Archive for Headline

Lessons From the Newest Electronic Money – Bitcoin

One of the more interesting developments of the modern electronic age of money has been the rise of Bitcoin, a decentralized digital form of money.  If you’re not familiar with it or you’re confused by what Bitcoin is, you’re not alone.  It’s a fairly new, innovative and complex form of money.  And that’s right, Bitcoin is definitely money.

Today’s Dominant Form of Money Versus Bitcoin

Anyone who understands the basic tenets of Monetary Realism know that many things can serve as money and many things DO serve as money.  After all, anyone can create money, but the trouble is in getting others to accept it.  And since money’s primary purpose is in the means of exchange, just about anything can serve as money as long as it meets that primary purpose.  The thing is, there aren’t all that many things that meet that need on a broad level.  For instance, lots of people like to claim that gold is money (which it is), but gold isn’t accepted for payment in many places.  Therefore, MR says that gold has a low level of moneyness (to better understand the concept of moneyness please see here).  Gold is money, but it’s just not a very good kind of money.  Bitcoin is actually very similar.  If you have Bitcoins you can buy certain things online that only a Bitcoin merchant will allow you to buy.  These merchants accept Bitcoins as a form of final payment.  To them, it’s a form of money with a very high level of moneyness.  But to a company like Wal-Mart a Bitcoin is like a gold bar.  It doesn’t give you access to anything in their store therefore its moneyness is virtually nil in a Wal-Mart.  Most retailers around the world view Bitcoins similarly.

In the USA, the primary form of money is bank deposits because bank deposits are the form of money that dominate the US payments system.  The US payments system, which is maintained by private banks, is the primary playing field for the purpose of exchanging goods and services.  In other words, if you want access to the most convenient and widely accepted form of payment (bank deposits), you need to become a member of the US payments system usually by becoming a bank client.  This gives you access to credit cards, debit cards, a bank account that allows you to withdraw/deposit cash, etc which allows you to interact on the US payments system.  Becoming a bank client is kind of like opening a Ticketmaster account so you can obtain access to the means of exchange to gain entry into a theater performance (you just want access to the tickets that give you access to a performance).  In the case of banking, you open an account in order to gain access to the US payments system so you can access the performance that is the US economy.  Obtaining Bitcoins is similar in many ways, but very different as I’ll describe below.

Bitcoin is a Truly Endogenous Decentralized Form of Money

Bitcoin is very different from bank deposits.  The US payments system is overseen and regulated by the US government.  In other words, the government has deemed the US dollar as the unit of account in the USA (in other words, money is denominated in US Dollars in the USA) and the government has given private banks the unique privilege to control and maintain the creation of the bank deposits (denominated in USD) that populate the payments system they operate.  This system isn’t decentralized (even though it’s controlled primarily by private entities) because it is regulated by the US government.  Bitcoin, on the other hand, is entirely decentralized, unregulated, etc.

Decentralization could be both good and bad for Bitcoin.  I think there’s a certain missing element of trust in an online money that has no oversight.  One of the key ingredients that stabilizes and maintains the US payments system is the backing of laws that enforce and regulate the proper use of bank deposits.  Banks can’t just issue deposits (loans) without working within the regulatory structure of US government law.  And the users of bank deposits can’t use this payments system for things that the US government might deem inappropriate.  When you legally exchange goods and services on the US payments system there is a certain level of trust derived from the fact that you have a legal system protecting your rights to use that system in a particular way.  In other words, the government helps embed a certain element of trust within the system by ensuring that its users operate within strict guidelines and by providing those users with certain protections against fraud, misuse, etc.  It’s by no means perfect (some might even argue the government has too much control over the laws binding the payments system), but having an institutionalized form of money helps to solidify the trust that is one component of its viability.  Bitcoin has no such integrated legal protections or oversight, which is both liberating, but worrisome in some regards.

Bitcoin is also interesting in that it circumvents the banking system.  In the US banking system money is created as debt in the form of loans which create deposits.  This means the money supply in the USA is market based (created by banks who compete for the demand for loans), but it’s debt based AND can therefore be costly to utilize.  In other words, you have to “pay to play” within the US payments system.  By decentralizing their payment system, Bitcoin is able to reduce the costs associated with money.  They’re also able to create money that is not directly tied to debt.  This is both innovative and liberating.

One of the more interesting elements of Bitcoin is its rise as a purely endogenous form of money.  I often refer to bank money as endogenous in that it is created entirely INSIDE the private sector, but even bank money exists on a centralized system (the US payments system) that is regulated by US government law.  But Bitcoin is completely decentralized and a purely endogenous form of money.  So the decentralization creates a form of money that has grown entirely independent of government and its taxes.  In other words, Bitcoin proves that money can exist ENTIRELY for the private purpose for the means of transaction. This not only shows that money can be entirely endogenous and independent of government, but that it can also grow entirely independent of government taxation.

The Bitcoin Money Supply and the K-Percent Rule

Bitcoin’s money supply is also automated.  It kind of reminds me of Milton Friedman’s k-percent rule to automate the growth of the money supply.  I won’t get into the way the Bitcoin money supply is automated because the computer based growth is WAY over my head, but all you really need to know is that it’s not controlled by a central bank or any bank at all.   This is a very interesting approach to managing the money supply.  The innovative thinking and creativity behind this concept should be embraced and explored further as money evolves in the future.

Where Does Bitcoin go From Here?   

Bitcoin is an extremely interesting and innovative concept that shows that money can be entirely endogenous and exist entirely independent of government.  But can it be sustained within our economy without the laws that help bind money as a social construct?   Can the element of trust be borne into such a decentralized digital money?  And more importantly, is this form of decentralized digital money inherently at odds with the existence of a money system and economy whose primary payment system exists on a government regulated and government taxed playing field?  Call me hopeful, but skeptical.

I think the innovation and creativity behind Bitcoin is brilliant.  It’s an incredibly cool and forward looking form of money.  But money is a social construct and within any nation that social construct is designed in such a manner that it serves primarily private purpose, but ALSO public purpose.  In other words, without a system of taxation attached to that money it is at odds with one of the essential components of money as a social construct.  After all, it is through taxation that public purpose is generated so a money system that is entirely for private purpose could be seen as being at odds with one of the main purposes of money.  The US government organizes and institutionalizes money within the government regulated banking system so that it can maintain a private market based money system that has strict oversight and tracking.  This not only allows for enforcement of rules and regulations, but also helps the government ensure that this money can be used for public purpose.  A truly decentralized form of money like Bitcoin has no such government attachment allowing for any form of public purpose.

I think Bitcoin can continue to exist as a subordinate form of money with a very low level of moneyness, but if Bitcoin were to grow to a point where it becomes a highly competitive form of money, but circumvents the laws, regulations and taxation of a system like the US banking system, my guess is that the US government will make it illegal for merchants to receive Bitcoins for payment.  And then 100 FBI agents get a few thousand Bitcoins each, buy something from US based Bitcoin merchants and parade them out on national TV for the entire nation to see why Bitcoin acceptance results in a $250,000 fine and 5 years in prison.  In other words, Bitcoin could very well become a victim of its own success as the US government would never allow another form of money to detract from public purpose due to high levels of monetary competition.  Of course, I am referring to the US government, but this view would likely be embraced by many governments around the world.

So Bitcoin is an interesting and extremely innovative form of money, but probably not a viable form on any grand scale since its inevitable competition with the US banking system will likely render it at odds with the goals of the US government.  I know the anti-government and anti-banking crowd won’t like that conclusion, but that’s how I view it.  A purely private purpose money is at odds with the formation of money as a social construct that partially serves public purpose as the US banking system does.

Hopefully, Bitcoin will continue to exist on a smaller scale so we can see how this de-centralized, electronic, innovative and forward looking form of money evolves.  There is much to be learned here and I think the US government should proceed with caution regarding any potential clamp down on this money system.  While we wouldn’t want the Bitcoin money system to detract from public purpose I think it is useful and educational to see how this form of money evolves and takes form over time.  But I worry that the party could come to an end as soon as the US government recognizes it as a very real threat to the US banking system and the payment system it regulates in the means of public purpose.


Understanding Inside Money & Outside Money

Understanding the Modern Monetary System

*  It’s more accurate for me to describe Bitcoin as being endogenous up to its fixed level at which point it becomes a purely exogenous fixed money supply.  

Some Thoughts on the Future of Home Prices

I was reading this report from Zillow on the future of home prices and it got me thinking about some of the macro trends in real estate.  I’ve turned much more constructive on housing in the last year than I had been for the past 5-6 years.  Before about 12 months ago I wouldn’t have told anyone to purchase a home in the USA, but about a year ago I started saying:

“If you’re planning on living in a house (as in, 10 years of actually living in a home) then you should have no great fears about buying today.”

Admittedly, the year over year surge in home prices has been greater than I expected, but the halt in price declines doesn’t surprise me at all.  After all, we’ve fallen 30%+ from the peak in many areas so the risk/reward structure of the real estate market has shifted favourably for buyers.   But I do worry that the misconceptions regarding housing persist as this quote from the Zillow report implies:

“We’ve just finished compiling our Q1 2013 Zillow Home Price Expectations Survey (ZHPES), where professional forecasters provide predictions for housing market growth in the near term. This survey marks a break with the past in that the survey benchmark is now the national Zillow Home Value Index rather than the Case-Shiller index. The prediction for appreciation in 2013 is 4.6 percent, with the lowest projection at 3.5 percent depreciation and the highest at 8.5 percent appreciation. This edition of the survey was compiled from 118 responses, including the projections of economists, market and investment researchers and real estate experts.

It’s also interesting to break up the market by growth periods to compare historical annual average rates to expectations, as done in Figure 2 above. Covering expectations for annual average growth to the end of 2017, the average of all respondents, at 4.1 percent, is above the pre-bubble average of 3.6 percent. Indeed, the optimists, on average, seem to expect the recovery to continue modestly picking up speed. And while on average the pessimists expect things to slow, it would not be too far below the pre-bubble average.”

Real estate returns are not rocket science.  Because they’re such a huge portion of the consumer balance sheet they tend to be tied very closely to wage growth.  Wage growth, by definition, is very closely tied to the rate of inflation.  That explains why the long-term historical return of real estate is roughly in-line with the rate of inflation.  But this survey from Zillow shows that real estate “investors” are probably still too optimistic.

I’ve compiled the same data using the Case Shiller nominal price index in figure 1 below.  US real estate has averaged about 3.7% since 1890.  That’s just a tad above the average historical inflation rate of 3.2% in the USA.  When I started calling housing a bubble back in 2005 it was largely due to this one simple mathematical reality – house prices cannot deviate from wage growth in perpetuity.  So when Robert Shiller started posting his famous inflation adjusted house price chart (figure 2) all over the place it should have sent us all into a worried frenzy.  But it didn’t for some reason.  Instead, most people shrugged it off and it directly contributed to one of the worst economic calamities in US history.

Looking forward, I wouldn’t expect house prices to break their bubble peak until about 2025.  Figure 1 shows the historical Case/Shiller data with Zillow survey results.  The most probable scenario (historical average) assumes a real return of about 0%.  But the average respondent to the Zillow survey expects 4% nominal growth.  That sends us back to new highs by 2022.  That’s not terribly unreasonable.  But the most optimistic real estate investors are expecting something closer to bubble-era nominal growth of 6% per year.  That gets us back to the bubble peak by 2019 and sends us shooting 41% over that level by 2025.  That’s just not realistic and not sustainable in any way.

Of course, the future won’t play perfectly to the averages or even my practical assumptions.  It’s entirely possible that the Fed’s implicit asset targeting approach will veer us closer to something like the “most optimistic” scenario.  Combine that with the broadly held myth that housing is a good “investment” (it’s actually a crappy investment in terms of  real, real returns) and we might have all the ingredients for the highly unusual post-bubble bubble.  I for one, hope prices stagnate with inflation rates and basically move sideways per the Case-Shiller chart, but I’d be lying if I didn’t say I am getting at least moderately worried about the impacts of the Fed’s policies at present.  It’s way too early to start declaring this an environment consistent with a disequilibrium like 2005, but we should be proactive thinkers, not reactive like our friends at the Fed.

(Figure 1 – Housing Scenarios via Orcam Research)

(Figure 2 – Real House Prices via Orcam Research)


Deficit Hypocrisy

I was watching this video on Yahoo Finance this morning with Jim Rickards of Austrian economics fame.   He calls the low interest rate policy of the Fed a “tax on savers”:

“[Interest payments] would have gone into the pockets of savers so they could invest and spend – people rely on it for their retirements.  This is looting savers.”

But there’s a contradiction in his commentary.  Rickards has stated that the “Obama deficit” is making things worse.  In an article last year Rickards wrote:

“Citizens who insist that government stop talking about cuts and start the actual process of cutting spending now have got it right.”

The problem here, is that the Fed’s zero interest rate policy has substantially reduced government interest payments.  In other words, if the Fed raised rates on government debt you’d start earning a lot more on your savings because all those retirees who own US government bonds would instantly start getting a government subsidy via the interest payments.

Interest outlays are part of the annual budget deficit.  For instance, at present, the government pays about $225B a year in interest outlays.  That’s about 1.4% of total debt with the current interest rate structure.  Let’s say the government decided to raise interest rates structure to something equalling 4% of total GDP.  That means the government would be paying total interest outlays of about $600B a year.  That’s almost $400B+ more per year for savers to “invest and spend”.   That’s a lot of money.  And it’s a significant rise in the government’s budget deficit since the interest outlays are a cost to the US government.

So, Rickards is contradicting himself here.  He wants higher interest payments so savers stop getting “looted” and a lower government budget deficit at the same time!   So which is it?  If you want higher interest rates on government debt (which makes up a huge portion of private saving since most of the government’s debt is owned by retirees, pension funds, etc) then you’re implicitly in favor of more deficit spending.  You can’t have it both ways here Austerians….

The Inherent Fragility of the “Wealth Effect”

You probably thought the boom/bust cycle experiment that started with Alan Greenspan was over when Ben Bernanke came to the Fed.  Or maybe you weren’t that naive to begin with. Either way, Bernanke is implementing very similar and in my opinion, dangerous economic policy.

When Greenspan was head of the Fed, he made it well known that the stock market was a favorite target of his.  This became known as the “Greenspan Put”.  This was the levitating effect of stock prices that placed a “put” or floor under the equity market.  Greenspan was even more explicit a few weeks ago when he said:

“the stock market is the key player in the game of economic growth.”

I believe this is an incredibly misguided view of what the stock market is.  The stock market is a secondary market where SAVERS exchange shares of stock in what is nothing more than an allocation of their savings. The price of those shares reflect the GUESSES of future expected cash flows.  And as we all know, what you have in stock market gains is not real until you cash out of the game and exchange your shares with someone else.  Of course, everyone can’t cash out of the game at the same time since all shares issued are always held by SOMEONE.  So there’s an inevitable bagholder if the you-know-what hits the fan.  There is no escaping that simple fact.

The risk of course, is that a stock market has the inconvenient truth of both a “poverty effect” as well as a “wealth effect”.  Owners might feel better off if shares increase in value.  But owners feel just as poor when they decline.  Of course, if you can keep it going in one direction it’s like a good ponzi scheme.  But if the shares deviate from their underlying fundamentals and a disequilibrium occurs you’re asking for big time trouble from an inevitable “poverty effect”.  It ripples through the economy as stocks take the stairs up and the elevator down when panic sets in.  Anyone whose been awake during the last 15 years knows how that feels.

The danger here is the illusion of real wealth where there is only nominal wealth.  And that illusion appears to have at least some impact on spending.  As you can see in the following chart (figure 1 via Orcam Financial Group), the personal savings rate is inversely correlated to stock prices.  So, the increased wealth makes savers feel better off temporarily and then when the air comes out of the market those savers suddenly realize that their stock portfolio is just an allocation of their savings and they stop spending as the poverty effect kicks in.

There doesn’t appear to be any question that such a strategy can work in brief periods of time.  But the question is whether we should be designing policy around such an inherently fragile part of the economy (stock prices).  More importantly, we should ask ourselves whether a policy of targeting stock prices will create a disequilibrium where stock prices become detached from their fundamentals and create the illusion of a saver who is wealthier than he/she really is.

Me, I prefer to let prices float as they will and implement policy that actually helps the underlying corporations.  If I were running a public company I wouldn’t waste my time talking up my stock price.  I would run the corporation to maximmize earnings per share.  Global central banks obviously think this is nonsense.  And so the whole stock price targeting theory reeks of ponzi finance and putting the cart before the horse.  Of course, no one can know when the boom turns into the bust, but it appears as though this sort of policy substantially contributes to the bust when it does occur.   And that’s where we are.  We are in the boom phase.  The bust will come (just as it always does) and when it does we’ll likely all turn to the same institution who helped the boom get out of control in the first place.

(Figure 1 – Personal Savings Rate vs SP 500)

Understanding Moneyness

This section will be a new addition/clarification to my paper on Understanding the Modern Monetary System.  

Modern forms of money are largely endogenous (created within the private banking system), but are organized under the realm of government law.  The specific unit of account in any nation deems what money will be denominated as.  The government therefore decides the unit of account and can restrict/allow certain media of exchange.  The unit of account in the USA is the US Dollar.  Organizing money under the realm of law increases a particular form of money’s credibility in the process of transaction.  The government also helps oversee the viability of the payments system and can decide what can be used within that payment system as a means of settlement.  In the USA the primary means of settlement are bank deposits and bank reserves.  Therefore, these forms of money serve as the most widely accepted forms of payment within the money system.

There are different forms of money within any society and they have varying forms of importance and “moneyness”.  Moneyness can be thought of as a form of money’s utility in meeting the primary purpose of money which is as a medium of exchange or a means of final payment.

In the USA the money supply has been privatized and is dominated by private banks who issue money as debt (which creates bank deposits).  Banks are granted charters by the government in the USA to maintain the payments system in a market based system.  Banking is essentially a business that revolves around helping customers settle payments.  So it’s helpful to think of banks as being the institutions that run the payments system and distribute the money within which that system operates.  Outside money (or money issued OUTSIDE the private sector – notes, coins and reserves) plays an important role in helping facilitate the use of the payments system, but primarily plays a supporting role to inside money (money created INSIDE the private sector such as bank deposits) and not the lead role.

Outside money could theoretically serve as the most dominant form of money in the system (for instance, if the government did not choose to use bank money to spend, but instead chose to simply credit accounts by issuing money directly), but takes a back seat to inside money by virtue of design.  That is, outside money always facilitates the use of inside money by serving as a support feature for inside money.  Cash, for instance, allows an inside money account holder to draw down their account for convenience in exchange.  Bank reserves help stabilize the banking system to serve interbank payment settlement.  These are facilitating roles to inside money.  Therefore, we place inside money as having the highest level of moneyness in the monetary system.

Inside money and outside money, however, are not the only types of money that exist in the money system.  It is helpful to think of money as existing on a scale of moneyness where particular forms of money vary in degrees of utility (see figure 1).  As Hyman Minsky once stated, anyone can create money, the trouble is in getting others to accept it.  Getting others to accept money as a means of payment is the ultimate use of money.  And while many things can serve as money they do not all serve as a final means of payment.

Since currencies are fungible on a foreign exchange market most foreign currencies have a moderately high level of moneyness. For instance, a Euro is not good in most stores in the USA, but can be easily exchanged for US Dollars of various forms.  SDRs and gold, which are broadly viewed as universal mediums of exchange, can be viewed similarly though they vary in degrees of convenience for obvious reasons.  Gold for instance, is widely viewed as money and can be easily exchanged for money, but is not widely accepted as a means of final payment.

Most financial assets like stocks and bonds are “money like” instruments, but do not meet the demands of money users in terms of having high liquidity or acceptability as a means of final payment.  These financial assets are easily convertible into instruments with higher moneyness, but are not widely accepted as a final means of payment.  Therefore, their “moneyness” is relatively low.

Lastly, most commodities and goods are low on the scale of money since they are unlikely to be accepted by most economic agents as a means of final payment.

(Figure 1 – The Scale of Moneyness)

On CPI and Owners Equivalent Rent

I noticed this story on Owners Equivalent Rent on the Atlanta Fed’s blog today.  It discusses the rationale behind using what the Bureau of Labor Statistics calls “Owners Equivalent Rent” in their CPI calculation.   Specifically, they say:

“This begs the question: In light of the recent strength seen in the housing market—and notably the nearly 10 percent rise in home prices over the past 12 months—are housing costs likely to exert more upward pressure on the CPI?

Before we dive into this question, it’s important to understand that home prices do not directly enter into the computation of the CPI (or the personal consumption expenditures [PCE] price index, for that matter). This is because a home is an asset, and an increase in its value does not impose a “cost” on the homeowner.”

The BLS says housing is not consumption, but investment so they don’t include it in the CPI calculation.  They rationalize this thinking by stating not only that housing “does not impose a ‘cost’ on the homeowner”, but also that “House prices frequently appreciate; in this respect they differ from consumer durables such as vehicles.”  These two statements are highly misleading.  Let me elaborate.

First of all, most houses are definitely depreciating assets.  From the second you build a new home someone else is building the same home with more innovative and updated technologies.  The primary reason why homes don’t decline in value is because the land appreciates in value and the home is frequently updated (in addition to other reasons).  This is a real cost to the homeowner over the life of the house.

The other substantial cost in “owning” a home is the mortgage.  Most of us do not buy our homes outright and the mortgage imposes a massive cost on the homeowner.  The word mortgage is derived from the latin meaning “death contract”.  Not only is mortgage debt the largest portion of consumer debt (approximately 75% of all debt), but it also accounts for about 75% of the cost of the home over the life of a standard 30 year mortgage (ie, you will pay about 75% of the cost of the home in interest ALONE over a 30 year period).  In other words, a mortgage is a lot like consuming your home bit by bit.  Taken together, the mortgage and the upkeep of homeownership are substantial costs that most people simply don’t include in their total return calculations of real estate prices leading them to say silly things like “house prices frequently appreciate”.    But the BLS completely ignores this by using their Owners Equivalent Rent calculation.

This was clearly a problematic view during the last 10 years when the real cost of a home caused huge problems for the economy as mortgage resets were one clear cause of the balance sheet recession.  Had we been paying more closely to house prices we might have noticed a disequilibrium in the economy a bit sooner than we did.  But the Fed and the BLS were focused largely on OER and thus a benign looking CPI reading.  My adjusted housing price index is far from perfect, but were we using something like this in conjunction with the CPI I think we would have had a much clearer picture of the potential problems in the economy and the supply imbalances that were potentially creeping into the housing sector.  Instead, this flawed view of the consumers most important asset price helped lead us blindly right over a cliff.

(Chart via Orcam Financial Group)

Why Recession Forecasting Matters….Still

Last October I wrote an important Orcam Research piece that described why recession forecasting can make a big difference.  Not only are recessions important in understanding future policy (since high unemployment tends to result of recession, but from the perspective of portfolio management, recessions tend to be when the worse loss of capital occurs.

Now, if one is able to build a cyclical model that helps decipher when recession probabilities are high, you can protect your portfolio from the periods when the market is at the highest risk of resulting in a permanent loss environment.   Likewise, calling a recession when one is unlikely to occur, results in being out of the market during a strong likelihood of gains.  Obviously, anyone who has been out of the market over the last few years has suffered from this.

Anyhow, it was nice Bill McBride at Calculated Risk elaborating on this point in a weekend post.  Like me, he was not calling for a recession in 2011 or 2012.  I call this “getting the direction of the tide right”.  In the macro world, if you get the direction of the tide right you’re very likely to look like a pretty good swimmer.

Anyhow, here’s more from Bill (via Calculated Risk):

“Imagine if we could call recessions in real time, and if we could predict recoveries in advance. The following table shows the performance of a buy-and-hold strategy (with dividend reinvestment), compared to a strategy of market timing based on 1) selling when a recession starts, and 2) buying 6 months before a recession ends.

For the buy and sell prices, I averaged the S&P 500 closing price for the entire month (no cherry picking price – just cherry picking the timing with 20/20 hindsight).

The “recession timing” column gives the annualized return for each of the starting dates. Timing the recession correctly always outperforms buy-and-hold. The last four columns show the performance if the investor is two months early (both in and out), one month early, one month late, and two months late. The investor doesn’t have to be perfect!”


Lessons From a(nother) Fund Collapse

I saw this story over at Josh Brown’s site about an “apple only hedge fund” that has apparently imploded.  These sorts of stories are nothing new, but it does get frustrating to see how people keep falling for these sorts of investment schemes.  And yes, they are schemes because they can’t deliver what they promise.  This doesn’t mean the fund manager is always a bad person or that they have malicious intent, but it often means they don’t have a sound understanding of portfolio construction or they don’t fully understand the role that savings/investment plays in your life.

I try to teach people who work with me through Orcam that their savings is not a replacement for their primary income source.  In other words, the savings you generate from your primary source of income is a repository.  You can gamble with it.  You can blow it all on booze and women/men if you want.  But like most of us, you need to protect it.  But too many people reach.  They get greedy with these funds.  Or they fall for the usual Wall Street sales pitch that they can/should beat Warren Buffett.  You know, if you don’t “beat the market” you’re a loser.  The truth is, most of us don’t need to “beat the market”.  We need to max out our primary income source and protect the savings repository in a manner that achieves one thing:

  • We need to allocate our savings in a manner that protects us from the loss of purchasing power and the risk of permanent loss in a manner that is consistent with positive risk-adjusted returns.
I’ve discussed this in more detail in an Orcam research piece titled “The ‘Investment’ Myth”.   When you start reaching out on the risk curve with your savings in a scheme that isn’t truly “investing”, but is actually an allocation of savings, you become susceptible to putting too much of your savings at risk in the type of allocation that could cause severe personal hardship.  And most of us don’t realize that this “investment” is actually your life’s savings until too much of it is gone.

There’s a place for true “investment” in all of our lives.  Most of us only truly invest in ourselves and don’t actually invest in anything else (except maybe your kids or the people you love).  But understanding proper portfolio construction is all about understanding the difference between savings/investment and designing portfolios that don’t put you in front of the permanent loss steam roller….