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Three questions that govern money

The author is a financial journalist and author of the book ‘More: The 10,000-Year Rise of the World Economy’.

Three linked questions are at the heart of today’s business decisions. What is a risk-free return that investors can protect? Is it reasonable to hope for a future? So which of my points do you (in my wisdom and all knowingness) find inaccurate? The answers to these questions affect everyone from charities through high pension funds to 60-year-olds who are thinking about how to make the best use of their pension fund.

None of these questions are easy to answer. Take a safe dose. This can be defined as short-term repayment of deposits (approximately zero at the time of writing), outgoing two-year Treasury bond (0.6 percent) or 10-year bonds (1.44 percent).

All of this is much lower in history and much lower than inflation (6.8 percent in the US). Advertisers seem to need to see that the value of their money is being violated in real terms and if they sell prematurely, there is a risk that they will lose money in the future.

If investors try hard to block their shares at higher prices, then 10-year Treasury bonds that are protected by rising prices will produce 1 percent, proving a real loss if kept at maturity. As the joke goes on, a safe return has become the risk of a relapse.

The impact of these low yields is huge, as some assets are valuable in relation to risk-free return. For example, companies that borrow from the bond market pay for the spread of government bonds to illustrate the risk of fraud.

As government bond yields have fallen, so has corporate borrowing costs. Pension funds use corporate yields to calculate the cost of retirement benefits; lower yields fall, then the cost of meeting future loans will be higher.

The rise in pension accounting accounts explains why many systems are in short supply even though the stock market has been performing well since the 2008 crisis. And that explains why there are so many bond buyers at so low yields.

Given the unpredictability of creditors, it is not surprising that many investors would prefer to rely on equities. But how can equities come about? The sustainable approach is to increase the risk to government bond yields. Historically, this has been around 4 percent worldwide, according to the work of Elroy Dimson, Paul Marsh and Mike Staunton of London Business School. Adding 4 percent to yields at a discounted price of 1 percent would give us a real expected return from 3 percent.

But do investors expect to repay their debts at such a low rate? It seems impossible, because of the way they piled up in stocks even in the face of the plague. On the contrary, if investors believe that future returns from equities are significant, then they expect greater risk from the financial sector. In other words, they think equities are more dangerous than they actually are. Again, this does not seem like a common idea.

However, the rule of thumb is that when current volatility is high, future returns will be minimal. In the United States, equity rates are very high, as measured by the (Cape) price index developed by Robert Shiller of Yale University, which compares stock prices and averages that companies have achieved over the past 10 years. The most recent Cape census was 38, the highest level at the dotcom peak in 2000.

But if future repayments are low, investors face very difficult decisions. Pension plans will need to solicit large sums of money from their beneficiaries or, in state-owned enterprises, from taxpayers. Individuals trying to collect a pension fund should save more now, and spend less; a way that governments trying to boost their wealth may not approve.

Similarly, if future returns are low, then the discount rate should also be reduced. Compassionate charities usually follow the 5 percent rule by choosing the money they can take from their foundation. It looks very high. Similarly, retirees with pension plans may need to lower their income by less than 4 percent a year to ensure that their income does not run out. Advertisers are given lots of information about the shares or currencies they can choose from and expect to conquer the market. There is very little time to talk about how much money they should set aside first.

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