The Importance of Saving and Why We Invest
http://www.learnbonds.com/ (thanks for the compliments, guys) that this blog has been pretty much entirely about investing since its start despite the title of "Life, Investments and Everything." I have wanted to establish this place as a source of useful information for investors that goes beyond the usual "soundbite" level of detail that is typical a lot of personal finance and investing online content. Judging by the posts that get the most hits, I have succeeded in providing some insight and (more or less) plain language explanations of some of the more neglected areas on investing (like junk bonds, merger arbitrage funds and equity indexed annuities). But I have neglected the other topics I meant to focus on, especially some of the "life" stuff. In the interest of providing useful information rather than babbling on about personal details nobody will care about, I thought it would be appropriate to talk about why it is important to save and learn to invest well. Given that it is May Day and people in many parts of the world are out there celebrating freedom and the personal dignity of earning a living, this seems like exactly the right time.
Many Americans have rediscovered the importance of having cash in the bank over the last few years simply to have resources to fall back on when things go very badly. I think it is great to see a divergence from the rampant, over the top consumerist culture I have seen all my adult life, but I rather doubt it will last. My fellow Americans love to shop and there are clear signs that the pent-up demand accumulated over the past few years of hardship is starting to slop over the levies of (temporary and fear-driven) frugality. This is unfortunate, since it is pretty clear that we as a nation need to keep saving. Retirements are under-funded, by and large. Many people are still generously leveraged beyond what they should be. Its not a great thing. I would not want to see the US or the world revisit the Great Depression, but it did have the long-lasting positive effect of instilling a culture of saving and frugality in a generation of Americans. There will be some people who have a permanent tendency toward saving and frugality etched into them by the recent downturn (we can see it in the popularity of blogs like http://www.mrmoneymustache.com/ ), but I suspect it will not be seen in the bulk of the population once memories have faded a bit.
So why should we save? As the last few years have demonstrated, it is extremely important to have a wad of cash in the bank when things go wrong. If you are suddenly tossed out of your job with no immediate prospect of getting another one and you have bills to pay, it is a great comfort to know you can make it 6 months, a year or longer on your savings. You will sleep better at night even if you keep your job and your lack of desperation and worry will both make you a more productive person and give more leverage if you have to negotiate. If you are self-employed, having a pile of savings is even more important since all businesses go through downturns and periods of scant or negative cashflow.
Another reason to save is to fund long term obligations. Want to retire some day? Guess what: you need money (and a lot of it). Plan on sending the kids to college? It is quite expensive and an awful lot of students have been finding out that student loans have a big downside risk if you graduate in the midst of a recession. Would you like to eventually own a vacation home or other large toy? You would be a lot better off saving up for it over a period of time rather than borrowing a pile of money to buy it now.
Perhaps the most important reason to save is to be able to take advantage of opportunities. This is really hard to quantify, but having cash gives you options which may be extremely valuable at times. As a younger man I worked reasonably well paying but very steady jobs and saved my pennies. When an opportunity came along during the boom years of the 2000s to jump to an extremely lucrative but very risky job, I was able to make the leap knowing that if things did not work out I had enough resources to carry me until I found another job. If I had been leveraged up to my eyeballs, I would not have been able to take the risk. While I was at my very lucrative job, I also saved my pennies. It was hard to do, since I was showing up every day in one of the wealthiest zip codes in the world where everyone was flush with money and spending huge sums and like most people I was tempted to join the crowd. Yet when the economy crashed and I lost my job in the teeth of a "no bid" labor market, I was extremely glad to have been saving. Later, when the opportunity came to relocate for a job in a beautiful place (see evidence in photo above) I have always wanted to live in, a pile of savings made it possible to sell my old home (at a loss), buy a new home and move a long distance at the drop of a hat. When the sale of my old home ran into difficulties that involved laying out hefty sums of cash, I was able to do it. If I hadn't been saving all those years, I would never have been able to take advantage of all these opportunities.
Why should we learn to invest well? Many people go their whole lives simply putting money in to CDs, savings accounts and the like. That is fine, but it doesn't leave you many investing options and it potentially leaves a great deal of money on the table (compound any sum you like over 25 years at 5% and 10% and see the difference in the terminal amount). Whether you buy into modern portfolio theory or not, having more options to invest is better than no having options. Dedicated savers (who are not investors) are finding out that in an era of historically low interest rates it is not good to be entirely constrained to one asset class.
Another reason to learn to invest is so that you can understand, dimension and become comfortable with the risks you are taking. For example, many of the dedicated savers who have exclusively put their money into savings accounts and CDs have come to the realization that returns in their chosen vehicles are too low for them to meet their goals. They have belatedly begun to investigate alternatives, generally with very little knowledge and a LOT of naivete. I see highly risk averse savers jumping into such spicy options as junk bonds, dividends stocks, mortgage REITs and other investments that have some very significant and not always immediately apparent risks. This is not a good thing. It is OK to want to keep your overall risk level high, low, or somewhere in between, but if you don't understand the inherent risks of what you are buying you don't have a means to identify, control and accept that level of risk.
I imagine I have now bored most of my readers rigid, especially those of you who come here for investment-oriented content. I appreciate your indulgence, but I think keeping a clear head about why we do this investing thing and what is important in life. I am profoundly grateful for the opportunities that have come my way and I am glad I had the foresight to be ready to capitalize on them. Hopefully some of my readers benefit from my meager writings and get to jump on some of their own opportunities. I will resume more hard-headed discourse on investing topics, but in the meantime I will offer the following on everyone's (least) favorite natural gas driller:
Chesapeake Energy (CHK) announced this morning that Aubrey McClendon has agreed to end his 2.5% participation in all of the company's wells in early 2014 and will be stepping down as Chairman of the Board. As you can see from the positive reaction in the stock (on gigantic volume), this is a really good thing. The main thing wrong with this company has long been its extremely poor corporate governance, and that is apparently rapidly being improved. It is a lot easier to fix silly things like poor governance than to fix a bad business or a bad balance sheet. One might wonder if this sudden move is to head off criticism that will surely rain down on management in the company's quarterly earnings conference call tomorrow morning, or if this is to allay a poor quarterly result. That is certainly a possibility. However, I would point out that the press release put out by CK contains a HIGHLY unusual statement from the company's largest investor (Southeastern Asset Management) indicating that they support this move. This tells me that all of the bad press around CHK's lousy governance and Aubrey McClendon's shenangians has finally gotten the institutional investors (who most definitely have the power to jerk the Board of Directors' collective chains) to get off the dime and start forcing the issue. This is a great thing for investors in CHK equity. It remains to be seen whether this is the end of improvements or whether things will finally end with Mr. McClendon leaving the company, but signs are very positive that the company will continue improving the main thing wrong with it.
As always, consult your advisor, do your own due diligence, take your own risks and be careful. Nothing I write is intended to be investment advice. Caveat emptor.
Disclosure: I am long CHK equity and options.