There are many pitfalls that can make you lose money and I will here try and deal with the most important types. This article should be read positively. It speaks of various threats and dangers to wealth and inevitably tends to contain negative thoughts and considerations. One should be positive, however, in the sense that these warnings should serve to make you a better investor by avoiding (or at least try to) the most common mistakes.
More and more, investment is international. Today we have more information about opportunities around the world than ever before and our money has more freedom to move. This series of articles is therefore written from the perspective of an international investor, one who can choose the country in which to invest as well as the business sector, the individual companies or index, and the securities, be they shares, preference shares, bonds, derivatives, and so on.
One of the first problems that comes to mind, when seeking to preserve wealth over time, is inflation. Inflation comes about because there is more money in the economy than the value of assets, be they goods or services.
As a result, the value in money terms of these assets rise and, inversely, the value of the money falls. Monetary authorities, such as central banks, attempt to control this inflation by increasing interest rates. In times of deflation, where the price of assets is falling, central banks cut interest rates.
Deflation is a problem because it is usually accompanied by falling profits. In times of deflation, cash is king. The same amount of money buys more things tomorrow than it does today.
Inflation is, in a way, more of a problem. Time passes and your money loses purchasing power. An inflation of three per cent is considered benign but it still manages to halve your money in 20 years! The problem with inflation is finding a solution. Different types of assets are rising in value at different rates and you have to anticipate these increases, shifting your money from one form of asset to another.
Inflation is often measured by measuring a basket of consumables, basic things we need to have a fairly decent life. But if the price of property is not included in the basket, for example, this will catch up with us tomorrow when we have to pay higher rent, or when we have to buy the same house at a higher price.
Certain inflation indices do take house rents in consideration but, even then, there is much in favour of the argument that even the price of shares has an indirect effect. If shares rise in value, so will the price of other assets, such as houses, roads and hospitals.
Our weakening dollar or euro or lira will have to make good. Indeed, to have a good picture of inflation, one should also input the taxes, licences, penalties and fees one pays to government which is really nothing other but the imposed membership fee of living in a particular country. These too inflate.
There is no one universal solution to inflation. You as an investor, someone with assets rather than liabilities, will have to watch what's happening and try to get a piece of the action. Buying one's own home and investing in shares usually helps. Shares have a "living" income, as against bonds, which usually provide a fixed, static income.
In trusting your money around in different countries, keep in mind also that governments generally prefer inflation to deflation. Inflation is more of a tonic to people (and thus helps catch votes) and has the added benefit of reducing the real value of government debt. That is why central banks should, as much as possible, be independent of government.
Another problem is taxation. Tax is all the money government raises in various ingenious ways from within its borders. Taxation is a great, if not the greatest, social tool. By means of taxation one can decide practically any social issue: wealth transfers, encourage certain activities rather than others, burden or lighten up cash flows, consumption patters, the level of savings and investments, etc.
Like most great things, taxation cuts both ways. To an investor, the study of taxation should be nearly as important as the study of the markets.
An investor should not only study what is being taxed and at what level, but also how it is being taxed, the administrative and other methods being used, and should also try to read between the lines of tax policy, laws and action.
Which activity is being encouraged? Which part of society is being preferred? Is there equity (fairness) in the taxing proces? All these are important things one has to study in order to try and form an idea of how the future may unfold.
The aspect of wealth transfer is very important and should be monitored carefully. Most modern social systems are based on taxing those who have (or seem to have) and giving money to those who have not (or have less, or seem to). Government also spends tax money on providing those services that it deems important. All this involves spending money.
There is therefore a tax-and-spend process which, in itself, if executed in a fair manner, is not objectionable and, indeed, may give society a stability which it might otherwise lack, and this stability itself creates wealth. That's the theory. In practice, this tax-and-spend process tends to expand, often pulled by the expenditure end, since governments around the world like to spend money.
This tax-more, spend-more expansion goes on until it is halted - either by human laws, such as those of the EU's Stability Pact, which are currently under attack (of course), or by the laws of economics.
I think it was George Bernard Shaw who said that if one robs Peter to pay Paul, one can count on the support of Paul. If there are more Pauls than Peters, guess who gets elected, and what happens... You get my drift. This is a vicious circle we should all be very careful to avoid, both as citizens and as investors, because it is the high road to ruin.
When you invest, think these things through and try not to get caught in traditional patterns of thought, e.g. left versus right. Look at the facts, analyse as much as you can. For example, I was speaking of the dangers of a tax-more, spend-more government but a government which taxes a lot but spends little may also be up to no good and, indeed, may be working to a hidden agenda.
With a spendthrift government, at least, money is re-recycled and people would have money in the pocket, at least until the good days last. Wisdom lies in balance and is therefore so elusive.
Paul V. Azzopardi is managing director of Azzopardi Investment Management Limited (www.azzopardi.com) which is licensed by the MFSA to provide investment services, including stockbroking. This article is only meant to provide information, which the writer believes to be accurate at the time of writing, and is not intended to give investment advice and its contents should not be construed as such. The value of securities, and the currencies in which they are denominated, may go down as well as up. Readers are requested to seek professional financial advice tailored to their own personal circumstances.