You’re wasting very
valuable time, Roger!
Tuesday, June 18, 2013
Speaking
of Scams…
Last week I talked about Ponzis and Pyramids and was planning to move on to something else. But I happened to catch a financial advisor on the radio as I was driving around town last Saturday. It was pretty much just an infomercial designed to get people to attend his seminars (no phone calls were taken) Not much useful information was given but lots of criticism of mainstream financial advice and advisors.
Last week I talked about Ponzis and Pyramids and was planning to move on to something else. But I happened to catch a financial advisor on the radio as I was driving around town last Saturday. It was pretty much just an infomercial designed to get people to attend his seminars (no phone calls were taken) Not much useful information was given but lots of criticism of mainstream financial advice and advisors.
As
this man tried to convince his audience of his superior knowledge he shared a
story about meeting with three finance professors at a major university. These
three professors (according to the man on the radio) told him that in their
upper-division finance courses they would advise their students to use 15-year
mortgages on their homes. He then went on to say that these finance professors
were AMAZED when he showed them how
much better off they could be if they took the difference in payments between a
30-year mortgage and a 15-year mortgage and invested that difference in a stock
fund. He went on to say that those professors had never seen anything like that
before.
SAY
WHAT! I almost drove off the road. This cannot, and I mean CAN NOT,
possibly be true. Leverage is one of the most basic concepts in finance. I have
written about it twice in this blog’s first two months (April 30th
and May 28th) His claim would be equally incredible had he told us that he wowed three mathematicians with the quadratic formula.
How
can I be so sure?
First,
I have taken virtually every finance course that exists at both the masters and
doctoral level and there is no doubt that anybody with a doctorate in
finance has a firm understanding of the basic principles. I have also taught in
all three areas of finance (corporate finance, financial markets and
institutions, and investments) and I am very familiar with the undergraduate
finance curriculum and it is extremely unlikely that any remedial rules of
thumb regarding mortgages would ever come up in an upper division finance class.
In fact, hardly any applications involving personal finance are covered in the
finance major. The curriculum focusses on corporate finance and business
problem solving. Yes, a personal finance class would cover these topics (and I
certainly address them in the personal finance class I teach) but this is a lower
division class designed for non-majors.
Most
people listening to the radio last Saturday probably believed this man’s claim
that he schooled THREE (not one, not two, BUT THREE) finance professors (he
also claimed to have trained over 3,000 financial advisors but only 200 could
pass his final exam! Does anybody see a turnip truck?).
So
where does this leave those listening on the radio? VULNERABLE! The whole point
of his story was to put a chink in the armor of those who we traditionally look
to as experts and to elevate those who are peddling less than stellar (and typically
very expensive) concoctions. Yes, he has them right where he wants them.
Moral
of the story: Watch your wallet!
Of
course, there is plenty that we do and do not know (for real) in the field of
finance. For those interested in what these are relative to investing, the
following article is required reading:
http://www.nytimes.com/2013/05/19/business/for-stock-picking-advice-dont-ask-an-economist.html?_r=1&
MM
Tuesday, June 11, 2013
Ponzis, Pyramids and Related Scams
Sadly,
there are scams everywhere we turn. While there are many variations, a couple
of themes are quite common: Ponzis and Pyramids.
Charles Ponzi may not have been the first, but he was the one who made it famous in Boston in the early 1900s. The Ponzi scheme is a way for an investment advisor/manager to attract more customers and more money. Funds received from new investors are used to pay older investors. With the older investors boasting of the enormous returns they received with superstar advisor Joe Bigbuck’s, more investors are attracted to Joe. This can be kept going for as long as high returns can be funded for the older investors with new investor money. This, of course, requires that new customers be brought on board in large numbers. However, with big publicity for "out smarting the markets", all these balls can be kept in the air for quite some time (e.g. Bernie Madoff).
A pyramid scheme is more complicated and is often disguised as a legitimate business opportunity. What it has in common with the Ponzi scheme is that it is a direct money transfer from one group to another. In other words, some people benefit at the expense of others (a zero sum game). Here, participants knowingly give money to those higher on the pyramid with the expectation that they will get to collect money from those they recruit as they are moved up the pyramid. So what brings in these new recruits? Greed! When they see how much those at the top of the pyramid have made, they cough up the money and go on a recruiting binge with family and friends.
Multi-level (or Network) marketing is probably the best known pyramid scheme. Okay, MLMs are not LEGALLY considered pyramids. Through massive lobby and compromise they have largely escaped the law. But that doesn’t change the fact that the economic function of MLM is that of a pyramid (in economics, if it looks like a duck, walks like a duck, and quacks like a duck, we still call it a duck even though politicians may call it a giraffe)
What differentiates multi-level marketing from a pure pyramid is that MLM involves the sale of a product. It really doesn’t matter what the product is because the product is merely a distraction. MLMs do, however, tend to invest heavily in the development of cosmetics and nutritional supplements because this allows them to make extraordinary claims -- that cannot be proved or disproved – and generate the hype and excitement necessary to charge multiple times the price of similar products. It is this difference in price that flows up the pyramid. Robert Fitzpatrick of Pyramid Scheme Alert sums it up:
... multi-level marketing schemes (MLMs), offer a "product" and claims that the "sale" of a product automatically makes them legal. Camouflaging the pyramid money through a "product purchase" and then calling the pyramid payments "commissions" is the preferred disguise for money-laundering in MLM pyramid scams. Usually the products are absurdly over-priced, not retailed, and are only purchased by the "salespeople." These purchases actually serve as "tickets" to participate in the pay-to-play scam.
So, why are people willing to pay extravagant prices for miracle skin creams, exotic juices, and honey made from super bees in the Sonoran Desert? Again, because they believe that they will be able to recruit others who will do the same.
The pyramid structure of MLM came to light in a big way when a law suit opened up the tax returns of Amway distributors in Michigan. In direct contrast to the claims of the MLM industry, only 1% (those at the very top of the pyramid) made significant amounts of money. Where did the money come from? It was a direct transfer from the bottom 99%. Where do these 99% come from? As you can imagine, constant recruiting is required to keep this going (another feature in common with the Ponzi).
Why MLM is legal has always been puzzling to me. On the other hand, it really shouldn’t be. An enormous amount of political contributions have been made by the MLM industry. This is the most plausible explanation as to why politicians continue to look the other way (See Marketplace video below). Also, in the early 2000s President George W. Bush placed a former Amway attorney in charge of the Federal Trade Commission. This was the fox guarding the hen house in the purest sense. Not surprisingly, Business Opportunity and Marketing Fraud exploded during this period (all in the name of free enterprise). Robert Fitzpatrick again comments:
“Anti-fraud law enforcement has become so lax and incompetent in recent years in both Canada and the United States that this is now the regular defense of fraudsters, including Bernard Madoff who ran a $50 billion Ponzi scam on Wall Street. Madoff mirrored Kippax when he had defended his scam for years on the grounds that "I can't possibly be doing anything illegal because the government has never prosecuted me."
Nowadays, MLMs do much (if not most) of their business in developing countries where pyramid laws are weak or non-existent (although they seem to be catching on as three Amway executives were recently arrested in India for running a pyramid scam). They promote themselves as an opportunity for the poor to move up the economic ladder but since all these firms do is transfer income from the bottom to the top, obviously these claims cannot be substantiated (As any economics 101 student can tell you, there is a big difference between creating wealth and merely redistributing it). While most people don’t lose large amounts of money, they do lose valuable time and effort that could have been used in productive endeavors (but in the case of the very poor – who are often primary targets of MLM marketing efforts -- even a “small” loss can be significant). Although focused on overseas business, MLMs are known to spread their gains charitably at home thus keeping the locals convinced that they “must be a good company because they are so generous”.
A great source of information is the Pyramid Scheme Alert. It is run by the aforementioned Robert Fitzpatrick who is the author of False Profits, an excellent book on the subject. See the link below.
http://pyramidschemealert.org/
This hilarious satire of MLM was never released to the theaters because a law suit was threatened by a deep pocketed Multi-Level Marketing company:
http://www.amazon.com/Believe-Larry-Bagby/dp/B001G5T6VC/ref=sr_1_4?ie=UTF8&qid=1369053354&sr=8-4&keywords=believe++dvd
The popular Canadian television program, Marketplace, investigated the outrageous claims of BIM. The link below takes you to that very interesting and informative episode: (BIM has since shut down)
http://www.cbc.ca/marketplace/2009/easy_money/main.html
Charles Ponzi may not have been the first, but he was the one who made it famous in Boston in the early 1900s. The Ponzi scheme is a way for an investment advisor/manager to attract more customers and more money. Funds received from new investors are used to pay older investors. With the older investors boasting of the enormous returns they received with superstar advisor Joe Bigbuck’s, more investors are attracted to Joe. This can be kept going for as long as high returns can be funded for the older investors with new investor money. This, of course, requires that new customers be brought on board in large numbers. However, with big publicity for "out smarting the markets", all these balls can be kept in the air for quite some time (e.g. Bernie Madoff).
A pyramid scheme is more complicated and is often disguised as a legitimate business opportunity. What it has in common with the Ponzi scheme is that it is a direct money transfer from one group to another. In other words, some people benefit at the expense of others (a zero sum game). Here, participants knowingly give money to those higher on the pyramid with the expectation that they will get to collect money from those they recruit as they are moved up the pyramid. So what brings in these new recruits? Greed! When they see how much those at the top of the pyramid have made, they cough up the money and go on a recruiting binge with family and friends.
Multi-level (or Network) marketing is probably the best known pyramid scheme. Okay, MLMs are not LEGALLY considered pyramids. Through massive lobby and compromise they have largely escaped the law. But that doesn’t change the fact that the economic function of MLM is that of a pyramid (in economics, if it looks like a duck, walks like a duck, and quacks like a duck, we still call it a duck even though politicians may call it a giraffe)
What differentiates multi-level marketing from a pure pyramid is that MLM involves the sale of a product. It really doesn’t matter what the product is because the product is merely a distraction. MLMs do, however, tend to invest heavily in the development of cosmetics and nutritional supplements because this allows them to make extraordinary claims -- that cannot be proved or disproved – and generate the hype and excitement necessary to charge multiple times the price of similar products. It is this difference in price that flows up the pyramid. Robert Fitzpatrick of Pyramid Scheme Alert sums it up:
... multi-level marketing schemes (MLMs), offer a "product" and claims that the "sale" of a product automatically makes them legal. Camouflaging the pyramid money through a "product purchase" and then calling the pyramid payments "commissions" is the preferred disguise for money-laundering in MLM pyramid scams. Usually the products are absurdly over-priced, not retailed, and are only purchased by the "salespeople." These purchases actually serve as "tickets" to participate in the pay-to-play scam.
So, why are people willing to pay extravagant prices for miracle skin creams, exotic juices, and honey made from super bees in the Sonoran Desert? Again, because they believe that they will be able to recruit others who will do the same.
The pyramid structure of MLM came to light in a big way when a law suit opened up the tax returns of Amway distributors in Michigan. In direct contrast to the claims of the MLM industry, only 1% (those at the very top of the pyramid) made significant amounts of money. Where did the money come from? It was a direct transfer from the bottom 99%. Where do these 99% come from? As you can imagine, constant recruiting is required to keep this going (another feature in common with the Ponzi).
Why MLM is legal has always been puzzling to me. On the other hand, it really shouldn’t be. An enormous amount of political contributions have been made by the MLM industry. This is the most plausible explanation as to why politicians continue to look the other way (See Marketplace video below). Also, in the early 2000s President George W. Bush placed a former Amway attorney in charge of the Federal Trade Commission. This was the fox guarding the hen house in the purest sense. Not surprisingly, Business Opportunity and Marketing Fraud exploded during this period (all in the name of free enterprise). Robert Fitzpatrick again comments:
“Anti-fraud law enforcement has become so lax and incompetent in recent years in both Canada and the United States that this is now the regular defense of fraudsters, including Bernard Madoff who ran a $50 billion Ponzi scam on Wall Street. Madoff mirrored Kippax when he had defended his scam for years on the grounds that "I can't possibly be doing anything illegal because the government has never prosecuted me."
Nowadays, MLMs do much (if not most) of their business in developing countries where pyramid laws are weak or non-existent (although they seem to be catching on as three Amway executives were recently arrested in India for running a pyramid scam). They promote themselves as an opportunity for the poor to move up the economic ladder but since all these firms do is transfer income from the bottom to the top, obviously these claims cannot be substantiated (As any economics 101 student can tell you, there is a big difference between creating wealth and merely redistributing it). While most people don’t lose large amounts of money, they do lose valuable time and effort that could have been used in productive endeavors (but in the case of the very poor – who are often primary targets of MLM marketing efforts -- even a “small” loss can be significant). Although focused on overseas business, MLMs are known to spread their gains charitably at home thus keeping the locals convinced that they “must be a good company because they are so generous”.
A great source of information is the Pyramid Scheme Alert. It is run by the aforementioned Robert Fitzpatrick who is the author of False Profits, an excellent book on the subject. See the link below.
http://pyramidschemealert.org/
This hilarious satire of MLM was never released to the theaters because a law suit was threatened by a deep pocketed Multi-Level Marketing company:
http://www.amazon.com/Believe-Larry-Bagby/dp/B001G5T6VC/ref=sr_1_4?ie=UTF8&qid=1369053354&sr=8-4&keywords=believe++dvd
The popular Canadian television program, Marketplace, investigated the outrageous claims of BIM. The link below takes you to that very interesting and informative episode: (BIM has since shut down)
http://www.cbc.ca/marketplace/2009/easy_money/main.html
MM
Tuesday, June 4, 2013
There
is one born every minute ...
As a faithful holder of the American Express Sky Miles Card I was rewarded with a certificate that allowed me to take a companion on a flight for a mere $99. I was planning on canceling the card but decided not to because I wanted to get that certificate. I would be taking my wife with me to a conference and that certificate would significantly lower the cost of her fare. (The annual fee was waived for the first year and one of the big selling points to keep the card -- and its $95 fee -- was the companion ticket)
The airfare to the conference was $422 each for a total of $844, but with my $99 companion ticket I would only have to buy one ticket for $422 (reimbursed by my employer) and then pay $99 ($123 with taxes) for my wife for a total of $545. What a deal!!! I would be saving $299! I was feeling like the cat that swallowed the bird. This alone would justify the $95 annual fee for the card. As long as I took my wife to this conference every year (and I was planning to do just that) I was in the black.
Oh, naive one. Did you really think that American Express and Delta Airlines were going to let you do this to them each and every year? Well, sort of. I mean, there were several hoops I had to jump through. I had to be a long standing "member" and each year if I didn't cancel the card I would get my companion certificate. It had to be redeemed 30 days before the flight and we had to stay at our destination at least 3 days. No problem. Yes! I snickered. I am going to cash in. (Plus, I'm a good person. I deserve this)
As I went online to redeem my certificate, my glee turned to "you have got to be kidding!" The flight I had chosen on Kayak was not even listed. None of the lower fare flights were listed. Only the most expensive flights were eligible for use with the companion ticket. I was given three choices, all priced at $697 ($275 more than the flight I had planned to take). Add the $123 companion fee and the total for both of us was now $820. Thus, the true economic benefit of my companion ticket was only $24 (844 - 820). I was deflated. Of course it was too good to be true. How could I have thought otherwise?
Yes, there is one born every minute and that minute it was me.
MM
As a faithful holder of the American Express Sky Miles Card I was rewarded with a certificate that allowed me to take a companion on a flight for a mere $99. I was planning on canceling the card but decided not to because I wanted to get that certificate. I would be taking my wife with me to a conference and that certificate would significantly lower the cost of her fare. (The annual fee was waived for the first year and one of the big selling points to keep the card -- and its $95 fee -- was the companion ticket)
The airfare to the conference was $422 each for a total of $844, but with my $99 companion ticket I would only have to buy one ticket for $422 (reimbursed by my employer) and then pay $99 ($123 with taxes) for my wife for a total of $545. What a deal!!! I would be saving $299! I was feeling like the cat that swallowed the bird. This alone would justify the $95 annual fee for the card. As long as I took my wife to this conference every year (and I was planning to do just that) I was in the black.
Oh, naive one. Did you really think that American Express and Delta Airlines were going to let you do this to them each and every year? Well, sort of. I mean, there were several hoops I had to jump through. I had to be a long standing "member" and each year if I didn't cancel the card I would get my companion certificate. It had to be redeemed 30 days before the flight and we had to stay at our destination at least 3 days. No problem. Yes! I snickered. I am going to cash in. (Plus, I'm a good person. I deserve this)
As I went online to redeem my certificate, my glee turned to "you have got to be kidding!" The flight I had chosen on Kayak was not even listed. None of the lower fare flights were listed. Only the most expensive flights were eligible for use with the companion ticket. I was given three choices, all priced at $697 ($275 more than the flight I had planned to take). Add the $123 companion fee and the total for both of us was now $820. Thus, the true economic benefit of my companion ticket was only $24 (844 - 820). I was deflated. Of course it was too good to be true. How could I have thought otherwise?
Yes, there is one born every minute and that minute it was me.
MM
Tuesday, May 28, 2013
Why Dave’s Mortgage
Analysis is Flawed
So what should you do?
HOWEVER,
Dave’s assertion that accountants and financial advisors are missing something (actually
Dave puts this much more harshly) is highly misleading and his analysis of mortgages
is seriously flawed. This is puzzling because Dave does a tremendous job of
demonstrating the opportunity cost of smoking, the opportunity cost of drinking
that expensive latte from Starbucks every day, and the opportunity cost of
Whole Life Insurance. He also does a great job of explaining the time value of
money and compound interest. BUT HE IGNORES BOTH OPPORTUNITY COST AND THE TIME
VALUE OF MONEY in his mortgage videos.
These
are enormous errors in any financial analysis. We must always consider the most
valuable alternative in any decision making process and no student should ever
leave a finance class without understanding that cash flows need to be in the same
time period in order to add and subtract them. Taking all these things into consideration,
it would be easy to determine that it is Dave who can't add, but that wouldn't
be any more accurate than Dave's denigration of CPAs and financial advisors. I
can only conclude that Dave just doesn’t want to complicate things (he is trying
to be a good dad). While his intentions may be honorable, the fact is that he
just isn't telling you the whole story. What he is keeping from you is the
concept of financial leverage. Certainly, financial leverage can be risky even
in the hands of the most sophisticated investors, but with so many financial
professionals (including Warren Buffett who is one of the richest men in the
world) advocating 30-year mortgages (as well as the professional journals, see
excerpts from these journals in my April 30th post: Why Putting Everything in Your Mortgage is
Risky), I want you to understand why this is the case.
Here
are the numbers Dave uses in his videos:
- Mortgage: $225,000 at 6%
- Monthly Payment for 15-Year Mortgage is $1,898.68. Multiply by 180 months for a total of 341,762.02
- Monthly Payment for 30-Year Mortgage is $1,348.99. Multiply by 360 months for a total of 485,635.93
The
difference between the 30 and 15 year mortgages is 485,635.93 – 341,762.02 =
143,873.91. This is how much a 15-year mortgage will save you according to Dave
Ramsey.
There
are two problems here: 1) these cash flows take place over time and therefore
do not have the same value. This means that we cannot simply multiply the
amount of the payments by the number of payments as Dave did above (remember, money
has a time value, a dollar today is worth more than a dollar tomorrow because
we can invest the dollar today and have more than a dollar tomorrow), and 2) we
must consider the alternative use of the difference in payments. The 15-year
mortgage payment is $1,898.68 and the 30-year payment is $1,348.99 with the
difference being $549.69.
A CRITICAL POINT IS THAT THIS $549.69 DIFFERENCE HAS
ALTERNATIVE USES AND THESE USES MUST BE CONSIDERED WHEN ANALYZING MORTGAGE
CHOICES.
Given
what we know about the historical returns in the financial markets, the 30-year
mortgage may be a very good option BUT IT ALL DEPENDS ON WHAT YOU ACTUALLY DO
WITH THE $549.69. If you opt for the 30-year mortgage and just spend the extra
$549 on who knows what, then you would have been better off with a 15-year
mortgage as Dave asserts. However, suppose you are very disciplined and invest,
rather than spend, that $549. Then what? We will look at three possible
scenarios. All numbers are after tax.
Scenario #1: The
investment return is equal to the mortgage rate
Okay,
you want to pay your house off in 15 years but you opt for the 30-year mortgage
and are going to invest the difference in payments at 6% for 15 years. You are
then going to take your accumulated investment proceeds and pay off the
mortgage. Here are the numbers:
- In 15 years, your monthly investment of $549.69 will total $159,860
- In 15 years, your monthly payment of $1,348.99 will leave you with a balance on your mortgage of $159,860
In
this case, you are completely indifferent between a 15-year and 30-year mortgage because you have exactly enough in your investment account to
pay off the entire balance. Thus, there is no benefit or savings by getting the
15-year mortgage over the 30-year. (For simplicity we are assuming that the
rates are the same on a 15 and a 30 year mortgage. In practice, rates on
15-year mortgages are a little lower and this difference in mortgage rates
would be included in your calculation of the difference in payments)
This
result should not be surprising. You are borrowing and investing at the same
rate so we would expect it to be a wash.
Scenario #2: The
investment return is greater than the mortgage rate
This
is where you can really do quite well by having a 30-year mortgage (and why so
many financial professionals recommend this). As noted previously, a 30-year
mortgage will have a lower monthly payment than a 15-year mortgage and if you
invest that difference each month in a stock index mutual fund over that 15-year
period, you can be well ahead of the game. Using Dave’s numbers of 12% (which he uses in his video on investing) for the
long-term return (maybe a little optimistic,
frankly), we have:
- In 15 years, your investment will total $274,614
- As before, your mortgage balance after 15 years is $159,860
After
paying off your mortgage, you will have $114,754 left over. In this case, a
15-year mortgage would not have saved you anything. Rather, it would have cost
you a bundle. You would have missed the opportunity to earn an extra $114K .
Scenario #3: The
investment return is less than the mortgage rate
This
time things didn’t work out as planned and the investment only returned 3%:
- In 15 years, your investment will total $124,764 and the mortgage balance (it doesn’t change) is $159,860.
- Since your investment returns are less than the mortgage rate, you won’t have enough to pay off the entire mortgage and will still owe $35,096.
So what should you do?
It
all comes down to how risk averse you are, how self-disciplined you are, and
how much you understand investing. For those who are not very knowledgeable
about investing and/or not very self-disciplined, I would seriously
consider the 15-year mortgage as Dave advocates. On the other hand, if history
is any indicator of the future (and it may or may not be), investment returns
are likely to be higher than mortgage rates over the long term and financial
leverage can be a great way to increase your wealth. As always, there are costs
and benefits (and risks) with any road we take.
MM
Tuesday, May 21, 2013
The
Crucial Importance of Profit
We often hear 'profit' spoken like it is a dirty word. The fact is, however, that without these nasty little profits, we would not have anywhere near the innovation, entrepreneurship, productivity, and standard of living we enjoy today. Why would anyone do all the work and take the risks of inventing and innovating unless they believe it will make them better off?
Let me explain it this way. Suppose you have been saving your money to buy a new mountain bike, priced at $1,000. Just as you are ready to lay your money down, a stranger comes up to you and asks you to lend him that $1,000 so he can buy a mountain bike instead. He promises to pay you back in one year. You will probably wonder why you should you forego the enjoyment of a full year of mountain biking just so this other guy (a perfect stranger) can ride? Most likely you will not make this loan because you are not getting anything in return.
BUT if you are compensated for giving up all that bike riding, now that is a different story. If the borrower offers to pay you $1,500 next year (instead of just returning your $1,000), you may be very happy to make this loan. It depends on whether or not the $500 interest adequately compensates you for the lost enjoyment. If $1,500 isn’t enough, then maybe $2,000 or $10,000 will do the trick. The point is that you will need to be made better off (make a profit) to be willing to defer consumption into the future.
The same thing applies when we purchase shares of company ownership in the stock market (or lend our money in the bond market, buy CDs, or deposit money in a savings account at the bank). If companies don't make profits that can be shared with their investors, we will not purchase their stocks and these firms will not have the funds needed to make investments in new technology and new products and our standard of living will be static.
So profits are desirable. Without the profit motive we wouldn't have automobiles, iphones, computers or air-conditioning. The pursuit of profits is what unleashes the forces of innovation. It is what allocates scarce resources to their highest valued use. It is what determines if we have too many hair dressers, lawyers, truck drivers, or not enough engineers.
Please see the Paul Solman video below (about 7 minutes)
What is Profit?
MM
We often hear 'profit' spoken like it is a dirty word. The fact is, however, that without these nasty little profits, we would not have anywhere near the innovation, entrepreneurship, productivity, and standard of living we enjoy today. Why would anyone do all the work and take the risks of inventing and innovating unless they believe it will make them better off?
Let me explain it this way. Suppose you have been saving your money to buy a new mountain bike, priced at $1,000. Just as you are ready to lay your money down, a stranger comes up to you and asks you to lend him that $1,000 so he can buy a mountain bike instead. He promises to pay you back in one year. You will probably wonder why you should you forego the enjoyment of a full year of mountain biking just so this other guy (a perfect stranger) can ride? Most likely you will not make this loan because you are not getting anything in return.
BUT if you are compensated for giving up all that bike riding, now that is a different story. If the borrower offers to pay you $1,500 next year (instead of just returning your $1,000), you may be very happy to make this loan. It depends on whether or not the $500 interest adequately compensates you for the lost enjoyment. If $1,500 isn’t enough, then maybe $2,000 or $10,000 will do the trick. The point is that you will need to be made better off (make a profit) to be willing to defer consumption into the future.
The same thing applies when we purchase shares of company ownership in the stock market (or lend our money in the bond market, buy CDs, or deposit money in a savings account at the bank). If companies don't make profits that can be shared with their investors, we will not purchase their stocks and these firms will not have the funds needed to make investments in new technology and new products and our standard of living will be static.
So profits are desirable. Without the profit motive we wouldn't have automobiles, iphones, computers or air-conditioning. The pursuit of profits is what unleashes the forces of innovation. It is what allocates scarce resources to their highest valued use. It is what determines if we have too many hair dressers, lawyers, truck drivers, or not enough engineers.
Please see the Paul Solman video below (about 7 minutes)
What is Profit?
MM
Tuesday, May 14, 2013
Who
are you who are so wise in the ways of science?
So logically, if she weighs the same as a duck, she's made of wood, and therefore ...
Critical
thinking is all the rage in higher education these days -- and for good reason.
It is critical to think critically J. But what exactly is critical thinking? Well,
sometimes it is best to begin with what something is NOT. This is one of my favorite
examples of NON critical thinking:
http://www.youtube.com/watch?v=zrzMhU_4m-g
http://www.youtube.com/watch?v=zrzMhU_4m-g
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