Good bye and good luck

1. Many thoughts jostled for first place, but the winner was that investing is a multi-decade enterprise. It's not a marathon. It's hundreds of marathons.

Most equity investors begin to grasp the intellectual and financial allure of the stock market in their twenties or thirties. Those fit for the course will be investing (however passively) until at least their seventies. This is a 40 year mission. There is no point - and much danger - in sprinting. Nor in rushing to measure your progress - as long as you don't do too much damage to your capital. Your capital is far more precious than your returns.

The biggest lie

2. Right up close behind that is the biggest lie in investment: 1.5 per cent. Sometimes more, sometimes less: the cost of active investment management.

Expressing the cost of investment management as a percentage of the funds being managed is surely the most expensive fraud ever perpetrated. It costs more every year than Bernie Madoff stole in his whole career. To 99 people out of 100, 1.5 per cent seems trifling. It certainly did to me until the penny dropped about 10 or 12 years ago.

At the very least, the figure should be expressed as a percentage of profits earned, which would make it about 20 per cent. If people understood they were being charged 20 per cent of their profits, they would be far less blithe about the cost of investment management.

But even "20 per cent" fails to convey the real burden. Were investors generally to grasp that the cost of active investment management typically involves giving up half of all the profits they will earn over 40 years, they would surely gouge their eyes out.

3. HALF? Where does that come from? Well that's point three: compound interest. You won't understand investment until you understand compound interest.

If you invest £10,000 next week and achieve eight per cent for 40 years, your profit will be £191,000. That's a magnificent piece of arithmetic, but it does not by itself demonstrate the real power of compound interest. So here's a puzzle to entertain you between Christmas pudding and the Queen's broadcast. Let's say your £10,000 still yields eight per cent for 40 years, but your investment manager skims off 1.5 per cent each year. What's the profit left for you in this case? To encourage some serious reflections on this profound matter, I'm not including the answer here; the editor has promised to slip it into his editorial in the next issue.

Now I have four points aimed at policymakers.

Westminster's antique shareholders

4. Topmost, the difference between beneficial owners and shareholders. Much government policy is predicated on the axiom that shareholders will defend their interests. This is akin to Alan Greenspan's pre-2008 insistence that bankers would never imperil banks. But it is more wrong.

Bankers at least were genuine bankers. But the shareholders so often referred to by politicians are not genuine shareholders. A hundred years ago most shares were held by wealthy individuals. The words "shareholder" and "beneficial owner" meant the same thing: a shareholder could clearly be counted on to act in the best interest of the beneficial owner, for they were one and the same.

Today most shares are held by institutions on behalf of ordinary individuals. These "shareholders" can by no means be relied upon to act in the best interests of beneficial owners. To wit, they waved through 20 years of rip-roaring director pay inflation whilst their clients - the beneficial owners - looked on aghast.

Politicians planning to use the word "shareholder" should ask themselves whether they are using it in its antique sense or its modern sense. They should see if their message still rings true when the following substitution is made: "non-beneficial owner".

This is way beyond semantics. It is my impression that politicians are simply unaware of the changing nature of shareholdership. They all carry around the comfortable and established nostrum that shareholders will ultimately exert authority over management; it's written in stone; it's an essential lever in the capitalist system. This lever does not exist. It is a mirage, a ghost, a chimera.

5. Next, policymakers should examine the symbiotic relationship between institutional shareholders and management. It's easy enough to appreciate that institutional shareholders will have a different agenda from their clients, the beneficial owners. They need to make money from their customers - ideally as much as possible. So they will charge hideously for their services (see above). But why would they let director pay escalate so fast and so undeservingly?

Because it takes the spotlight off their own undeserved high pay. When FTSE 100 directors routinely pull down £1m a year, what's abnormal about the fund managers who allocate their capital also making £1m a year? These people are all from a single social echelon. Most of them would consider it unpardonable to attack each other's pay.

Would prison work?

6. A third point which I would urge upon policymakers is to consider the potential benefits of jailing company directors who preside over catastrophic value destruction. Am I alone in thinking that if Fred Goodwin, James Crosby, Victor Blank and others - for instance George Simpson who turned the titan GEC into an after dinner burp - would have been more careful had they known throughout their careers that if they turned the risk tap too far they could end up doing time?

7. My final suggestion for policymakers: set auditors free. Auditors are supposed to take a sceptical look at management. Instead, they are in their pockets, condemned to bite their lips and sit on their hands, because auditors are selected by management and paid by management. 180 European banks needed government rescues in the wake of the crisis. 180 of those banks had clean audit reports in 2007.

The annual shareholder vote on the audit appointment is a charade. Only one nomination is ever made: it's like an election in a communist country. In fact it's worse because even if the election was opened up, no other candidates would come forward. The current setup has resulted in the audit profession merging its self into a global quadropoly: if the shareholders sought a new auditor, client conflicts would probably stand in the way.

A company should be required to change its auditor every six to ten years. At this point shareholders should always be presented with a genuine choice between at least two firms. This would instantly shift auditor allegiance from management to shareholders. It would also cause the breakup of the Big 4 firms as progressive accountants who despair of the current audit model would see an opportunity to create a new one. The restoration of genuine shareholder control of auditors would be a giant leap in corporate governance.

Older means poorer

8. Finally some reflections for individual investors. The first for those who do not know they are investors: pension scheme members. The old people around you living on pensions built up in the 40 years to 2000 are a generation apart. They were very lucky to have been born into a narrow slot in history which saw the pension ball land on black time after time after time.

Your retirement in 2030 or 2040 will not be like theirs. It will start later and it will be poorer. You will have a smaller pension pot, which will have to be spread over a longer retirement. Longer means thinner means poorer. Many more people will encounter unexpected poverty in old age.

9. Inflation is coming back. The only answer to the engulfing ocean of national debt, in Europe as well as the UK, is inflation. As soon as it can be engineered, Mario Draghi and Mark Carney will set their inflation dials to seven per cent. And once that seems normal, they will turn it up higher. Never mind that central bankers are supposed to abhor inflation. When you're dealing with debts beyond your worst nightmares, you can abhor inflation in principle but engage it in practice. Even inflation-hating Germans will breathe sighs of relief: there are more German taxpayers than there are German savers.

10. And because inflation is coming back, fixed interest will disappoint whilst equities will become more attractive. Companies can cope with inflation: they simply raise their prices. Inflation decimates fixed interest.

Gearing and Governance

11. This column has never majored on company analysis. Nevertheless that subject has always been in the background. The one aspect of this art that I would urge all readers to master is gearing. Never buy a share without knowing the company's debt profile and being happy with it. And recognise that gearing means more than borrowing. It means any unavoidable expense, especially rent. When reviewing a company's accounts, always work out its fixed charge cover. A company with low balance sheet gearing might appear to have a correspondingly reasonable level of profit after interest. But if it has paid two or three times as much away in rents, you ought to work out how much would be left in the event of a downturn.

12. This column has castigated hundreds of managers for failing in their reasonable responsibilities to shareholders. For instance to keep them informed and not mislead them; to approach M&A activity cautiously, to invest where necessary to maintain a company’s earning capacity, to invest judiciously to grow that capacity and above all to show some restraint in the executive pay race. These finer governance responsibilities of course form no part of the essential plumbing of capitalism. They are founded on respect and the long term commonwealth. Managers who weigh their own interests far ahead of shareholders' interests will naturally be blind to these responsibilities and will usually reap net personal benefits from this blindness, especially if they don't expect to be around for too long.

So don't expect to be treated with respect. But when you do witness such treatment, value it as if it were a lowly geared balance sheet. You should favour companies where visibly good governance has a history of at least five years and you should permit yourself some excitement if it stretches to 10. I reproduce here one of the most exciting tables ever presented in this column (in April 2012). It was based on a list by Glass Lewis, a US proxy voting firm, showing the most overpaid and underpaid bosses of quoted companies in the USA. The original table included one year share price movements, which showed the companies with underpaid bosses modestly outperforming those with overpaid bosses.

On a hunch I looked up the 10-year share price movements of the companies. This revealed a staggering gap in performance. There's more to good governance than bosses' pay of course, but I believe it is a meaningful proxy. By careful evaluation of an individual company's statements to shareholders, you can create a better proxy.

10 year share prices (as of April 2012) of S&P500 companies with the most…

If you are a regular reader of this column, you would enjoy one or more of: Ben Graham, The Intelligent Investor; Adam Smith, The Money Game; Burton Malkiel, A Random Walk Down Wall Street; John Bogle on Investing. All these books will seem a bit dated, but the messages are timeless and the writing itself is on the highest level.

The writing is also very good in these more modern books: Charles Ellis, Winning the Loser's Game; John Kay, The Long and Short of It; Richard Oldfield, Simple But Not Easy.

Finally, you should download the dated, modern and timeless annual letters of Warren Buffett to shareholders from 1977 to date, which totally reoriented my understanding of investment when I first found them shortly before I started to write this column.

I'd like to say thanks to the editors I have worked with: Ceri Jones, Matthew Vincent, Oliver Ralph, Jonathan Eley and John Hughman. Also to Robert Ansted and my long-suffering sub-editor, Victoria Thornton. I wish them and you a Merry Christmas.