Naive Investor Chapter 7: Cash.

You're yawning, so let me say, Cash/Money is more complicated than it seems. In many ways, for many naive investors Cash is somewhat of an automatic investment choice. We get paid in cash and then - it sits in our bank account. The act of not spending cash is the investment decision. Some people struggle with this, but for most of you, you read books on investment to get out of cash and in to other things.

But I promise you that cash has very much a life of its own.

Ethicality

I'm going to start with Ethics because it is the most illustrative factor in decisions to be made. Cash alone is innocuous, innocent if you will. It isn't the root of all evil, its just a medium of exchange.
But I believe it is unethical to sit on cash uninvested. Why? For reasons of Opportunity. Let's imagine a very simple planet where we have two people Grandma Betsy and Radical Raphael. Grandma Betsy has $200k saved up under her mattress and otherwise scrapes by on a pittance never spending or drawing on her nest egg for fear that one day she may have to eat it.
Raphael wants to create something beautiful, maybe some frescos, or a statue or something to inspire future generations. But instead he is starving because he is young and has far more ambition than financial means. He wishes he had some money to eat.
Betsy has cash she doesn't use. Raphael needs cash in order to do something creative/constructive/productive. Betsy should invest her cash in Raphael, otherwise she is passively denying him the opportunity to do something with it. Sure she can retain a sensible amount, the amount she cant afford to lose (maybe $50k) but her life will be so much more meaningful if she stops concentrating on surviving and starts thinking about creating - that is the beauty of investing your cash, you actively can create beautiful wonderful things even if you aren't an artist/scientist/engineer/architect/writer whatever.

The only decision remaining is 'how much is enough cash to sit on?' I would suggest, for people who still have the capacity to earn income about 6 months salary. Why? If you suddenly get fired tomorrow it means you have half a year to find a better more suited job instead of taking the first job offered to you.

The rest you should invest, not just to make money but to create opportunities for those that will actually carry the human race forward and furthermore the moment you do, you will also be one of those people that carry the human race forward.

Hopefully post chapter 6, it goes without saying that investing your surplus cash in 'investment' properties isn't helping anybody.

Earnings

Money/Cash doesn't earn money directly. That's the short of it. Money is money. You deposit it in a bank it earns interest though. How can the bank pay you interest? You create a deposit with them ostensibly to 'safeguard' your money, the first thing they do is lend your money to somebody else. For an ordinary savings account the bank will pay 1% or less, they pay so little because they need to lend it out confident that they can beat 1%, they need to beat 1% in order to pay your interest and take a margin for themselves.
So in short if you create a deposit you are really lending money to a bank, who on-lends it to someone aka they invest it for you and scrape of most of the returns. Furthermore for every dollar somebody deposits in a bank, thanks to some accounting trickery the banks lend out about $16, so they really win. Furthermore, property mortgages comprise pretty much 100% of banks lending practices, so not only are you missing out on the big earnings from your investment, it's being invested unethically too. :(

Price

How can money have a price? Money is the price of things right? Yes, but if we convert it to a bullshit mathematical statement

Money = price of things.

We can reverse it so:

Things = Price of money.

This is inflation, already covered in Chapter 3. You always need to beat inflation, and most interest (even in high-interest online savings accounts) won't actually beat inflation.
Perhaps the best illustration is a saying from an old colleague of mine 'they keep putting the price of petrol up, but they don't increase our wages to pay for it.' If wages increased in line with the price of petrol there would be no point to putting the price of petrol up.
I like to think of this tendecy for money to reassess it's own price as the mysterious sentience of money, or 'reality trumps all' similar to Chief Seattle (or whoever) saying 'only when the last fish is gone from the stream, and the last blade of grass has withered and died will we realise we can't eat money.'
Money sitting on a shelf is always thinking about all the things in the world it could be exchanged for, and it reassesses its self-worth. Disturbingly it is usually writing itself down. But it can do this all by itself. Because no matter how much money you have there are only so many resources we have access to. So naturally as those resources get depleted and the money supply increases, the money becomes worth less.

P/E Ratio

The P/E Ratio doesn't really exist, so lets talk interest. There's two kinds of interest of which nowadays we only use one - compounding interest.

There's a lot to interest but hey, we're naive investors so lets stick to a nice thumby rule we can comprehend easily:

Interest = Confidence

So to illustrate - you deposit your cash in a bank, the bank gives you 1% that means the bank has to be confident that it can reinvest your money and earn a return of more than 1%, and it should it could just buy a government backed bond at 6%. The government can raise money through taxation so let's take another route. Let's say it lends it at 7% to a member of the general public. Which means that member of the general public has to be confident they can beat 7% notice that the bank by turns is less confident in the borrower than you are in the bank. But not much. If that guy borrows at 7% and puts it into something highly risky, he is less confident thus demands higher compensation for the risk.
So he asks for 20% interest, thus it's like a test, somebody who borrows from him at 20% has to be confident that they can get 21% return at least. As risk escalates, confidence decreases and higher interest is demanded. Keep in mind, if you lend for something high risk at 20% and it goes bust, then that is your problem, you were willing to lend the money and the 20% was your compensation for the risk you were taking. In principal you are expected to make more than one loan so only 1 in 5 go bad and you suck it up because you are getting 80% return from the other 4... (at least in that example, in all probability 4 out of 5 will go bad, don't try this at home).

Risk

Cash is low risk, thus low profit. In fact in the short term foreseeable future, it is so low risk it comes close to fulfulling the 'greatest risk is no risk at all' principal. Leave your money in cash inflation will erode its value. Such that that $1500 you scrimped and saved for in the 1950s wouldn't last a week today.

Furthermore, lets add catastrophic risks. Let's talk 'the miracle of compound interest' borrowing from 'The Road to Serfdom' by Michael Hudson:

The eighteenth-century philosopher Richard Price
identified this miracle of compound interest and observed,
somewhat ruefully, that had he been able to go back to the
day Jesus was born and save a single penny—at 5 percent
interest, compounded annually—he would have earned
himself a solid gold sphere 150 million times
bigger than Earth.

Now nobody has ever saved up through the miracle of compound interest such a huge amount of wealth, which tells you periodically things come along and wipe the slate clean. This happens thanks to leverage. Say hypothetically that banks lend out $47 for every $1 depositted, and say they lent this money to fund a speculative real estate bubble in California/Nevada. And hypothetically that bubble burst with a bunch of defaulters. Then the bad debts come in $47 times over and the bank cant honor its deposits, this wipes out all the careful savings of those relying on the miracle of compound interest.

So yeah, these things can happen, GFCs, Weimar Republics, All kinds of shit goes down to periodically wipe out savings.

Liquidity

Put simply, Cash is as liquid as it gets. That in many ways is the whole point of cash.

Frequency of Payments

There's two kind of frequencies to worry about.

1. How often does the bank pay interest into your account (monthly, quarterly, semi-annually, annually etc.)

2. How often does the bank compound the interest. Don't get impressed by a huge amount of compounding periods eg. daily, it may result in an effective interest rate less than a slightly higher but compounding semi annually interest rates. 5% compounded daily is more impressive than 5% compounded monthly, but it's doubtful that 5% compounded daily will be worth more than 5.5% compounded annually.

Opportunity Cost

Coming full circle to the ethics we kicked off with. The opportunity cost of money is put simply everything you could buy with it. But most importantly its the cost of what somebody else could do with the cash in a productive activity. That's the opportunity cost of sitting on cash because it makes you feel more secure. Whether it's denying a family in Afghanistan $10 to buy a goat, or denying some physicist $500,000 to make a time-travelling hot-tub.

So that's it, Money is the boring default, but it is more complicated than you think, it can write itself down, it compounds, it can be created by banks, it can be obliterated by mass stupidity, it can theoretically compound to be more valuable than the earth itself.