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Former All Black captain David Kirk, now chair of Rugby New Zealand, joins Listener.co.nz as a columnist taking a philosophical look at money, finances and living well. The cofounder and chairman of Bailador Technology Investments, Kirk sits on a number of other boards including investee companies of Bailador and charitable organisations.
When I sat down to write this column, I found I hadn’t quite finished with the last one. You will recall that in October 1986, the first tutorial essay John Grey set for me was ‘Freedom is freedom from chains, all else is metaphor. Discuss’ and that one of the publications on the reading list was Sir Isaiah Berlin’s Two Concepts of Liberty. This week’s column is about opportunity, and Berlin’s famous paper is a good place to start.
In his essay, Berlin identifies two notions of freedom. The first he calls “negative freedom”. This is freedom from chains or restraint or coercion by others. This is the classic liberal freedom. “The only freedom which deserves the name is that of pursuing our own good in our own way” wrote John Stuart Mill. The nub of negative freedom is that each of us must be afforded a space in which we can act as we please for our own ends, whatever they may be, so long as we do no harm to others. How expansive that space is, and what constitutes and justifies appropriate constraint, is endlessly debated.
Berlin’s second notion of freedom is “positive freedom”. The distinction is subtle. It is all very well, Berlin argues, to be free from restraint, but this does not necessarily translate into being free to lead whatever life we may choose. We are positively free when circumstances are such that we are free to be “our own masters, subjects not objects, self-directed, not acted on by forces as if we were a thing”.
The distinction is between the establishment and maintenance of a bounded “space” in which we are all free to do as we please so long as we don’t interfere with the aims of others, and the establishment and maintenance of circumstances in which we are free to be masters of our own destiny. Further examination reveals layers of complexity in the distinction. Perhaps, in the end, it is the difference between “to do” and “to be”. In any event, Berlin’s Two Concepts of Liberty is readily available online for those who want to understand him better than I can explain him.
That the exercise of freedom requires opportunity and the capacity to choose seems to be a commonsense truth. Kris Kristofferson disagrees in his song, Me and Bobby McGee, when he sings, “Freedom’s just another word for nothin’ left to lose.” Aleksandr Solzhenitsyn explores the same theme in The Gulag Archipelago, when he says to the jailer set on breaking his will, “… when you’ve robbed a man of everything he’s no longer in your power — he’s free again.”
I will restrain myself now and with some relief come back to the practical world of investment choices and the importance of understanding not simply opportunity - should I invest in this or that? - but the notion of opportunity cost. The cost of not doing something.
Why, you may ask, should I want to know anything about what I didn’t do? No point crying over spilt milk, or lamenting a theoretical loss, better just to get on with what is in front of us. In everyday life, I am firmly in this camp myself. I hardly ever think about what would have happened if I had done something I didn’t do. I admire Robert Frost’s poem, The Road Not Taken, but with respect, he has no idea whether taking the road less travelled “made all the difference”.
We cannot know the counterfactual in life because, unless we believe in predestination, there is no such thing. We didn’t make that choice, the train of events that would have followed if we had made that choice didn’t happen, ipso facto there is no counterfactual. If wishes were horses, beggars would ride, says the old proverb.
Opportunity cost is an important analytical tool in investment and finance. The simplest -- and most useful for most people -- way of thinking about opportunity cost is as the comparison between the returns received by various types of investment. For instance, if you put your money in a bank account, you might get a 3% return. Alternatively, if you invest in a share market index you might, over an extended period, achieve a 7% return. The opportunity cost of putting your money in the bank and not the share market over the same period is four percentage points.
Of course, you gain some important benefits from having the money in the bank -- security, immediate access and predictability of return being three -- but you also have, to give it its full name, “an opportunity cost of capital” compared with the alternative of investing in the share market of those four percentage points.
Another important application of opportunity cost of capital is in assessing risk-adjusted returns. This is a method for quantifying one of the benefits of putting your money in the bank, namely the security of a bank account. It is agreed that putting your money in a highly reputable bank is less risky than putting your money in the share market. But how much less risky and how does this effect the opportunity cost of capital?
I am now officially out of space so the answer to that question and more on the opportunity cost of capital will have to wait.
