Who is best at evaluating investment risk?
June 30th, 2009 | Published in Economics idea
Who is in the best position to evaluate the chances of success of a business venture? The standard answer is that people investing their own money will make the best decisions because they don’t want to lose their money. In a world with perfect knowledge and information, this makes sense. In the real world, however, it does not.
The success or failure of a business venture depends on a lot of things. The business needs to be able to manage a myriad of tasks to successfully produce a product. Once a product is made, it needs to be marketed. Success or failure in the market place depends on many factors that are outside of the control of the business. An investor needs to have a thorough understanding of a business and the relevant market conditions to make an informed investment decision.
Most people aren’t able to interpret a business plan or annual report. They can’t evaluate the quality of a businesses management team. They don’t have a good grasp of economics. No matter how carefully they want to invest their money, they simply don’t have the skills needed to evaluate the risks.
The people best able to evaluate a business venture would have academic training that gives them the tools to process information about businesses. They would have experience in the sector working with other similar businesses. In short, they would need to be specialists.
Most people don’t directly manage their investments even today. There are legions of bankers, investment advisers, and fund managers who make most of the decisions. It seems that specialists investing other people’s money tend to do better than untrained individuals investing their own money.
If investment decisions are best left to specialists, government can be just as good at investing as anybody else. They just need to hire the right specialists. The technical exercise of managing risk is the same for for-profit and non-profit organizations. A government managing investments could just as easily invest in non-profit producers as for-profit producers.
