These days, most people fail to see the virtue in simply storing one’s earnings in a savings account. It is sometimes called “hoarding money” and is often seen as selfish, but there is a very strong justification, which, interestingly, is both selfish and altruistic, for putting savings in a simple index fund.
The biggest reason behind the high standard of living of western countries, and other rich countries, is the high amount of capital invested in these countries. This capital consists of the accumulated wealth of many people in the form of productive infrastructure, equipment, education, etc. A conveyor belt, machines, or on-the-job training are good examples of this capital. It’s easy to see how they help someone produce more things without them having to work harder or longer. But where does this capital come from?
Canadians earn income from many different sources and inevitably decide what they want to do with it. Essentially, they can save their income or spend it. A person might, for example, go buy a shirt. The only way this can happen is if this person wants a shirt while someone is willing to sell them one. The seller must want the money more than the shirt and, conversely, the customer must want the shirt more than the money. Because of this, one could say that this transaction is a very good thing. A person might instead decide to save their money for later. There are many reasons why someone would do this. There may be some people who want to leave their children with some money or some who simply wish to be prepared when they get a bad surprise. Very few people, however, stuff cash under their beds as a manner of saving. Most people invest their money in some sort of savings account.
A savings account is not like any other bank account because, usually, they yield a much higher rate of interest than other accounts but it is harder to withdraw money from them. One of the most popular kinds of savings accounts is known as an index mutual fund. They are called this because many peoples’ savings are pooled in order to invest in the components of a market index. Some of these indices track hundreds of stocks which makes it impractical for a single person to invest in them. Some popular examples of these indices are the Hang Seng Index in Hong Kong, the Nikkei 225 Index in Japan, and the Standard & Poor’s 500 Index (S&P 500). The S&P 500 tracks 505 stocks of companies mostly based in America and gives a somewhat general picture of how the stock market is doing. These index funds are very popular because they are relatively safe, have a relatively good yield, and the cost of operating them is very low. People who invest in these don’t feel like they are “gambling” since there is almost no stock trading.
Now, these stocks aren’t just numbers moving around in New York City. In fact, usually, anyone from anywhere in the world can invest in stocks being traded online in any market. When a company’s shares, i.e. stocks, increase in value, due to people wanting to buy them, it can split some of them and sell them in order to raise some capital. With this capital, the company can pay employees’ wages, purchase equipment, etc. This is how the investment of savings into index mutual funds by wealthy westerners can benefit poor foreigners. In effect, many factories abroad are indirectly owned by average Canadians, Americans, or others. Of course, a shirt factory in China can make no money if no one wants to purchase their shirts, but everyone benefits if they are able to produce them more efficiently.
In general, as people get richer, a larger portion of their money is invested while a smaller portion is used for consumption. With this in mind, it is logical that if westerners were to give their savings to Chinese workers, or if they simply bought Chinese products as a way of ‘getting the economy rolling’, there would be less aggregate investment. The Chinese folks who get this money would obviously be richer in the immediate, but would likely see almost no increase in their wages unless they collectively invested the money they received into Chinese businesses. A Canadian person can therefore pursue their self-interest while greatly helping poorer foreign workers by simply investing their savings in various index funds.
Written By: Jacob H. Dufresne
Originally Published: March 2016