almanack

Finance and Economics

A compendium of principles and lessons learned about finance and economics.

Save and invest since an early age. If you don’t make huge mistakes and you manage risk the compound interest will do the rest for you.
Manage risk and minimise your losses. Invest in assets that you understand and that you are convinced about the theses behind them. That way you won’t panic when the market goes down. Noob investors tend to behave when they face their first bear market like a diver that has a problem when they are deep underwater: they tend to go up too fast and they can get hurt and lose conscience. The best way to avoid this is to have a plan and stick to it.
Diversify your investments. Don’t put all your eggs in one basket.
Always invest the money that you don’t need, and invest in assets in a way that will allow you to sleep at night.
Prices are not determined by utility, but by the demand pressure over scarce resources. This is why the “Bitcoin doesn’t have an intrinsic value” or “gold doesn’t generate any productive output” are not valid theses. A glass of water has more utility than a bullion of gold but, depending on the context, water is not scarce. Generally, one would pay more for gold than water because it is scarce, unless you are in the desert, where the dynamics may change. This is a good way of thinking about prices when investing.
There are several types of inflation, and it is really important to be able to identify them. The most common ones are: Monetary inflation, when the money supply increases, the value of the currency decreases. This is the most common type of inflation and the one that most people refer to when they talk about inflation; and Price inflation, when the price of goods and services increases. This is the type of inflation that most people are concerned about, as it affects their purchasing power.
On monetary inflation: the effect of issuing more FIAT money (through central bank policies, government debts, or commercial bank deposits) is the same as when investors holding stocks are diluted after a new round of investment. When you hold FIAT, you are implicitly an investor on that currency, and you can be diluted by the central bankers, commercial banks, and/or states that control it.
When investing in stocks as a financial instrument think of them broadly speaking as bonds, that generate future cash flows yearly. The company that you invest in should be capable of maintaining this bond-like behavior long-term.
Debt is not bad (without it we wouldn’t have the global prosperity that we are experiencing), but excess of debt is risky. Even an excess of capital can be risky because it leads to bad decisions. Having money without knowing what to do with it leads to bad decisions.
“It pays to build up savings in the good times so there are savings to draw on in the bad times. There are costs to having too much savings as well as too little savings, and no one gets the balance exactly right.” - Ray Dalio
If debts are denominated in a country’s own currency, its central bank can and will “print” the money to alleviate the debt crisis. This allows them to manage it better than if they couldn’t print the money, but of course it also reduces the value of the money. If the debt is not denominated in currencies that their central banks can print, then they will have debt defaults and deflationary depressions measured in the currency that they owe and can’t print.
More active investors are beating passive investment because the latter is becoming less efficient. It’s still able to give you an average market return, but it may be a good idea to complement some active investment to traditional passive strategies (trying to avoid big losses that may drag you).
Using PUTS can be a great tool to buy a stock at a desired price when it is currently a bit more expensive that you would be willing to pay for it.

There’s a stock @10.5 that you want to buy @10.
You make a PUT for @10.
If the PUT executes in 3-months you keep the stock.
In the meantime you keep the money to buy the PUT in a monetary fund to get some return from it.

Always set up different investment in boxes with a clear focus and a good understanding of their risks and their average return. It all boils down to having an investment goal and a return focus according to your risk profile. This will determine the allocation in stocks, private equity, bonds and cash.
There are different type of instruments within private equity and not all are equal:

VCs invest in an idea and a team. They are early company and require several small investment to achieve an average return of 15-18%. It is a double-digit return with high-risk.
Growth funds invest in companies that are already making money, or at least have a established business model but that can be grown to create one order of magnitude more of values. Traditionally these funds can make also 15-18% returns on average with a bit less of risk than VCs (because the business has been shown feasible, but now it is a matter of figuring out if it can scale and grow –either internationally or to other markers/products–).
Buyout funds invest in established companies that are not operating well or efficiently, the funds buy them to optimise them and improve their business squeezing additional returns from them. These are the lowest risk strategies but they also offer close to 15% on average with lower risk.
Finally, there is the investment in real estate or infrastructure which has the lowest of the risks and offer around 10-12% returns on average. All these instruments should be balanced efficiently and not all should be included in the same box (as if private equity is always the same box).

In investing, returns can either by consistent or erratic.I prefer consistent incremental growth. Filtering for linearity helps find companies that look like this (R² = 0.98):Look for companies that
The 10-year US Treasury yield is a good indicator of the risk-free rate of return. It behaves as a great proxy for interest rates and future inflation. We need to check how it is behaving compared to the aforementioned metrics (reference: Chapter 10, from page 202 of Ray Dalio’s “How countries go broke”).
When investing, minimising losses is as important in the long-run as maximising gains. A 50% loss requires a 100% gain to get back to the original value. This is why it is important to have a plan and stick to it, and know clearly what you are investing in and the risks involved.

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