Session 3. When Savings Are Productive

Savings don’t have to be productive. You could put your money in a hollow tree and never take it out. That might or might not allow other people to buy and consume more, but it would not increase the quantity of goods and services available to the community.

Productive savings happen when the resources available for consumption are turned to making improvements in our capacity. Over the long run, our true savings grow about as fast as our economy grows. What happens to your particular savings depends first on that real growth and second on how the growth pie is shared with other investors. Everything else is an illusion – the money illusion.

The money illusion can make us think our money is growing even when we are gradually falling behind because of inflation in the prices of things we buy. It can also fool us into thinking that our long-term wealth is growing simply because we own paper "securities" of higher and higher price. If productive resources do not back it up, this kind of wealth is like the children’s game of musical chairs. If you are the last one left standing when the music stops you find out it wasn’t wealth at all. If you can look beneath the money illusion you will be a better investor.

Success at Kitty Hawk

Source:  Library of Congress

One of the best ways to increase real wealth is to own a business that keeps improving its capabilities. Innovation, often based as much on common sense as on new technology, is the ultimate source of the greatest profits. However, most of us don't have the interests or skills to build a company. Maybe that isn't such a bad thing, because there is a lot more to life than people supervision, accounting, haggling with vendors and listening to customer complaints. But most of us do have some funds that can be productively used by a business. By buying part-ownership in the business, we can share the risks and get part of the profits.

Here's the trick, though. The share of the economic growth pie we get depends on the price we pay for this part ownership. (It also depends on how we handle risks and taxes, but the initial price we pay is critical.)

Unless we truly possess skill for spotting innovative companies before their ownership becomes high-priced, or identifying down-and-out companies before others realize they are about to enjoy a turnaround, or if we enjoy and are good at the game of musical chairs involved in trading on market psychology and momentum, we might well be content with playing the law of averages. That is, we can buy shares in a varied collection of different businesses. Because the economy is gradually becoming more productive, we can still increase our wealth through sharing in average profits.

The key concept for this session is that your only real assurance of increasing wealth is to pierce the veil of the money illusion.  Take inflation into account. Don't get caught up in the game of which stocks to own unless you want to devote considerable time and have the talent to realistically expect to outwit other investors who are busily trying to outwit you.  If you do have skill, or if you are taking up investing as a hobby or sport, you still need to buy at the right price.

At this point, it may be instructive to visit some companies that illustrate different degrees of innovation and different levels of pricing. Remember, savings are just as productive when invested in average companies at average prices as when invested in innovative companies at high prices.  The company is not the stock.  Any of these companies could be a productive investment at the right price.

Field Trip to Companies Selling At Different Prices

EBay

Extremely innovative concept -- equally extreme part ownership price based on the promise of future profitability.

 

Abbot Laboratories

Pharmaceutical company with long history of new drug introduction and successful marketing. High price and high profitability.

 

Walt Disney  

Still a strong competitor, but in the mature entertainment industry which is under attack by new technology.  Medium price and only fair profitability.

 

Dana

A leading automotive parts company for many years. Now fallen on hard times, with low price and intermittent losses.

 

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