- Margaret Curtis, MD
The Napkin Rule
Updated: Jan 30, 2019
Sound investments are so simple they can be explained on the back of a napkin.
Stocks are partial ownership of a company. Stocks are bought and sold in the stock market.
Bonds are loans to companies or governments. Bonds are bought and sold in the bond market.
Real estate is property that can be used, rented out or sold.
Warren Buffett has become one of the richest people on earth by investing in companies that sell: ketchup, chewing gum, insurance, candy and furniture, plus a railroad and a chain of truck stops. You wouldn’t even need an entire napkin for those.
Of course you still have to use your judgment, and of course you can still lose money in these investments. But for the average investor (that’s you and me), simple investments that you understand are the best place for your money.
Here are some examples of investments that fail the napkin test:
Interest rate swaps are “derivative contract[s] through which two parties exchange financial instruments…based on a notional principal amount”.[1]
A strap is “an options strategy using one put and two calls with the same strike and expiration.” [2]
An inverse transaction "cancels out a forward contract that has the same value date."[3]
These fail the test, as do cryptocurrency, triple negative ETFs, and - for most of us - options trading. Sure, you could study up on these and get in the game, but you don’t need to. Take advantage of the simple investments and keep your day job.
1. https://www.investopedia.com/terms/i/interestrateswap.asp
2. https://www.investopedia.com/terms/s/strap.asp
3. https://www.investopedia.com/terms/i/inverse-transaction.asp
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