In a market based economy there are four essential inputs required to create wealth.
- Natural Resources
- Skilled Labor
- Intellectual Capital
- Financial Capital
As an investor, you are providing financial capital, and as a result you are entitled to your share of that increase in wealth, the “capital market rate of return.” So what is the “capital market rate of return?” It depends upon the amount of wealth created in the economy. In a recession, it will be less than zero. When there is economic growth, true “wealth” is created.
The problem is most investors do not even come close to getting what is rightfully theirs. The return on equities over the past 100 years has averaged approximately 10%, well in excess of what most investors earn. Admittedly, a positive return on capital is not there every year, but if there were no return on capital, capitalism would have failed as an economic system many years ago.
So why do investors leave so much on the table? They make two big mistakes. They have a portfolio that is not properly diversified, and/or they try to time the market. When you attempt to pick the “winners” or attempt to time the market, in my opinion, you are speculating, not investing. Speculation can be fun, and as long as you understand that is what you are doing, it’s okay. I used to tell my clients, take a part of your capital that you can afford to lose and have some fun, play the market, bet on basketball games, go to Vegas, but whatever you do never speculate with your “investment capital.” You may destroy your financial future.
2 responses to “Capitalism 101: How Wealth is Created”
Gold Dan, absolute gold this blog.
I still remember you explaining this very concept in more detail at a conference here in Melbourne Australia a few years ago. We miss you, come back soon! Matt
This is great Dan. I like reading your articles in context to my small business and how to think through internal investments as well as long term market investments when I do. I appreciate your info.