The Wisdom of Finance summary

Let’s face it⁠—insurance has a bad reputation. We imagine boring, nerdy, even ghoulish executives profiting from the misery of others. But as with many things in finance, this is a reductive view. 

In fact, insurance originates on the swashbuckling high seas. As shipping goods across oceans carried such risk, insurance was invented to share this risk among many parties – including all the owners of the various goods on board the ship. 

“Don’t put all your eggs in one basket!” How often have you heard that old chestnut? It’s not bad advice for investors: unless you’re Warren Buffet, betting everything on just one or two stocks can spell disaster in a world where firms go bust every day. 

Enter the principle of diversification – the art of spreading out risk across many stocks from diverse economic sectors and geopolitical areas. So if ExxonMobil’s share price takes a beating, no sweat: your stocks in Toyota, Heineken, and HSBC compensate.

Remember the Parable of the Talents, from the New Testament? 

Before going on a journey, the master of a house entrusts three servants to look after his money. He leaves each of them a slightly different amount, according to their talents. 

When you head to the bank and ask an advisor to help you set up a new savings account, you enter into a relationship common to finance. You’ve become a “principal,” and the advisor, your “agent,” is there to carry out your instructions. 

This relationship is replicated throughout the world of finance. For instance, shareholders are principals who’ve tasked their agent, the CEO of a company, with returning good value for their investment. The CEO is a principal, too, who empowers her agents – the company’s employees – to work for the company. This principal/agent relationship helps clarify the motivations of those who work with money.

January 11, 2001 marked the beginning of what was supposed to be “the romance of the century.” Whose romance, you ask? Two movie stars? A prince and princess? Competing athletes? Think again. 

The date marks the merger of two corporate giants of the age: the internet pioneer AOL and  entertainment behemoth Time Warner. Venture capitalists called it “the single most transformational event” in American business.

Suppose you want to start a new company that specializes in selling oat milk. You’ve identified a key market for the product, designed a cool logo, and purchased a domain name. Now what? Certainly, you’ll need money – to purchase stock from wholesalers, hire your staff, and pay distribution costs. Most likely, you’ll need to borrow capital from a bank or private lender.

In other words, to get off the ground, you’ll first need to go into debt. 

Imagine yourself the owner of a delivery business that has hit a rough patch. You’re confronted with a choice: for the business to survive, you can either lay off your talented new apprentice, or require everyone to take a big pay cut. Which do you choose?

Life is full of difficult, complicated decisions like this. And, sadly for us, we can’t avoid them.