The 6th October will see
- The end of our investment quarter, followed swiftly by our investment review blog.
- It also sees the 9th anniversary of me taking personal control of our investment returns.
- The 4th anniversary of our discretionary permissions and
- The 2nd anniversary of our AIM Portfolio.
There is much to say about all of those anniversaries in the coming weeks, but before I do….
Ever wondered how we make money?
At a base level it’s very simple to understand because we have only a couple of options.
- We can employ the money we have, or
- We can buy things in exchange for our money.
However before we start let’s also understand that on occasion we could decide not to even try to make money; we could do nothing. We can deposit our money in a bank, any bank. They will take it and give us a laughable amount of interest in return. That will not make us money but it will preserve what we have in the short term.
You have probably noticed that I have taken that choice for us recently. We are very cash heavy across all of our model portfolios at the moment. With stock markets either at, or within spitting distance of their all time highs, a bit of time out seems sensible to me. In 2008 I did the same for 9 months and it proved to be an excellent choice. That said we are now ready to invest some of that excess cash. We are just waiting for an opportune time.
So back to trying to understand how we make money usually.
Employing the money that we have
We can earn interest by lending our money to others. We can lend it to individuals, to companies or to governments. A bit like a bank does with our money anyway, but this way we get to keep all the profit.
Lending to Individuals
Known as peer to peer lending. It’s a new market and much of it is transacted on-line. Its not regulated well yet so it’s a bit like the Wild West. We don’t lend there.
Lending to Companies
Known as buying Corporate Bonds. Companies need to borrow for a variety of reasons. Usually to fund expansion. Companies vary in their ability to repay their debts and their ability not to go bust. The highest risk lending pays the highest interest returns. The highest risk are known as junk bonds. Although that should put many investors off, because junk bonds are bundled up with other better quality bonds, many investors un-wittingly own them. We currently don’t lend any companies our money, but we have done so in the past and probably will do again in the future.
Lending to Governments
Known by them as “investing in our gilt-edged securities”. What a positive spin they put on borrowing our money. No! Investors lend incompetent governments our hard earned cash. It is the safest form of lending as Governments usually repay their debts at the end of the term. How? They just borrow off Peter to pay Paul. We can’t see the point of lending to them currently, given the possible maximum future profit we can earn will probably be less than future inflation. The interest they offer is pitiful and in some cases negative!
Exchanging our money to buy things
Things like company shares
Here we make money if the shares we buy today become more attractive to other investors in the future. They may be prepared to pay more for those shares than we did. When we buy a share of a company, we own a tiny percentage of that company’s future profits. If it’s future looks bright the price goes up because many others will want to buy our shares off us, if not, the price goes down.
Many companies distribute a little of their profits each year. These are dividends which help us to make ends meet without having to sell our shares until we are ready.
Things other people can use
We can buy all sorts. Property is the obvious one to buy because other people, businesses, local authorities and even governments will pay us rent to be able to occupy our buildings. We can earn rent on cars, wind-farms, health-centres, hospitals, ports, motorways, bridges. The list is endless. When we own these things, as long as other people need to use them then they will pay for the privilege.
Ever wondered why we didn’t make money for years?
Well between us the investor and our selected investments, we placed a middleman, usually an insurance company with expensive products and opaque funds. The funds invested in exactly the same assets described above, but they charged us mightily for providing the structure. Together we don’t need middlemen anymore, because we can own our investments directly.