Lecture Notes by Dr. Anne Marie Macy
Copyright 2012: Material is for classroom use only. No part of the material may be used outside of the classroom without Dr. Macy’s written consent.
Material must be cited correctly.
Dr. Anne Macy – Investments
OPENING THOUGHTS ON CONSUMPTION
Investment is the current commitment of resources for a future benefit that may or may not be realized but is anticipated at the time of commitment. I like to think of investments as a current commitment for future consumption.
Think of the economics identity: Y = C + S + T. Income is equal to consumption plus savings plus taxes. Y- T is disposable income or what is left over after you pay taxes. Consumers have a choice between consuming the income and saving the income. Consumers typically choose consumption. Why? Well, there are many reasons but a few are that consumption is a lot more fun, peer pressure to consume, a desire to “grow up,” a way to compensate for things lacking in your life and other ideas. Basically, the current society is made up to promote consuming. Thus, saving or investing (terms in this sense are the same) is a choice against the common norm, which makes it a hard choice. Many people want to save but they just cannot over the long term.
It is kinda like dieting. You can diet for a day or a week but eventually the sweets are just so tempting you have to eat one and then another and then another…
So, is there a difference between saving and investing? Not really but people typically think of saving as an act of accumulating money so they can invest or buy a house or whatever. Thus, saving is a precursor to investing. I would like you to think of saving as a form of investing.
With saving, one is investing in cash.
Now back to disposable income. Consumers have a choice between consumption and savings. I would like you to think of the equation as present consumption (C) and future consumption (S).
Savings is just an accumulation of wealth for future consumption. Maybe if you think of it this way, saving will not be so hard. You are not saving to save but saving for a reason – to buy the house or car, to go on trips, to afford a family, or for retirement. Think of how you will spend the savings instead of just savings. It makes it easier because you have a definite goal. I know this from experience not a textbook.
It is this first choice, to wait to consume, that is the hardest in investing. Picking a mutual fund or a stock is fun – but saving the money to buy the stock and then waiting for the stock to appreciate, this is the hard part. It is so hard that most Americans do not make the choice.
Instead, they choose present consumption to the point to excess.
The latest figures from the Federal Reserve have that the average credit card debt at over $7,300.
About 25% of households do not have credit cards. Of those that have credit cards, about 60% carry a balance. For them, the average credit card balance is over $15,000. This is huge. How can you save if you owe $15,000 just on your credit cards? Personal bankruptcies are high. If one adds in car debt, mortgages or other debt, the average person spends one-fifth to one-third of his/her before tax income on debt. Debt rivals food and utilities as a cost of life.
Dr. Anne Macy – Investments
All this debt means one thing: people are consuming so much more now (more than they can afford) that they will have to pay off the debt in the future with future income. However, if future income is going to pay for past consumption, the amount available for current consumption at that time is severely limited. In addition, forget about future consumption; there is nothing left.
Many financial economists are worried sick about the debt levels carried by Americans. Even more worrisome is who is carrying the debt. People in their prime earning years can carry more debt because they have the income for the debt. However, new figures are