Spend, save, invest, repeat or give back

Money flows from financial assets to the economy, back and forth. This is what make investing so special and different from other activities involving money. 

Most people work to make money. An investor uses money to work for him or her.

You can do four things with money:

• ·    Spend it
• ·    Save it
• ·    Invest it
• ·    Repeat or Give it back

Spending and giving are both a form of consumption. 

At first, investing could be seen as a derivative of saving money. That said, while saving is static and expect to receive nothing else than the return of the money, investing is really different in that it is also looking to make money and a return on the money.

To save money, you must spend less than you earn. This puts the priorities in the right order: income generation always precedes capital accumulation.

Income and capital are what investors are interested in. Capital is nothing else than an accumulation of income and the net present value of future net income streams. Income is nothing else than a form of monetisation of capital. The word capital itself stems from the words cheptel or cattle. It’s an asset that provides a yield and a growth opportunity: milk (income) and meat (assets). Drink all the milk and it will be difficult to grow meat (in fact, because natural attrition, you will deplete your cattle). Reinvest the milk and we will probably grow meat and cattle. The higher the yield, the more we will be able to grow your cattle and keep more milk for you. Therefore, capital is both an accumulation of income and way to produce income. For an investor income is a way to acquire capital in order to generate more income.

Both investments and savings consist in postponing future consumptions. But they differ in that saving money is putting money aside at no risk and therefore no real returns, (a mattress in anticipation of leaner days or larger planned purchases in the future), whereas investing involves taking risks in exchange of greater real returns. 

For a saver, the prime objective is the return of his or her money. Cash, bank deposits, money market funds and to some extent gold are the typical savings, whose absolute returns are zero or at best risk free rates i.e. covering up for the debasement of monetary value through inflation.

The two objectives of an investor should the return of his or her capital (same as savings) and the generation a real return (in excess of inflation or risk free rates). For an investor, the goal is the generation of the maximum real return in excess of the risk free rate/inflation. 

In the economic world, there is no free lunch. Competitive forces make sure that any return up and above the risk free rate comes at a risk, something every student in finance learned when reading the work of Markowitz. 

If rule no 1 should be the preservation of capital, rule no 3 should be to make the maximum amount of money on the capital invested at the lowest possible risk. Rule no 2 is to always remember rule no 1, that is putting preservation of capital and risk control first and returns second.