OK, let's unpack this. Welcome to the Deep Dive.
Today, we're taking on a subject that, well,
it underpins everything from our retirement plans
to global economics. We're talking about the
art and science of investment. We are. And we've
gone through this incredible stack of sources.
You provided a real map of the whole investment
landscape. And our mission today is. Pretty ambitious.
We want to go way beyond just the simple definitions.
We're going to try and unpack the entire ecosystem.
I mean, the history, the different types of assets,
the strategies people use, and the key numbers
that really define this world. The goal here
is to give you those. Aha moments, right? Where
it all clicks into place, but without feeling
like you're drowning in information. Exactly.
Real usable knowledge. Perfect. So let's jump
in with the absolute core principle. I mean,
if we strip away all the jargon, what does it
really mean to commit your resources today in
hopes of getting more back later? It's fundamentally
about deferred consumption. That's the textbook
way of putting it. Waiting for the bigger marshmallow.
Pretty much, yeah. Broadly, it's the commitment
of resources into something expected to gain
value over time. But in finance, it's simpler.
It's the commitment of money to receive more
money later. It's just a calculated delay of
gratification. And that more money later, that
return, isn't just one thing called profit. The
sources are really clear that it comes in a few
different flavors, and you need to understand
all of them. To see the whole picture. Absolutely.
The main goal is generating a return, but it
can show up in three primary ways. The first
one, the most obvious one, is the capital gain
or loss. So that's just the price going up. I
buy a stock for $10. It goes to $15. I sell it.
That $5 difference is my capital gain. Precisely.
And the key word there is sell. We have to distinguish
between a realized gain. the cash is now in your
account, and an unrealized gain. Until you actually
sell it, that gain is just a number on a screen.
It's phantom wealth, really. It could disappear
tomorrow. Same goes for a loss. Okay, so that's
the lump sum part. Yeah. What about the steady
flow of cash that a lot of investors, especially
retirees, depend on? That's the second form,
periodic income. This is the cash flow you get
while you're still on the asset. So you're talking
dividends from stocks, which is, you know, a
slice of the company's profits. Or interest from
bonds. Or interest from bonds, rental income
from property. For a lot of people, this income
stream is actually the main reason they're investing
in the first place. And then there's this third
one, this global wild card that throws a wrench
in the works the second you invest outside your
own country. That would be currency gains or
losses. It's a huge factor. If you own an asset
in, say, euros, your total return back in U .S.
dollars is going to swing around based on the
exchange rate. So you could pick a winning stock
in Europe, but if the euro weakens against the
dollar. Your gain could get wiped out or even
turn into a loss. It's this extra layer of risk
and potential reward that you just can't avoid
in a global market. That sets the stage perfectly
for the biggest, most fundamental rule of investing.
Yeah. The trade -off. You're always, always balancing
risk and reward. It's the iron law. You can't
escape it. The calculus is simple. Investors
demand higher potential returns from riskier
investments. It's their compensation for taking
on that extra danger. And the flip side is, if
you want safety, you have to accept lower potential
returns. Exactly. Low risk, low potential reward.
And we have to be clear, the other side of high
risk... isn't just high reward it's the chance
of high or even total losses right so let's define
risk because the risk of putting money in a savings
account is just fundamentally different from
i don't know buying a portfolio of emerging market
stocks oh completely different worlds a savings
account especially one that's federally insured
has almost no risk the only danger is the bank
itself defaulting and you know government insurance
usually covers that it's a very remote possibility
but wait you just mentioned currency so Even
a super safe savings account can have risk if
I open one overseas. You got it. If you decide
to save your money in Swiss francs, you're now
exposed to foreign exchange risk. If the franc
takes a nosedive against the dollar, the value
of your savings just went down, even if the bank
is perfectly safe. And investments are just.
They're in a whole other league of uncertainty.
Orders of magnitude more risk. With investments,
you have market risk, liquidity risk, industry
-specific risk. It's a much wider, more complex
set of variables. Even for something tangible
like property. Even property. You have risks
of a market crash, tenants who don't pay, unexpected
repairs. The sources do note, though, that property
investors have a tool others don't. A mortgage.
Using leverage can mitigate some personal capital
risk, or you can use a lower loan -to -value
ratio to keep more equity in the asset. So if
this tradeoff is baked in, what's the number
one defense an investor has against getting wiped
out by all this risk? Diversification. It's the
one thing everyone agrees on. Don't put all your
eggs in one basket? It's that simple. But it's
based on a powerful statistical effect. Spreading
your money across different assets, different
industries, different countries, it's proven
to lower the overall risk of your portfolio.
It's especially crucial for anyone new to this.
It's your safety net. To really hammer home this
idea of high stakes, let's look at an industry
that is the poster child for both massive wins
and catastrophic failures. Biotechnology. Biotech
is the perfect case study. Investors are chasing
these. Just life -changing returns from tiny
companies that might have the next blockbuster
drug. But the risk. Yeah. The risk is almost
hard to comprehend. It's staggering. The data
is just sobering. About 90 % of all biotech products
that are researched, 90 % fail to ever make it
to market. 90. So you have a 1 in 10 chance of
success from the outset. At best. And it's not
a quick process. We're talking about a massive
commitment of time and money. The average prescription
drug takes 10 years. A full decade. And $2 .5
billion in capital to develop. Wow. Let me just
process that. As an investor, you're giving money
to a company that needs a decade and $2 .5 billion
for a project that has a 90 % chance of ending
in complete failure. That's it. That is the absolute
definition of high risk. And it's why that 10
% that do succeed have to deliver such astronomical
returns. You need that one winner to pay for
all the losers and then some. It's a crucial
point, especially when we contrast it with something
that isn't really investing at all, because it
has, in theory, no risk. I'm talking about arbitrage.
Right. We should touch on that. Arbitrage is
important because it proves the rule. It's the
simultaneous buying and selling of the same asset
in different markets to profit from a tiny price
difference. But you're not holding it. There's
no long term capital commitment. And no real
risk. You lock in the profit instantly because
it doesn't involve bearing risk over time. It's
not investment. It's a different beast entirely.
And it highlights why risk is so central to everything
else we're discussing. OK, so now that we have
the core calculus down risk versus reward, let's
map out the universe of things you can actually
invest in. We can split it into two big buckets,
starting with the pillars of the modern economy.
Traditional investments. Right. The traditional
universe has four mainstays. First up, you have
stocks. This is just ownership or equity in a
publicly traded company. You buy a share, you
become a tiny owner of that business. Second,
bonds. If stocks are ownership, bonds are basically
a loan. An IOU. Exactly. You're lending money
to a government or a corporation. In return,
they promise to pay you regular interest payments
and then give you your original money back when
the bond matures. Generally seen as safer than
stocks, but with lower potential returns. Third,
and people forget this one, is cash. Yes. Holding
cash is absolutely a strategic decision. It's
your ultimate safety asset. Professionals use
it to lower portfolio risk, stay liquid so they
can prance on opportunities, or even bet on currency
movements. It has what's called option value.
but a power to act. The power to act, exactly.
And fourth, real estate, bricks and mortar. The
tangible world. Real estate is powerful because
it can do two things at once. It can generate
that periodic income we talked about through
rent, and it can also appreciate in value over
time, giving you a capital gain when you sell.
Okay, so those are the big four, the classics.
But the financial world never sits still. Let's
get into the new frontier, the alternative investments.
The stuff that falls outside that traditional
bucket. And this list has just exploded. We can
start with private equity and loans. This is
all about investing in businesses that aren't
traded on a stock exchange. So things like venture
capital, right? Investing in startups. Venture
capital is a big one. Also angel investors, equity
crowdfunding. It's a huge specialized world.
It also includes other types of loans like private
mortgages. The catch is that your money is usually
tied up for a long, long time. Very illiquid.
Then you have the things you can physically touch.
Commodities. Tangibles and commodities, yeah.
These are physical assets. Precious metals like
gold and silver are the classic examples, often
used as a hedge against inflation. But it also
includes energy. like natural gas. And as the
source wonderfully points out, Potatoes. I love
that. It really grounds it, doesn't it? We're
talking about these complex financial instruments
and then potatoes. But it's a great example of
a commodity driven by raw supply and demand,
by weather, by harvests. Right. Then we have
things valued purely for their rarity and cultural
significance. Collectibles. High value items
where the price is all about scarcity and demand.
We're talking fine art, rare coins, vintage cars,
even investment grade wine. They're very subjective.
And again, very hard to sell quickly. We're also
seeing new asset classes created by government
policy. Yeah, the sources point to environmental
assets, specifically carbon credits and offsets.
This is basically turning pollution control into
a tradable market. Companies can buy and sell
the right to emit carbon. And finally, the category
that's completely upended everything. The digital
world. Digital entities. Cryptocurrency and NFTs.
These are assets that live entirely outside the
traditional financial system. They come with
immense volatility and a whole new kind of technological
risk. They're really pushing the boundaries of
what we even consider an asset. So we've got
the assets, but let's talk about the sophisticated
techniques, the kind of stuff you see hedge funds
using. This is where it gets really complex.
It really does. These advanced strategies often
boil down to two things. The first is using derivatives.
Okay, so a derivative is a contract whose value
is derived from something else, right? An underlying
asset. That's the perfect way to put it. Its
value is based on the performance of a stock
index or an interest rate or a commodity price.
Things like forwards, futures, options, swaps.
They sound intimidating. What's the basic idea
behind them? At their core, they're tools for
managing or transferring risk. A futures contact,
for example, lets you lock in a price today for
something you'll buy or sell in the future. An
option gives you the right, but not the obligation
to do that. They're about controlling uncertainty.
The list in the source material also includes
some infamous ones like collateralized debt obligations,
CDOs, and credit default swaps, CDSs. Yes, the
stars of the 2008 financial crisis. A CDO is
just a bundle of different debts packaged together
and sold to investors. A CDS is basically an
insurance policy against a bond defaulting. Incredibly
powerful, but also incredibly complex and risky
if not managed properly. Which brings us to the
second major technique, using borrowed money.
Leveraged investing. It's as simple as it sounds.
You fund your investments with borrowed money.
The goal is to make a higher return on the money
than you're paying an interest on the loan. It
magnifies your gains. Dramatically. But it also
ruthlessly magnifies your losses. It's like pouring
gasoline on the fire. It makes everything bigger,
both good and bad. And that connects directly
to one of the most controversial strategies out
there. Short selling. The ultimate bet against
a company. You borrow shares of a stock, you
sell them immediately and you hope the price
plummets. Then you buy them back cheap, return
the borrowed shares and pocket the difference.
It's a high risk bet on failure. This whole sophisticated
market we've just described with its derivatives
and its short sellers, it didn't just spring
up out of nowhere. This has been evolving for
a very, very long time. Millenia, actually. The
roots of this go all the way back to ancient
Mesopotamia. The first forms of credit and lending
were essential for agriculture and trade in that
region. And they figured out pretty quickly that
they needed to write down the rules. Oh, yeah.
The Code of Hammurabi from around 1754 BCE is
incredible. It has formal rules for loans, for
collateral. It sets maximum interest rates. It
defines the rights of creditors and debtors.
a legal framework for finance thousands of years
ago. Fast forward to the Roman Empire. The sheer
scale of it must have demanded a more complex
system. It did. The Romans had these financial
specialists, the Argentarii. They were like proto
-bankers. They gave credit, they took deposits,
they handled payments. And crucially for an empire
with many currencies, they exchanged money. They
were the intermediaries that made the whole economic
engine run. But the real DNA of our modern system,
the legal and commercial ideas, that comes a
bit later from the Italian city -states, right?
That's where you see the huge leap. Merchant
banking families in places like Florence and
Venice, they develop things like the bill of
exchange. This was a piece of paper that allowed
a merchant to pay for goods in another city without
having to physically transport chests of gold.
Which would have been incredibly dangerous. So
this is the birth of financial instruments, of
paper representing value. Exactly. It made trade
safer, faster, and much more scalable. It laid
the foundation for everything that came after.
And that scalability was put to the test during
the Age of Exploration, which really created
the modern idea of public investment. Right.
These long -distance shipping voyages were incredibly
expensive and incredibly risky. If your one ship
sank, you were ruined. So what did they do? They
sold shares in the voyage. They sought outside
investors to share the cost, and in return, they'd
get a share of the profits if the ship came back.
Shared risk, shared reward. That's modern investing
in a nutshell. It is. And that need for capital
led directly to the creation of the first modern
stock exchange. In Amsterdam. In Amsterdam, 1602.
It's considered the world's first. And it was
set up to trade the shares of just one company,
the Dutch East India Company, the VOC. They were
the first to issue publicly traded stock. And
the exchange meant those shares could be bought
and sold continuously. That's the birth of market
liquidity. The Dutch were clearly on a roll because
they also came up with the idea of pooling money
together, which is what most of us do today through
mutual funds. They did. In the late 18th century,
a Dutch businessman named Adrian van Ketwich
created the first known investment trust. It
let small investors pool their money to buy a
diversified portfolio of assets. It's the same
exact concept as a mutual fund today. OK, so
by the time we get to America. The pieces are
there, but it needed a catalyst to really get
going. And that catalyst was Alexander Hamilton.
His big move after the Revolutionary War was
to take all the messy separate war debts from
the states and bundle them into new federally
issued bonds. He created a single reliable asset.
He created the first big liquid securities market
in America. And from there, it formalized very
quickly. In 1792, you have the Buttonwood Agreement,
where 24 brokers in New York agree on a set of
rules for trading with each other. The beginning
of the New York Stock Exchange. The very beginning.
It was formally organized in 1817. And by the
end of the Civil War, it was a mature market
trading hundreds of securities. It was ready
to finance the Industrial Age. We've covered
the history. the assets now let's get to the
how the strategic playbook the different philosophies
investors use let's start with the classic the
one everyone associates with warren buffett value
investing value investing is all about finding
bargains the core idea is that you're buying
assets you believe the market is undervalued
you're looking for a dollar's worth of a company
that you can buy for 50 cents and this was all
codified by buffett's mentor benjamin graham
Right after the 1929 crash. That's right. He
literally wrote the book on it. Security analysis.
The method is all about digging deep into a company's
financial reports to find its true intrinsic
worth and then checking if the stock price is
below that. To do that, they use specific financial
ratios. Let's talk about the big one. The price
to earnings ratio or PE. The P .E. is probably
the most famous valuation metric. You just take
the company's stock price and divide it by its
annual earnings per share. What it tells you
is how much investors are willing to pay for
each dollar of that company's earnings. And as
a value investor, you're looking for a low number.
Generally, yes. A low P .E. suggests the stock
might be cheap relative to its earning power.
You're paying less for the same amount of profit
compared to a company with a high P .E. But context
is everything here, right? A P .E. of 15 can
be cheap for one industry and expensive for another.
Oh, absolutely. This is a crucial point. You
can't compare the P .E. of a slow growing utility
company to a fast growing tech company. The sources
note a P .E. in the low teens is normal for telecom.
But for a high tech firm, a P .E. in the 40s
might be totally reasonable because investors
are baking in massive future growth. You have
to compare apples to apples. So if earnings can
be a bit fuzzy with accounting tricks, what's
the more conservative metric value investors
use? That would be the price to book ratio, or
PB. This compares the stock price to the company's
net assets, but it excludes all the intangible
stuff like brand value or goodwill. It's focused
on the hard assets. The things you could sell
off if the company went bust. That's the idea.
It gives you a sense of the liquidation value.
Value investors use it as a sort of safety check.
If the PB is low, it suggests you're not paying
much for the actual physical stuff the company
owns. Okay, now let's flip the script. If the
value investor is a detective looking for a hidden
bargain, What is the growth investor? The growth
investor is a futurist. They're not as concerned
with what a company is worth today. They're obsessed
with what it could be worth tomorrow. They are
actively looking for companies with the potential
for massive future earnings growth. So the goal
here isn't a steady dividend check. It's all
about the stock price soaring. Capital appreciation.
100%. Growth companies rarely pay dividends because
they're reinvesting every penny they make back
into the business to fuel that growth. And as
a result, these stocks almost always have a much
higher P .E. ratio than their peers because that
high price reflects all that future optimism.
And this strategy was popularized by T. Rowe
Price Jr. His insight was to invest in what was
the phrase? Well -managed companies in fertile
fields. The fertile fields part was key. He meant
industries that were undergoing huge disruptive
change and had years of expansion ahead of them.
So who is this for? It sounds higher risk. It
is. It's best for investors with a long time
horizon who can stomach the volatility and don't
need the immediate cash flow. And venture capital
is basically this strategy on steroids. It is
the purest form of growth investing. You're betting
on very young private companies, hoping one of
them becomes the next big thing. The ultimate
high risk, high reward game. OK, strategy three
is a totally different animal. It's not about
the company's financials at all. It's about psychology.
Momentum investing. Right. The core idea here
is simple. Trends persist. A stock that's been
going up will probably keep going up and a stock
that's been going down will keep going down.
It's about riding the wave. So what do they do?
How do they find these trends? They look for
stocks that have shown strong, consistent returns
over the last, say, 3 to 12 months, and they
buy them. They hold on as long as the upward
momentum continues, and they sell as soon as
it starts to fade. And in a down market, they
just sit on the sidelines. No, they play that
too. In a bear market, they'll short -sell stocks
that are in a clear downward trend, betting that
the negative momentum will continue. So if they're
not looking at P -E ratios, what are they looking
at? They use what's called technical analysis.
They're looking at charts, at price patterns,
at trading volume. They use tools like moving
averages or the average directional index, the
ADX, which measures the strength of a trend.
It's all about market behavior, not company performance.
But the sources say there's a lot of debate about
whether this actually works long term. There
is, because you're essentially trying to time
the market, which is notoriously difficult. Many
economists believe that over the long run, a
company's fundamental value will always win out.
So momentum can be powerful in the short term.
But there's no real consensus that it's a reliable
long term strategy. Let's move to our fourth
strategy, which isn't about what you buy, but
how you buy it. Dollar cost averaging. Or DCA.
DCA is a behavioral superpower. It's just the
discipline of investing a fixed amount of money
at a regular interval, say $200 on the first
of every month, no matter what the market is
doing. And the example and the sources on the
power of this is just incredible. It really shows
how consistency is the key. It's astounding.
It shows that if you just invested $500 a month
for 40 years at a 10 % average annual return,
you'd end up with over $2 .5 million. The driver
isn't genius stock picking. It's just relentless
consistency and the power of compounding. So
what are the main benefits besides just building
the habit? Two big things. First, it smooths
out volatility. And second, it saves you from
the temptation of trying to time the market.
How does it smooth things out? It seems counterintuitive.
Because your fixed dollar amount buys more shares
when the price is low and fewer shares when the
price is high. Over time, this actually lowers
your average cost per share. You're automatically
buying more aggressively during the dips without
ever having to predict them. So what's the downside?
There has to be one. The main one is just that
you tend to pay more in brokerage fees because
you're making lots of small transactions. With
fees being so low today, it's less of an issue,
but it's still a factor. And this idea, this
very defensive strategy. also came from Benjamin
Graham. It did. He coined the term in his book,
The Intelligent Investor, in 1949. He said DCA
users are likely to end up with a satisfactory
overall price. It's another example of a strategy
born from a desire for stability and risk management.
And finally, we have the newest kid on the block,
micro -investing. This is all about accessibility.
It's designed to make investing easy and automatic
for people who don't have a lot of money to start
with. It's about turning investing from a big,
scary decision into a small, regular habit. So
we've talked a lot about individual investors,
but the reality is most of the money in the market
flows through these giant intermediaries. Let's
talk about that ecosystem. That's right. Most
people invest indirectly. Their money goes into
pension funds, banks, insurance companies, these
massive institutions that manage trillions of
dollars. And their power comes from pooling all
that money together. Exactly. They take money
from millions of individuals and put it into
these huge collective funds. You might know them
as mutual funds, investment trusts, or in Europe,
they're often called SACIVs. This scale allows
them to make huge investments and keep costs
down. So what's my relationship as an individual
to that big pool of money? You hold a claim on
the assets in the fund, but you're also paying
that intermediary a fee for managing it all.
So you get the diversification and professional
management, but it comes at a cost. OK, let's
go back to the core of this. How do you actually
judge if a company is a good investment? Let's
give the listener three essential tools to evaluate
a company's financial health. Right. Three key
metrics to look at. Let's start with what I think
is the most important one. Free cash flow or
FCF? Why is FCF a better measure of health than
just, you know, the profit number they report?
Because free cash flow is the actual cash a company
has left over after it pays for its operations
and reinvests in itself. It's the real spendable
money. Net income or profit can be affected by
all sorts of non -cash accounting items. FCF
is much harder to fake. It tells you what's really
in the bank. And for an investor, what's the
appeal? A company with high and growing free
cash flow is a beautiful thing. It means they
have the money to pay down debt, buy back stock,
or most importantly, pay you a healthy dividend.
It's a sign of real financial strength. OK. Metric
number two isn't about performance. It's about
risk. The debt to equity ratio, or DE. The DE
ratio tells you how a company is paying for its
assets. Is it using shareholders money, which
is equity, or is it using borrowed money, which
is debt? It's like looking at someone's personal
balance sheet. How big is their mortgage compared
to their down payment? So a high DE ratio means
the company's relying a lot on debt, which sounds
risky. It is riskier. Because debt comes with
mandatory interest payments. A company with a
lot of debt is less flexible and its profits
can be much more volatile, especially if the
economy turns down. So a high DE is an automatic
red flag. Not necessarily. Again, context is
key. You have to compare a company's DE for other
companies in the same industry. A big manufacturing
company will naturally have more debt than a
software company. The red flag is when a company's
DE is way out of line with its peers. All right.
And our third and final metric, the one that...
Directly connects profit to an individual share,
earnings per share, or EPS. EPS is simple but
powerful. You take the company's total net income
and divide it by the number of shares out there.
It tells you how much profit the company is generating
for each single share of its stock. And this
is the E in the PE ratio we talked about earlier.
Exactly. It's the foundation of that ratio. At
the end of the day, as a shareholder, you want
to see a company with a consistently high and
growing EPS. It's the most direct sign that the
business is becoming more profitable, which should
eventually be reflected in the stock price. We
have covered so much ground today. We started
with that core idea committing money now for
more money later. We mapped out the entire universe
of assets from stocks and bonds all the way to
golden potatoes and even NFTs. We did. We traced
the history of it all from the legal codes. in
ancient Babylon to the proto -bankers in Rome,
and then to that first real stock exchange in
17th century Amsterdam trading shares in the
VOC. And most importantly, we went through the
strategic playbook. The detective work of value
investing with its PE and PB ratios, the futuristic
optimism of growth, the trend surfing of momentum,
and that powerful discipline habit of dollar
cost averaging. And I think the core takeaway
from all of this is pretty clear. Success here
really boils down to two things. First, you have
to understand the risk and reward profile, what
you're buying. And second, you have to apply
a defined strategy with discipline over and over
again for a long time. We established early on.
The universal truth. High risk comes with a chance
of high losses. It's unavoidable. But here's
the final thought I want to leave you with, and
it's something we touched on. We talked about
how Benjamin Graham created the framework for
value investing after the 1929 crash. He formalized
dollar cost averaging in 1949 to help investors
be more stable. These core defensive ideas were
born from periods of extreme financial pain.
Which raises a really interesting question for
you to think about. If these critical valuation
metrics and defensive strategies weren't created
in boom times to chase bigger gains, but were
actually forged in the fire of historic market
crashes, what does that tell us about their primary
purpose? Are they offensive tools designed to
maximize gain? Or are they fundamentally defensive
shields born from a painful need to quantify
risk and, above all, avoid catastrophic loss?
Keep that tension between offense and defense
in mind. Thank you for joining us for this deep
dive. Until next time, stay well informed.