Over the last ten years, I’ve watched the way disruption has impacted markets and investors. As a member of Whitnell’s Investment Committee, it’s my role to anticipate changes and position our clients to achieve their long-term financial goals. You might be wondering how innovation and disruption will impact your investment portfolio over the next several years or longer.
I am of a generation that grew up with innovation and disruption as a way of life. I do not fear it. Actually, I embrace it. But it is not without perils, especially if you get caught off-guard. After reflecting with colleagues on this topic, I’d like to share an example of change, five guiding principles for addressing disruptive change, and what it can do to your long-term investment portfolio.
AN AOL DIAL-UP STORY
When I was a teenager in the mid 1990s, my parents got a dedicated telephone line for my sister and me. I suppose they didn’t want us tying up the home phone all the time. It was a smart move on their part because our behavior was about to change a lot. We were about to substantially increase the amount of time we spent with that phone line.
One of my greatest joys as a teenager was hanging out with friends. When we got our own phone line, my sister and I used to talk to friends for hours on end. It was a big deal to find a way to get three people from three different phones on the line at the same time. Then along came AOL dial-up with instant messenger and suddenly the game changed.
We could have 20 to 30 conversations going simultaneously on the same phone line that used to allow for only one or two conversations at most. That was a radical shift. Our behavior shifted too. We started spending more time on that phone line. We could suddenly do something that the phone never allowed before. We could walk away from a conversation and come back to it the next day or even later and it was still there because of the chat feature.
My sister and I never saw ourselves as early adopters of new technology that would give rise to an entirely new industry and countless new business models. We just thought the technology was cool and fun. Our monthly subscription to AOL was a small price to pay for the joy of being with friends in this radical new place called cyberspace.
INNOVATION VERSUS DISRUPTION: WHAT’S THE DIFFERENCE?
Before I go further, I want to describe how I see innovation and disruption as two sides of the same coin. Innovation, to my way of thinking, is about a series of incremental steps that suddenly give rise to new opportunities. These can appear to be overnight events, but they are far more likely to be a series of small changes that took a long time to coalesce into the opportunity. Disruption is how those opportunities are applied to markets, businesses and specific industries. Innovation usually comes first, followed by disruption. Let me give you an example.
Let’s take ride-sharing as a case study. Mobile phones had been around for more than a decade before the rise of Uber, Lyft and other companies. Satellite and GPS technologies had been around a long time too. Then came the rise of apps. Put these three technologies together—mobile phones, GPS and apps—and suddenly you had a major opportunity.
Innovative companies saw how to parlay these technologies into a business model called ride-sharing. They rolled it out and suddenly it began to disrupt traditional transportation businesses in ways few could have predicted. If you would have asked a 30-year old cab driver in 1985 how much he feared the telephone, he would have probably laughed at you. But 30 years later, an offspring of the phone has so disrupted his industry that it is a mere shell of what it used to be. It is quite possible, after 30 years of driving a cab, that he might just be out of a job.
SOURCES OF DISRUPTION AND INNOVATION
Having described disruption and innovation, I also think it’s important to define where it can emanate from so we can anticipate it. Part of my role, as a member of the Whitnell Investment Committee, is to track and understand trends. This puts us in a forward-thinking position to guide our clients to take advantage of disruption. When I think of where disruption will come from over the next several years, here are some key areas:
- Technology. This is the obvious source. When most people think of disruption, they might just put the word “technology” in front it, as in "technology disruption.” While technology will likely lead the pack of disruptors in the future, it probably won’t be the only source.
- Politics. Every four years, the political winds can change within the US. The policy changes that sometimes follow can have far-reaching consequences for investors.
- Regulatory bodies. These bodies often have the power to change rules and regulations as they see fit. Changes to regulations can have a significant impact on investors, either directly or indirectly.
- Emerging business models. As innovation turns into disruption, new business models can emerge quickly. For example, MP3 file sharing radically interrupted the traditional music business. A very few companies, like Apple, saw an opportunity to turn digital streaming and downloads into a subscription service called iTunes. This gave rise to lucrative new revenue streams that Apple had never tapped into. Investors would be wise to pay attention to how emerging business models will impact companies in which they are invested.
- Habits and behaviors. As habits change, so can financial outcomes. For example, my sister and I quickly adapted to AOL, then to web browsers and then to online commerce. Today, nearly half of my family’s monthly shopping needs are fulfilled online, not in a traditional store. Economic indicators suggest that my family’s behaviors are similar to millions of other families who probably also went through similar phases. Again, investors would be wise to track these trends.
These are just some of the sources of disruption that I see today that can impact investors. But the real question is—what do we do about it?
THE FIVE GUIDING PRINCIPLES
When I think about how innovation and disruption can impact investment portfolios, five guiding principles come to mind:
- It seems unlikely that innovation and disruption will slow down.
- Periods of disruption produce winners and losers.
- Disruption and innovation will impact investing, likely in unforeseen ways.
- While many things will change, your need for returns won’t change.
- Non-professional investors will likely struggle to keep up.
IT SEEMS UNLIKELY THAT INNOVATION AND DISRUPTION WILL SLOW DOWN
Have you heard of Moore’s Law? In 1965, Gordon Moore, co-founder of Intel, claimed that every 24 months or so, the number of transistors on a microchip would double even as the cost of microchips would drop by half. This phenomenon is behind much of the technology disruption we’ve witnessed, as powerful and inexpensive computers have entered every area of our lives.
While Moore’s Law will be tested over the next few years, because shrinking transistors has become more challenging, how the chips are used could very well be the new frontier of innovation. Some computer chips are being designed specifically to support the use of artificial intelligence, an area that could disrupt life as we know it. I recently attended the Consumer Electronics Show and met very human looking and sounding robots. If we think of these robots as first generation today, what will they be like in 5 or 10 years?
My point here is that I cannot see a slowdown anytime soon in innovation and the disruption that follows. I believe investors would be wise to plan on disruption.
PERIODS OF DISRUPTION PRODUCE WINNERS AND LOSERS
A moment ago I presented a case study from the transportation industry: ride-sharing. Uber and Lyft are the big winners. Traditional taxi companies are the losers. This is what disruption does. It divides industries and sets in motion trends that can be hard to recover from. Will the taxi industry find ways to recover? If the music business is any indication, that seems unlikely.
An entire ecosystem of stakeholders once marked the music industry. Music labels made records. Radio stations played the records. Local stores sold the records. But with the rise of digital file sharing and streaming services, everything changed. Music labels saw a substantial drop in the sale of CDs, their primary revenue streams. Terrestrial radio stations now compete, often ineffectively, with internet streaming services and downloads. Local records shops are nearly gone. Some twenty years after the rise of MP3.com, there is little reason to believe that any of these stakeholders will return to their former glory. This change is permanent.
However, not every disruption to an industry ecosystem automatically sounds the death knell for the entire industry. For example, the DVD is another technology that realized disruption with the rise of streaming video services. However, smart retailers who saw the disruption coming altered their business strategy. Many of these retailers found other products to fill the gap left over from the decline of DVD sales. But the makers of DVDs and business models predicated primarily on the sale or rental of DVDs, like Blockbuster Video, fell into unrecoverable tailspins.
My point is that there are quite a number of valuable companies who have been around a long time and will be around a long time. They often have years of data and financial resources to make pivots at the right moment. Those who do so remain attractive to investors.
Investors would be wise to closely analyze how periods of disruption will impact their portfolios. It’s a fairly simple proposition. If you can see it coming, you want to side with the winners and exit the losers.
DISRUPTION AND INNOVATION WILL IMPACT INVESTING, LIKELY IN UNFORESEEN WAYS
I cannot predict the future. I have no crystal ball that tells me what I should advise our clients to invest in. But I can spot trends and predict how I think those trends will impact certain types of investments. Even so, there is no way that I know of to be 100% right all the time.
For the Whitnell Investment Committee, this means we have to be nimble. Over the last several months we have been discussing and dissecting the proverbial wisdom that has guided portfolio construction for decades. For example, traditional wisdom suggests that for every year you are alive, that percentage of your portfolio should be in fixed income strategies like bonds. In other words, if you are 60 years old, 60% of your portfolio should be in fixed income. Does this approach still hold water in today’s economy and the economy we can see over the next couple of decades? I’m not so sure about that.
The Whitnell Investment Committee is beginning to question much of the proverbial wisdom and expose it to the scrutiny of empirical evidence and observable trends. I cannot state where our analyses will take us. But I can say, for certain, that we are not being static and assuming that what has always been in the past will also be in the future. I believe smart investors will do the same.
WHILE MANY THINGS WILL CHANGE, YOUR NEED FOR RETURNS WON’T CHANGE
Our clients look to us to guide their investment portfolios to produce reasonable rates of return for the risk taken. This will not change. Our clients will still want to retire without worries, send their children and grandchildren to college, live comfortable lives and enjoy financial freedom. These desires remain a constant, no matter what happens with innovation and disruption. I believe the same thing will be true for investors the world over.
NON-PROFESSIONAL INVESTORS WILL STRUGGLE TO KEEP UP
Two factors will make it harder, in the future, for non-professional investors to realize satisfactory rates of return for the risk taken, completely on their own. First, the pace of disruption will likely continue and possibly increase. Second, the amount of research, analysis and experience required to make good judgment calls will also likely increase. Most working professionals simply will not have the time or energy to do this.
I would also predict that in the near future, teams will produce better results than solo flyers. At Whitnell, we’ve practiced this philosophy for decades. This is why we have an investment committee and not just an individual. We bounce ideas off each other and bring differing perspectives to bear on our recommendations.
I believe it will be very challenging in the future for non-professional advisors to keep up with the pace of change, to avoid being disrupted and instead to take advantage of disruption. Achieving this will likely require a tremendous amount of research and the perspectives of a team of professionals.
At Whitnell, we tend not to think of our clients as investors. We think of them as clients, with busy lives and big goals. We often see ourselves as the investors, analyzing our clients’ needs, making recommendations, re-balancing their portfolios at crucial pivot points and keeping them apprised of market trends. Ultimately, our clients do need to approve our recommendations. But they rely on us to provide guidance.
I grew up with disruption, adopting new technologies and services as soon as I could. I do not fear it. I embrace it. I believe it creates very real opportunities, if you can spot them and take advantage of them. If you would like to discuss the state of your portfolio and how innovation and disruption might impact you, my door is open. Let’s talk.
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