Creating Value through Investing

Passive investing - in the stock or bond markets - does create value, but in a vague, theoretical way. By participating in these huge public markets, one is helping to facilitate the funding of large business ventures, even if it often feels like one is simply funding outrageous CEO compensation. Investments in the bond market theoretically help facilitate government spending, even if it feels like one is simply enabling governments to build ever larger fiscal holes.

There are opportunities to add value through alternative investing; for instance, by buying an old house, fixing it up, then renting it out or selling it. But this sort of thing is quite different than investing in public markets:

 Perhaps most importantly, public markets are very liquid; you can sell your investment just about any time, and you can know almost exactly what you will be able to get for that asset at any time; check a website and in minutes you know what you can sell your shares of Apple stock for, or what your treasury bonds are worth.

In addition to the very important virtues of liquidity and transparency, public markets have extremely low transaction costs; my infrequent stock trades cost $8, even when the trade is for thousands of shares. The transaction costs for alternative investments are far higher. For instance, in the case of residential real estate, typically 7-9% of the total value of the transaction, once you include brokerage fees, transfer tax, deed recording, and legal fees.

On the other hand, if you buy an asset like a house, you actually control it, which is a far different matter than investing in a publicly traded stock. To have any influence over the way a publicly traded company is run, you need to make an investment of hundreds of millions of dollars; possible for a hedge fund, but not for most of us. On the other hand, you can decide how much to invest in renovating a house, how much to spend on each item, and whether to rent or sell the house. With a public investment in the stock or bond markets, your only real decisions are what to buy, and when to sell. And if you follow our advice regarding index funds, most often you won't even be making a decision as to "what" to buy; you'll simply be buying the broad market of stocks or bonds.