Blog. LogicOfFinance.com: Saving and Investing Puzzles

Haven?t you heard that saving and investing are immensely important from your banker, financial advisor and financial regulator during the past couple of years, even this many times that you don?t remember how many? Perhaps you have learned it in a hard way while having lost your job and home and everything because of not having had savings during the current crisis.

Your advisors may be right but... Saving your savings turns out to be a real challenge in the current times of uncertainty. Furthermore, individual investors ? at least those who do not belong to the privileged group of the so-called High Net Worth Individuals (HNWIs) ? face an even bigger puzzle.

The puzzle of macro & markets

We are being bombarded with contradictory data and information about macro & markets from so many different sources. The summary below is by far not a comprehensive overview, but just to give you an idea.

* Growth of global economy has been sluggish at best, unemployment remains high, outlooks are bleak, various confidence indices are flat or trending downwards etc. ? yet many stock markets have picked up rather nicely after the major slump in 2008/2009.

* Different smart people are reading out different things from the very same data: some are arguing for the deflation in the coming few years (good for savers, bad for borrowers) while the others are warning for inflation (bad for savers, good for borrowers at least when having fixed their interest expenses).

* Indeed, even gold price and bond yields are telling different story about the inflation expectations.

* Central banks are being reported as ?printing money? but... the broad money supply and lending have not increased much.

* Some are saying that policy makers are moving in the right direction (bad for the values of the perceived ?safe haven? assets) while the others claim that they have no idea whatsoever for bringing economy back to track (good for the ?safe haven? assets).

Welcome to the World of Finance where things far too often do not make sense to common sense!

The good news is that all these contradictions can be explained with the (even though seemingly illogical) logic of finance when looking closely enough and not forgetting the very nature of humans.

The bad news is that explanations can only be provided when looking backwards; I do not know any single person or organisation that can reliably predict the future and is actually capable to look into everything. Indeed, IMF has failed severely with this task in the past; central banks have lost control over the money supply; economic forecasting models which have served us this long, are now broke.

I?m not even going to describe here how single persons like you and me, as well as masses can be manipulated by providing them just tiny fragments of the whole story (maybe I?ll do it in some of my later blog posts...). That?s easy because most of the people have a ?pike?s memory? and almost zero attention when it comes to the ?boring stuff? such as finance. [The word ?boring? is in quotation marks because things become interesting as soon as one realises how masses could be manipulated in one?s benefit just by making things look boring.]

Definitions: savers, investors and gamblers

Before discussing the puzzles for savers and investors, we should be clear in definitions. One of my professional contacts, Ken Faulkenberry who has been in the investment arena for more than 25 years, has proven to be a great help at this. I use his definitions published in the blog of Arbor Asset Allocation Model Portfolio.

Saving is income that is not spent or put at risk. In other words, saving involves money put aside for the future with capital preservation as the primary goal. Items/events you might be saving for include: emergencies, a car, or an event such as a luxury vacation or wedding.

Investing is having a claim on an entity that produces a product or service with the goal of profit and the risk of loss. It is different from saving because now your money is at risk (based on your own approval and understanding). Examples of investing include:

* Individual stocks, bonds, most mutual funds, most ETFs, etc.

* Real estate used as rental property or for production of goods and services as well as buildings such as factories, office space, retail space, etc.

No matter the specific asset, investing involves the possibility of profits as well as losses based on performance of the underlying assets.

Gambling is accepting risk based on chance. Almost all gambling involves risk that exceeds the expected reward. In other words, gambling usually involves dividing up a fixed pie among winners and losers based on chance. Examples of gambling include: currency trading of futures and options (except hedging), commodity futures and options trading (except hedging), all lotteries.

Puzzle for savers

?Save or not to save?? (I?m paraphrasing Hamlet: ?To be or not to be??) This is the most fundamental question given the inflation outlooks.

If the answer is ?yes? then in what currency should your assets be denominated: EUR, USD, JPY, GBP, AUD, CHF, SEK, NOK, CNY or any other currency? The old sage is that all of your assets and liabilities should be in the same currency, but what about your prospects to travel if your government is wrong and your central bankers are wrong about the inflation outlooks (which they most probably are because of their very own interests)? Should you become an investor or a gambler instead of being a saver, or perhaps simply enjoy the present day by spending more now?

Puzzle for investors

Investing appears to have certain definite advantages over saving, no matter the inflation outlooks. Companies can price their products and services accordingly, incomes of employees and/or number of employees can be raised and reduced accordingly (even if layoffs and deleveraging are always accompanied by challenges) and so one.

Yet appreciation and depreciation of asset values critically depend on government interventions and misleading policies...

Furthermore, plentiful complicated investment and trading strategies make things even more difficult: global macro, event-driven, directional, relative value, long/short equity and so one and so forth. Several of these strategies involve at least certain degree of leverage and/or gambling, after all (even if not being presented in this way)...

The most common investment advice still goes: ?Buy, hold and pray.? The most common mutual fund strategy still is: ?Set and forget.? By setting the limits to the mutual funds, advertising of hedge funds, qualifications of (self-made) financial advisors etc, regulators are trying to save you from the various investment frauds. By doing that, they are also ?saving? you from hedging your potential losses, let alone above average returns. In this light, it is insane that at the same time you not only can but also are encouraged to take enormous risks via the various online trading platforms.

Gambler against your will

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Many even in the financial industry may not recognise it, but most of us are, in one or another way, involved in the ?money game? which is a gamble or a ?hot potato game? if you wish. In this game, one needs to:

* Buy risky assets when these are available at discount;

* Benefit from them as long as possible;

* Sell them off just before the others start worrying about the discrepancies between the fair values and asset prices.

This gamble comes down to the (im)balances between the assets and liabilities of the many economic subjects, and how these imbalances are being perceived and distributed. No matter if saving or investing, it?s all about making right bets about the uncertain future (unless trading on insider information or otherwise having the power to manipulate the markets).?

No one is consistently precise in forecasting market turnarounds, but major discrepancies in asset valuations should still be possible to figure out and utilise for the benefit of a careful (individual) investor...

Source: http://blog.logicoffinance.com/2012/11/saving-and-investing-puzzles.html

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