The idea of “putting your money to work” probably appeals to you. You want your money to do something for you, right? But what does that really mean? After looking at a few financial websites, I’ve identified three broad categories of “money working” in current use:
- Using money wisely
- Maximizing your compensation
- Investing
I can’t argue with using money wisely or maximizing compensation, but when I hear someone talk about putting money to work, my mind turns immediately to investments.
Money is a unique asset. It serves as a medium of exchange, a store of value, and a unit of account. The table below provides some examples of each of those functions. Fundamentally, the functions have to do with liquidity and stable value. You want to be able to easily trade your money for “stuff” today, tomorrow, and into the future — that’s liquidity. You also want to know how much stuff you can buy with a given amount of money over those same time periods — that’s stable value.
My point is simple. As we “put money to work,” going from cash to bank accounts to CDs to bonds to stocks, we move further and further away from “money.”
Cash is clearly money. If you have cash, you can open your wallet or purse and look at it. You can go to a store and hand over some cash and walk out with stuff.
Bank accounts are very close to money. You can receive your salary in your checking account and spend it by writing a check or swiping a debit card. But these accounts are less liquid than cash. They are FDIC insured loans you’ve made to the bank.
Certificates of deposit have more limits than savings accounts. You buy a CD and receive a specified rate of interest if you hold it until it matures. If you cash it earlier, you may face penalties, losing potential interest or even part of the principal. With bonds, the picture changes. Bonds are loans too, to the U.S. government, to a municipality, or to a company. The prices on your statement may be higher or (sadly) lower than what you paid for them. Deposit insurance doesn’t apply to bonds.
While bonds represent borrower (issuer) promises to pay, only Treasury bonds have the backing of the U.S. Treasury. Other bonds have “credit risk,” the possibility that the issuer will default.
In short, bonds are different from money. Bonds make interest payments like savings accounts and CDs, but to buy stuff, you must sell them for money. And you may get back less money than you paid for them.
Finally, we come to stock. Companies issue stock to raise money to finance their operations. Stock is a receipt for money you give to a company’s management who use it to run the company. Your statement lists how many shares in each stock you have, how much you paid for them, and the most recent price. Stock prices are unstable. Even the stocks of companies that seemed solid and reliable can go down, sometimes by a lot, even to zero. The table below lists some of the public companies that went bankrupt in just the last three years. Shareholders’ stock became worthless.
When you look at your brokerage statement, it’s harder to see the relationship to your money. Stock statements and certificates seem to be written in a different language. They mention:
- Earnings, revenue growth, competition, and profit opportunities
- The economy, consumer confidence, inflation and how they affect stock prices
Just as with bonds, you must sell your stocks if you want to buy stuff, and you may find yourself with less money than when you started. They also say nothing about stability and purchasing power.
There are also many others in the conversation. Everyone seems to have an opinion about your stocks, their future value, and whether current prices accurately represent what the stocks are worth.
Why Is This A Problem?
We tend to think of our bonds and stocks as money.
That leads to applying “money ideas” (especially “store of value”) to non-money holdings. For example:
- “I have $50,000 in savings, $150,000 in my 401(k), and $100,000 in my IRA, for a total of $300,000.”
- “I put $100,000 into my brokerage account. My statement says it’s worth only $75,000, but I “know” it’s going to come back to at least $100,000.”
- “I put $100,000 into my brokerage account. It went up to $125,000, but my statement says it’s worth only $105,000. I “know” it will recover to $125,000.”
Stocks and bonds are financial assets, but they aren’t money. Their values fluctuate. Bonds represent a known series of cash flows (interest and principal payments), but the value of those flows changes every time interest rates change. Stocks represent a claim on future company profits. The schematic diagram above illustrates the important differences. Investments that offer the potential for higher returns have less liquidity and value stability than money.
Thus, in the investment context, “putting your money to work” really means:
- Buying risky financial assets
- Going from:
- Store of value to profit (and loss) opportunity
- Unit of account to an account
- Medium of exchange to something you must sell, maybe at a loss, to buy stuff
Saying “putting money to work” sounds much safer than “buying risky financial assets.” This word choice can deceive us about the risks we are taking.
What Should We Do Instead?
- Vow not to say, “put money to work.”
- Remember that money is special — its (relative) stability and liquidity are unique.
- Translate anyone else’s comments about “putting money to work” into “buying risky financial assets.”
- Understand the risks of these financial assets and decide what to do with our money with those risks in mind.
This is hard! “Money thinking” pervades our view of the financial world. Because dollars are the unit of account in the U.S., we talk about all assets in dollar terms. We picture half-million-dollar houses and $50,000 cars. We know what our dollars can buy. However, our confidence in money’s liquidity and stability should not extend to stocks and bonds, and it’s wise to avoid expressions that encourage us to do that.
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