Basic Economics by Thomas Sowell

Author:Thomas Sowell
Language: eng
Format: mobi, epub, azw3, pdf
Tags: economics, Business & Economics, General
ISBN: 9780465081387
Publisher: Basic Books
Published: 1900-12-01T00:00:00+00:00

Risk and Time

To take an extreme example of how risk can vary over time, while a dollar invested in bonds in 1801 would be worth nearly a thousand dollars by 1998, a dollar invested in stocks that same year would be worth more than half a million dollars. All this is in real terms, taking inflation into account. Meanwhile, a dollar invested in gold in 1801 would in 1998 be worth just 78 cents.

The phrase "as good as gold" can be as misleading as the phrase "money in the bank," when talking about the long run. While there have been many short-run periods when bonds and gold held their values as stock prices plummeted, the relative safety of these different kinds of investments varies greatly with how long a time period you have in mind. Moreover, the pattern is not the same in all eras.

The real rate of return on American stocks was just 3.6 percent during the Depression decade from 1931 to 1940, while bonds paid 6.4 percent. However, bonds had a negative rate of return in real terms during the succeeding decades of the 1940s, 1950, 1960s and 1970s, while stocks had positive rates of return during that period. In other words, money invested in bonds during those inflationary decades would not buy as much when these bonds Were cashed in as when the bonds were bought, even though larger sums of money were received in the end. With the restoration of price stability in the last two decades of the twentieth century, both stocks and bonds had positive rates of real returns.

Risk is always specific to the time at which a decision is made. "Hindsight is twenty-twenty," but risk always involves looking forward, not backward.

During the early, financially shaky years of McDonald's, the company was so desperate for cash at one point that its founder, Ray Kroc, offered to sell half Interest in McDonald's for $25,000-and no one accepted his offer. If anyone had, that person would have become a billionaire over the years. But, at the time, it was neither foolish for Ray Kroc to make that offer nor for others to turn it down.

The relative safety and profitability of various kinds of investments depends on your own knowledge. An experienced expert in financial transactions may grow rich speculating in gold, while people of more modest knowledge are losing big. However, with gold you are unlikely to be completely wiped out, since gold always has a value for jewelry and industrial uses, while any given stock can end up not worth the paper it is written on.

Nor is it only novices who lose money in the stock market. Harvard's $13 billion

endowment fell by 10 percent-more than a billion dollars-in less than three months. In the past, colleges and universities kept their endowments in safe investments like government bonds but, during the stock market boom of the 1990s, many went for higher rates of return in the private financial markets. As The Wall Street Journal put it,

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