Personal Investments – Economic Memo #33

I’ve always had an interest in investments. In high school my math teacher sold me $50 worth of United Home Life and a sail boat he owned. I’ve relayed my disastrous experience with the sailboat in an earlier Economic Memo. (Earlier Memos are available by emailing Ryan Pivonka in the College of Business.) United Home Life did not turn out much better. I still have the current company form (1 share) and it’s a nuisance.

Fortunately not all of my investment decisions turn out poorly. What I have learned over time is the rule I use for all investments now and drill into my students over and over again in the principles classes.

Number #1 Hill Investment Rule

It’s your Money, Stupid! If you can’t explain to an eight-year-old the investment and have them explain it back to you, then don’t make the investment.

In other words, you must have a complete understanding of the following:

1. Why you are making the investment?

2. What is the risk of the investment?

3. How quickly you can get the money back?

4. What is the return from the investment?

Over the years I have developed the Hill Investment Cube which I teach all of my principles students (over 20,000 now). It is simply a combination of John Maynard Keynes demand for money and the three considerations of any investment (Risk, Liquidity and Yield).

Keynesian demand for money is really an exercise in determining what you want the money to do for you.

He proposed that you demanded money for three reasons.

1. Transactions demand is the money you need for your daily expenses like rent, gas, utilities, etc.

2. Precautionary demand is the money you need for a rainy day. This covers insurance and a pot of money that would replace your net income (take home pay) for six to eighteen months.

3. Speculative money is the money that if you lose it, your lifestyle will not change. Over your lifetime your lists of things you need for each category will change.

Every five years or so you should sit down and make a list of all the things you need in each category and then put dollar amounts next to them. For example, a college student will put his or her sports car in transactions and list the precautionary amount needed for retirement as a small fraction of the total dollars needed. A fifty year old will list a beater van and raise the retirement amount significantly. The 70 year old balding, overweight, wrinkled male will list his candy-apple red corvette as an essential transactions demand. Every student in the Economics principles classes at Lewis has to list the items for each type of demand for several stages of the life cycle.

The Hill Investment Cube

Combining the concept of Keynesian demand with the characteristics of the any investment forms the Hill Investment Cube. Hill Investment Cube Across the top we have the types of demand and vertically we have the characteristics of demand. 1. Transactions demand requires low risk, high liquidity and as a result results in low yields since it is money you need now. 2. Precautionary money is needed over six to eighteen months so it can be assigned low to moderate risk, moderate liquidity and low to moderate yield results. 3. Speculative demand is money you can blow and not have it affect your life style now or later. It is assigned high risk, variable liquidity and high yield.

The types of investments fall out from you determination of your goals for each type of money.

Transactions demand limits you to low risk investment. You need the money now.

Savings accounts, cash and money market accounts paying currently zero to one percent interest are your only options. Business Sector

The best thing you can do with this type of money in terms or a return is to list your credit cards payments and make a plan to eliminate them as quickly as possible. They are a transactions demand that will yield a double digit return.

Precautionary investments include Short-term low-risk bonds or funds. Business Sector 10Speculative investments include a wide range of real estate, growth stocks, high risk junk bonds, and gambling.  Business Sector 11

 Your Planning is done Now on to Specific tools of Modern Investing

Step #1: Never forget your goal for the investment.

You must sit down an clearly plan out your true needs for the three types of investments and be able to explain them to an eight year old who can spit it back so you understand it.

Step #2: Do your research on risk, liquidity and yield.

The following websites are very good at providing information on the market’s investment opportunities and risks.

I like the fidelity and Reuters sites the best. Let’s use the fidelity site as an example but I encourage you to check out and play with the other sites. Make sure you keep it simple.

1. Determining risk:

a. You have decided the type of money this is and assigned the risk you are willing to take. b. Go to the Fidelity site and there is a bar on the side that you can move the bubble to more or less risk. Choose the risk. c. Hit the results button and it will give you all the funds at that risk.

2. Determining Yield

a. Click on the Category tab at the top and it will rank the yields Year-to-date, life-time and so on. b. Keep in mind the returns change so you want to look deeper into the ones you have chosen as candidates. Click on the name of the fund.

i. You now get the full story and you can compare the results and make your choices. ii. Fidelity has portfolio suggestions for all types of funds too and you should pull those up and note the criteria the experts use to pick their portfolio’s.

The stock screeners work the same way on these sites.

So it’s as simple as that. Risk, Liquidity, and Yield.

If you are very conservative choose funds and stocks that have a long history of dividends. Utility stocks are called “Widows and Orphan stocks” because utilities pay consistent dividends and over time increase price.

About Larry Hill

Dr. Larry Hill is Chair and Professor of Economics. Areas of interest include economic analysis, energy economics cost benefit analysis and economy. To subscribe to the email list of Dr. Larry Hill's Economic Memos, contact Tracey O'Brien at Credentials include 1967 B.S., Indiana State University, 1968 M.S., Indiana State University, 1976 Ph.D., Northern Illinois University He is a member of honorary fraternities in economics and social science. He is currently writing a book on Managerial Economics and revising previous book, "The Basic Macroeconomics of the American Economy"

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