I heard today of some hedge fund or investment company returns in excess of 30%. Whether you believe that or not - I do - does this mean that something has become 30% more valuable? What could that be in today’s world? Nothing tangible, I’m thinking. Maybe a promise (e.g. mortgage, IOU, European money, ?) Did someone create some wealth? Did something increase in value? What happened? I realize I’m asking for a brief course in econ, but is there a relatively simple explanation for a simpleton of how something can appreciate today, when all we hear is how bad the global economy is?
Even if the economy is the downward part of a business cycle, that doesn’t mean that all the markets heading downwards. And even if a market is heading downwards, that doesn’t mean that all the securities in it are losing value. And even if a security is losing value, institutional investors can make investments that will profit when prices go down. The trick is finding the investments that are likely to make money, and coming up with the capital to make them.
“It’s no trick to make a lot of money if all you want to do is make a lot of money.”
OK, a quick course in economics.
There are several basic roads to creating wealth. While their basics differ considerably, the common denominator is that somebody wants them enough to offer money for them.
That may seem obvious, but hides a lot of profundity.
Wealth used to start with gold or precious gems. They have no intrinsic value, but are rare and shiny and are perfect for displays of status. What are they worth? Depends on how rare they are and what the need for status is. Could there value increase by 30% in a short time if there’s a lot of competition for them? Certainly.
Now apply the same principle to other realms.
Everybody needs food, shelter, and clothing. There’s a drought and crops fail. The remaining crops are worth more. The population grows and there are only so many houses in desired locations. They become worth more. Clothing normally doesn’t appreciate or fail so rapidly, but high status clothing can cost much, much more than ordinary clothing.
You need materials to process the food, build the houses, weave the fabrics. Commodities are raw materials in bulk. They are subject to the same rules of supply and demand. Prices can soar if they become harder to get or if new processes are developed that require more of them.
Companies use commodities to make products. That’s part of their costs. The products are part of their profits. Some companies do this far better than others, and so the present value of those companies are far higher than others.
The future value of companies tends to parallel present value, but some companies are much more likely to increase value than others. You can bet on the increase of that value in a systematized way. That’s called the stock market.
You don’t even necessarily need commodities or companies. You can make value out of essentially nothing. That’s what intellectual property is. A novel, a song, a software program, a patent, all take relative nothingness and can make it extremely valuable.
So that’s a whole long list of ways something can worth 30% more at the end of the year than it is today. And I haven’t even mentioned the whole financial industry, which exists to exploit these various and sundry rises in value and make them available to more people than just the ones directly involved.
In today’s world I would run, not walk, if someone offered me a hedge fund that promised a 30% return. But it’s not impossible and it’s not magic. There are undoubtedly a huge number of things you yourself - you the OP and every other one of us - would pay a 30% premium to own or have or do or consume. As long as that is true for the individual, it will be true for the mass.
That’s where wealth comes from. Always has. Always will.
I believe that some things do increase in value over time. My question is, then, what types of things - specifically - could be increasing at that rate right now? My guess was that wealth was not being created, per se, but that something did, in fact, find itself in greater demand, and I wondered what that could be. (maybe those things are not mutually exclusive). With the stock market steady or losing value, what is becoming more valuable? With US housing prices falling, and other prices falling, what is becoming so much more expensive, i.e. in greater demand?
Also, and I don’t know exactly where the 30% number comes from, but that can reflect the opportunity cost versus a standard such as the S&P 500. IOW, the amount of money invested at the start of a certain time period would be worth 30% more than if the investor had invested in a S&P 500 index fund. Note that if the S&P is tanking, the 30% might just mean that the fund didn’t tank as fast, but may have still lost money. The fine print usually mentions that past performance is not an indicator of future performance, but the person selling you the fund goes out of his or her way to highlight the 30% in neon. And they make you late for lunch, but that is another story…
FWIW,
Rob
12 months ago, you could buy a barrel of oil for $70
Today, you could sell that same barrel for $105
(of course next year there’s a chance that it might be a lot less)
Wealth is being created. That’s the definition of a return on investment.
We live in a world economy. Stop thinking about the United States and ask yourself what’s growing anywhere in the world, for any reason. That’s where the smart money is going and that’s where it’s being made.
A lot of commodity prices have risen rapidly in the last year. Gold and silver priced in USDollars have gained close to 30% at some points in the last 12 months - shares in extraction industries may have gained even more if the market anticipates a growth in future demand. The theory is that emerging industrial economies (China) are driving demand, while supplies aren’t growing.
OTOH it might be easier to understand hedge funds if you think of it in terms of speculation (gambling) rather than economics.
A given hedge fund could certainly have shown 30% growth for last year even in a bad market by doing a lot of shorting (betting on share prices dropping), derivatives and currency trading, or simply getting lucky, trading volatile stocks a lot at the right time - buy low, sell high, rinse, repeat. There are various strategies (and automated trading models) for maximizing returns, but once enough funds jump on the bandwagon, they cancel each other out.
The key to high returns is leverage - getting the most bang for your buck. Trading derivatives can generate much higher returns than trading stocks, but can also generate much greater losses.
So obviously an aggressive fund that showed 30% gains last year is more likely to show 30% losses next year than a more conservative fund which only showed 7 or 8% gains last year. Risk and reward.
Are you thinking that all funds are improving by 30%? There is a lot of fluctuations in the market, so it is perfectly possible that some funds are increasing by 30%, and some are losing 30% (and they’re not talking about it) but most are losing on the average.
Just think of how well you can do with tomorrow’s newspaper, no matter what the market in general is doing.
What did those funds do last year, and what will they do next year? The variance on ROI over all funds is very large.
Others have gave good replys so far, but remember, not one talks anout how their fund lost 30% at a party. That’s why “day trading” seemed like such a great idea a few years back. The winners were bragging and the losers kept their mouths shut.
I’m going to take a stab at the OP. All the replies downpost are good and reasonable replies. But they might have missed the intent of the OP. I interpret the OP to ask how can any single economic activity, say a gold ingot or a share of stock, really increase in value by 30% in one year? Obviously supply and demand accomplish that-a barrel of oil for instance. But, the oil is still only going to produce the same amount of gas which is only going to result in the same number of miles driven as last year. So, even though the price went way up due to demand, did the value? The economists would say yes. But, my response to the OP is different.
I propose that one reason for sharp increases in value is the expectation of future price rises. Lets imagine that an investor believes an economic activity, say a gold coin or a share of stock, will increase by 10% per year for the next five years. That investor might be willing to pay 30% more this year for that item because she believes that after five years it will be worth more than what she paid for it. The seller either doesn’t share that opinion or would rather get 30% now than wait five years. A market trade is born and the item increased in value by 30%. It was more than price, the value (the expected value) increased because the trader is gambling on the economic activity of the future. If they are wrong, say if they predicted that house prices will continue to rise forever, then they will lose money when the economic activity loses value.
This is still supply and demand, only extrapolated into the future. No conceptual difference at all, which is why economists put them together.