My investment philosophy essentially boils down to "value creation" over "speculation".
What is economic value?
I think this is crucial to an understanding ultimately of what money is, or what it represents. If your goal is to "make money", then we ought to have a good definition of what money even is.
So by economic "value" or "utility", we mean things that basically help people survive better. A house is valuable because it gives me privacy and shelter from the elements. It gives me a secure place to store my belongings where they will not get damaged or stolen. It can also house facilities for cooking and washing so I can feed myself, and somewhere warm and dry to sleep at night.
These things are, of course, extremely valuable. Hence why houses tend to cost a fair chunk of change. If you've ever been a student and tried to save some money spent a night slumming it in a car you will immediately appreciate your nice warm house when you return to it the next day.
If my hair gets too long and shabby then I'm always appreciative of a barber who can trim it into something more socially acceptable.
I'm also a big fan of breathing, and I generally prefer nice clean, non-toxic air that is rich in oxygen.
So value can come in terms of natural resources that we need for survival, man-made products that save time or can improve the way we utilise natural resources, and other people's labour when they do things that assist us.
There are things which I would argue have negligible economic value, for example digging a hole in some soil then filling it up again. And there are things like producing and selling heroin, that have a negative economic value - in the sense that they actually are harmful to consumers. We can also have products that may be beneficial to the consumer, but harmful to innocent by-standers - like living next door to a nightclub. Maybe great for the paying customers but for the flats above you will not be getting much sleep on a Friday night!
What is money?
So when you really think about it, the purpose of money is to "represent" economic value. The idea is that a $10 note can be exchanged for things that are of somewhat equal value. I can shine someone's shoes for a tenner, then use that to buy myself lunch.
Since money always involves people at some level, it essentially forms the basis under which we organise human labour. It's how we allocate resources to each other and decide who gets what. In theory at least, I should not be able to consume a fancy lunch unless I've gone and shined a lot of shoes. So in the ideal situation, it would be fair in the sense that a lazy layabout doesn't get as many nice things as a guy who has worked hard and helped lots of other people.
Of course we have corruption and other issues but essentially this is the point of it.
So money in and of itself is of course not valuable, but it does represent the value that exists in the economy. I find this idea poorly understood by some people. Money is not a commodity like wood or sand. If I can accumulate lots of wood, then I can build a lot of houses. But if I accumulate a lot of money, it only entitles me to a percentage share in the economy that currency is representing.
So if I simultaneously destroy large portions of said economy to obtain my millions, I'm destroying the very value that the thing is supposed to represent. Personally I find Zimbabwe a master-class in this backwards thinking. Simply hoarding the money doesn't really create any wealth, if the productive capacity of the economy is destroyed in the process and you get hyper-inflation. There is more money but less actual value backing it and so poverty is the result.
Asset Valuations - Yield
Investment generally has 2 ways of providing a return. One is having cash-flows generated from the assets you own. For example, a rental property, when properly managed, should provide regular income for the owner of the property.
The other is "equity", or "capital gains". In other words, I purchase an asset for a particular price, then I sell it later for a higher price. In theory at least, the asset should have gone up in value. But this is only "ethical" (in my opinion), when there has been value creation and not simply price speculation.
To keep it simple, if I buy a dilapidated house that was being rented out for $1000 per month. And I redo the kitchen, tidy up the garden, fix the roof etc. Then I can rent it out for $2000. This is because there has been genuine value created. People prefer to live in houses that don't have a leaky roof and an overgrown garden.
I should also be able to sell it at a higher price, because the asset is producing higher cash-flows. This is what we would typically call the "yield" of an investment. I.e. what percentage of the price of the asset is generated in revenue each year. Making $12,000 a year in cash-flow for an asset I paid $200,000 for would be a 6% yield. If the cash-flow goes up to $24,000 a year, then the property could be worth as much as $400,000.
In this type of investing, everyone wins. Tenants get nicer houses to live in, investors get better cash-flow from their assets.
The increase in wealth is driven by meeting people's needs, and everyone benefits because value is being created.
Asset Valuations - Equity
If someone purchases an asset, not because they want to receive the cash-flows from it, but because they want to sell it later at a profit, then we have to question their motives. There is a legitimate motive which is - I believe this asset will increase in genuine value. This would be a prediction about shifting economic requirements (like maybe investing in lithium mining right at the invention of lithium-ion batteries). The asset simply becomes more valuable because people's needs have changed. Fair enough.
Or it could be that you understand work will be done to increase the genuine value of the asset - like adding a new bathroom, or a company investing in a new product line.
Investing in start-ups is quite similar. You believe their new product is needed by society, and you trust the founders to deliver it.
These types of investing activity should be rewarded with profits, because they are doing the essential economic work of resource allocation. Predicting societies future needs and allocating human labour to solve those problems in advance is very difficult to do and should be richly rewarded. We need those visionaries to be given the profits so they can do it again and pioneer the next generation of innovation and change.
However, there is another, more sinister motive for chasing capital gains:
Finding a bigger idiot
There are many, many examples of this throughout history. For example "Trading Sardines", and "Tulip Mania", or the Global Financial Crisis of 2008.
These economic catastrophes are always created by the ancient "investment" strategy of finding a bigger idiot. What would be more accurately called "speculation", and even more accurately called "gambling". I could even go so far as to call it "legalised theft". However, you do have the choice to participate in such markets so "theft" is stretching it too far, even though it's not very far off it (especially if fraudulent claims are made to unsophisticated investors).
Here we are buying an asset (or sometimes an "asset"), simply because we believe it will go up in price. And this belief is largely driven by the fact that it previously went up in price. Price that is, not value.
I put "asset" in quotes, because sometimes the things being traded have no underlying value. The story of "trading sardines" was that due to migratory changes, sardines became difficult to catch. So the price of tins of sardines went up, then became subject to a speculative bubble, to the point where a single tin could cost thousands. The legend goes, that a particularly rich fellow, who actually loved to eat sardines bought a tin only to find it completely rancid. It was explained to him that they are not "eating sardines" but "trading sardines".
When people are only buying something in the hope that it goes up in price, they are not buying it because it has any genuine use to anyone. Or the genuine use is so low compared to the price. You could argue that it is idiotic to pay large sums of money for something of little to no value, unless of course you are able to find someone even stupider than you are, to pay an even higher price for something of little to no value.
People are always drawn into these types of "investments" by the rapid gains enjoyed by others. Look at NFTs or the myriad of junk crypto projects. Early "investors" are making 10X or 100X their money, and everyone else wants a slice of the action. Money piles in, and more "profit" is created. This accelerates until a fever pitch is created, before the inevitable "Minksy Moment" where the entire thing collapses.
It's basically a ponzi scheme in a different format, and is something I don't agree with for multiple reasons:
- It is very risky. There is a high chance you become the biggest idiot and lose your money
- It rewards gamblers who have not created any value
- It rewards criminals who fraudulently promote such "assets" for their own gain at other people's expense
- The only way to create "winners" is to also create "losers". Wealth is transferred not created
- It often preys upon the financially desperate, who are attracted by the potential short-cut to wealth
- The crash often causes massive economic and social instability
So I would argue there are good personal reasons not to be suckered into this for your own financial prosperity.
There are also moral reasons not to engage in such activities, even when you feel you are "missing out" on some massive opportunity.
You may as well just buy a lottery ticket, or go take a punt in a casino.
The house never loses
Casinos never lose money, in the long-run, because the odds are stacked in their favour. A roulette wheel has some 54% chance of favouring the house. They might lose the odd bet, but in the long-run it will always come good.
So build an investment strategy where the odds are stacked in your favour. The odd one may not do as well as you were hoping for, but over the course of years and decades you will have a sure path to wealth because you did it ethically.
And you can feel good that you helped other people out along the way.