Thursday, January 27, 2022
Time value of money
One of the many consequences of the internet is the growth of retail investing, facilitated by apps like Robinhood. The disadvantage of retail investing is that most people have very little financial knowledge. Buying a meme stock based on a recommendation on Reddit is gambling, not investing. Unless you either have a time machine or a functioning crystal ball, it is impossible to predict speculative gains on stock purchases. The better strategy is generally to buy low fee exchange traded funds (ETFs) and profit from the general upward movement of the stock market.
These days, however, it would be wiser to select the ETF you invest in more conservatively. There is a difference between "growth stocks" and "value stocks". If you invested in growth stocks after the 2008 financial crisis, you probably made a pretty penny up to now. But there are indications that for the coming years value stocks might perform better. Why is that so?
The principal problem here is the time value of money. $100 today is worth more than a promise of $100 next year. In times of very low inflation, which is what we had for many years now, the difference isn't all that great. That was great for growth stocks, whose potential value is mostly in the future. But now inflation is going up, and so are interest rates. That favors bonds and value stocks over growth stocks, because the potential future returns of growth stock have to be heavily discounted by inflation. Companies with low amounts of debt do better in times of high interest rates than companies that are heavily indebted.
While I am currently putting a lot of money into buying a house, that is not an investment strategy. I am buying the house I want to live in for the next decades, not because I think it will appreciate in value. Higher interest rates result in higher mortgage rates, which over the coming years will probably reduce demand in real estate. I would advise against speculative investment in real estate for the time being.
While the dot.com crash of 2000 and the financial crisis of 2008 certainly taught us that growth stocks and houses can be risky investments, it is very hard to predict how bad it will get. What is certain is that 2022 will be a rocky year for investments. So I would advise caution: Conservative investment in value stocks is probably a better option right now than growth stocks, crypto currency, NFTs, and collectibles. At the same time, putting your money under your mattress is also not a good strategy in times of inflation.