Finance: What are the Five Principles of Finance?

What are the five principles of finance? 1) The time value of money. 2) Risk and reward are related. 3) The market as a popularity contest v. a weighing machine. 4) Cash is king. 5) Agency problems.

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Transcript

00:23

financial return from that investment almost guaranteed. well you could play it

00:27

safe investing in low-yield American Treasury bills, or you could show a bit

00:31

more gamble by investing that same money into a somewhat riskier index fund of

00:35

bonds or stocks. either way here's the magic formula take the dollar amount you

00:39

invested and multiply it by one plus the rate of return ^ years. so yeah you want

00:46

to be making your money work for you. if you invest it it collects interest, or

00:50

returns profits. keep it under your mattress and about the only thing it's [money on top of bond]

00:54

gonna collect are bedbugs. okay second principle second finger risk

00:58

and reward are related- kissing cousins- yeah so they can't get married shame

01:03

they look like such a cute couple. okay so here's a question. why do you get

01:06

8% returns from the stock market in equities and you only get 3% from safe T-Bills

01:11

bills. well a bunch of things affect rates of investment return but the

01:14

biggest issue revolves around whether you'll get your money back, and/or a

01:18

positive multiple of your money back when you're done. check out bond

01:22

performance over time. steadily onward and upward but nobody's becoming

01:26

spectacular ly rich off of them. stocks on the other hand while you might make a

01:31

fortune but he also might have to stomach some extreme lows along the way. [graph showing ups and downs of stocks]

01:35

you're basically putting your money on a virtual rollercoaster and hoping it

01:39

survives the experience, but hey no risk no reward.

01:42

over time the stock market has a whole lot of reward. alright third principle

01:46

the middle finger hey watch where you point that thing. the market as a

01:50

popularity contest versus a weighing machine.Thank You Warren Buffett. what

01:54

does this mean? well there's short term versus long term thinking. when it comes

01:58

to investing. you want to be long-term greedy because hopefully well you're

02:02

gonna be here for a while on earth. invest in a company like Google early in

02:06

its history and you're gonna be set for life. same do the Amazon Facebook and

02:10

those guys. invest instead in a crap company called fidget spinner mania who

02:16

knows what your fortunes gonna do it's risky. you might go from $10 to $12 in a

02:21

week but only wake up six months later when it's trading at 12 cents a share.

02:25

yeah you want to avoid fads duh. and yeah it's not that easy to spot the early [stocks of fidget spinners down ]

02:29

signs of the next google, but well that should be your goal. all right principle

02:32

number four your ring finger, cash is king.

02:36

well the dog toy company, bite me I squeak, yeah that's the name of it

02:40

might show a million bucks in profit, but you don't know how they've expensed

02:44

their plastic molding machine, what clever maneuvers they've used to pay

02:48

minimal taxes. well the only way to fairly evaluate the value of the company

02:52

is follow the cash. and look through accounting tricks which can change the

02:56

bottom-line earnings in a whole lot of different ways all right moving quickly

03:00

on and finally your pinky finger, agency problems. well you might be picturing [pinkie finger held up]

03:04

this guy in a slick suit in a Hollywood office selling clients time into a

03:08

studio system with let's do lunch a regular catchphrase.

03:12

well yeah it's basically the same thing in finance. a client hires an agent and a

03:16

relationship structure is formed. that is there are legal requirements around the

03:20

behavior of that agent. specifically the agent has to look out for the best

03:24

interests of his client, and he has to put his own best interest on the

03:27

backburner. well this structure is a really big deal in the financial world

03:31

because so many poor unsuspecting people have been screwed over in the process of

03:36

big city slickers taking their dough with no comeuppance. those fast-talking

03:41

grifters are really deserving of a yeah you know knuckle sandwich, yeah put all

03:45

five of those fingers to good use if that ever happens to you. [man holds up hand ]