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Allocation of What? Most asset allocation are allocations of different Asset Classes You want to diversify your risk not your assets
Mid Crap
Large Crap
Foreign Crap
It doesn't really matter. Rain. sun or snow it will still behave like crap.
It the same for stocks. For the most part stocks will behave like stocks. Small Cap Mid Cap Large Cap When the market tanks they all go Cap-put.
Like This.
But, before you do that you need to know where money comes from. How does new money get into the economy and eventually into the markets?
U.S. Currency comes from the US Government. Some people think it comes from China, like coffee makers, but it doesn't.
When the government spends money on anything, it is new money in the economy.
When the government taxes it removes the money. The money isn't re-spent it is destroyed.
It works like this. New money is spent into the economy and old money is taxed. The government doesn't spend your tax money, but people like to believe it does.
The money pools in the economy as private sector liquidity The private sector liquidity is what we spend, save or invest.
The bank wanting to get interest buys a million dollar treasury bond
Now, everything balances the government spent a million dollars that is deposited in a or many banks. The banks buy bonds and now the government has borrowed back its own money. So now there is a million dollars of new money and a million dollars of government debt. Everything balances.
Once again, everything balances the bank loaned 100,000 dollars to the boat owner. Then it reserved the loan with the money it lent. So now there is a 100,000 dollars of new money and a 100,000 of bank debt. Everything balances.
Government Taxes
To make money you investing you have to catch the money as it flows through the system.
To make money you investing you have to catch the money as it flows through the system.
Ask yourself where does the money go inside the economy on its journey from creation to destruction? If it goes to bid up the price of your financial assets you'll make money.
In this model, money is save if it is put into a government-guaranteed bond or bank account. Anything else is investing or spending.
When it is invested it moves from buyer to seller without being destroyed or removed from the economy
Money Supply
Stocks
Real Estate
Buyers money
When you buy a stock the supply of money in the economy doesn't change it just goes from buyer to seller. So how can you make money?
Seller's money
So if in an imaginary world we diverted all of our money to stocks they could never go up in value because there is only so much money. (assuming our money supply is unchanged)
If there is only $100 dollars in the money supply that is the most you can sell your stock for.
For stocks to increase, investment money has to be diverted from elsewhere in the economy from savings or consumption.
If you want the to spend more on the investment you have to spend less on the other two things.
Less spending Less saving
More investing
That's why we usually don't have goods and service inflation at the same time we have a bull market and economic growth (spending growth). Think about the 1990's. Good market low inflation. Or the 1970's high inflation lousy market.
If the money gets saved in a government bond instead then the currency disappears out of system until the bond matures.
This is because a dollar is a type of bond a bill of credit that's why we call them bills. If you buy a bond with a another bond from the same issuer one is canceled out. The currency disappears for the length of the bond.
When the money is spent on investment and consumption it is recycled from buyer to seller. But when it is saved it is take out of the system.
When money flows to stocks it is recycled back into the economy. When it goes to government bonds it is not.
When currency flows increase into government-insured savings instead of consumption we get
DEFLATION
Deflation occurs when the price of assets, wages, goods, or services decrease. This usually bad for the economy because the price of assets goes down but the level of debt remains constant. . This is what happened during the financial crisis.
Deflation occurs when the flow of money goes into governmentguaranteed savings. This money cannot be recycled into debt repayment and makes it difficult to pay down the debt.
As the flow of money is redirected the price of stocks decrease and the price of government bonds increases.
To combat deflation with Quantitative Easing the Fed buys government bonds to create a shortage and make it harder to save.
When the money flows into consumption instead of savings we can sometimes get
INFLATION
General or goods and service inflation occurs when the prices of wages, goods and services increase. It isn't always bad. It is good if your wages increase and you owe a lot of debt. You can pay off the debt with cheaper dollars. This happened in the 1960s and 1970s.
Inflation occurs when the flow of money goes into consumer goods, fuel and food. This leaves less money for savings, stocks and bonds
The price of stocks tends to decrease and the price of government bonds increases.
To combat inflation in the early 80s the Fed sold government bonds to create a surplus and make it easier to save.
Fed sells Gov. bonds creating a surplus Money is remove from there economy The money flows from other places
ECONOMIC EXPANSION
When money flows into investments instead of consumption or savings we usually get
ASSET INFLATION
Investors like inflation that increases the value of their investments. Most allocations focus solely on this economic outcome. Asset Inflation. But if assets don't inflate neither does your portfolio value.
Most standard allocations rely predominately on asset inflation. If financial asset prices don't inflate then the allocations perform poorly.
A risk allocation doesn't allocate between types of assets it allocates between economic outcomes
Here is a simple portfolio composed of investments allocated to the four economic outcomes.
Find out more about money flows and risk -managed allocations in the book.