Social | Basic Finance | Founders' Review Editorial

My daughter asked about her high school finance classes. I wrote down my explanation for others to read.

I explain finance more simply, like in engineering schools, not business schools. Business schools teach extra practical knowledge for professional certifications. Engineers just need to understand investing basics and business planning.

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Think of the economy as a soccer field. The central bank is the goalkeeper, passing money (like the ball) to nearby players. The opposing team makes it hard for the money to reach the forwards.

In the real economy, money is passed as credit. It eventually returns to the central bank, the goalkeeper or into the goal in case of the bankruptcy. Some players might keep the money. There are multiple "balls" of money in the system. The central bank keeps passing out more.

If money doesn't reach the forwards, it's called quantitative tightening. The central bank needs to release more money to keep the economy moving.

If there's too much money, some players (the wealthy) might collect it without using it. Sometimes they might start using more money with their neighbors, leading to higher prices and inflation.

To value companies and decide what to buy, consider this: Bond investors want their money back with interest. For example, investing $100 today might give them $3 yearly for four years, plus the original $100 back. The total value is the current worth of these future payments, $112.

Stock investors expect long-term gains. They might receive $2 yearly in dividends for a $100 stock, earning $40 over 20 years, plus the stock's sale value.

Value investors look at a company's assets (like buildings) minus debts. This "book value" is what's left for stockholders. For instance, $100 in assets minus $60 in debt equals $40 equity book value.

If a company stops being profitable, it might default. Stockholders can sell assets to pay debts. Debt holders get paid first by law, making bonds less risky than stocks. This is why bonds usually offer lower returns than stocks.

Diversification is key in investing. It's like rolling many dice at once to spread risk. Professional investors buy many different stocks to balance gains and losses.

Regular investors risk their own money without professional advice. Young investors often prefer local stocks for growth. Older investors usually choose safer options like government bonds to protect their savings. They may not have the job to earn more, so they favor not risking their assets built up.

Financial advisors charge fees for their expertise. Smart individual investors often copy the strategies of successful investment funds by looking at the holdings of their portfolio and buying them selectively.