Don’t glaze over - stay with me here! Clients often ask me about different individual investments such as gold, silver or a residential property that loses money.
Although investing is a fundamental concept, it is one that many people seem to struggle with. A basic understanding however, can mean the difference between a comfortable retirement and welfare for 30 years.
Investing can be described in a few different ways. You could define it as:
- Laying out money now with the expectation of more money in the future.
- Transfer PURCHASING power now with the expectation of a higher PURCHASING power in the future.
The real risk is the LOSS of purchasing power over the holding period. In this way, assets can fluctuate greatly in price without being risky IF there is a high likelihood that they will deliver increased purchasing power.
And a ‘non fluctuating’ asset can in fact be very, very risky.
Most investments fall into three different classes:
- Currency based such as cash, bonds, mortgage funds etc. While they may not fluctuate in value, they are subject to inflation and government decisions such as “Quantative Easing” (printing money to increase inflation). In the current low interest rate environment, the real income from these investments is nil and often negative after tax.
- Investments that don’t produce anything. (Gold, silver, artworks, classic cars etc). They are purchased with the HOPE that a future investor will pay more than they did (in the 17th century even tulips became hugely valuable). As the asset doesn’t produce anything, it requires a greater number of buyers who in turn think it will be worth more in the future. And one ounce of gold in 30 years will still be one ounce of gold and will have produced no income.
- Productive assets. This actually makes a profit. Always a good idea! It might be a business (shares) or real estate that generates income. Not all real estate or all businesses are profitable of course, but the right ones will grow in PROFIT at a higher rate than inflation.
So don’t just believe what you sometimes hear such as “gold is a hedge against inflation”, “all shares are risky” or “real estate doubles in value every seven years”. This is just simplistic nonsense and is usually a sales pitch job dressed up as advice. To create long-term wealth, we need to accumulate investments that have real underlying value based on income and not just perceived pricing.
Circumstances can change quickly. That new “safe as houses” investment in the latest booming mining town bought by your super fund with borrowed money that looked so good at the slick property seminar, may in fact destroy your wealth and any retirement plans for your family.