Monday, October 1, 2012

The Magic Money Tree

I wrote about this issue over a year ago, but this recent article gives me an opportunity to reinforce the idea.  Data from a survey shows that truly free checking accounts are becoming less common and that other banking fees are increasing as well.  The cause, of course, is the well-intentioned efforts of our government to play hero by protecting us from those evil bankers.

What a large number of Americans don’t seem to understand is that there is no magic money tree to fund programs, pay insurance claims or make up for business losses brought about by regulations.  The money in our economy moves within the system and does not appear out of thin air.  When shoplifting increases, the store loses in the short term but eventually finds a way to pass losses along to their customers in the form of slightly higher prices, otherwise they go out of business.  If the local government workers get a raise in pay or benefits, our taxes increase or some other expense must be cut.  If regulations on credit cards change in the name of consumer protection, the banks figure out other ways to make up for it.  We are all part of that system, and actions within the system can usually be traced back to our money.  This reduction in “free” checking and increase in other fees is a typical example.

Some wonder why stores, banks or insurance companies don’t just take it out of their “obscene” profits.  The answer is fundamental to investing.  If you are willing to settle for a low return on your money you choose a low-risk investment.  Put it in the mattress for absolute safety but no return.  Put it in an FDIC-insured bank account for a small amount of interest.  The more risk you take, the more return you deserve, because sometimes the risk doesn’t pay off.  That’s why stocks, investments in businesses, usually return more than bonds, which are merely loans to companies.  Usually government bonds pay less than corporate bonds for the same reason.  In general, if you buy shares of a company that drills for oil or flies airplanes you take on more risk than if you buy shares of a company that delivers electricity to your house.  If your friend wants you to invest in a new invention or to start a new business, you expect a much higher return.  (Hint: If anyone tells you of a high-return investment that's "a sure thing," you can bet it's a scam.)

As companies face new threats, their risk increases so they owe their investors a higher return.  Threats may be the possibility of increased lawsuits, new government regulations, or merely facing the unknowns of being first to enter a new market.  They shouldn't permanently take these losses out of profit, which represents a return on overall investment, because the risk is higher, not lower, and their investors deserve a higher, not a lower, return.  They are not just being greedy or evil.  The result, however, will often be that we, the consumers, pay more for the same product or service as an indirect result of that added risk.

 Perhaps politicians understand this and are just trying to fool us when they take credit for a new law or mandate to protect us, but let’s give them the benefit of the doubt and assume that they don’t get it either.

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