Tuesday, February 03, 2015

My Mini Me, Your Mini Me

Things are complicated. I know that, but you don't have to play. The Swiss 10-Year Bond yield is now negative. That may sound complicated and there are lots of things that happen around that, but it can be simple. If you buy this bond, what you are doing is lending the Swiss Government money for 10 years. Lending is however an odd word since you will be paying for the pleasure. How much people will buy this 'loan' from you for may vary during the 10 years, but if you just hold it (and ignore inflation), you know what your, sorry I mean the borrowers, return will be. I have always struggled with bonds (as in why to buy them) and so do not claim to be an expert in any way. Many of the bond experts I know don't actually invest their own money in bonds. They improve the returns for other investors who have already chosen to invest in bonds. That is a valuable service, but not encouraging for people looking for something to invest in.

Source: The Washington Post & Bloomberg

I wrote about how money isn't actually a thing. The rich don't have 'hoards' of wealth. Money basically serves as a paper trail for ownership and a signal of potential spending power. Stuff happens, money just indicates who it is happening for and helps it happen. I like to think of money as an employee... or a Mini Me. Unless you are born to wealth, you are the primary employee to start in Me Inc. If you put your money in cash, you are allowing your Mini Me to work for someone else. Since so many people put their money in cash, there is no need to pay you very much, if anything at all. This is why Banks don't pay very much return on money market accounts. Supply is not limited. Putting you money in cash is like letting your Mini Me have a sleep at the bank until you need them. The Bank then lends out your Mini Mes (keeping a few in case people need them), but charges a more reasonable rate and asks some questions of the borrowers. It doesn't just lend indiscriminately. That is why people and businesses have to make a case to borrow. The bank wants to know that the money is going to be used productively and is likely to be paid back.

If you 'invest' in a bond, you are lending money. The bond just allows you to sell the loan to someone else. This means you are the one lending the Mini Me rather than the bank. The yield is the salary your Mini Me is paid. Or in the case of Switzerland, the salary you pay for your Mini Me to work. In all cases the value of whatever work the Mini Me does goes to the borrower. A Government will spend your money and if they are good, invest in infrastructure and services that improve the quality of life for citizens. They will pay you back through taxes, future borrowing, or printing more money. Unlike governments (and lay people), a business shouldn't borrow just to spend. A rational business owner will only borrow the Mini Me if they believe that he will make more than the salary required. That is where the wealth will go.

If instead of letting your Mini Me sleepover at the bank, or go work for the Government, you get it to work for you, you get to keep whatever is made. If you don't use it, Mini Me grows bigger. If you are both feeding him aggressively and he is doing stuff that lets him feed himself, he grows faster and faster. Eventually Mini Me becomes Min Me, then Mi Me, then mMe and finally Me. At that point, if you don't change your required standard of living, you can go do something else. You won't work for money, your money will work for you.

I do believe the markets are pretty efficient. What I think that means is that they are good at balancing supply and demand and moving assets around to where they are productive. The problem is that who gets the benefit of the productivity depends on who decides to let their Mini Me sleep, work for someone else or work for them. Some people will gladly pay you nothing or let you pay them to let your Mini Me work for them. My issue with the idea of the Efficient Market is that people think cash and bonds are risk free assets. We are taught that equities are risky assets. How many times have you been told that you should slowly shift assets to hold more bonds as you get older to reduce risk. Risk is much more complicated than that. Very important to know though is that it is wrong to think that you get paid to take risk and can naively take risk off the table. At the moment, cash and bonds are return free risk. The only thing you know is that your Mini Me will be waiting for you when you decide to use him.

I will keep My Mini Me to myself thank you very much. And I will make sure he is doing something productive.

*I will make former colleagues in compliance proud by putting a disclaimer. This is not advice and I take no responsibility for you acting on it. This is the way I think. We are all responsible for our own decisions. The one thing you can't choose is to take no risk. You can choose to try and understand the risks you take. Good luck. Have you hugged your compliance officer today?
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