Understanding today's economy is hard enough without having to wrestle with popular misconceptions and misinformation. In a new series, Paul Solman and guests debunk the conventional wisdom to help make sense of our economic world.
Your 'savings' are usually put into the safest places or products that allow you
access to your money at any time....
When you 'invest,' you have a greater chance of losing your money than when you 'save.'...But when you invest, you also have the opportunity to earn more money than when
you save.
PAUL SOLMAN: Saving -- safe. Investing -- risky. This is a
thing you read over and over again everywhere on the Internet. All these
different financial literacy sites, so called, and I happen to know that it
personally gives you agita, [Professor Zvi Bodie], or palpitations, sometimes
high blood pressure. This drives you nuts, right? Why?
ZVI BODIE, Professor of finance, Boston University: It drives me nuts because it contradicts what we
teach in the basic course in economics, even in high school. Students are
taught that saving equals your income minus what you spend on consumption. That's
the definition of saving.
PAUL SOLMAN: It's what's left over.
ZVI BODIE: It's what's left over after you consume your
income. How you invest it is about, you know, how much of it goes into a
savings account, how much of it goes under a mattress, how much of it goes into
stocks and other risky assets. So, investing in and of itself is not taking
risk. You can invest safely. It's simply how you are allocating your saving and
the aggregate or the total investment in any given period of time is by
definition equal to the total amount of saving.
PAUL SOLMAN: Well, but you can understand then why people
would conflate the two and say, "Oh well, savings and investment - it's the
same amount, so it's the same thing." But...
ZVI BODIE: Well, I think what causes the confusion is that
you're using the word "safe" and you have things like savings
accounts. So, in the popular parlance, as opposed to the economics definitions,
it is the case that saving is what you put into a savings account.
False belief: Investing equals risk
PAUL SOLMAN: But so what's the difference? Why does it make
you so upset? I mean, it's just because it betrays this fundamental discipline
that you teach and grew up in, or you think that there's actually something
pernicious happening as a consequence?
ZVI BODIE: There is something very pernicious happening and
that is that you have, in not following the economics definitions, you have now
made it impossible for someone to invest safely by definition. Because if you
want to invest, you have to take risk!
PAUL SOLMAN: According to this...
ZVI BODIE: According to this new rubric, let's say -- the
popular rubric. So, if I choose for example, as I do and you know this, to put
100 percent of my savings into safe Treasury-protected accounts -- I-Bonds,
TIPS. According to the popular definition, I'm not investing. But I sure as
hell am investing!
PAUL SOLMAN: And as I am I when I follow your lead in so
doing. So, what's happening is that the investment community, by promulgating
this notion that investing is taking a risk and saving is playing it safe, is
essentially inducing people to take more risk than they otherwise would?
ZVI BODIE: That is correct. And it's not the only way they
do it because in general they say saving is what you do for the short run,
investing is what you do for the long run. So, the minute you say, "Well, I'm
saving for retirement," then they say, "Well, that means you want long-run
investments like stocks."
PAUL SOLMAN: And, of course...and here's the way we'll end
this Finance Fallacy segment: They make a whole lot more money selling us
stocks than they do selling us anything else.
At an annual meeting of economists, Paul and Zvi asked several professors of economics about the SEC's explanations of saving and investing, as taught on the SEC's Web site. The overwhelming response: The explanations are wrong. Watch the video here.
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