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Money—more accurately defined here as "currency"—is worthless no matter how much of it is printed if it cannot be exchanged for the things we desire.

So you see, what we want to earn is not money itself, but the things behind money—resources, products, and services.

Understanding this "natural resources + labor + technology" logical framework should give us a basic understanding of how money, or rather "wealth, is generated."

Now our thinking about where money comes from is quite clear. Humanity has created immense wealth by utilizing natural resources, investing wisdom and labor, and developing scientific and technological innovations, a significant portion of which is created by companies.

The organizational structure of modern joint-stock companies, along with the capital market system, allows ordinary people to participate in this wealth creation process—of course, while sharing the benefits, each participant also bears corresponding risks, accepting the possibility that the money they invest could be wiped out by a big wave.

Nevertheless, creating wealth authentically, sharing it reasonably, and accumulating it steadily is a dividend of the times that each of us can enjoy today.

We want to earn not money itself, but the things behind money—resources, products, and services. On one hand, money represents these things behind it. What we actually want is not money, but the ability to pay for these products and services.

On the other hand, money is the medium of exchange that society gives us when we create this wealth, or in Naval's words, it is the IOU that society gives us: "Hey, you created something; this is your IOU, and in the future, you can exchange it for what you need." If we summarize these terms—money, wealth, companies, and investment,

It would look something like this: behind money are products, resources, and services, which constitute wealth; wealth is what people truly need; companies are more efficient organizational forms that allow us to create wealth more effectively; investment is putting money in the form of capital into the process of creating company value.

Where does the income from investment come from?

One way is through plunder, taking others' mediums of exchange. Historical wars and plundering between nations, including some harvesting behaviors in the stock market, are examples of this; another way is through creation, treating our IOUs as capital invested in companies, participating in the overall wealth creation process of society. When the companies we are shareholders or creditors of create greater value and earn more income, we also receive corresponding returns based on prior agreements.

"Why do people want money?" Because money can be exchanged for the resources, products, and services people need. Money is not the goal; it is a tool. "Why does money increase?"

Natural resources: the wisdom and labor already present in the environment; human thoughts and actions; scientific and technological tools and techniques produced to improve efficiency. The long-term development formed by the combination of these three creates the underlying assets that increase overall societal wealth. "Why is this money relevant to us?"

Wealth creation usually occurs at the company level because this form can share operational risks, save costs, and reduce competition. The organizational structure of modern joint-stock companies and the modern capital market system enable ordinary people to participate in wealth creation, share wealth, and accumulate wealth.

The act of investing is precisely participating in wealth creation. At the same time, since natural resources + wisdom and labor + scientific technology = increase in overall societal wealth, when some people make money from investments, it does not necessarily mean others lose money. This is not a zero-sum game. "Where did the money go?" Investment is not an abstract numerical concept. Investment means we are putting our money into one or more companies, which then use that money to create more wealth. Wealth can only be obtained through the combination of existing resources in the real world, human wisdom and labor, and scientific technology (i.e., underlying assets). The real world also means that returns coexist with risks.

So what we should ultimately care about is: Which company are we putting our money into? Which industry? What is the source of its returns? Is this source reliable (i.e., does it meet the most basic common sense and axioms of the world)? The above can help investors avoid the vast majority of scams and risks.

The questions are:

(1) What kind of money is being earned? (2) How much money can be earned? (3) How to earn this money? (4) How to spend this money?

Extensive research by predecessors shows that the foundation has sources:

The basis of market fluctuations comes from multiple aspects, including macroeconomic factors, industry and regional information, news events, changes in market structure, technological advancements, and policy adjustments.

• Macroeconomic factors: Evidence shows that macroeconomic data releases, central bank announcements, bond auctions, and other macro events have a significant impact on the market. Additionally, changes in the real exchange rate are also influenced by nominal shocks, while factors such as government spending, trade openness, and capital flows significantly affect the real effective exchange rate.

• Industry and regional information: In the Chinese securities market, industry information is more dominant in driving changes in securities prices than regional information. This indicates that industry and regional information are important factors influencing market fluctuations.

• News events: News events account for about 50% of all market fluctuations, including election results, sovereign rating downgrades, and unexpected natural disasters. These news events drive market price changes by affecting investor sentiment and expectations.

• Changes in market structure: The entry and exit of markets have significant impacts on market structure and performance. Additionally, market segmentation phenomena can lead to different market responses to exchange rate changes.

• Technological advancements: Big data is changing every corner of economics and finance, although this data is largely excluded from macroeconomic and financial research. Technological advancements, especially in information technology, have profound impacts on market structure and function.

• Policy adjustments: Policy adjustments, including monetary and fiscal policies, have significant impacts on market stability. For example, monetary policy announcements can reduce market instability.

The basis of market fluctuations arises from the combined effects of various factors, including macroeconomic factors, industry and regional information, news events, changes in market structure, technological advancements, and policy adjustments. These factors interact and collectively influence market volatility and development.

The first two items involve changes in the target assets purchased by market participants, while the third item involves the game between market participants using corporate equity as chips, which is unrelated to the companies themselves. Let's categorize and discuss.

1. Corporate Value Addition

The economic performance of a country is generally measured by GDP. GDP stands for "Gross Domestic Product," which refers to the total value of newly added products and services in a country within a year. It is these newly added products and services that provide the necessities for people to eat, wear, use, live, and travel, as well as for social reproduction.

The survival and development of humanity and the continuous growth of its needs drive the sustained development of GDP. Throughout human history, especially in modern times, it is clear that the total amount of products and services created by human society has been continuously increasing.

The national economy is the result of human productive labor, shared by people and their organizations. If we distinguish according to the entities involved in creating and sharing GDP, it consists of four parts:

1. Taxes and fees taken by central and local governments;
2. Personal income from participating in GDP creation;
3. Donations received by the non-profit sector and intermediary service fees provided by the service sector;
4. Corporate profits.

"How to Pay for War" mobilizes the economy from a production perspective, so war significantly impacts the economy, stimulating America's productive potential. The expenditure method of accounting illustrates this productive potential.

Dr. Wang Han observes from the perspective of the balance sheet that if the state = enterprise, then currency equals capital, and GDP is akin to profit. The asset market value/GDP = the country's price-earnings ratio. (So under monetary easing, if GDP does not increase in proportion, it means the overall capital return rate of society declines.)

National statistical data is calculated using the production method, while analysis uses the expenditure method (i.e., the three drivers of growth), which is straightforward but can reverse cause and effect.

After the reform and opening up, new statistical indicators like GDP replaced the original material balance sheet indicators.

1. Judging Economic Prosperity (Overall Economy)

The three accounting methods of GDP:

1. Income Method: Wages + Taxes + Depreciation + Corporate Profits
2. Expenditure Method: Household Consumption + Corporate Investment + Government Procurement + Net Exports
3. Production Method (Value-Added Method): Total Output - Intermediate Inputs.

Nominal GDP is the market value of all final products and services calculated using current year prices. Real GDP is the market value of all final products and services calculated using prices from a base year (constant prices). The GDP deflator = nominal GDP/real GDP * 100% reflects the overall inflation level in the economy.

Clearly, all enterprises in a country as a whole can not only share profits but also see those profits continuously grow. In modern economies, about 70% of a country's GDP is created by enterprises, and the profitability of enterprises is higher than that of individuals and intermediary organizations.

Keynes' "How to Pay for War" mobilizes the economy from a production perspective, so war significantly impacts the economy, stimulating America's productive potential. The expenditure method of accounting illustrates this productive potential.

From the balance sheet perspective, if the state = enterprise, then currency equals capital, and GDP is akin to profit. The asset market value/GDP = the country's price-earnings ratio. (So under monetary easing, if GDP does not increase in proportion, it means the overall capital return rate of society declines.)

GDP (Gross Domestic Product) reflects the total economic volume but does not reflect economic quality, and there are three statistical methods:

1. GDP (Income Method): Wages (income of workers) + Taxes (government revenue) + Corporate Profits (enterprise income) + Depreciation (enterprise income), which cannot reflect production.
2. GDP (Expenditure Method): Household Consumption + Corporate Investment + Government Purchases + Net Exports. Government purchases are mostly distributed among consumption and investment, so it can be broken down into the three drivers: GDP = Consumption + Investment + Net Exports.
3. GDP (Production Method): Value-Added Method = Total Output - Intermediate Inputs.

PMI: The barometer of the manufacturing industry.

GDP: Mainly measures the results of production.

To put it simply, PMI might be the preparation for buying groceries, while GDP refers to how many dishes are served at the table. PMI can inform us about economic conditions ahead of time.

2. Judging Economic Engines: The Three Drivers (Real Industries)

One cannot rely solely on the M2 growth indicator to judge whether the money in hand is depreciating. A simple way is to subtract the GDP growth from the growth of M2 to see if this value aligns with the observed CPI growth. This result roughly represents the target value for outpacing inflation to prevent wealth depreciation.

4. Judging Whether There Is Inflation (Individual Life)

CPI is an important indicator for measuring inflation in our lives (this indicator includes housing prices).

CPI is related to consumption, while PPI reflects the factory prices after production and processing before consumption; this index can also reflect inflation. This indicator can be used to assist in judging inflation.

Data and other potentially useful information can be found on the following websites:

National Bureau of Statistics website www.stats.gov.cn
People's Bank of China website www.pbc.gov.cn

Economic fluctuations are like the changing of seasons; however, economic fluctuations sometimes do not go through a complete cycle, skipping certain links or continuously experiencing the same link.

Investment and financial management are like the seasons we experience. In different seasons, we may have different routines and preparations; for example, wearing more clothes in winter and fewer in summer. In the investment and financial management market, we also have different strategies and asset allocations during different phases of economic fluctuations.

Although not every listed company is an excellent enterprise, due to various conditions such as profits, profitability, potential for subsequent financing, and listing costs, overall, listed companies have a higher level of returns than the average level of all enterprises in society. Both the operation of the Chinese securities market for over 20 years and the longer practices of developed countries have proven this.

Research shows that from 1995 to 2014, the return on equity (ROE) of all enterprises in China maintained an average annual level of nearly 10%, while the ROE of listed companies during the same period exceeded an average of 12% (do not underestimate the 2% difference in return; over 20 years, the profits earned from a 12% return on assets are 150% more than those from a 10% return). This means that if one were to buy all listed companies, they could achieve operational returns that surpass the average return level of all enterprises in society.

The subsequent reasoning is simpler: among all listed companies, those with an ROE higher than 12% will have profitability exceeding the average of listed companies.

This is actually a trivial statement but often overlooked. This statement implies that if one were to buy all enterprises with ROE > 12%, in the long run, these enterprises will earn profits higher than both the overall listed companies and the overall society—this is essentially the entire secret of Buffett's investment framework.

Buffett's thoughts have been mystified by too many people. It is simply believed that:

(1) An excellent enterprise can outperform the average growth rate of societal wealth. Just as the top three students in a class will have scores higher than the class average;

(2) If one can invest in these excellent enterprises at a reasonable or even low price, in the long run, the wealth growth rate will also exceed the average growth rate of society. Countless successful businessmen throughout history have done this; it is neither mysterious nor difficult to understand;

(3) He finds Mr. Market, who often provides better trading prices, to be a foolish opponent;

(4) He discovered and utilized the leverage of insurance companies early on. Thus, the stock god was forged. For us, the fourth point may have few opportunities, but understanding the first three points and focusing on finding excellent enterprises while waiting for reasonable or low prices may not make you Buffett, but you certainly won't end up poor. The end.

The Purchasing Managers' Index (PMI) is an index compiled from the monthly survey results of purchasing managers in enterprises. It encompasses various aspects of enterprise procurement, production, and circulation, including both manufacturing and non-manufacturing sectors, and is one of the internationally recognized leading indicators for monitoring macroeconomic trends, possessing strong predictive and warning functions.

Industrial added value is defined as the added value of industrial enterprises above a certain scale, referring to those with annual main business income of 20 million or more. Like the calculation method for real GDP, it is a "quantity" indicator. The cyclicality of agriculture and services is not as strong as that of industry. Industry is an important variable reflecting the economic cycle and the degree of economic heat.

Industrial added value most accurately reflects short-term economic growth conditions. The three statistical principles of industrial added value show that industrial added value trends align with the yield trends of 10-year government bonds, and lead them.

1. PMI 50 is the line between expansion and contraction. Above the line indicates economic expansion, while below indicates contraction.

2. PMI is divided into official PMI and Caixin PMI; official PMI focuses more on the economic prosperity of large state-owned enterprises, while Caixin PMI emphasizes small and medium-sized enterprises.

3. When analyzing PMI data, seasonal factors need to be excluded. PMI is a month-on-month indicator.

4. Among the sub-indices, special attention should be paid to the new orders index and the indices for raw material inventory and finished product inventory.

5. The PMI index is generally positively correlated with GDP, the Shanghai Composite Index, and bond indices.

How to Statistically Analyze?#

The added value of industrial enterprises and their profits.

PMI (Purchasing Manager's Index) is derived from the monthly surveys of purchasing managers, indicating whether conditions have improved, worsened, or remained the same compared to the previous month, and is divided into two types:

1. Official PMI: Jointly released by the National Bureau of Statistics and the China Federation of Logistics and Purchasing, published monthly.

   (1) Includes:

   Manufacturing PMI: A total of 13 survey items, of which 5 (new orders index 30%, production index 25%, employment index 20%, supplier delivery time index 15%, raw material inventory index 10%) are used to calculate PMI, while the remaining 8 are not included in the PMI calculation.

   Non-Manufacturing PMI (Non-Manufacturing Business Activity Index):

   Composite PMI Output Index:

   (2) The sample mainly includes large state-owned enterprises, reflecting the economic prosperity of state-owned and large enterprises.

   (3) Data is affected by quarterly fluctuations, with adjustments made quarterly, but the adjustment effect is poor.

2. Caixin PMI: Compiled by Markit Financial Information Services and authorized for release by Caixin, published monthly.

   (1) Includes: Manufacturing PMI, Services PMI.

   (2) The sample mainly includes small and medium-sized enterprises, reflecting the economic prosperity of small and medium-sized and private enterprises.

   (3) Data is affected by quarterly fluctuations, with adjustments made quarterly, but the adjustment effect is poor.

Manufacturing PMI is positively correlated with nominal GDP growth rate, stock market (Shanghai Composite), and bond market (10-year bonds), except for the water buffalo period from 2014 to 2014.

2. Financing Value Addition

Holding shares of listed companies provides an additional source of profit, which is the financing rights of listed companies. When listed companies issue new shares to other shareholders at a price above net asset value or split off some assets to independently list and finance at a price above net asset value, these actions are often referred to as "raising money." If we are shareholders, it means we are raising others' money to increase our own company's net assets.

CCI (Consumer Confidence Index)

If PMI measures the economy from the production side, then CCI approaches it from the consumption side.

As the name suggests, CCI is an indicator used to reflect the strength of consumer confidence. According to encyclopedic definitions: the consumer confidence index indicates that when the economy can ensure more job opportunities, higher wages, and lower interest rates, consumer confidence and purchasing power will increase.

M2 (Money Supply)

Previously, I explained that CPI (Consumer Price Index) is an indicator for measuring inflation, but since it does not consider housing prices, it is not very suitable for measuring inflation in our country.

Therefore, it is generally believed that the increase in the money supply minus the increase in wealth represents the amount of inflation, meaning:

Inflation Rate = M2 Growth Rate - GDP Growth Rate.

However, it must be added that financing above net asset value will increase the company's net assets, but it does not mean that financing above net asset value is advantageous for new shareholders. I opposed Guotou Power (hereinafter referred to as "Guotou") issuing new shares to major shareholders at 7.95 yuan (when the stock price was about 7 yuan). Guotou's net asset value was just over 4 yuan; the 7.95 yuan issuance did indeed increase the company's net assets, but it did not necessarily increase the interests of other shareholders. Because that 4 yuan corresponds to a profitability value higher than 7.95 yuan, if the major shareholder wanted 7.95 yuan, they could simply go to the market to buy shares from those who valued Guotou at less than 7.95 yuan, thus avoiding forcing other shareholders to relinquish their equity.

Perhaps the Guotou case is not clear enough; let’s assume a contrasting example to illustrate. When the market price of Kweichow Moutai (hereinafter referred to as "Moutai") was 100 yuan in 2013, its net asset value was about 40 yuan, with a total share capital of 1.038 billion. If Moutai intended to issue 300 million new shares to a new shareholder at 120 yuan each (the new shareholder would invest 36 billion, and total share capital would become 1.338 billion), this would not only be three times the net asset value but also 20% higher than the market price. If viewed in isolation from the perspective of increasing net assets, it might seem that the 120 yuan directed issuance is quite advantageous, and one should vote in favor.

However, from the perspective of company ownership, the old shareholders would be ceding about 22.5% of the company's ownership to the new shareholders; from the perspective of net profit, from 2013 to 2016, Moutai's total net profit was nearly 63 billion, of which the new shareholders would own about 14.2 billion; from the perspective of dividends, over four years, the new shareholders would have received cash dividends totaling about 5.8 billion (assuming a dividend of 8.5 billion in 2016, totaling nearly 26 billion in cash dividends over four years); from the market value perspective, today’s market value is over 400 billion, with new shareholders holding over 90 billion of that... No matter from which angle, the returns for new shareholders are astonishing. These profits should have belonged to the old shareholders but were taken by new shareholders through the trick of "high" price issuance.

The above is a side note to illustrate a principle: financing above net asset value will increase the company's net assets, but it does not necessarily benefit old shareholders. Only financing that is significantly higher than the intrinsic value of the enterprise will increase the interests of old shareholders.

In the A-share market, issuing new shares at high prices or increasing share issuance is quite common, with the extreme form being IPO listings, which bring enormous wealth to original shareholders. Splitting off subsidiary assets or independently listing them is still relatively rare domestically, but the principle is to carve out an asset and sell part of the equity at a high price. These are easy to understand.

3. Short-term Unordered Fluctuations in Stock Prices

What is most tempting about the stock market is precisely these short-term unordered fluctuations. It is called "unordered" because for hundreds of years since the birth of the stock market, countless top minds have been trying to find the 规律 of stock price fluctuations. As long as one finds a method to grasp stock price fluctuations, even if one can profit 10% from high selling and low buying once a month, with a principal of 100,000, one could become a billionaire in about ten years, ranking among the top 100 on the Forbes list of China. However, countless theories and practices have proven that humanity lacks the ability to master short-term stock price fluctuations—at least up to now, this ability has not been achieved.

Among the three sources of profit mentioned above, the first two factors are overall profitable, and due to the second factor, the profit rate will be higher than the average return on equity of listed companies, which is certain. Those chasing short-term fluctuations, due to stamp duty and commissions, are overall at a loss, which is also certain: based on the 254 trillion trading volume in 2015, with a 0.1% stamp duty and 0.025% commission, the net loss was 317.5 billion. Based on the 50.77 million holders disclosed by the China Securities Depository and Clearing Corporation at the end of 2015 (one ID card counts as one holder regardless of how many accounts), the average loss exceeded 6,000 yuan. Of course, there are inevitably a few individuals who, due to luck, insider information, or other factors, achieve returns above the average, resulting in profits or even windfalls.

Therefore, to target the first two sources of profit, you are in a pond where the water level is constantly rising. If your IQ and knowledge are at average levels, you can reliably achieve returns slightly above GDP growth; if you are slightly above average, you can achieve excess returns; even if you are slightly below average (as long as you are not too far behind), you can still maintain positive returns; only if your IQ and knowledge level are significantly below average can you incur losses.

Conversely, aiming to obtain the third source of profit requires that you be above average in terms of ability, knowledge, and luck compared to all participants in the game to avoid losses. Otherwise, whether you are at or below average, it is a big "草书"—death! I don't know if you are confident that your ability, knowledge, and luck are above average, but I certainly am not—though I can't say I never was; I had some confidence 20 years ago. Later, I found that no matter how hard I worked or how long I stayed up, I was merely fluctuating with luck and trends, unable to secure reliable returns. Over time, the outcome inevitably led to losses and bankruptcy, and thus I lost that confidence.

Moreover, the emotional changes in the game lead to unordered fluctuations in stock prices, often bringing additional surprises to those aiming for the first two sources of profit—emotional stock price drops often provide opportunities for those aiming to profit from corporate value addition to buy in at prices far below intrinsic value, which can be an additional bonus.

In this market, those chasing short-term fluctuations likely account for over 90%. Whether they realize it or not, this action reflects a belief that they are above average and can obtain short-term fluctuation profits, coming to the market prepared to rob money from opponents (who may be your friends, teachers, predecessors, peers, bosses, or neighbors).

With such intentions, daily fluctuations represent either successful robberies or being successfully robbed. Fluctuations over one or two days, one or two limit-ups or limit-downs, represent victories or failures in robbery, naturally leading to excitement, pride, or distress, anxiety, and confusion with stock price fluctuations.

If you are here for corporate value addition and to take advantage of new shareholders, you will inevitably hold with a long-term mindset, buying at favorable prices. Because corporate value addition relies on production and sales personnel accumulating day by day, order by order; it is impossible to dig up a gold ingot with one stroke; waiting is a natural virtue. Similarly, good events like high-price issuance or spin-offs do not happen every two weeks; they often occur over years or even decades.

With this psychological preparation, the random value of unordered fluctuations (buying far below intrinsic value and selling far above intrinsic value) can naturally be seen as a bonus, a way to take advantage. If you have it, take it; if not, that is just the way it is; let others with the same investment system take advantage.

With this understanding, when you buy in at a 30% discount and the market price drops to a 50% discount, you won't panic or fluster. That is merely more bargains, more opportunities to take advantage of; if you have the ability, continue to accept it; if not, let others who share the same investment philosophy take advantage—though you may not know who they are.

Credit

1. Renminbi Loans Include:

   (1) Household Loans: Short-term consumer loans, credit card overdrafts; medium to long-term mainly housing loans.

   (2) Corporate Loans: Including bill financing, short-term financing for enterprises (to supplement operating capital), and medium to long-term financing (the most substantial, reflecting investment demand).

   (3) Non-Bank Financial Institution Loans: Financial institutions other than commercial banks and specialized banks, including public funds, private funds, trusts, insurance, securities, financing leases, and financial companies.

2. Social Financing Scale Includes:

   (1) Funds provided by financial institutions to the real economy through on-balance sheet business: including Renminbi loans, foreign currency loans.

   (2) Funds provided by financial institutions to the real economy through off-balance sheet business: including entrusted loans, trust loans, and unendorsed bank acceptance bills.

   (3) Direct financing in the financial market: including corporate bonds, non-financial corporate stock financing, and local government special bonds.

   (4) Other methods of providing funds to the real economy: insurance company compensation, investment real estate, deposit-type financial institution ABS, loan write-offs.

Currency

1. Different Measures of Money:

   M0 = Currency issued by the central bank - cash held by commercial banks.

   M1 = M0 + unit demand deposits.

   M2 = M1 + personal savings + unit time deposits + other deposits.

   M1 mainly consists of corporate demand deposits; in the past, unit demand deposits were primarily for the liquidity needs of expanded reproduction. Thus, M1 can be simply considered as the liquidity funds for real estate and infrastructure. A decrease in real estate and infrastructure investment will lead to a decrease in M1.

   M2 mainly consists of residents' medium to long-term deposits; if residents withdraw medium to long-term deposits to convert to housing loans, M2 will decrease.

2. M1-M2 Scissors Gap:

   A high M1 indicates a fast money circulation speed. If enterprises are optimistic about the future, they will convert deposits into demand deposits, leading to a narrowing of the M1-M2 gap.

   However, since residents, local governments, and real estate developers are currently repairing their balance sheets, the M1-M2 data is affected by deleveraging, masking the borrowing situation of prosperous sectors, and one cannot simply conclude the economic situation based on the size of the gap.

3. M2/GDP:

   This approximates the leverage ratio of the real economy.

   As social leverage increases, social financing and money gradually fail to reflect the state of the economic fundamentals. In the deleveraging phase, these indicators become ineffective, failing to reflect changes in the economic structure for the better and decoupling from the stock market. The reasons are:

   1. In social financing, the borrowing entities are local governments, developers, etc., who borrow money for infrastructure and real estate, driving economic growth. Now these borrowing entities are busy repaying debts and using funds to fill holes (government operations, debt repayment, etc.), unable to invest to generate GDP. Therefore, social financing and credit indicators cannot reflect positive changes in the economic structure. However, economic growth cannot collapse; otherwise, it would lead to deflation and unemployment. China has the central government issuing bonds to support the original leverage of real estate and local governments, stabilizing the investment portion of the economy.

4. Is it necessary to diversify allocation with a small amount of funds?

   This depends on each person's investment ability. For those with genuine investment capabilities, having a small amount of funds is a significant advantage. There are indeed some excess return opportunities in the market that can only accommodate a small amount of capital. If the fund amount is small, one can participate fully.

   However, the paradox is that those with genuine investment capabilities will not have too small amounts of capital; while the vast majority of ordinary people lack professional investment abilities.

   Therefore, for the vast majority of ordinary people, regardless of the amount of capital, it is necessary to consider diversified asset allocation. Specific models that have been proven effective can be referenced.

   The simplest asset allocation model is the dynamic rebalancing model of stocks and bonds. Investors can set the holding ratio of stocks and bonds according to their risk preferences, such as 5/5, 2/8, 3/7, etc., and then rebalance based on the degree of deviation or rebalancing cycle.

   For example, in the initial state, the ratio of stock assets to bond assets is each 50%. If you set a deviation threshold of over 20%, you will rebalance. When the stock market rises sharply, and the proportion of stock assets reaches 60% of the total position, you should sell stock assets and buy bond assets to restore the allocation ratio back to 5/5; when the stock market falls sharply, the operation is similar but in the opposite direction.

5. How to view diversified asset allocation?

   The number of asset types you allocate depends on how many types of assets you can understand. The primary principle of investment is "do not invest in what you do not understand." When we rashly invest in a field we completely do not understand, the risks are limitless.

   "Do not put all your eggs in one basket" holds true only if you are very familiar with these "baskets" and have thoroughly checked them, ensuring that the "eggs" will not fall out.

   Friends will surely ask, how do you define "understanding"? Personally, I believe that to understand an asset, you must accomplish at least the following three things.

   First, understand the development history of the asset, especially historical crisis events.

   Investing is about the future performance of the asset, but as Winston Churchill said, "The farther back you can look, the farther forward you are likely to see." After understanding history, you can roughly understand your current position and the various situations that may arise in the future.

   Second, clarify the sources of returns and risks for this asset.

   The essence of asset allocation is to find the assets with the highest long-term returns while minimizing the correlation of holdings. Only by understanding the sources can we truly understand the correlations between assets, while merely looking at historical data backtesting will overlook many pitfalls.

   Third, conduct a stress test for yourself.

   Suppose after buying this asset, the price drops by 50%; would you feel anxious? If not, you probably understand it; otherwise, you likely do not. I remind you: people tend to overestimate their risk tolerance, so when conducting such stress tests, be honest with yourself.

   Do not allocate just for the sake of allocation. While I have always advised everyone to do a good job in asset allocation, I never suggest doing so just for the sake of allocation.

   The reason we invest in certain assets is that the returns and risks of these assets have cost-effectiveness and are beneficial to us.

   Common misconceptions include two points:

   Allocating assets you do not understand; following the trend to allocate overheated short-term assets. There is no asset that is a must-buy. There are many ways to make money in the world, and making money does not necessarily have to rely on investment.

Summarizing my thoughts around these eight words serves as an explanation to myself and hopefully provides some help to everyone.

In my view, these eight words convey:

Do the right thing; the result is a byproduct;

The result is not under our control;

Let go of attachment and entanglement;

Focus wholeheartedly and dedicate yourself fully.

Do the right thing; the result is a byproduct.

This world is particularly interesting; sometimes, the more straightforwardly you pursue results, especially the more urgently you seek short-term results, the less you obtain.

When you calm down, slow down, and think clearly about what you truly want, doing what you love and focusing on creating value while continuously pushing your boundaries, the things you originally wanted often come unexpectedly.

This applies to investing, running a business, and living.

Take investing as an example. The fruit of investment is performance; the cause of investment is the path and mindset, the investor's understanding of the world.

Warren Buffett's partner, Charlie Munger, believes that successful investing is merely a byproduct of our careful planning and focused actions in life.

Ray Dalio, in "Principles," also believes that those who achieve great things never prioritize making money as their primary goal.

Dalio believes: Success is a byproduct, an extra reward for being true to oneself and pursuing one's inner desires.

Dalio implements principles throughout every corner of Bridgewater Associates, aiming to reduce decision-making costs for himself and his employees, allowing everyone to focus more and thus reap the byproduct of success in the process of pursuing their inner desires.

It is often said that "high risk leads to high returns," but investment masters and experts also tell us that "low risk is necessary for high returns." Are these two statements contradictory?

Actually, they are not contradictory.

"High risk leads to high returns" does not mean that high risk necessarily brings high returns; rather, it means that high risk leads to more uncertain outcomes—perhaps higher returns, perhaps lower, or even losses. We need to use our knowledge to assess the possibilities of various situations and make decisions about whether to invest and how much to invest.

On the other hand, masters like Buffett say that "low risk is necessary for high returns" from the perspective of margin of safety, indicating that we need to control the cost of buying in. If you buy too expensively, it is impossible to achieve high returns.

You see, just a few words encompass a lot of understanding about risk. Only by truly understanding the concept of "risk" can we distinguish between these two statements and not feel confused.

This content is excerpted from "The Most Important Thing in Investing," where Howard Marks elaborates on what risk is. Understanding risk is essential for identifying and controlling it.

Investment is all about one thing: dealing with the future. No one can predict the future with certainty, so risk is unavoidable. Therefore, dealing with risk is an essential (I believe fundamental) element of investing. Finding investments with potential for appreciation is not difficult. If you can find enough of them, you may already be heading in the right direction. However, if you cannot properly deal with risk, your success cannot be long-lasting.

The first step is:

Why is risk assessment an essential element in the investment process? There are three compelling reasons.

First, risk is a bad thing, and most clear-headed people wish to avoid or minimize it. A fundamental assumption in financial theory is that human nature is to avoid risk, meaning they are willing to accept lower risks rather than higher ones. Therefore, when investors consider an investment, they must first assess its riskiness and their tolerance for absolute risk.

Second, when considering an investment, investment decisions should take into account both risk and potential returns. Due to risk aversion, investors must be enticed with higher expected returns to take on additional risks. In simple terms, if both U.S. government mid-term bonds and small business stocks have the potential to achieve a 7% annual return, everyone would rush to buy the former (thereby raising its price and lowering expected returns) while selling the latter (thereby lowering its price and increasing its returns). This relative price adjustment process is known as "equilibrium," which aligns expected returns with risk.

Thus, in addition to determining whether one can tolerate the absolute risks associated with an investment, the second task for investors is to determine whether the investment returns are commensurate with the risks taken. Clearly, returns are just one aspect to consider when investing, while risk assessment is another essential aspect.

Third, when considering investment outcomes, returns merely represent gains; assessing the risks taken is necessary. Were the returns achieved through safe or risky investment tools? Were they obtained through fixed-income securities or stocks? Were they gained by investing in large, mature companies or small, unstable ones? Were they acquired through liquid stocks and bonds or illiquid private equity? Were they achieved using leverage or without leverage? Were they obtained through concentrated or diversified portfolios?

When investors receive reports and see that their accounts earned a 10% return that year, they likely cannot judge whether the investment manager's performance is good or bad. To make a judgment, they must have some understanding of the risks the investment manager undertook. In other words, they must be clear about the concept of "risk-adjusted returns."

Understanding risk is the first step. The second step is identifying risk. The final critical step is controlling risk.