Whose Means?

What can someone else do with my $10 that I am not able to do myself?

Well, quite a bit actually. In fact, when you get right down to it, this is essentially why stock market exists.

When I purchase a stock, I am engaging in the transaction based on an assumption that the company I am investing in is better suited to make effective use of my capital than I am. I am wagering that my $10 will be put to better use by the company than I would otherwise on my own.

In theory, every time one considers a new investment, the question should be asked, "can I achieve a greater return on capital by my own means, or do I believe that this company will employ my capital in a more efficient and effective manner than I can?"

To illustrate my point, imagine that I own and manage a successful accounting practice. One day, a friend offers me a role as a silent partner in his new lemonade stand franchise if I would be willing to provide some venture capital to get his business off the ground.

Assuming that I have limited capital, how do decide whether financing my friend's lemonade stand is a sound investment decision?

There are two kinds of questions I should be prepared to answer before I make my decision:

The obvious questions

1. What kind of return on equity do I expect from my friend's lemonade stand?
2. Does my friend seem to have a good business model?
3. Do I know anything about my friends business history? Has he done well in the past? Do I anticipate he will succeed in the future?
4. Will I receive a fair share of equity in the lemonade stand proportionate to my investment?
5. Will the lemonade stand pay a dividend from earnings?
6. Etc.

The not-so-obvious questions

1. What is the current return on equity of my accounting practice?
2. Is there room for growth in my accounting practice or do I feel that acquiring additional market share will be costly?
3. How is my accounting practice's cash flow? Do I need the extra capital to satisfy my current or long-term liabilities?
4. Will an infusion of capital in my accounting practice allow me to better position myself for industry changes?
5. Am I diversified, or does having my capital tied up in my accounting practice leave me exposed to sudden changes in the market or extraordinary events?
6. Etc.

Of course this process will be different for everyone and for every investment decision, and indeed, unless you manage your own business the scale will usually weigh heavily in favor of investing beyond your own means of production, but the questions should be asked nevertheless. If nothing else, it is a good exercise in evaluating the viability of an investment.