Tuesday

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 9 The Real Economy in the Long Run
Chapter 27 of 36 Basic Tools of Finance
Section 2 of 16
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Almost everyone eventually deals with the economy's financial system, including:
· deposits in bank accounts
· take out a mortgage to buy a house
· invest in stocks, bonds, and funds for retirement account
There are two related elements in almost all financial decisions: time and risk.
The financial system coordinates the economy's saving and investment which are main determinants of economic growth.
The financial system involves decisions and actions we make and take today that affect our lives in the future.
But, we cannot know the future.
When a person decides to save money for retirement or a firm decides to borrow money for an investment the decision is based on a guess about the likely future result.
The actual end result can be very different from what was expected.
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In this chapter some tools are introduced that help us understand the decisions people make when they participate in financial markets.
Knowledge of the basic concepts and tools of finance is important for understanding how the economy works.
This knowledge is also helpful for making personal financial decisions.
This chapter covers three topics:
· comparison of values of sums of money at different points in time
· management of risk
· time and risk analysis to examine what determines the value of an asset
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risk management
risuku kanri
リスク管理
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Since in the long run investing in broad stock market funds or ETFs will maximize wealth and minimize risk, why would anyone want to invest anything else? ChatGPT:
For most people, that is the conclusion many economists and financial advisors reach: a low-cost, broadly diversified stock index fund or ETF is often the best long-term investment choice.
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But there are several reasons people invest in other things:
Different time horizons.
Someone who needs money in one or two years may prefer bonds, CDs, or cash because the stock market can decline sharply at the wrong moment – e.g. when they need to sell for money to pay bills.
Risk tolerance.
Even if broad stock funds maximize expected long-run wealth, not everyone can emotionally tolerate seeing their portfolio fall 30–50% during bear markets.
Some people sleep better holding low return but more stable value bonds.
Income needs.
Retirees often want more predictable income and lower volatility, so they may hold bonds, annuities, or cash reserves.
Diversification beyond stocks.
Real estate, Treasury bonds, and certain other assets sometimes perform differently from stocks.
They may reduce expected returns but can smooth the ride.
Belief in outperformance.
Some investors think they can beat the market through stock picking, sector investing, factor investing, or buy-and-sell active management.
A few succeed, but most studies show, after fees and taxes, most active investors underperform broad index funds over long periods.
Non-financial goals.
People may invest in businesses they understand, rental properties they enjoy managing, collectibles they value personally, or socially responsible investments that align with their values.
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If the goal is simply to maximize the probability of achieving the highest long-term after-fee wealth with minimal effort, a diversified, low-cost stock market index fund or ETF is difficult to beat.
The main reasons to own other assets are to match one's time horizon, emotional comfort, income needs, or personal preferences rather than because they are expected to produce higher long-run returns.
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Why do many people invest in and manage their own small businesses? Is the profit usually more than the gains they could receive from investing in the general stock market? CGPT:
Many people invest in and manage their own small businesses because they hope to earn returns higher than those available from the general stock market and because they value the independence, control, and personal satisfaction of being their own boss.
Successful businesses can indeed generate profits far exceeding the stock market's historical average return of roughly 9–10% annually, especially if the owner's skills, effort, and innovation create a thriving enterprise.
However, the risks are also much greater: many small businesses fail or produce modest returns, and owners often invest substantial amounts of time and energy in addition to money.
Small business ownership combines investing with a full-time job, offering the satisfaction of running one’s own business with the possibility of exceptional profits
But it comes with lack of diversification and much higher risk than simply owning broad stock market index funds.