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Alternative Approach to Income
A lot of people always aspire to earn more than what they take home from their full time jobs. The truth is – your full time job is only a path towards real passive income.
Don’t waste your time pursuing active income your entire life. For as long as you are earning some salary, save as much as you can within realistic limits. The savings you accumulated must be used towards investing in some form of passive income. The most common source of passive income is rental income from real estate assets. The problem with rental in Singapore is the high barrier to entry simply because everyone is competing for the same outcome. If you are thinking about dividend stocks, you are right. That’s another avenue subject to the firms paying out dividends. I know many firms that promises to pay dividend but stall payments for years or even change their dividend policies over time.
The solution to pursuing quality income is a change of your mind set. $10 worth of active income cannot be compared to $1 of passive income. By my definition, passive income requires you to do almost nothing, but allows you to continue receiving the income stream without substantial risks.
The most common question is how to achieve a stream of passive income? For a start, you will need a few streams of active income to achieve a critical mass. When you have achieved the critical mass of savings, you will be able to enter another realm where special investment opportunities are available to you.
Imagine this. If you have only $1000, you don’t even have much investment opportunities. You may be inclined to set up a website and do some affiliate marketing. But everyone is doing the same thing. Students, housewife and everyone else who has access to $1000 will be competing with you. In economic terms, businesses below $1000 face perfect competition subject to the uniqueness of your ideas.
If you have $100,000, the opportunities are wider. One may consider a loan and takeover a retail store, opting to keep the staff and existing business in order to collect the revenues. One may also buy over a factory, a warehouse or an office to lease out. Again, the more your savings, the more opportunities are available to you. And as these opportunities arrives, you will find that “expensive” opportunities have less competition than “cheaper” opportunities. Can most students, blue collared workers takeover a coffee stall? Can they certainly buy over a facility?
You get the point. The hard truth is that passive income comes easily with accumulated savings.
If you don’t have high income stream at the moment, you will unlikely be able to create a meaningful passive income unless you do something less realistic. Remember that 99% of the people are pursuing realistic goals and the most accurate analogy is to fish in an area with the least players.
1. You can take advantage of what other people are passionate about. Say grooming services for pets. Some people can be very passionate about pets and some to the point of obsession. Grooming services are not cheap but people are willing to spend. Say this customer wants to give his Pug a new look every week, then you secured your returning customer. And to no surprise about making a hobby out of your pets, we now have a doggie pedicure. It just shows that the opportunities are limitless. People have also come out with customized ideas about anything – cars will be a good example. From just manufacturing unique accessories to redoing the full package, find anything you can tweak to make it better. Now rather than just owning a customized pimped ride has turned itself into a sport. After experiencing minor successes, outsource the management of the small business and leverage on someone with a strong passion.
2. I would prefer to invest money on someone with huge passion in an interesting concept subject to the right terms, such as 51% ownership of revenue, than to invest my own time in something new. I knew a friend who was crazy about toy planes. He was only 18 when he was well known for crazy flying techniques and for his maintenance skills of these toy planes. I wasn’t the least bit interested but I knew as much as to invest $8000 in a few toys with this boy. The idea was to start a home store, purchase a few inventory pieces, resell the pieces that he had value added on. In no time, I recouped my investments and earned more than 300%. I can’t be bothered to learn the skill, but I make sure I do not let opportunities like this skip by.
3. Another way is to aim to be the first in your respective market! Remember the Rubik’s cube. It has sold more than 350 million of its kind worldwide since its invention in 1974, and still being sold today. Being revolutionary is priceless. But being the first in line is even better. Ever heard of Patrick Bossert? He is a 12 year old schoolboy who published the first manual on how to solve the Rubik’s cube in 1981. His book sold more than 1.5 million copies and several editions were published.
What worked really well with the success of Patrick Bossert is that his idea has an existing base of customers which led to his popularity. It is always smart to look for business where you know that there is a demand – that people are actually looking for it. This makes marketing more effective.
If you find an idea that you are passionate about or if you are able to be the first in a selected website, the only requirement needed for you to make money is the ability to work your computer and take advantage of the World Wide Web. With the rise of social media available on the internet, you can set up a website for free. This can be your platform for marketing your business, ideas or services. You don’t need to spend too much if you prefer a full featured website, you can get one for less than $100. No one cares even if you have a criminal record or an awesome degree as long as your product is what they are looking for.
In another example, I saw some successful e-tailor website popping up around the world. Some became million dollar businesses. In respond to this trend since 5 years ago, I helped my mom to start a website and essentially located a top tailor set up to help her target the e-tailor industry in Singapore. She wasn’t the first in the world, but she was the first to set that up in Singapore. Today, this business continues to be a viable stream of income.
There will be some barriers along the way in developing your ideas and marketing them. You may want to get your idea or product out there before anyone else conceptualizes the same idea. However, you may be in danger of analysing too much, afraid of presenting an idea which is not fully polished; overall you’re just not ready. You might be also taken aback by the fact that once your idea is out there, people might just copy them. These are reasonable fears. However by not doing something you are not necessarily putting yourself in a winning situation. Take the risk and get your idea out there, share it with people who can help you develop it into a materialized product or a service. Once your idea is out and you were first on the idea, you have the right to own the idea. Be known as the founder – the originator of the concept, and just laugh about those who want to replicate you. This goes to show that your idea is a good one and should motivate you to make it better if not perfect.
Experience is a good teacher and you’ll learn from your mistakes and successes as you go along. By simply being first on developing your idea means you have more room for improvement. Remember that there are more than 7 billion people in the world and even though everyone is unique, great minds do think alike. That one potential moneymaking idea of yours can be another’s million dollar idea by tomorrow. Do leverage on having a head start.
Summarily, passive income is very important in order for one to maximise the meaning of life. Imagine if you didn’t need to depend on the income to survive, how would you treat your work? Would you stop working? Certainly not! The new found freedom will help you to perform your job to the very best! You will not be afraid of speaking the truth, you will have much more confidence about yourself and you will definitely work towards effective goals rather than trying to impress the many layers of bosses above you.
In my estimation, more than 99% of the people in the world are convinced that they are incapable of achieving great things. Great things like becoming a billionaire, starting up a MNC (Multi-national Company), a prime minister, a president of a country, or to become someone who can make a great change in the lives of many people.
This will never change; I think 99% of the people of the world do not like to take risks. And because the majority of the people of this world will never change and that they will never expect to achieve the extraordinary, they aim for mediocre achievements such as being the owner of an HDB (Housing Development Board) flat. They aim to have a medium size saloon car. They aim to have a peaceful life. But the level of competition for these realistic goals, they are really the fiercest. If you can just imagine the number of people bidding or queuing up for an HDB flat, you will see that this competition is very tough and very time consuming. Some of them are very energy consuming. Just an example – the number of students that aim for first class honors in their respective universities. Everybody aims to be first class honors or second honors. They believe that by getting that result they can get a non-mediocre job. This is exactly why many people seem to be stuck in the middle level income. Because they aim for the same goals, the same jobs, the same degrees; and to some extent it is easier to sell an idea to raise a hundred million than to sell a very realistic idea that is a very common to raise a hundred thousand. It is easier for us to aim for big goals quite fitting to be called as unrealistic rather than to aim for very mediocre goals.
In fact, realistic goals and goals that are expected are usually not so inspiring. They don’t fuel you to achieve the best of yourself. And at some point when the competition gets so tough, most people throw in a towel. They quit. Some people are trying so hard to get first class honors then get so stressed out eventually quitting the university. There are some people who are trying to be the top performer in their companies. They get stressed out and later on find themselves in psychiatric treatment just to remedy and put their lives back to order. For realistic goals, the potential payoff is so mediocre and so average while on the other hand, your effort is so much. If you have to knock your head against the wall just to get a certain outcome that everybody aims to achieve, then I question “What is the purpose”? But you have a choice. You can choose to go for something that is unrealistic but is not unachievable in anyway. For example you may not be able to get that first class honors and get that top government job or that top banking job. Instead of getting to the top, one could challenge oneself.
We have seen so many successes in Singapore. The successes of the top tuition teacher or the top blogger in Singapore are things in the past. These have been attempted over and over again. If you try to copy what has been achieved then you are really getting into some trouble because there will be a lot of people who are trying to do the same thing to replicate the success. So in some way, to become successful is really about avoiding what is realistic and avoiding the frequently taken path, instead, take a different direction to a path that is less realistic.
Taking myself as an example, I decided to start a shirt making company leveraging on my mother since she is a tailor. She provided the skill set, IT knowledge needed, and the seminars they had with me as a young Singaporean. That’s www.goodshirtseveryday.com. The second thing I’ve done was to really sidestep what insurance agents and advisors are doing to provide the most objective financial literacy education at www.seekingreturns.com which really pays off based on exceeding expectations. For one, many people appreciated the effort we put into making sure they get the best education. Second, many viewed our businesses with jealousy. They said that “Hey that’s an exciting business”. Although you are not earning a lot but it gives you the freedom and confidence to explore what you want to do in the future.
I think in short what I’m trying to say is don’t just pursue the ordinary – the goal setting mindset that I want to be the best principal, the best army officer, or the best banker. Moreover, thinking about getting into a top investment bank or wanting to be a lawyer. These are realistic goals and you really have to bleed and sweat to be successful in that measure. If only smart people will consider these things and take into account that realistic goals are hard to achieve when the competition is so tough, they have achieved more if they attempted something unrealistic; something less ordinary. It is the same when you go fishing. When you fish, do you go to where the people fishing are or do you go to a secluded corner where nobody is fishing? I think the clear answer is the latter. It is common sense to find a spot where there are fewer fishermen. The same analogy can be applied to our life as well. Don’t aim to hit homeruns where everybody else is aiming. Aim for bigger, aim for extraordinary, aim for less conventional goals because these things really count. In addition, your success can be achieved in a more interesting way. You will be able to achieve success easily and lead a life that is better. Just look at your circle of friends, those people who got rich by being a banker and those people who got rich by selling something fascinating and funny. Who has a more interesting life and who do you want to be? Ask yourself that and I hope this article will inspire you. Thank you.
Understanding the quality of a management team is widely regarded as a fundamental aspect of appraising a company for credit or investment. However, there seems to be a disjuncture between this fact and the analysis presented by investment banks and market commentators. There are studies that have examined the biographies of senior managers, but there is rarely a scientific methodology for benchmarking management.
The Mechanics of Appraisal
The overarching approach of analysts in the securities industry has been to try and develop ever more accurate diagnostic tools for predicting the performance of a particular security. There is a certain breed of investor that looks askance at charting and technical analysis, but their investment approach tends to rely on an indiscriminate reading of publicly available data such as annual reports, stock market announcements, or press releases.
Financial Performance Over Time
In the case of offering credit, particularly short term of asset based finance, then this approach may well be enough to achieve reasonable security in the credit. However, where the focus is on a security, or other instrument that offers the potential for longer term capital growth, there has to be a consideration of the ability of management to realise this potential. Despite this, analysts pay scant attention to the potential of management; perhaps because they do not have too much personal contact with them, or are afraid of losing it if they do, or simply because they do not believe it relevant. Analysts can get access to management if they are determined to do so, but few seem to be interested. Furthermore, despite public blandishments that past performance is not necessarily a guide to future returns, most analysts are content to work with the assumption that there will be reasonable continuity over time and that adaptability is not necessarily a key management competency.
Rectifying this would require a comprehensive analysis of management personnel, and moreover, that analysis must be cognizant of the following points:
1. The economy is dynamic, and therefore adaptability is a key management competency.
2. Management itself is a dynamic process, and so adaptability must be a way of management as much as a way of business.
Dynamism & Diagnostics
The economy at large, as well as the securities market specifically, are constantly shifting. The relentless pace of technological development and the constant demand for information and metrics means that there are never two situations exactly alike in the economy. Therefore the job of the analyst is to try and render this maelstrom both understandable and predictable. Generally this is achieved by dissembling the whole into pieces small enough to be tracked and understood; however, this process of dismantling the economy completely removes any element of dynamism from the model.
Responsibility & Requirements
This is not suggest that the practices of most analysts are without merit, or that their job is an easy one. However their job is approached, it requires the synthesis of an enormous number of components and variables; therefore, breaking these down into small, abstract, pieces must seem attractive. However, to ignore the role of time and dynamism is fatal, because the analysis of objects such as balance sheets and financial statements refers to events past, and does not give an insight into the current goings on; to factor those in, an analysis of management is required.
The Importance of Management
This is not to minimise the importance of studying past financial performance, merely to set it in a wider context. Studying financial performance, particularly during lean years, will shed light on the capabilities of the management at that time. However, in judging the future performance of the business, and thereby whether to invest in it or extend credit, the final judgement will come down to an analysis of whether management will be able to adapt and profit from the changing circumstances of the future. That is a different proposition altogether, and cannot be divined from financial statements; indeed any determination arrived at from financial analysis alone will be superficial at best, and wholly incorrect at worst.
It is not possible to cogently argue against the importance of management, and many analysts will argue that they invest significant effort in understanding it. However, any analysis of management must be based on useful and realistic yardsticks. Too often, analysts appraise managers on the basis of no concrete measures, but a response to corporate communications, publicly available information and past financial performance; none of which can help measure the future in a precise manner.
A simplistic stock screen might suggest that a company with large sales, strong profits and soaring stock prices has a highly capable management team. However, that would not reveal a situation where a company has plateaued on the back of long term but expiring contracts, and now faces nothing but decline unless management can reverse things. Conversely, a company that issues a profit warning may not be managed poorly, as the profit warning may have been much worse with a lesser management team. This underlines the difficulty of measuring management potential, and the need for the right metrics to accomplish this.
The Techniques of Appraisal
Two things prevent the average analyst from understanding management potential. First, they rarely have enough time to conduct the in-depth company research on all of their portfolio companies. Second, even if they did have the time, they are unlikely to have the training in scientific management appraisal techniques necessary to do the job properly. Therefore, there is a need to develop simple metrics for an analyst to use, so that they can adequately assess management without having to revert to a management consultant each time, and leave them for special situations.
It would be a reasonable assumption for the analyst to hold that the very recent performance of management is likely to be continued in the very near term, and therefore recent financial statements will suffice. However, they will not suffice for considerations over a 3, 5 or 10 year time horizon. It is also reasonable to assume that when thinking over these longer periods of time, the current leadership may not be in place in years to come, and that future leaders will be progressing through the company, and developing their own ideas about the future of the business; management should be concerned if they are not.
That is not to say that such forward thinking will guarantee success, more that it makes it more likely by minimising risks and maximising preparation. From the perspective of the analyst, a good rule of thumb would be to determine whether the management meets three criteria – understands its basic business, plans for the long term and promotes flexibility. That will provide a decent basis for understanding whether management is prepared for future changes.
Understanding & Measuring Management Potential
The analyst should then concern themselves with broadening and deepening their initial assessment through direct contact with the management. There are four pillars to the necessary research.
First, does management have a clear and realistic view of the long term future. The key to this is whether there is depth to the response, rather than a generalised picture of growth and success. Are objectives clear and achievable, and is there a clear plan for flexibility? Often these initial questions will demonstrate where there is a weakness within management. By defining objectives and relating them to the things management currently does, the analyst can determine whether management are leading change or letting it happen to them.
Second, how well do management operationalize their long term objectives. Put simply, do they have the correct policies and procedures in place to ensure that they can meet their objectives, while still maintaining profits and growth. Often management teams will be some way towards doing this, but not all the way, and the analyst should seek to define the current position of the company.
As a corollary to this, the higher the level a manager, the greater their focus should be on planning. Thus, the executive function should not be about managing the day-to-day running of the company, but positioning the company for the future. As with most aspects, the job of the analyst is to get below the superficial responses of executives who will never claim that they are not planning. Key points to determine are:
- The scientific composition of sales forecasts
- Comprehensive cost and break even analyses
- Being able to relate different strands of research and projection to each other
- Focusing on profitability over the long term
- Having a plan to manage stakeholder relationships
- Planning to plan
Management that can answer all of these queries are likely to be equipped to handle the challenges of the future. Management that can only respond in generalities will be much less likely. Furthermore, good management will always be aware that there are limits to planning, and will be financially prudent in order to weather any potential lean times.
Understanding how the company is organized will be of vital importance to both the analyst and management. Frequently, management themselves do not have an organizational chart or any clear understanding of how the organization is laid out, and moreover, why it is organized the way it is. This is not a static chart, as it should change organically as management plans change. That being said, having an organisational chart does not mean that management automatically has a firm grasp on this issue. Therefore any questioning must determine their understanding of the different components of the chart, and how that merges to a whole; and whether that then is the most efficient organisational structure for the company.
Start-ups or other similar early stage organisations can often rely on the driving force of one or a few people, and do not need to think seriously about devolving power or defining clear reporting lines; however, that organisations ability to grow into a larger, sustainable, company will be dependent on management’s ability to learn and deploy those skills.
Organisational charts, management schemas, handbooks and jargon are not an end in themselves, they will not generate profits by themselves; but they are symptomatic of a management team that is thinking and planning the future. Where management are too busy with day-to-day operations, they are failing in this regard. The analyst cannot profess to understand every detail of management plans, but they can determine whether management are serious about them, and know how to deploy them.
Fourth, and perhaps most important, is what the current management team are doing with regards to succession planning; where is the future talent coming from? As before, the analyst must be willing to punch through superficial replies, and get management to be precise about who is going to retire, when, and who is earmarked to replace them. If management cannot answer this with precision, then the analyst should be very concerned. The analyst should also determine whether the board of directors is made up of operational managers or whether there are strategic roles, and similarly whether there is balance of age and gender. In the final analysis, the organisation will depend entirely on the people charged with running it.
Finally, does the management have a means of insuring that its carefully laid plans are actually carried out. All too often it is easy to go through a planning process and then get caught up in the day-to-day operations of the business and not follow-through. The analyst will need to ensure that management has clear policies to ensure that plans become actions. This can be tested by determining the quality of information for all areas of the business, not just aggregated figures for the whole company, and whether that translates into a set of controls and warnings.
In assessing an investment of any type, an analyst will be faced with a huge array of considerations to weigh up. It should be recognised that past performance is only a partial guide to future performance, and that the real indicator of potential is the abilities of management; and their ability to adapt and make the most of the future.
Competition & Profits
It is not sufficient for managers to focus on growing sales volume alone; operational efficiency and responsiveness are the keys to driving profit in an exceptionally competitive global economy. The ability of management to recognise and action this sentiment is of paramount importance.
How to Appraise Management
With this in mind, analysts need to shift their thinking from purely statistical measures of analysis to determining the ability of management to understand long term objectives and planning, and their ability to deliver on those things. The analyst is not necessarily there to understand the minutiae of the plans, but to determine whether management even hold the plans, and whether they can deliver on them. Short term financial performance is not a good indicator of management potential, but long term financial performance relies on it.
If we continue to disregard of the evident results of unsustainable investments, there will be unimaginable results. We live in a finite planet with finite resources such as labour, capital and land. It is doubtful whether economic growth supported by excessive credit and questionable ethical standards will perpetuate without a substantial change in the way financial leaders conduct their investment decisions.
As financial professionals, investment decisions shape operations and influence outcomes across many sectors. A plant that fails to adhere to environment regulations will save money, profit investors, but lead to negative externalities in the environment. A specific investment decision may benefit the investor in the short run, but hurt the global ecosystem in the longer run.
Unproductive growth, based on sub-optimal use of human capital and other resources is clearly not sustainable. Some of these unsustainable businesses have significant and irreversible tolls on the planet. One example of the negative effects of sub-optimal planning is carbon emissions. Reuters reported that China, the world’s biggest emitter of CO2, made the largest contribution to the global rise, its emissions increasing by 9.3 percent in 2011, the body said this was driven mainly by higher coal use.
The classic line, “To ignore firms with potentially ethical concerns may mean your investments would not grow substantially”, will be familiar to us. However, the same defence was used to support the slave trade. To ignore firms that invest in slaves meant that 19th century abolitionists’ investments would not grow substantially as those that did. But the statement that there is no such thing as an ethical investment misses the point. It is more accurate to say that there is such a thing as an unethical investment. This statement also misses the point because unethical decisions make the investors some money for some time, but these decisions definitely affects the society negatively in the longer run. In the slavery trade example, if investment decision makers stood firm against the trade, the economy could arguably grow more rapidly as we empower the slaves to be more economically productive.
In another situation, it is also unethical to profit from other people’s misery and suffering and from degrading the life of future generations. Examples of grossly unethical investments that we, as professional financiers face on a daily basis comprise tobacco, gaming, adult entertainment, arms and heavily pollutive firms. It is our responsibility as investment professionals to stand by the correct ethical decision. We need to realize that traditional growth models that do not consider sustainability often fail completely. Just look at the unsustainable spending and credit growth in the recent credit crunch!
Growth-planning has to take a different course with proper analysis of expected future challenges, whether is it depriving a child of proper education or depriving someone of clean environment. Implications for financial services are clear. As financial professionals and stewards of our clients’ capital, we need to take a balanced approach to investing, focusing on sustainable capitalism. We shape the behaviour of all sectors in the economy. Financial services professionals are also thought to be leaders in many fields, based on capabilities such as PE, M&A and consultancy. As such, we can do a lot more to ensure sustainable growth, as often, we are the gatekeepers of capital and investments. It is our duty to remember that economic growth is not our divine right and not mathematically possible over a sustainable period.
Therefore, in considering and selecting investments, the investment criteria should be much wider than just financial returns on investment. We need to bear in mind that our investment decisions should be ethical and should lead to sustainability. Buying low cost manufacturing companies often turn out to be sweatshops that usually have poor working conditions, unfair wages, unreasonable hours, child labour, and a lack of benefits for workers. It is reported that one out of six children in the world today is involved in child labour, doing work that is damaging to his or her mental, physical and emotional development.
Government and central bankers need to realize that, with sustainable growth, obtained by optimal planning, global conditions can and will improve. The economic worldwide crisis in 2007 and 2008 was subjected unsustainable credit growth based on a de-regularized market. They have to anticipate a future crisis and do their growth plans accordingly. What comes to mind is the inevitable expected carbon crisis of the future. Another inevitable crisis looming, is the escalation of the middle class in the next decade. Massive job creation projects are essential to maintain a balanced and sustainable economy.
Given the desperate need for growth, we have created QE, deep austerity cuts and other financial programmes. The root of the problem, however, is the short-sighted way we define growth and the way we reward growth. Many see growth merely as increase in value, stock price or in a broader picture, GDP. But these are flawed as they are numerical configurations; they are growth numbers that affect a small number of people at the top. To sustain global resources we need to measure the quality of growth, equality and happiness of all societies.
A number of other growth measures are available, including the Genuine Progress Indicator (GPI), the UN’s Human Development Index (HDI), the Organisation for Economic Co-Operation and Development’s Better Life Index and the Happy Planet Index. Once again, these are measures based on mathematical configurations. Perhaps we can explore measuring growth in multiple dimensions. How do our measures of growth implicate on the environment and the fabric of our society through the evident inequalities that characterize the current system? Can we find a way to grow in a sustainable way where all of society as well as the environment will benefit?
With a world population of about 7 billion people, forecasted to grow to 9 billion by 2050, the challenges we face are unprecedented. We cannot bury our heads in the sand, the problem won’t go away. The status quo cannot sustain our planet, cracks will appear. It can be compared with maintaining a ruined cathedral; we need to rebuild the cathedral, not refurbish it. We can add new layers of paint and make it appear new, but the cathedral, with all its traditions will eventually collapse.
As financial professionals, we need to realize that we are approaching the tipping point of the scale. Our single-minded pursuit of growth driven by capitalism within the financial sectors has been at the root of much of what now afflicts the world. Some exploit the poor; some ignore environmental threats, all in pursuance of personal wealth. Companies with bad environmental practises are often rewarded for monetary achievements. As ethical investment professionals that are future ready, we need a more balanced approach, one that focuses on both sustainable capitalism and sustainable growth. This idea may not resonate with many; much less affect their daily work. But one thing is clear – we will need change makers and inspiring leaders in order to ensure an infinite planet with infinite resources.
Our growth model has led to complex regulations, creative accounting and rate manipulations. We have rewarded excessive risk takers and while traders enjoy their salary, it is at the expense of the poor. Our excessive systems caused inflation to soar with negative implications worldwide. We desperately need more balanced growth. We have a staggering number of unemployed youths in developing nations. In January 2013 theguardian.com posted that according to the International Labour Organization (ILO) a record 202 million people could be unemployed across the world in 2013. The result of this will be an unproductive growth with no jobs and no demand, with a net economic operational loss. Job creation on a massive scale is necessary, but again, for sustainability it has to be properly planned with thorough analysis of future demands and challenges.
Moreover, the welfare status, especially in Europe, is increasingly under threat. Governmental promises regarding entitlement programs are no longer affordable. There will be defaults, either the official kind, the less likely option, or through inflation. The opinion of many is that due to increased debt figures and the associated central bank responses being at such a scale, a more sanguine outcome is just not possible. To reverse these negative effects, ingenious planning will be required.
We thus have a very interesting and challenging decade or two ahead of us. Much of what we have simply taken for granted will be or will need to be challenged. We can no longer depend on asset valuation growth to sustain our livelihood in developed nations. We have spent an estimated $10 trillion (combined with a massive rally from the early 2009 lows in equity, real estate, corporate bonds, and commodities). To date, we have a historical equity growth from the last crisis, but employment availability numbers have not shown any growth. Without growth in this section of the economy, equity growth will not be sustainable.
The growth in financial markets has no downstream beneficial effects on the world. This is evident in the huge loans required by third world countries to sustain their populations. Hyper inflation may already be evident in asset classes, if not necessarily in the official Consumer Price Index data (i.e. consumer goods inflation). Inflation also reflects erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Inflation also reflects erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.
So, why is the whole concept of sustainability important for individual investors? And why should financial advisers care?
As financial professionals, many of us have the memory of the dotcom bubble (which popped spectacularly in 2000-2001) and the U.S. housing crisis, to serve as reminders that if we invest in something that is unsustainable, there is a high risk we will suffer substantial capital losses. In the case of the tech bubble, the NASDAQ lost about 75% of its value from its peak. More than half of the companies that were listed went out of business. When the U.S. housing bubble burst, house prices dropped more than 40% over a five-year period. A focus on sustainability should lead to lower risk, in fact, many studies point to higher returns.
The concept of sustainable investing is thus not simply a pleasant and satisfying idea; it has real-life implications. I urge the members of our society to pick up the burden of ethic and lead the industry towards greater heights.
Investment industry has garnered a lot of negative perception in the eyes of the general public especially in the aftermath of the current financial crises. The most prevalent perception is that the investment professionals have no ethics and they do not follow any rules or guidelines for making the morally right choices. The only force that seems to be guiding them is greed. Whether this awareness of ethics is a recent trend or has been on the rise can be understood by this very old example picked up from the New York Times Index. In 1981 there were only 3 articles published under investments ethics segment while the same number rose to 73 in 1991. There has been an increasing trend in the awareness of the subject of ethics. Even more so with the ethical violations in the financial sector coming to light ever since the economic crisis began in 2007.
It’s not the case that investment advisors or people working in the investment industry are bad people and have no moral values, they are just the same as people working in any other economic sector. They all have the sense of right and wrong like all of us but in the modern world of complex business decisions many a times there is no clear right or wrong. Some situations have no set precedents and sometimes no clear standards exist to guide during those times. These are the situations that bring subjectivity and involve personal moral judgment in the decision-making process. The decisions taken in these situations can go either ways. If the end result of the decision turns out to be profitable for the company as well as for the investor then nobody would think further about it, but if the decision results in losses then allegations of fraud and ethical violations are made by the press and the general public. During the course of investigations it might come to light that there was a violation of some ethical standard or the other but then does it imply that all the decisions that resulted in profitable outcomes were morally and ethically correct? This argument does not absolve the people as well as the companies in the investment industry from their responsibility towards following the standards set by the regulators. It basically highlights a problem that industry faces today, the modern day business transactions and decisions have become very complex and to encourage self-regulation the regulators need to simplify their requirements and the regulatory environment.
Importance of Ethics Education
With the increased awareness comes the question of fixing the responsibility on someone for creating ethically trained professionals. More emphasis is laid on the inclusion of business ethics or ethical training in the universities. A lot of colleges and business schools have included the ethical training as part of their course curriculum. You would think this should make the investment world free from any ethical violation! But that is not the case. The reason is that our home is our first school. Ethics is not something that can be taught in the classroom following which the students will immediately become ethical. Before a student reaches university or enters any professional college he or she has already built some sort of an ethical foundation. From childhood to youth, a person encounters various situations during growing up years where he or she has to decide between right and wrong. A very small example of such a small decision taken during formative years can be this – in school playground a child finds some money and then he or she has to decide whether to keep it in his or her pocket quietly or to ask other children around him or her whether it belongs to one of them. These small decisions become the basis of a persons ethical foundation which is influenced by the teachings or learning’s from the values passed on by the family. To expect universities or colleges to churn out ethically rounded and trained individuals in a time period of two to three years through classroom teaching of ethics is not a reasonable expectation. This does not imply that ethics should not be part of the curriculum but it simply states the fact that ethics cannot be taught in classrooms alone. The main purpose of introducing ethics courses is to reinforce the ethical and moral thinking while taking any decision in life whether personal or professional.
Various methods need to be explored to make ethical thinking a way of life. Ethics is not a subject that needs to be taught to investment or business students only. It should be part of every student’s curriculum, irrespective of his or her professional course. For students pursuing careers in the investment industry or the business world, it should be offered as a separate course dealing with business or investment ethics. This is important because the business world is very dynamic and complex, the general ethics being taught to all might not be applicable in the real world scenarios in the investment industry where regulations as well as business transactions have become very complex. Another innovative way in which the universities can increase ethical training is by including multiple sessions on the subject of ethical concerns in each and every professional course so that these concerns get addressed while teaching the course curriculum in the normal course of study. Just offering investment industry specific courses is not enough, these courses will only yield the desired results if business managers from the world of business teach the students the dilemmas faced by them in the course of their decision making process. The purpose would be defeated if an academician, who has never faced real life business situations, is given the job of teaching business ethics to students.
Another important part in ethics education is the process of teaching ethics. Some people believe in the approach of setting guidelines and instructing what is right and what is wrong. It is similar to classical conditioning where over a period of time by reiterating the rules your thinking is conditioned in such a way that you know what is right and what is wrong. This kind of teaching is successful to only a certain extent, as it cannot possibly cover all the situations that one might face in the course of conducting business. The other approach is called the positive approach. This method deals with teaching the ways of taking ethical decisions when faced with situations where there are no rights and wrongs. A person is at times faced with certain grey situations where there is no clear black and white. The positive approach deals with these areas and helps in developing a thinking process that is ethically sound. The universities and companies need to include a mix of both these approaches in their training curriculums to instill ethical thinking in their students or employees.
Importance of Ethical Culture in Organizations
An individual spends more time at his or her workplace than in university or college. Good or bad decisions are not a reflection of people being good or bad, the decision-making is largely influenced by the culture and ethics of any organization. This makes it imperative to have a strong culture of ethics at work place so as to guide employees into making ethical decisions. Young employees at the start of their career are naïve. They have morals and want to do things that are morally right but they lack focus. They imbibe the work practices of their managers at the work place. If the managers follow ethical guidelines while conducting their business then their team members will also pick up those traits at work. On the contrary if the managers disregard the ethics guidelines and violate them while taking decisions then it sets precedence for violating ethical standards or guidelines. The young people who are fresh out of college or universities think that it’s acceptable to bend the rules a bit just like their manager. The ethics education in the college classroom can take a back seat at work place where young people follow and look up towards their manager for advice and direction. They may be led to believe or understand that the real life decisions have a different set of rules than the ones taught in the classroom scenario. This is the reason why the managers always need to lead by example. To enforce new guidelines and regulations the managers need to implement them first and make them a way of doing work so that the team members also pick them up.
Enforcing the ethics guidelines is the responsibility of every organization. To ensure this, training and education has to be a continuous process at any organization. To assume that the employees have learnt about ethics and regulations at college and will continue to be compliant with them is the wrong approach. By hiring professionals who have attended ethics training in college or university, or by circulating ethics guidelines among its employees does not make an organization ethically strong. The company needs to continuously ensure that the employees understand what is circulated in the guidelines, are up to date with the recent changes in the practices and they also know what to do or whom to contact when faced with dilemma. For this the company needs to have dedicated teams responsible for training employees on new regulations affecting their business as and when the regulators enforce them. There has to be a mechanism in place to record evidence that the employees have understood the new guidelines. This can be achieved by encouraging employees to take online tests or by completing surveys around ethical training and guidelines at periodic intervals. The company should also clearly communicate the names and contact details of the persons who can be contacted in the times when employees have to take difficult business decisions which do not have any clear right or wrong.
To counter the negative perception being faced by the investment industry, the companies need to take many initiatives in the ethical behavior department such that they send out positive signals to the public. Companies need to focus their energies on ethical training and in creating an ethical work culture within them. They also need to publicize the fact that they are ethically focused and have a very strong culture of ethics in the organization. The managers need to lead by example and for that they need to be up to date with the ethical issues and practices and should frequently remind the team members on the company policies and guidelines. The organizations in the industry need to create a platform where they can come together at certain intervals of time like quarterly or annually, discuss the challenges being faced by them as an industry and come up with ethical resolutions to the problems. The investment industry also needs to step up efforts in removing the perception from the minds of the people that they do not guarantee returns. They need to disclose in very clear terms to the potential investors that they don’t guarantee returns and there is a risk of low or negative returns in investments. The advisors on their part also need to ensure that the investors maintain a balanced portfolio and not a high-risk portfolio so as to protect them against high losses in case of markets going down.
All these initiatives will not only create a positive outlook in the minds of the general public but will also reduce the instances of ethical violations in the investment industry. Reduction of ethical violations is something that the investment industry will need to focus on given the proliferation of sales based relationships with clients and in some cases, the extreme “rewards” in certain roles that can impact the objectivity of the professional.
Alex Lew, CFA, CFE
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