3 Reasons to Invest in Technology

This article was originally published via Linkedin on 10/02/2021.

I used to be more cautious about investing in technology, following the wisdom of legendary capital allocators like Warren Buffett who famously avoided the sector during the height of the dotcom bubble in late 1990s.

Buffett's reasoning is clear: You should only invest in what you thoroughly understand and in companies that have some form of 'moat' to protect them from competition (e.g. powerful brands, regulatory barriers to entry, patents, etc.). This is why Buffett would prefer to own relatively straightforward businesses like American Express or Coca Cola than say Illumina, which develops systems for the analysis of genetic variation and biological function.

I agree with Buffett. However you can outsource the thorough understanding of the underlying business to a reputable investment manager - it is what people do when they buy shares in Buffett's holding company, Berkshire Hathaway. When assembling a portfolio of investments funds, you can pick management firms like Lindsell Train that specialise in consumer goods/staples or funds like Blackrock Gold & General which specialise in the daunting business of owning gold mining companies. To diversify into tech, you can also include fund houses like Baillie Gifford, which has a unique process and an amazing track record of selecting founder-led businesses at the forefront of digital innovation.

Yes, technology can be risky but avoiding it over the long term can be much worse. Hence the right level of diversification is essential.

So here are three reasons why I have become convinced about increasing exposure to tech-oriented businesses:

1. Asymmetry of Returns

If you buy shares in a company, the maximum you can lose is 100% of what you put in. However the amount you can gain is unlimited. Hence the upside and downside are not symmetrical.

Obviously losing 100% is not ideal, so you should avoid having too many eggs in too few baskets. The point is that the risk of investing in technology can be far outweighed by the potential reward of being on the right side of progress over the long term.

2. The Law of Accelerating Returns

I picked up this evolutionary concept when reading How to Create a Mind by futurist, Ray Kurzweil.

The idea is that the more technology we create, the more we can use that technology to create more technology and so on. Following the same logic as compound interest, this has an exponential effect.

The power of compounding is often demonstrated by the fact that if you start with a single penny and double it every day, you will end up with just under £5.4 million by day 30.

Even though tech stocks may look expensive right now, successfully capturing the pace of accelerating returns over the long term is more important.

3. Low Interest Rates, Inflation & Deflation

The 2008 recession and then the COVID-19 pandemic have resulted in extreme measures taken by the world's governments: Massive increases in public debt, manipulation of interest rates to historic lows and excessive money printing via emergency policies like 'Quantitative Easing'.

These policy prescriptions have become the new normal. They have us stuck in a situation where financial markets, real estate markets, individuals and governments depend on cheap money. If interest rates go up by any meaningful degree, we are all trouble.

The question then is, can't we just keep interest rates artificially low forever? Well, conventionally, what is supposed to happen is that lower interest rates and money printing will lead to inflation. At that point, the only way central banks can combat inflation is to raise interest rates.

However we are not seeing any worrying levels of consumer price inflation despite all of the new money that has been pumped into the global economy over the last dozen years. Why?

This brings us back to technology.

Technology is tremendously deflationary. The increased efficiencies and conveniences it brings to our lives has a downward pressure on consumer prices. The deflationary force behind tech, coupled with increased global trade (e.g. cheap goods from China), have lowered costs enough to enable the continuation of what would otherwise be very inflationary government policies.

Furthermore, it is these inflationary government policies that help to boost the stock market. Low interest rates mean you get virtually no return on a savings account, which incentivises people to take more risk by investing.

Inflation is certainly still a risk that should not be ignored, hence a well diversified portfolio would include some index-linked bonds and gold.

However it may be that the accelerating, asymmetrical returns from technological innovation are able to keep inflation at bay and the monetary system ticking along while we look to a more prosperous and exciting future - one that is perhaps much closer than we think.

Disclaimer: This article does not constitute financial advice - it is not tailored to one's personal circumstances. As with all investments, your capital is at risk.