I chose to read Naked Economics because I think that having at least a basic knowledge of economics is extremely important when we are looking at early retirement and financial independence. While it may not enhance your ability to invest, it can help explain why the market is moving. We are investing over very long periods of time, but it is still good to at least know what your money is doing and be able to have an inclination as to why it is gaining or losing value.
I loved Naked Economics because it promoted deep thought and it provided explanations for each principle it brought up. One cool example was on page 105 where the author referenced the Hope Scholarships proposal from Bill Clinton in 1992. This was the idea that after graduation, students should be able to pay back loans based upon their career choice. For example, an investment banker would owe more to the government than a social worker. This sounds like an awesome idea in principle, but as we come to find out, the economics of this just don’t work. I’ll let you enjoy Mr. Wheelan’s explanation for why.
Possibly my favorite part of the book was around page 162 where Wheelan began discussing stock picking, and the economics of why it is so challenging to beat the market. This is the economic justification for investing in index funds. Basically it comes down to the “efficient markets theory”. This is the idea that asset prices reflect all available information- when everyone has access to the same information, which is the case for a publically traded company, they will act in a similar fashion. Wheelan provides the following quote as well:
“Stock prices settle at a fair price given everything we know or can reasonably predict; prices will rise or fall in the future only in response to unanticipated events- things that we cannot know in the present” (Wheelan 163)
Basically the conclusion reached is that stock prices are generally unpredictable. You have no better legal chance to know whether a stock will go up or down than anyone else. This same statement can be made about most financial advisors and explains why so few are able to consistently beat the market. I really enjoyed learning about the economics of a major staple of early retirement investing.
Another point I really enjoyed was the discussion around inflation. I thought it was a great explanation, and it really supports the importance of investing instead of leaving funds in lower earning accounts (savings, checking, CDs, etc…). We talked about this earlier in our post about putting our money to workputting our money to wkr.
“Even savings accounts and certificates of deposit, which are considered safe investments because the principle is insured, are vulnerable to the less obvious risk that their low interest rates may not keep up with inflation.”
This is exactly what is happening in the U.S. right now. Even the best online savings accounts are yielding around 1% interest, but inflation is roughly 3%. That means that every year your money sits in a savings account, it is losing 2%. That is bad business and a fatal blow to early retirement.
All in all, I really enjoyed Naked Economics, and I was able to breeze through it in about a week. The information is thorough and a great first read for someone who might not be an expert on economics. This is a book that will absolutely get you thinking and it does a great job explaining the “why?” for a lot of the investment and lifestyle principles that we will carry with us on our journey towards financial independence.