This episode starts with the time value of money and quickly becomes an exploration of the time value of everything. Finance professor Stephen McKeon takes us through his past working at a winery, starting a drone company, to his current outlook of always choosing a happy versus wealthy life. The episode bounces between balances sheets and the purpose of life—and how the basics of all those scary words like stocks, bonds, and annuities aren’t so scary. McKeon uses some wonderful examples to illustrate the concept of investing, including how to invest in outer space asteroid mining, judging a company by how risky the CEO is (hint: see if the CEO has pilot’s license), and of course, cryptocurrencies—something that keeps getting him in the news constantly. As always, host Troy Campbell and editor Alec Cowan drop in some additional research and stories. The episode grows in complexity and subject matter as it progresses, but everything is always sewn together by the simple concept that a dollar today is worth more than a dollar tomorrow.
What We Learned
Investing and Time
“Even if you don’t plan to work in finance, you’re going to have to deal with people who work in finance in order to meet your goals,” Professor Steve McKeon explained. So it is essential that we all know at least the 1O1 of finance, and in this case, the 1O1 of financial investing.
McKeon explains that at the highest level investing is as simple as “how long it’s going to be before you get your money back, and how confident are you or how certain are you that you’re going to get your money back with a return that’s appropriate for the level of risk.”
While that’s a lot of stuff, it isn’t as overwhelming or difficult as one might think.
101 Everywhere: Time Value of Investing
This episode is subtitled “Time Value” because it is based on the simple idea that if you invest in something today—be that a stock or a skill—it is likely the case that you gain more from that investment over time. That’s a finance principle, but it is also a great principle for life.
In Romance … Invest in something that will continually pay out over time, such as dance lessons.
In Friendship … Spend time checking in with friends in different cities. This is a simple act that is often overlooked.
In School … Take that extra class because the more you learn now, the more future you will have to earn the dividends of those skills.
In Work … Make sure you are automatically investing in a savings account if you can afford it.
In Public Policy … Think about how to build infrastructure that doesn’t just fix a problem but that will create a sustainable future.
In Health … Invest in learning health behaviors and facts, so you will be better prepared in the future to make health decisions—especially when you are not as young as you are today.
The Misconceptions
As always, our guest demystified the topic and corrected a lot of misconceptions. Here are three:
- We think that investing is for those who are math people or for people with lots of money, but actually, investing is for everyone because we all have to work with finance.
- We think that investing is just about money, but actually, the principles of investing are much bigger than just monetary investments.
- We think of investing as this thing that is its own realm, when actually, it is part of every project because everything needs to be financed.
The Balance Sheet
At the center of investing is the balance sheet. A balance sheet is just a spreadsheet that calculates the point at which your idea is profitable and how profitable it is.
Here are the three basic steps for creating a balance sheet.
Step 1: Write It All Out
Just write out all the cash inflows and outflows from a project, which are all the different ways you will be spending and bringing in money, such as investors, sales, and costs of products.
McKeon elaborated on step one through the example of investing in a new corporate project: “There’s usually large outflow in the beginning in order to get the project going, and then, as you begin to sell whatever the good is—maybe that’s precious metals from an asteroid or maybe it’s tickets on your hyperloop, whatever revenue stream you have—those would be inflows that happen later in your project. So, the first step is you line those things up, and that usually requires a spreadsheet.”
Step 2: Apply Discount Rates
Once you have all your cash flows on the spreadsheet, you must discount them, which means to value them in accordance with how much they are worth today. So, here is where that popular term “discount rate” comes in. Luckily, there are lots of established metrics you can use to think about inflation and other factors.
McKeon explained further: “The second component is once you’ve analyzed the amount and the timing of these inflows and outflows, you need to discount them. So if it’s five years away, it’s not as valuable as if it’s three years away. And so, you need some sort of discount rate to discount everything back to today.”
McKeon then further elaborated on how to discount the project number you have for the future earnings of a company by comparing “something like GE, a very large stable company with stable cash flows and stable projects” or a company like “a startup drone software firm, [with] lots of uncertainly about future cash flows.” He explained that, “You’re pretty sure GE is going to make that amount, so you wouldn’t discount it. There’s still some uncertainty. But with the drone software company, it could be a 1,000—or it could be 5,000—or it could be zero. So in that case you’re going to discount it more heavily, so the cash flows from the software company are worth less to you today than those from a company like GE because you’ve got more uncertainty revolving around the software firm.”
Step 3: See What It Says
“Then it’s simple,” McKeon said. For step three, “You take all the different streams of things that are happening over different years and discount them back to today and add them up. And if it’s positive, we call that a positive net value project, and that’s something that you want to pursue.”
Firms and Risky CEOs
McKeon looks at factors that affect firm success. Investing at the firm level is all about understanding these factors. In a fun project with some serious science underneath it all, Steve and colleagues looked at CEOs who pilot private planes (a generally risky activity). They found that these CEOs take more risks in their businesses. This shows up in demonstrations of how the company is performing, such as the amount or volatility of their stock returns.
McKeon explained, “The thing we found was piloting small aircraft. So, then what we did was we took the pilots and said how do they run their companies? It came through in virtually every policy we looked at. So, they took on higher leverage, they acquired more companies, and they had more volatile stock returns . . . . The CEO’s risk tolerance, so how comfortable they were with taking risks, really impacted the way their businesses were run.”
Education as an Investment
McKeon said, “Your education can be viewed as an investment in your future. Lots of research has shown that you’re going to generate more income in the future. So it makes sense that you spend money now on your education in order to reap the rewards for years to come. It’s also the reason why getting a degree in your twenties might be more valuable than getting a degree in your sixties because you have more years in which to reap the rewards of your investment.”
Quotes from the Episode
“Exploration-as-investment is something that people miss when thinking about investment.”
“Bitcoin is the one that everyone’s heard of. It turns out that actually there are hundreds and hundreds of crypto assets.”
“Money can buy happiness, but only up to a certain point.”
“When teaching . . . I try to pick something that’s just entertaining. The actual setting doesn’t matter. You’re just trying to get them to use this time value of money concept, so one year we evaluated Peter DeMantis’s Planetary Resources, which is where they go out into space and lasso precious resources.”
Steve McKeon’s Investing Basics
Professor: Steve McKeon
Location: Lundquist College of Business, Department of Finance
Teaching Style: Conversational with short lecture parts
Class Size: Approximately 40-60 students
Important Homework: Balance Sheet
Major Project: Evaluating the financial viability of an ambitious project, such as Hyperloop or asteroid mining