Investing is often a complicated subject. And with the proliferation of media, the over-abundance of pundits and opinions, it’s hard to know how invest in today’s world. Essentially, there are two options as to how to handle savings—consume or invest. The investment world affords two options: purchase assets, or lend your money. There are a wide variety of assets to buy, from stocks and real estate to art, antiques, precious metals, jewelry, collectibles and more.
There are several lending options as well. You can keep your money in the bank, lend money to Uncle Jerry (California muni bonds), or to Uncle Sam (U.S. Treasury bonds), or to corporations. The creative minds of Wall Street also provide investors the ability to invest in mortgages, an “opportunity” that eventually got so out of control that a financial crisis ensued.
There’s reasonable doubt as to whether making a loan qualifies as an investment. After all, the best-case scenario when you lend money is to receive a market rate of interest and then the full return of your principal. Even modest levels of inflation erode the purchasing power of the principal received when the loan matures. For instance, at the current Federal Reserve targeted inflation level of 2 percent, if you lend a dollar today when you get it back in ten years the dollar will have the purchasing power of 82 cents today. The purchasing power of a dollar lent for 30 years in an environment of 2 percent inflation will erode by 45 percent.
The asset advantage
Our firm is a big proponent of owning assets. Well located and conservatively financed real estate and large, liquid highly rated stocks are excellent stores of value. Any investor willing to hold onto high quality assets over a long period (20-plus years) has a high likelihood of earning three to five percent more per year on their investments than what they could have made lending their funds over a comparable duration.
The only catch is that you have to hold onto these assets through a market cycle, riding out the inevitable market declines. This is easier to do in theory than in practice, but with a 20-year or greater investment time horizon, do you really care what your portfolio (or house) is worth right this minute? If you do, you shouldn’t, and you also shouldn’t listen to market pundits whose primary purpose in opining is to encourage you to shift your investments in their direction.
As to the financial crisis, here’s the simple explanation. Any homeowner appreciates the option to borrow at a fixed rate of interest for a long period of time. If rates go up, you have a cheap loan. If rates go down, you can borrow at lower rates to pay off your higher cost loan. Add in the fact that mortgage interest, with some limitations, is tax deductible, and you see it’s a pretty good deal to have a fixed rate mortgage.
By definition, if it’s a good deal to be a borrower, it can’t also be a good deal to lend. And yet every person and institution that “invested” in mortgage-backed securities played the role of lender. Since the banks that issued these opaque securities were interested more in volume than quality, credit discipline started slipping dramatically, and eventually lenders suffered losses of a magnitude that nearly brought down our financial system.
Bankers knowingly lent money to borrowers who had little or no chance of ultimately repaying the loan, and then packaged these loans to sell to greater fools. These lenders committed fraud, often with federally insured money. That is a crime to which virtually no one was held accountable. The recapitalization of the banks through the Fed’s zero interest rate policy successfully reflated asset values, helping those who owned the assets, but the end result has been an increasingly widening gap between the haves and have nots. And that has greatly exacerbated political divisions, resulting in our current state of extreme national disquiet.
Jumping off my soapbox, the question remains: how should an investor allocate assets today? That is too complicated to address in one column, as every individual has a different tolerance for risk, but in general, the longer you have to invest, the more you should be allocated toward owning assets (stocks, real estate) and the less you should lend your money. For investors in the stock market, we would strongly counsel a highly diversified approach that would include a meaningful allocation to both developed non-U.S. and emerging market equities.
Andy Mathieson is the founder and president of Fairview Capital, a registered investment advisory firm located in Greenbrae. Andy and his wife, Ann, have four adult children, and have been Kentfield residents since moving to Marin County in 1992. He can be contacted at andy@fairviewcap.com or (415) 464-4640.
