economics of investing

Make a spreadsheet like the one below for each stage of life

Young free adults (22-30)-young married (30-45), rethinking the meaning of life (ages 40-55), the capital accumulation year and thinking about retirement (ages 55-65), the grandkids and glory years (ages 65-75),

and fill in at least 15 transaction demand items, three precautionary items, and three speculative investments you would have at that stage of life.

Once, you have completed that exercise fill in the current stage of your life cycle with the following. Do not send me the income column, realistically estimate the income needed to fulfill each type of demand. Add your sources of income and see if you cover everything you need to cover.

Economics of Investing
Modern Lectures
Copyright 2003
1
Economics of Investing
Table of Contents
A. Factors of Investing and Kinds of Money
1. Stages of Life and Types of Money
1.1 Stages of the Life Cycle
1.2 John Maynard Keynes and the demand for money
1.3 Stages of Life Cycle and Types of Money Demand Combined
1.4 Characteristics of Investments
1.5 Exercise #1
2. The Hill Investment Cube
2.1 The Hill Investment Cube
2.2 How do you determine your preference for risk?
2.3 Yield
2.4 Exercise #2
B. Economic Concepts that Influence Investment Decisions
3. Supply and Demand
3.1 Demand
3.2 Supply
3.3 Combining Supply and Demand
4. Business Cycle
4.1 Business Cycle without Government
4.2 The Business Cycle with Government
4.3 Determining where in the business cycle the economy is currently and
what investment guidelines to use is an important step in deciding what
investments to choose
4.4 The best Investments to make during each Stage of the Business Cycle
4.5 Exercise #3
5. Leading Indicators and other Economics Variables to determine the stage
of the business cycle.
C. Investment Instruments
6. Basics of Stocks
6.1 Types of Business, Terms, and Related Issues
6.2 Common Stocks and Profits
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6.3 Let’s discuss some stock terms
6.4 Growth, Growth and Income, and Income companies
6.5 DRIPS, Splits, and Mergers
6.6 Compounding Interest from Bonds or Dividends from Stocks can be a
very Effective Investment Strategy
6.7 Stock Index’s give an Investor an idea of where the market is headed.
7. Bonds, Mutual Funds, Commodities, and Other Investments
7.1 Definition, Facts, and Bond ratings
7.2 Types of Bonds
7.3 Mutual Funds
7.4 Commodities
7.5 Options
D. The Road Map to Investing
8. Steps along the Route to a Successful Investment Plan
8.1 Step #1: The Plan: Determine the type of money, Risk, Liquidity, and
potential yield
8.2 Step #2: Determine the Stage of the Business Cycle and Potential
Investment Instrument.
8.3 Step #3: Determine the Potential Specific Investments Using Stock
Screeners
8.4 Choosing the best investment for your requirements
8.5 Summary of choosing the Investment that suits your needs.
8.6 Exercise #4
E. Protecting your Money
9. Starting your own Business
9.1 Summary of Steps
9.2 The Steps
10. Life Skills: Money and Safety Protection Tips
10.1 What and Where to Carry your valuables when you are Out and About.
10.2 Credit Card and ATM Safety Tips
10.3 Protect your money on vacation tips and in crowded places
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Preface: Organization of Seminar
This seminar is organized in five sections. The first section covers the
concept of determining what kinds of money you possess and the factors that
are important in determining investments for each type of money. The
second section looks at the economic factors you must consider when in
making those investment decisions. The third section looks at the investment
instruments you can choose to invest in. The forth section provides a “blue
print” or “road map” of steps you need to take in determining the investment
that best fits your needs. The last section reviews practical tips on how to
protect your money against identity theft and while you are out and about.
A. Factors of Investing and Kinds of Money
1. Stages of Life an Types of Money
Economics has had increased visibility since the Great Recession started
in 2008. People get nervous when the stock market is volatile (many stocks
fell 40% from October, 2008 to March, 2009), bonds were no bargain
(government bond mutual funds average return drops to 1%) , banks fail,
houses are foreclosed, bailouts and stimulus packages are at the top of the
news.
This author can not count the number of times he has been asked in the
last few years where the economy is going and where should invest my
money?
My answer is always the same. I can not advise you where to put your
money specifically but I can give you some economic theory and tips that
will allow you to determine your own investments. In other works, I am in
the business of education and not as financial advisor. I can help you
determine rules, understand the economic sea that surrounds you but I can
not specially say: “Invest in this or that”.
You may want reply: “What good is that to me?” The answer is easy:
“IT’S YOUR MONEY STUPID!” It does you absolutely no good for the
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author to try to determine the unique mix of investments that are going to fit
you, since you are an every evolving person. A set of investments that fits
you today, may not work for you tomorrow. Unless you understand your
own investment strategy and are able to explain it simply, it is not a good
strategy. No one else can do that.
The basic rule of investing is: “It is your money Stupid!” It is a very
simple rule. It means the unless you can expand your investment to a eight
year old and have the child explain it back to you so it makes sense, then you
do not do it. Paul Samuelson, the great Nobel Laureate Economist,
substituted his wife for the eight year old child, but that’s a little
discriminatory. What he really meant though was that you had to understand
the decision so well that you could easily and simply explain it to someone
who had no understanding of the subject and have them understand it.
1.1 Stages of the Life Cycle
You will change stages of life as you get older and your needs will change as
well. You investment strategies will have to adapt to those changes. The economic
activity will change and you will have to adapt to that as well. The one thing that
should stay constant is your understanding of the factors that influence those
decisions and the unique simple strategy you are applying to those changes.
This book is aimed providing the basic economic tools you can use to navigate
the waters of life with sound investment choices.
Let us start our journey to establishing you investment strategy by realizing
that life takes us through many stages and our strategy must be adapted to those
stages.
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Determining what you invest in generally depends on your position in the
Human Life Cycle. The young college graduate faces many different life cycle
constraints and opportunities than the Senior citizen. As a young Married couple
your alternatives are significantly different than a middle aged adult. By the time
you are 45 you are being to feel your own mortality and your perspective on life
changes as does your investment constraints and alternatives. By the time you are
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Stages of Life
Young Free Adult Stage (22-30)
The dates may very here but concept is the same. This is the stage where you have few responsibilities to anyone but
yourself. You may not think it or was easy but life is free and easy in this stage. You can good bum around Europe or start a
business.
The Young Married (30-45)
Times change and so do you. In this stage you are worried about medical care for you children, vacations, education for your
family, advanced education for yourself. You can’t live in a tent on $10 a week anymore.
Rethinking the Meaning of Life (45 to 55)
Don’t worry, everybody does it. This is the stage of life where you, your partner, and or kids are getting older. If you are
single you do not escape this stage either, a lot of water has crossed the dam. There are a lot of divorces that occur in this
stage as a person looks realistically at their own mortally and asks themselves if they are happy pursuing the same life path
for the rest of their life. Changing careers and starting business occur in this stage.
Capital Accumulation Years and thinking about retirement (56-65)
The thought of retirement becomes real during this stage. You begin to look at the future as tomorrow not next week. You are
at the height of your career and productivity. The kids are gone or going very soon and you worry the government pension
will not be there.
Grand Kids and the Glory Years (66-75)
Now you are retired and you again have the freedom of determining your own course in life. Many times that includes
vacationing, grand kid’s educations, and making sure that your investments will cover future medical costs.
Winter of your life: failing health and limited mobility (Greater that 75)
Here is where you start thinking that 75 year old is not old anymore. Sooner or later though you know your health will begin to
dominate your decisions.
you are now looking at retirement as a necessity and accumulating wealth. Finally,
you get to the glory years or retirement and grandchildren. Sadly, during the next
stage is the last stage security and medical care become your most important
concern.
As you can see from the Life cycle slide the characteristics of your life style
change significantly depending on the stage you are located. None of us experience
each stage the same way another person does, and the length and time each stage
occurs can vary. The bottom line though is that we all good through these stages.
1.2 John Maynard Keynes and the demand for money
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In the 1936 the Father of Modern Day Economics, John Maynard Keynes,
published his great work The General Theory of Employment, Interest, and Money.
In that book he theorizes that people demand money for three reasons.
Transactions Demand
The first reason or type of money demand Keynes hypothesized was called
Transactions Demand. This is your every day needs demand. Transactions demand
is generally short run demand for money to support your current life style. Food,
Transportation expenses, housing expenses, etc. are good examples of this type of
demand.
It is important to note that everyone has a different view of what their
current needs for their life style are. Some would consider saving for a child’s
education are current life style needs, while others would not consider that
important. It is important that you sit down and list those things that are needed for
your current Transactions demand before you ever start your investment planning.
Precautionary Demand
Lord Keynes considered Precautionary Demand the second type of Demand
for Money. He noted that everyone had emergencies come along and needed
money to take care of those emergencies.
“Economists use to consider six months of net pay as the minimum necessary
amount of Precautionary money that you should have on hand. But in current
economic conditions that should be extended to 18 months.
This type of demand for money includes: paying doctor bills, being laid off or fired
contingency money, and a host of other emergency money.
Speculative Demand for Money
Keynes noted that many people amass enough money to sustain their life
style and precautionary needs. You then consider investments that will reap large
returns and of course they assume more risk of losing the money.
If you lose
the money it will not affect their life style. This is called the Speculative Demand
for Money. Going to the Gaming boats, Las Vegas gambling, Stocks, bonds, Puts
and Calls, Commodities, Mutual funds, and all sorts of other investment
alternatives can be considered speculative money.
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John Maynard Keynes and the demand for money
In the 1936 the Father of Modern Day Economics, John Maynard Keynes, published his great work The General Theory of
Employment, Interest, and Money.
In that book he theorizes that people demand money for three reasons.
Transactions Demand
The first reason or type of money demand Keynes hypothesized was called Transactions Demand. This is
your every day needs demand. Transactions demand is generally short run demand for money to support your
current life style. Food, Transportation expenses, housing expenses, etc. are good examples of this type of
demand.
It is important to note that everyone has a different view of what their current needs for their life style are.
Some would consider saving for a child’s education are current life style needs, while others would not consider
that important. It is important that you sit down and list those things that are needed for your current Transactions
demand before you ever start your investment planning.
Precautionary Demand
Lord Keynes considered Precautionary Demand the second type of Demand for Money. He noted that
everyone had emergencies come along and needed money to take care of those emergencies.
“Economists use to consider six months of net pay as the minimum necessary amount of Precautionary
money that you should have on hand. But in current economic conditions that should be extended to 18 months.
This type of demand for money includes: paying doctor bills, being laid off or fired contingency money, and a
host of other emergency money.
Speculative Demand for Money
Keynes noted that many people amass enough money to sustain their life style and precautionary needs.
You then consider investments that will reap large returns and of course they assume more risk of losing the
money. If you lose the money it will not affect their life style. This is called the Speculative Demand for Money.
Going to the Gaming boats, Las Vegas gambling, Stocks, bonds, Puts and Calls, Commodities, Mutual funds, and
all sorts of other investment alternatives can be considered speculative money.
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1.3 Stages of Life Cycle and Types of Money Demand
Combined
The Young Adult and the Demand for Money
The young adult 22 to 30 years of age Transactions requirements are
generally high. Significant transactions demands for the Young adult include: Party
time needs, food, rent money, car payments, and the Tuition loan repayment bills,
among other things.
It is generally hard for the young adult to accumulate the 6 months
precautionary reserve needed for emergencies like these.
Speculative money is usually not available at this age. If it were Common
Stock, Savings accounts, and CD’s would be good investments.
Young Free Adult (22-30)
Transactions Demand:
Tuition and
College Loans
Car Payment
Apartment Rent
Food, Beverage, and
Entertainment
Precautionary Demand:
Living Expenses for
Unemployed periods
Retirement Accounts
Car Insurance
Dentist Bills
Traffic School Costs
Speculative Demand
Common Stock
Savings Accounts
Certificate of Deposits
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The Young Married and the Demand for Money
The young Married 30 to 45 years of age Transactions requirements are
generally high.
They include: Children needs, food, house payment, car payments, and the
Tuition loan repayment bills, among other things.
It’s generally still hard for the young married to accumulate the 6 months
precautionary reserve needed for emergencies like these.
Some speculative money is available during this time, but it is very limited.
Young Married (30- 45)
Transactions Demand:
Children’s needs
Food
Tuition and
College Loans
Car Payment
Mortgage and Home
Improvement Loans
Future
College Expenses
Precautionary Demand:
Living Expenses for
Unemployed
periods
Retirement
Accounts
Car Insurance
Dentist
Bills
Home
Insurance
Speculative Demand
Common Stock
Savings Accounts
Mutual Funds
Certificate of Deposits
Savings Bonds
Rethinking the Meaning of Life Stage and the Demand for Money
Rethinking the meaning of life transactions demands can be extensive. In
addition to the normal demands your children have grown to the point where there
are no cheap things for them to buy.
Precautionary demand continues to be a burden in this stage.
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In this stage the person is now has enough discretionary income for
speculative demand investments.
Rethinking the Meaning of Life
( Ages 45-55)
Transactions Demand:
X
Marriage
Certificate
Food
Children’s
Vacations
Children’s
Needs,
including
future college
expenses
Tuition
Precautionary Demand:
Living Expenses
for Unemployed
periods
Retirement
Accounts
Car Insurance
Car Payment
Dentist
Bills
House
Payment
Divorce
(Optional)
Addiction
(Optional)
Home
Insurance
Speculative Demand
Common Stock
Savings Accounts
Savings Bonds
Mutual Funds
Certificate of Deposits
Commodities
Real Estate
Capital Accumulation Years and thinking about retirement Stage and the
Demand for Money
The Capital Accumulation 55 to 65 years of age Transactions requirements
are finally getting less. They include: food, vacations, car payments, but the house
is paid for and the children are starting on their own.
It’s generally easier to accumulate the 6 months precautionary reserve
needed for emergencies like these.
Some speculative money is available during this time.
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The Capital Accumulation Years and
Thinking about Retirement ( Ages 55 – 65)
Transactions Demand:
Food
Vacations
Florida Condo
Payment
Children’s
College
Expenses
Car Payment
Precautionary Demand:
Living Expenses for
Unemployed periods
Retirement Accounts
Car Insurance
Dentist Bills
Home Insurance
Speculative Demand
Common Stock
Savings Accounts
Savings Bonds
Mutual Funds
Certificate of Deposits
Other
Real Estate
Commodities
Grand Kids and the Glory Years Stage and the Demand for Money
The Grandkids and Glory 65 to 75 years of age Transactions requirements
are finally getting less. They include: food, vacations, car payments (depending on
income level), Grand children needs, but the house is paid for and the children are
on their own.
It’s generally easier to accumulate the 6 months precautionary reserve
needed for emergencies like these.
Speculative money is available during this time.
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The Grandkids and Glory Years (Ages 65 -75)
Transactions Demand:
Food
Car Payment
Vacations
Grand Children’s needs
Retirement Accounts
Precautionary Demand:
Living Expenses for
Unemployed periods
Car Insurance
Dentist Bills
Home Insurance
Other
Speculative Demand
Common Stock
Savings Accounts
Certificate of Deposits
Mutual Funds
Commodities
Real Estate
Savings
Bonds
Winter of your life: Failing health and limited Mobility Stage and the Demand
for Money
The Winter of your life Transactions requirements are getting less and less.
They include: food, health care, bus and rail transportation, nursing home care, etc.
Grand children needs, but the house is paid for and the children are on their
own.
It’s generally easier to accumulate the 6 months precautionary reserve
needed for emergencies like these.
Speculative money is available during this time.
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The Winter of your life (Greater than 75)
Transactions Demand:
Food
Vacations
Health Care
Grand Children’s needs
Retirement Accounts
Precautionary Demand:
Other
Health Insurance
Speculative Demand
Common Stock
Savings Accounts
Certificate of Deposits
Mutual Funds
Commodities
Real Estate
Savings
Bonds
1.4 Characteristics of Investments
When one invests he or she must consider three factors. Risk is defined as
the chance of loss. Every investment has risk and spreading that risk among
investments is a very important consideration. Another factor is liquidity. Liquidity
is defined as how quickly do you want to get your money changed in a spendable
form. The last characteristic is yield. This is the profit divided by the cost. It is also
called rate of return.
1.5 Exercise Number One
Make a spreadsheet like the one below for each stage of life and fill in a
least 15 transactions demand items, three precautionary items, and three
speculative investments you would have at that stage of life.
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Transactions Demand
Precautionary Demand
Speculative Demand
Number Item
Risk Liquidity Yield Item
Risk Liquidity Yield Item
1 Food
low daily
low Car insurance
low 6 months low Buy stock A
2 Gas for car
low 3 days
low
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Risk Liquidity Yield
high 1 year
high
Once, you have completed that exercise fill in the current stage of your life
cycle with the following. Do not send me the income column, realistically estimate
the income needed to fulfill each type of demand. Add your sources of income and
see if you cover everything you need to cover.
Transactions Demand
Precautionary Demand
Speculative Demand
Number Item
Risk Liquidity Yield Income Cost Item
Risk Liquidity Yield Income Cost Item
1 Food
low daily
low
Car insurance
low 6 months low
Buy stock A
2 Gas for car
low 3 days low
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Risk Liquidity Yield Income Cost
high 1 year high
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2.0 The Hill Investment Cube
We have seen Maynard Keynes the great economist of your time defined the
demand for money as having three components: Transactions demand,
Precautionary demand and Speculative demand. It has also been noted that there
are essentially three components of any investment: Risk, Liquidity, and yield.
Dr. Hill came along in the 80’s and combined these concepts into the Hill
investment cube. Basically the cube theory considers that each type of demand
carries a unique set of investment criteria.
For example, Transaction demand items by definition must generally carry
low risk, must be liquid, and as a result this money provides little yield. Rent for
housing is a transaction demand that has to be paid at the end of every month. So if
a person gets paid every two weeks then they will have to save money for this item
till the end of the month.” If they lose the money before the end of the month they
will become homeless. So it makes sense that the money must be kept in a low risk
place where it can be gotten immediately. Because the market pays higher for
longer terms of money use this requirement for quick access to the rent money will
result in a yield will be low.
Precautionary demand requires low to moderate risk, liquidity is a little
higher since the money is needed over a six month period and Yield is slightly
higher as result. Your car insurance is generally paid semi-annually, so it requires
less liquidity. Thus the yield will be higher.
Speculative demand is money that I can afford to lose so you can take higher
risk on this money. Liquidity on this type of money can be variable, so Yield must
be higher. Buying 100 shares of GE stock is an example of this type of decision.
2.1 The Hill Investment Cube
This concept can be shown pictorially in the Hill Investment Cube.
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The Hill Investment Cube
d
nd
an
ma
e
m
e
D
sD
ry
ion
a
t
c
ion
sa
ut
an
a
r
c
T
re
Risk
Low
Liquidity
High
Yield
Low
d
an
m
De
e
v
i
lat
cu
P
e
Sp
Low/Moderate
High
Moderate
Varies
Low/Moderate
High
When you consider each type of demand and the investment characteristics
for that type of demand there are only certain investment instruments that meet the
criteria for each type of demand. For example, saving and checking accounts
(Money Markets) are the only instruments besides cash that satisfy most
transactions demands. Money for food and rent which require low risk, high
liquidity, and result in low yield has to go into my checking or savings account.
These are general rule, of course, and a person can experience exceptions the
transactions demand having low risk, high liquidity, and low yield. Savings for my
kid’s college education could be an exception case.
Some persons consider their children’s education a requirement or transactions
demand that would hurt their life style if I did not provide for them. That is why
you consider each item very carefully and determine the type of demand it is and
then you must consider the characteristics required for that item. Generally,
transactions demand has low risk, etc. but a specific item may have different
characteristics. If you consider you’re children’s education fund a transactions
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demand the risk would change to low or moderate, liquidity would be low since
you need the money 18 years from birth, and thus the yield would be moderate.
Transactions demand and Investment Choices using the Hill Investment Cube
sac
n
a
Tr
Risk
Liquidity
Yield
Low
nd
ma
e
D
ns
tio
Savings Account
Money Market
High
Low
In the case of Precautionary money: saving accounts and Money market or
checking accounts, short term Certificates of deposit, low to moderate risk bonds,
or bond funds will satisfy the low risk, high liquidity, and low yield requirements.
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Precautionary Demand and the choices using the Hill Investment Cube
Pr
Risk
Low/
Moderate
Liquidity
Moderate
Low/
Yield
Moderate
nd
ma
e
D
ry
a
on
uti
a
c
e
Checking Accounts
Savings Accounts
Short term CD
Low Risk Bond
or Bond Fund
In the case of Precautionary
money: saving accounts and
Money market or checking
accounts, short term Certificates
of deposit, low to moderate risk
bonds, or bond funds will satisfy
the low risk, high liquidity, and low
yield requirements.
In the case of Speculative money: Growth stocks, Real Estate, Puts and
Calls, Commodities, Gambling and a host of other investments will satisfy the high
risk, varying liquidity, and high yield requirements. This is the really exacting type
of demand. You get the challenge of taking risk and making it yield high returns.
There are many theories of investment that try to achieve maximum yield and
minimum risk. It is a real challenge.
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Speculative Demand for Money and the choices using the Hill Investment Cube
nd
ma
e
eD
tiv
a
l
ecu
Sp
Risk
Liquidity
Yield
Low
Growth Stocks
Real Estate
Gambling
High
Low
The following list of items is a practical application of the above concepts.
This list is a “cheat sheet” for the Hill Investment cube.
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