it to income that investors not only anticipate to achieve, but have the right to achieve.
Our financial strategy generates adequate costs — in terms of accuracy, far besides much costs — and thus (by definition) does not produce adequate value for marketplace participants.
The planet of finance actually earns a living, utilizing those who gain a living, drawing from nature, working in trade and production. It is essential to request that the financial sector functions more effectively in the public interest and for the sake of investors than today.
John C. Bogle, Enough. Real Measures of Richness, Business and Life, Maklerska.pl Publishing House, 2024, translation by Anna Gąsior-German
Footnotes:
* Oh, my God * There is, indeed, a chance that not all financial companies put their own interests ahead of their clients' interests. erstwhile John Thain, erstwhile head of Goldman Sachs, became CEO at Merrill Lynch in late 2007, he was asked what the 2 forms disagree from. Thain replied, “Merrill truly puts the client first”. You gotta decide whether this message matches the truth.
** I resent the managers of these funds, on the another hand, a maximum of 15% of the taxation rate that the national government applies in a situation called the carried interest. This obscure name refers to the share of the profits of funds paid to these managers. specified a low taxation rate is simply a slapper for all those hard-working citizens whose importantly lower incomes are frequently subject to standard national taxation rates, and these are twice or more higher. It is besides known to me that clever taxation plans let you to shift payment of advance payments to taxation or to avoid taxation at all and thus make further profits, provided that payment is deferred in time. Well, it is amazing that the attempts at taxation reform, to which legislature was promised, were blocked by well-paid lobbyists hired by managers of this kind of funds.
