Tuesday, May 17, 2011

Investment Fundamentals - A Quick Note

Investing has become a mainstream phenomenon, especially in the US, where everyone and their bequeathed cat have an investment fund of some sort, whether it be a general account, an IRA, a 401K, an education savings, their pension, endowment, or a myriad of others. Quite frankly, everyone has some skin in the game whether they know it or not. 'Investments' take on a variety of forms including stocks, bonds, commodities, currencies, real estate, and everything in between. However, few people understand the fundamental principle behind true investment.

Let's consider investing in its purest form involving three principle parties: the saver, the broker, and the entrepreneur. The broker's job is to bring the saver and entrepreneur together with the objective of striking a mutually beneficial deal. If the deal goes well, the outcome goes something like this:
  1. The saver gives the entrepreneur funds to grow his enterprise. In return, the saver owns a portion of the company and shares in the profit.
  2. The entrepreneur obtains the required capital to grow his enterprise, become more productive, profit, and generally grow the economy.
  3. The broker receives a commission for bringing the entrepreneur and saver together, facilitating a transaction that he believes will benefit both parties (not like Goldman Sachs...)
The idea is concise, as sound theories tend to be, but you won't hear such simple logic from investment advisers or brokers. The reason is quite simple, they have lost touch with the idea of real investment. The incentive structure revolves around obtaining clients or facilitating transactions rather than understanding the economics and viability of the investments involved. The latter requires due diligence and a sound understanding of how the world works, what drives it, and where it's trending. Investment classes fluctuate in-and-out of favor, but the cycles can be anticipated and capital can be allocated to where it produces profits and benefits society as a whole---increasing the standard of living for everyone.

If Wall Street were less of a casino, we had sound money, and investment revolved around real production, the standard of living would dramatically increase. The take away: when investing consider  what your money is actually doing and whether it is truly viable given current and future economic trends.

1 comment:

  1. Excellent. Love your posts. Very succinct and informative.