Creative Destruction and Successful Investing

Successful investing is a topic rooted in common sense. After all, if you could not invest with a reasonable expectation of success, why would you bother? How do you invest in a chaotic world of change so as to increase the odds of a favorable outcome?

First, recognize that “change itself” is a constant. “Creative destruction” constantly reorders the investment universe. What has the internet and digital advancements done to old line standbys like Sears, Kodak, and Radio Shack? A 2012 article by Richard Foster, “Creative Destruction Whips Through Corporate America,” indicated that on average a company listed as part of the S&P 500 stock index is replaced about once every two weeks. Noted Foster, “In 2011, a total of 23 companies were removed from the S&P500, either due to declines in market value or through an acquisition. At the current ‘churn rate,’ 75% of the S&P 500 firms (listed)in 2011 will be replaced by new firms entering the S&P500 by 2027.” Radio Shack was dropped from the index in June as its stock price sank below $1 a share as bankruptcy threats loomed.

“Creative destruction” may be a good thing if you are paying attention, or you have professional money managers watching the market for you. IBM was founded in 1911. A successful behemoth, did they see Microsoft (founded 1975) or Apple (1976) coming? Enterprises moribund by complex legacy systems rarely are the innovators. The Post Office did not see FedEx or UPS coming. Along with the maligned one percent, the dynamic U.S. stock market gives ordinary Americans an amazing opportunity to build wealth if they will take advantage. The American Benefits Council estimates that nearly 80% of full-time workers have access to employer-sponsored retirement plans. More than 80% of those workers participate, on average saving 6.8% of pay while employers kick in 4.5% of pay. Capitalism at work!

The purpose of saving is not to buy stuff. That may be the end result but the big picture purpose is financial independence, freedom from stress and worry, and the satisfaction of meeting personal obligations. A goal of investing is to accumulate future buying power, and that influences rate of return targets and the necessity for taking risk.

Take a simple goal of growing savings at 3% annually over the rate of inflation and taxation, whether taxes are paid currently or are deferred. If inflation is averaging 2.5% annually, and you add 3% over inflation, your after-tax target is 5.5%. If your average tax rate (federal, state, local) is 25%, leaving you with 75% to spend, you must invest to achieve 7.33% annually as an average over time. (5.5/.75=7.33). Obviously, you cannot achieve that without some risk of loss and volatility. You must manage risk.

Some rules. Only lend to relatives or friends if you are content merely to be a nice person or suffer ill will when you have the audacity to expect repayment. Second, the ultimate risk is complete loss of any investment. Ask yourself, “If I lost all of my money on this investment, would my lifestyle or that of my family suffer measurably?”

Resolve to accumulate enough liquid capital to allow you, and your family if married, to live a year or more with no income. That’s peace of mind in case of a career reverse or some other challenge. Keep debt under control. Marketers want you to spend freely and will provide the credit. “Freedom” can be dangerous at times, as parents know. Janis Joplin, in her 1971 hit single, Me and Bobbie McGee, sang, “Freedom is just another word for nothing left to lose.” How to use money and credit wisely is a constant learning experience.

Have sufficient reserve funds and insurance so you can handle the slings and arrows of life. In counseling clients, a true financial planner, as opposed to a narrowly-focused product pusher, will start with the “what if?” questions, making sure that your personal or family security foundation has all bases covered with up-to-date legal documents in place.

Diversification will minimize the risk of loss from any one thing, but volatility is a reality. There is upside as well as downside volatility. Seek information and education. Money isn’t everything, but it helps!

Lewis Walker is President of Walker Capital Management, LLC. Certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with Walker Capital Management, LLC. lewisw@theinvestmentcoach.com