He is one of the most influential men in history. He is respected in almost every culture around the world. In Dante Alighieri’s 14th-century epic, The Divine Comedy, he writes of him;
‘I saw the Master there of those who know,
‘Amid the philosophic family,
‘By all admired, and by all reverenced;
‘There Plato too I saw, and Socrates,
‘Who stood beside him closer than the rest.’
The man I’m referring to is, of course, Greek philosopher Aristotle. Like all philosophers, Aristotle would often sit in silence and ponder. He would let ideas of human nature and the physical world flow into his mind. In his book Politics, written 2,366 years ago, he even reasoned why he thought money existed.
His initial thought was that every object had two uses. The first being the object’s intended use. The second was the possibility of selling or bartering that object.
Aristotle thought we would use a plough to plough the fields — its intended use. Or that we would use the plough to trade for an Ox, sack of grain or other form of good.
Having physical coins, or other forms of money, did not arise until people started to trust each other and the external authorities of the time (kings, governments, etc.), Aristotle thought.
However, while he might be one of the most brilliant men in history, Aristotle’s ideas have been wrong a number of times. And his idea on money isn’t an exception.
David Kinley, author of ‘Debt: The First 5000 Years,’ completely disagrees with Aristotle. Kinley believes money was invented when the obligations of ‘I owe you’ transitioned into a quantifiable ‘I owe you one unit of something.’
If we take this view, money has been around as long as credit which has existed since the dawn of civilisation. Man has always attempted to borrow from his neighbour. If it wasn’t cold hard cash, then it was crops or tools.
But the invention of fiat money (paper money), which holds no real value, is the underlying cause that could wipe out your cash at the bank. I’m not disagreeing that fiat money has led to rapid economic expansion and prosperity. But it is open to abuse by governments and central banks.
Digging the hole deeper
The ability to create more money is a large reason why your savings won’t be worth much in the future. Of course, inflation is generally a good thing in moderation. More money circulating the system will likely put upward pressure on prices. However, this also has an effect of lowering the currency’s value.
Let’s say you have all your money in the bank. You’re a saver and you think it’s smart to have your money in a safe position.
You might be earning 2% to 3% on your savings account. At the same time, your money is also losing its value. How? As more money is created, each unit is worth less.
I’ll use a simple example to explain.
Assume a country has 100kgs worth of gold as federal reserves. So they’re insuring 100kg worth of gold across their fiat money. If they start to create money at an accelerated rate, each unit of currency become less valuable. There is more currency within the system and, therefore, is still divided up to equal 100kg of gold.
This is of course a very general example, but it shows you how saving isn’t the smartest idea. Worse still, the Aussie dollar isn’t even backed by gold anymore. Instead it’s backed by trust.
In backing a currency by trust, the disincentive to create money has been removed. This is why, instead of saving, investors generally choose to buy assets which hold their value.
Creating accelerated returns
Assets can be defined as resources, property, goods, effects, valuables…the list goes on. But what we commonly think of assets are things like bonds, stocks, real estate and commodities. All of which are bought to create value for investors.
A common question investors will ask is: What’s the best asset to invest in? And it really comes down to what the investor wants to do. Do they want to take on no risk and earn steady, less exciting returns? Or do they want to take on a bit more risk and potentially earn explosive returns?
My preference is the latter. I’d rather take on extra risk in order to earn high returns.
But there is usually a misconception about risk. A lot of the time, risky investment can be managed.
For example, you could buy a put (an option to sell) on a stock you’ve just bought. This allows you to limit your losses to an extent. You could also set stop-loss orders. These orders sell out your position once the stock has dropped to a certain point.
While it is risker investing to achieve higher returns, don’t think of it as a speculative punt. One of the investments that can potentially earn triple-digit returns are small-caps.
It seems logical when you think about it. Bigger companies are already mature. The next step for them is to either cut costs or grab extra slices of market share. However, a small-cap stock is just getting started.
They have huge potential to aggressively grow profits. They may even have the potential to break into new industries. As earnings increase, this is usually followed by a spike in the share price. But remember, you’re taking on additional risk in order to boost returns.
But if you invest only what you’re willing to lose and cut your losses early, your winners should more than make up for the losers.
Junior Analyst, Money Morning
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