Negotiating Your Investments Read online

  Are the agent’s preferences the same as yours? For example, an agent may prefer a quick sale while the principal is willing to hold out for a higher price. Or the principal may be ready for a take-no-prisoners bargaining style that is opposed by an agent who must continue to work in the community. I witnessed an extreme example of this as a young attorney in New Hampshire. The rules there, at that time, did not prevent a district court judge from also being in the private practice of law. One Tuesday morning, a colleague of mine found herself on opposite sides with a lawyer before whom she would be appearing the very next day. Certainly, she must have had doubts about just how aggressive to be with this opponent today, judge tomorrow.

  Agents often have interests and incentives that are not well aligned with those of their principal. Frequently, this conflict grows out of an agent’s fee structure or way of getting paid. For many years, I have taught a real estate case designed to highlight the sharp divergence of interests between a real estate buyer and the Realtor she is working with. The aha! moment comes when the buyer realizes she wants the lowest achievable price but her agent will make the most money with a higher price.

  As an aside, and a source of embarrassment to me, several years passed before I understood the full scope of the Realtor’s incentives. I taught my students that the buyer’s agent had strong financial reasons to want the sale to occur at the highest possible price. Levitt and Dubner take up this problem in Freakonomics and point to a stronger motivation that, in many cases, supersedes the preference for a higher price.1 In Chapter 2 of their book, we are introduced to a real estate agent who is warm and caring and full of useful information. She appears to have our interests at heart. But does she? As Levitt proves, her strong incentive is to get us to close the deal quickly so that she can pocket her commission and go on to the next sales effort. Many real estate agents try to (subtly) pressure the seller into taking the first decent offer that comes along. So, too, the agent working with the buyer will try to get him to make a high enough offer to get the deal to close.

  Like everyone else, agents are just human beings. In general, people have a strong tendency to respond to their own interests. Even those at the very highest levels of governmental, social, or commercial life usually take the actions they believe will further their own goals and objectives. Indeed, one way of looking at human relations is to start with the assumption that a person’s sole motivation is to advance his own interests. Such a rational actor furthers the well-being of others only if he believes that to do so also somehow maximizes his own benefit. To put it simply, most agents facing a serious conflict of interest have a difficult time doing what is best for their principal at the expense of that which is better for themselves.

  Where such conflicts of interest exist, a principal is left to question the wisdom of taking advice from the agent. Is the delegation of authority imprudent? How much should we trust this person? How strong does a conflict of interest have to be before it starts to affect her actions? How much temptation for personal gain will compromise the judgment of someone offering advice or acting on our behalf? At some point, the question shifts so that a prudent person must ask, “Would we be foolish to trust in this situation?”

  Chapter Summary

  There are times when a negotiation can benefit from the involvement of a skilled agent. Such agents may bring to the table special expertise, emotional detachment, influence, or process knowledge. They are employed in the hope of gaining an advantage through their expertise or connections.

  There are significant reasons to resist the introduction of agents into a negotiation. They add expense, complexity, and communication difficulties.

  Agents frequently have interests that conflict with those of their principal. This can raise problems of trust, divided loyalties, and the potential for breaches of duty.

  Careful consideration of advantages and drawbacks are warranted before bringing agents into a negotiation. There may be some situations in which you are simply better off without them.

  Note

  1. Steven Levitt and Stephen Dubner, Freakonomics: A Rogue Economist Explores the Hidden Side of Everything (New York: Harper Collins, 2005), 215.

  PART II

  APPLYING NEGOTIATING PRINCIPLES TO INVESTING

  In Part I of this book, you learned about negotiating as it is taught at Wharton, Harvard, and other universities throughout the United States. In Part II, you will see that these methods can be applied directly to investing and, when you do so, they will help you achieve even better outcomes. Failing to comprehend that the investment decisions you make are part of a series of negotiations will cost you money. Not making the effort to improve your investment negotiating skills will cost you even more. Luckily, understanding investing as a series of negotiations and getting good at doing it is well within your reach. My goal in Part II is to guide you in applying the skills and techniques from Part I of this book to the activities we might call your “investing life.”

  It is important to note that I use “negotiating” in this context to cover the entire process described in Part I. Thus, a negotiation begins with preparation and research that commences long before anyone contemplates sitting down together at a bargaining table. It involves studying facts, circumstances, and historical records. It requires thinking about alternatives outside of this deal and working actively to strengthen ours and, perhaps, weaken theirs. You need to seriously examine your own interests and those of every other negotiator. You must put much thought into the nature of the relationship and the goals surrounding it. You must make great effort to ensure the likelihood that the other side will fulfill all promises. In other words, the concept of negotiating employed in this book is an intricate series of actions that work together toward ensuring good outcomes. It is neither easy nor quick; rather, it requires study, effort, planning, and patience.

  Negotiation encompasses the entire process, from preparation through final implementation. Therefore an investment, such as purchasing common stock, is by my definition a negotiation, even though the investor-negotiator never has the opportunity to talk to or communicate with the seller of that security. Market transactions eliminate your ability to manipulate some parts of the negotiating process. Those that remain, however, offer ample opportunities for advantage and relative success.

  Different negotiation situations may bring different parts of the process to the fore. For example, some investment negotiations are directly about the acquisition of securities, properties, or contracts. Others are between you and one or more intermediaries such as brokers, advisors, or middlemen. There are occasions when one cannot even tell the difference. In any of these circumstances, though, the skills this book offers will help you in critical ways. When purchasing shares in a liquid market, the most valuable of your negotiation skills might be preparation, research, and awareness of your best alternative. When discussing fees with a broker, greater advantage might come from information exchange, analysis of interests, and wise structuring of commitments. Even though different types of challenges will reap rewards in different parts of the process, your overall results will be dramatically improved by negotiating ably, skillfully, and thoughtfully.

  As we did in Part I, we start Part II with the ending and with my favorite question: What is a good outcome? That is to say, what end result of your investing life will get you what you really, really want? Where will a successful journey take you and how will you know when you have arrived?

  Chapter 13 will encourage you to think with care and self-awareness about whether your stated objectives are fully compatible with your truly “good outcome.” Why are you investing and what do you hope to achieve? Are you being honest with yourself? Should you broaden or narrow your goals as an investor?

  What distractions, impediments, or feints threaten your investment efforts? In particular, which specific systems and situations might interfere with attaining the best possible investment outcomes? In Chapters 14, 15, and 16, we examine
some systematic challenges that are especially problematic for negotiators in the world of financial services. As you will see, the issues of conflict-of-interest, asymmetric information, and trustworthiness are critical to an investor-negotiator and cannot be ignored.

  Those chapters lead directly to a discussion of professionalism. Which qualities are essential if you are to receive worthwhile guidance? The ideas expressed in Chapter 17, researched and explored for two decades, are the best answers I can offer for dealing with the challenges posed. They are also my contribution to solving one of our society’s biggest problems: How shall we safeguard the wealth workers have saved up over years to ensure a comfortable retirement? As you will see, my solution to both your problem and that of the nation is the same: the creation, training, and socialization of true professionals whose skill, loyalty, and sense of caretaking is so great as to shrink the challenges from vast to minimal.

  The solutions put forth in Chapter 17 are clearly aspirational and would require significant changes. Whether our society can embrace moving toward such professionalism as an answer remains to be seen. You, however, can use these ideas to distinct advantage. Finding a “true professional” who possesses all the qualities described in Chapter 17 is a powerful answer to the urgent difficulties that investor-negotiators face. Unfortunately, it presents a new quandary; you must be able to identify and engage such a professional. While the future holds promise for a great increase in the number of financial experts who are “true professionals,” at present they are as hard to find as a needle in a haystack. The message to you as an intelligent investor-negotiator is that if you choose to seek expert guidance, the search for such a professional will be worth the effort.

  Having examined the most significant systematic challenges facing you as an investor-negotiator, we proceed to applying the elements and stages described in Part I for negotiating your investment life. Focusing a sharp “negotiator’s eye” on all that is occurring will make you a better investor and get you superior investment outcomes.

  To the surprise of many people, it is you, the investor-negotiator, who holds most of the power. It is a “buyer’s market” for people who have capital to invest. In addition, though, those who are trying to persuade, entice, or sell you investments face overwhelming competition. You are actually the one in the driver’s seat. Chapter 18, about the power of alternatives, will help you understand this fact and mobilize the power that comes with it.

  After considering alternatives, we examine the importance of knowing and clarifying your genuine interests and those that drive the other side. Next we explore identifying the best of many possible options for structuring the deal. Chapter 21 is about the use of objective standards of fairness. Other elements of negotiation involve identifying the kind of relationship that is best for you and choosing the optimal communication tools to advance your effort. Then we look at commitment—deciding what to be bound to, how tightly, and when. Once you are prepared and ready, Chapter 25 walks you through the four stages of an investment negotiation.

  Let’s get started.

  Chapter 12

  Why Is Investing Really Just Another Type of Negotiation?

  The care and management of your financial life is best understood as a series of negotiations. An investor is seeking a deal in which she will exchange payment for some instrument that (she hopes) will appreciate in value. This may be a stock (an ownership interest in an enterprise), a bond (debt), or some sort of commodity (a thing that has value). Or the object of the deal may be some derivative or combination of those things. In any case, the terms of exchange are bargained for until a final agreement is reached. Both sides are looking for value from the deal, and each side hopes to claim as much value as possible.

  You should remember that there is always someone on the other side of the negotiating table. The person you are buying that stock, bond, or gold coin from is just as interested in getting the best possible deal as you are. This is equally true whether you are interacting directly or through intermediaries such as brokers or advisors. They want the best possible price, and you want the best possible price. In that, your interests are in direct conflict.

  Investing Is Similar to Other Big-Ticket Negotiations

  For reasons explored later, though, most people do not comprehend financial transactions in this way. In particular, we are frequently blind to how similar making an investment is to buying any other kind of property—a strange thing considering the whole world seems to understand that buying a piece of real property, such as a house, is a negotiation. Everyone appreciates that the seller is trying to get the highest possible price from the buyer and that the buyer is seeking the lowest cost from the seller. They are instinctively on their guard around those elements of the negotiation that are “zero sum”; every dollar in one side’s pocket is coming out of the purse of the other side. Such a real estate deal strikes everyone involved as a negotiation, and the participants are all aware that they are sitting on opposite sides of the bargaining table.

  As with investing, a home buyer may be in several different negotiations at once. Not only is there bargaining between buyer and seller but, also, there is an ongoing negotiation between principals and agents. How much the real estate broker gets paid, and in exchange for what, forms another negotiation entirely. It can get complicated pretty quickly. For now, though, the thing to notice is that several negotiation processes are occurring simultaneously.

  Rather than thinking about real estate deals, however, let’s consider a classic tale of negotiation in America: going to the automobile dealer. This is a situation where virtually everyone in the country is aware that they are entering a negotiation. It is the stuff of Hollywood movies and family folklore. The preparation, the tire-kicking rituals, and the haggling are all familiar. Who hasn’t had a good laugh over the idea of the car salesman going into the back to ask his manager? And what family doesn’t have some myth concerning the hard bargain driven by a crusty old uncle or grandfather back in the day?

  Everyone in the auto showroom is on notice that sitting across from you is a person, part of a team, who is trying to separate you from as much of your money as possible. You, on the other hand, are trying to pay the lowest feasible amount for the car. The salesman’s living depends on the rewards he gets from selling autos at relatively high prices. The dealership’s owners must sell cars dear to pay the overhead. At the very least, they cannot “give them away” at their true cost. The cash flow problems of the owners are not your concern, though, and you would be delighted to get the car for less than the wholesale price they paid for it. In most cases, neither side is any too concerned with the problems faced by the other, nor is anyone thinking all that much about what is “fair.”

  Do Not Be Fooled into Thinking It Is Something Other Than a Negotiation

  What would happen, though, if you went to the car dealer thinking the experience was more akin to visiting your doctor? What might result if you simply determined to follow the guidance of the car salesman, believing that his efforts are motivated by concern for your well-being? If you viewed the car-buying process not as bargaining but rather as a time to do as you are told, what outcome would you expect?

  Let’s take this fantasy a step further. Imagine that when you arrive at the Toyota dealership, you are greeted by a man in a pinstriped suit. After sitting you down in a fancy and well-appointed office, he explains that they are no longer in the business of selling cars. “We are now ‘car advisors,’” he announces, “and our job is to analyze your needs and future for the purpose of selecting exactly the right automobile for you.” He promises that, after using a systematic scientific process that takes your entire life into account, his company will scour the universe of cars to identify just the right one for you and your family. The process that follows includes computer questionnaires, long discussions, question-and-answer sessions, and investigation into your past automotive history. It even incorporates a “dream book” designed by p
sychologists at a prestigious university to gather and interpret your nocturnal desires. A number of appointments are needed, and several outside experts enter the conversations. It would be rather exhausting, were the focus of the inquiry not you. Your interest in your own life holds your attention, so you are willing to see the thing through. Finally, after much talk, reams of paperwork, significant computer analysis, experts, reports, and conferences, an answer emerges. It is, you are told, highly scientific in its derivation and focused entirely on your needs. “It seems,” announces the car advisor, “that the best car for you is a Toyota Camry.”

  Of course, in such a scenario you would likely be taken to the cleaners. The highest possible price would be charged for the car itself. Furthermore, all sorts of add-on items, options, and accessories would be included to drive up the final price substantially. You would end up paying a small fortune for the vehicle. Without the countervailing force of your haggling back, they would push and push until you could go no higher.

  You weren’t really fooled, though, were you? It is fairly clear that the whole “scientific process” in our fantasy scenario was ancillary to the dealership’s real endeavor, which is selling you a Toyota. It was also quite apparent that all the scientific analysis was serving the purpose of diverting your eyes from what was truly going on. And, of course, that truth was simply a salesman trying to sell you something. What was it that, like a Las Vegas magic trick, you were being distracted from noticing? That a negotiation is taking place and you are the only one positioned to defend your interests and insist on fairness. Everyone knows that you go into the car dealership to negotiate the purchase of a new car.