Welcome to Known Unknowns, the most rebellious pension newsletter on Substack.
Where’s the outrage?
These are fascinating times. I reckon the pandemic will shake up our relationship with risk in unexpected ways. We already see significant disparities in risk-taking coming out of it—and I don’t mean mask-wearing. On the one hand, more entrepreneurship, moving, and job changes. On the other, it calls for the government to take on more of our risk—individually and society-wide—with more industrial policy and regulation.
I don’t think people fully appreciate how critical risk is to growth. Not only personal and economical but our continued prosperity. Growth comes from innovation, but innovating is inherently risky—in devising and marketing a new idea. Additionally, you need a financial market to price risk and supply capital—a financial market full of risk-takers. It’s a common refrain lately that risk can be engineered out of growth—just ask China or the new supply siders—while maintaining prosperity. But this kind of growth is not sustainable because it does not produce enough innovation. Innovation requires rebellion because you need to sincerely believe that your method of doing things is superior to everyone else’s.
And this is why I am worried about Gen Z. They just seem so compliant, I can’t make sense of the negative correlation between age and out-door mask wearing in my neighborhood. Even long before 2020’s pandemic restrictions, there was a noticeable decline in rebellious behavior and individuating from their parents. This is concerning not only for their well-being but also because you need to be defiant to be a great innovator. I am channeling Joel Mokyr here—coming up with good ideas requires rejecting the prevailing wisdom and questioning your elders. You can’t be a rule follower, let alone an obsessive rule enforcer and moral scold—as many young people seem to be lately.
Writing this column got me wondering how my level of rebellion stacks up. I like to think it does, but doesn’t everyone see themselves that way? Who thinks of themselves as a follower? I have received many emails from young people telling me they participated in social justice marches, so they are indeed rebels.
Maybe. But as Mokyr argues, innovation requires an environment where you can test ideas, even bad ones. If people get angry, call you a heretic, and throw you in prison, you can go somewhere else and find acceptance. In that case, maybe the current political fragmentation is not so bad.
One theory for the lack of rebellion is that people fear downside risk or discomfort. But life is about trade-offs, and so is policy. The growth and prosperity we receive from a market economy come with downturns from time to time. And while stimulus and transfers can smooth the bumps, they can’t provide total certainty. We now see that with inflation. It has many fathers, some purely pandemic related. Still, we made many policy choices that threw gas on the fire to prevent economic hardship and give some people a small windfall for their trouble. Maybe that was a good decision at the time, but now we are living with the consequences. And perhaps there is worse to come.
Should retail investors own stock?
You might find it surprising I floated the idea a few weeks ago of making it much harder for retail investors to buy individual stocks and steer them to index funds instead. After all, I generally think people should take more risks (and should have more stock exposure), and what is riskier than stock speculation (other than NFT speculation)? Just because people should take more risks doesn’t mean they should take bad risks. Stock picking is so inefficient for individuals, and I am against inefficiency. Whether it is a constraint on optimal risk-taking or taking a risk without any extra potential reward.
I struggled with this one because owning individual stock makes us American. Limiting it to accredited investors —someone has to speculate, and better it be those with time and means--- feels like a betrayal of our values. I bought my first individual stock to see what was involved. Turns out it was no different from buying through a mutual fund—maybe even more straightforward. I get a warning for opting out of my over-priced default target-date fund in my 401(k) plan. As much as I hate clunky regulations, I feel like something similar should happen when buying individual stocks.
There are valid questions to be asked here. Is there too much indexing? Does that make the financial system more vulnerable and less efficient? I’ve never worried too much about this because institutional investors will never fully index. They have no incentive to; they make up a significant market share. But now that markets are getting a little frothy, there are many theories that a larger market share in index funds will increase volatility.
It is worth noting that volatility fell as indexing increased in the last decade. But we don’t know if lots of indexing creates or exacerbates more tail risk. Will markets crash even more if we are hit with a 3-sigma plus event? I guess we’ll find out. But even if it is, are the lower fees and greater efficiency a worthwhile trade-off for the occasional bump in volatility? That’s a question of values and what risk means to you. Innovation is risky—especially financial innovation.
Until next time, Pension Geeks!