Economics @ Home © Volume 1 Issue 11

Output and Growth - Part 4 (Final Part)

In the previous three issues, we have talked about the importance of output and growth, and underlined the two main ways to expand output, i.e. through increase in efficiency and growth of resources. In the last issue, we explored the detriments of leakages which sets a prelude to the goal of the final part of this series. In this issue, we will explore ways to grow our resource base on a macro and micro level.

As mentioned in the previous issue, the key to growth is savings because savings lead to investment, which consequently leads to growth in capacity. What do you think of when you think about "savings"? At the macro level, savings is basically derived from the realized government budget surplus at the end of each financial year. You can think of savings as a form of retained profits. Of course, the role of the government is not to maximize profits (that would actually defeat the purpose of having a government as a market regulator), the government is however responsible towards economic growth. While this may be achieved through growth in efficiency, the government is also responsible in incentivizing growth in capacity.

In the previous issue, I talked about investing in infrastructure and human capital. While all these are part of the budget, I feel that it is important to maintain a slight surplus for investment purposes to grow the government's "savings". Think of Singapore's Temasek Group, a specialized investment machine that has the sole purpose of growing the size of funds. As many wise men have aptly expounded, the goals of politics and economics will never converge in the short run, simply because politics focuses on the short term while economic growth is a long run goal. Nonetheless, this only stresses the importance of a stable government (which has been miraculously achieved by Singapore) so that it can focus on the long run of the nation without having to please the voters in the short run so that it gets reinstated at the next election.

I do however maintain that foreign exchange reserves are not classified as excess funds because these funds are usually invested in liquid assets because their purpose is for emergency usage. It is intuitive that we should save money for emergency purposes but any educated person should know that postponing current consumption for future gains is not an unfamiliar concept.

However, as I exhibited in the previous issue, dumping your funds in fixed deposits (FD) is merely a slow but sure way of getting poorer. Where else can we put our funds?

Although more and more people are becoming aware of investing their money in the stock market, many are still wary of its risks. People are afraid of the unknown and are even more lazy to learn about the stock market. I am not here to allay your fear of the stock market, but merely to explore some alternatives that might actually generate some real positive returns. I will tackle these investment vehicles in the order of least practical to the most practical in my own point of view. I take no responsibility for the performance of these investments because most of them require some amount of knowledge and skill as well as a lot of hard work. After all, there is no such thing as a free lunch. I cannot and will not advise anyone to just dump your money in any of these vehicles and hope that they generate luxurious returns because that is not possible and it is also illegal for me to induce purchases in some of these investments because I do not have an investment advisor license.

1. Fixed Deposits

I cannot mention enough how useless these instruments are in terms of growing your funds. The era of high interest rates are gone. With expected inflation to be low in the coming years, there is very little chance for interest rates to be scaled upwards. Even so, on average, fixed deposit interest rates merely track inflation over the long run. In fact, the yield spread could even be used as a predictor of expected inflation. That exemplifies how strong the correlation is. So, there is no way of beating inflation if you place your funds in fixed deposits. However, it is important to note that these investments are basically risk-free.

2. Amanah Saham Bonds (and other Amanah Saham stuff)

I feel these funds are more for entertainment value than for anything else. Even, the ones that guarantee 5% returns for the next however many years still have very little potential to beat inflation. Nonetheless, these instruments are slightly better than fixed deposits, which is why many people are willing to spend hours waiting in line at the banks to subscribe to these funds. An even funnier fund is the one that invests in equities. It promises to track the KLCI. There is almost no skill in that because any person with a trading account can basically allocate his funds equally throughout the KLCI counters and you would basically get the same performance, but without incurring management fees.

3. Property Investments

This one is pretty debatable. While it may generate potentially high returns, I feel it is not practical for beginner investors like you and me because of three reasons. First, its initial capital outlay is extremely high. The down payment to purchase property is very high, which may tie up our funds to invest in other opportunities as and when they emerge. Second, property investment is extremely illiquid. This ties in closely to the first reason because it is extremely difficult to dispose off these investments when we want to realize our gains or purchase other opportunities that we deem to be better. Third, in most cases, we have to incur guaranteed costs while our incoming cash flow is unpredictable. That is to say, we have to pay monthly instalments on our loan while we may have difficulty renting out the property, assuming that the property is already completed.

4. Unit Trusts (Equity funds, to be specific)

This category is huge. There are tons of different types of unit trusts. However, I will focus mainly on equity funds because the rest are just a combination of 1, 2 and equities. First of all, let me explain what a unit trust is. Basically, it is a collection of funds from investors with a particular set of investment objectives placed in the hands of a fund manager to invest according to those objectives. Equity funds is a unit trust fund that invests predominantly in equities (stocks, if you're unfamiliar with the term equities). One of the main attractions of equity funds is that the potential returns tend to be higher. Nonetheless, this is debatable because the performance of the fund greatly depends on the abilities of the fund manager. So, due diligence is still needed when selecting a fund to invest in. Like I have preached before, there's no such thing as a free lunch.

Why do I feel that this is more practical than the previous three investment vehicles? First, the concept of unit trust allows one to invest with very small capital. Minimum initial investments are around RM1000. Second, if we can find an able fund manager, we can ride on the "expertise" of the fund manager to obtain better than average returns. Typically, decent performing unit trusts average about 8% per annum in the long run. That is far higher than your long run FD rate. As to why the returns are so high, it is because the funds are invested in equities, which are companies listed in the stock market, which (hopefully) run a good business to churn a good profit that allows high returns on investments.

The drawback of unit trusts is, however, the management fees that you have to pay the fund manager. While this is not a fee that you have to fork out money and pay regularly, but it will be deducted from the fund based on the performance of the fund manager. Usually, this fee tends to be rather high. In addition to that, there is a commission that needs to be paid to the agents of unit trusts for marketing the unit trusts for the company. These fees can sometimes eat into the returns of our investments. Nonetheless, unit trusts tend to outperform plain deposits in the long run.

5. Equities

This is the most interesting and possibly the most promising investment vehicle of all. While diving into share investment without any knowledge is risky, knowing what you are doing reduces most of the riskiness involved. It is true that the risks of investments are there, but due diligence to ensure a high margin of safety minimizes the risks involved. Ben Graham, the guru of value investing said "Investing is most intelligent when it is most business-like". This sentence sums up what investing is all about.

Imagine yourself starting a business. Think of a list of criteria of how you want your business to be. These are the criteria that you should be looking for in the companies that you invest in. I do not condone speculation and will never do so. I am an advocate of value investing and the idea of value investing is simple. It is like paying RM5 for something that is worth RM10. If this does not attract you, then it will never attract you at all.

While the idea is simple, the work is hard. Most people would preach the risk-return trade-off in investing by saying that in search of higher returns, we must take more risks. This is totally untrue. What I know to be definitely true is that in search of higher returns, we must do more work. The key phrase of this issue is "due diligence".

I am in no position to teach anyone about value investing at this point. What I can suggest is to read widely regarding value investing. Books like "The Intelligent Investor" and "Security Analysis" by Benjamin Graham are vital. Think of reading as an investment in your personal growth. That is how you grow your personal resource base as well.

As a final note, you should note that one of the most important things in investing is that there is no formula for it. There is no one true way to grow your money. There are many ways to grow your resources. Some are able to grow it at a faster rate, some at a more conservative rate. One thing for sure is that nothing comes for free. Effort is essential.

After a possibly arduous journey over four issues, it is useful to go through the important things to take from this mini-series. We talked about what output is and the importance of maximizing output. We also talked about the two ways to maximize our output, via efficiency and growing our resource base. In this final issue, we explored the ways in which we can grow our personal resources. I would like to end by reiterating the recurring message throughout this series, which is "money does not grow on trees". So I urge you to invest in yourself if you seek to maximize our output and growth.