The Two Purposes Of Investing

Two purposes of investing? That's right, and this is one of those times in history that make this clear. We would all love to accomplish the first purpose, which is to make money with our money. But in a time when all investments seem a little uncertain to say the least, and the currency is being destroyed by the most massive printing of dollars in our lifetimes, we may mostly just want to preserve what we have saved.

This basic wealth preservation is the second purpose of investing. Stick that money under a mattress and it will be eaten up by inflation. If in ten years or so we end up with a dollar worth half of what is is worth now, you need to have doubled your money just to stay even, to buy the same number of loaves of bread or the same car or whatever. One way to preserve that buying power is to invest in things that hold value as the currency is devalued. Traditionally these "stores of wealth" include gold and other precious metals as well as real estate.

Preserving Wealth

Its promoters say gold has never gone to zero and has always retained its value over the long run, but that can be a pretty long run. It may be true that an ounce of gold will buy roughly the same amount of wheat or house as it did two hundred years ago, but what if you bought it in 1980 at around $800 per ounce. It would have been over 25 years before you got back to even - without accounting for inflation. In fact, as I write this page (fall 2009), gold is at about $1,060 per ounce - a record for all time that would still represent a lousy return for anyone who bought gold in 1980.

Consider if you had simply put your money in the bank and averaged a 4% return since 1980 (easily possible given the 10% CDs available at the start of this stretch). $80 would have grown to $2,500 by now, more than double what the price of gold has done.

It is true that gold and raw land may hold value better than most things (and silver may be better than either at the moment), but it is still a matter of timing. This is because the "market," meaning people, overreact at either end of troubled times. They rush into gold, for example, driving the price too high too fast, and then when things seem stable again, dump it too fast, driving the price down dramatically.

One lesson in this might be to buy when these things are still cheap. Don't take this to mean gold is done climbing. Yes, you could have bought it at close to $400 per ounce about four years ago, but it may still triple from its current price of $1,060 before this run is over. Predicting the timing and extent of these moves is next to impossible.

But there is a bigger problem with this kind of "investing." Gold doesn't produce income. In other words, it is in a sense the same as sticking the money under your mattress, albeit a hopefully more inflation-resistant mattress. The goal, unless you have a lot of faith in your timing, is to do nothing more than preserve what you have in terms of buying power. In this respect, it may not even be fair to call this investing.

Consider land, another one of the ultimate "stores of wealth." Unless you guess well which area that will grow faster than others and buy at the right time, the best that can be expected is that when you someday sell for twice what you bought it for the money will buy the same amount of groceries and other goods. In fact, since you have to pay property taxes, if all you do is match inflation, you lose a little each year. This, then, is at least a way to lose your savings more slowly than hiding them under the mattress or in a bank account. Not an inspiring thought.

Here's one more less-than-inspiring thought. If you set aside ten percent of everything you make for 40 years, and for all the "growth" in dollar terms you get, all this retirement fund does is stay even with inflation, then all you have is enough money to pay the bills for four years. You will almost certainly live for more than four years after retirement.

Making Money With Money

The first goal of investing is typically to make your money work for you to make more. So, while there may be a place for investments in metals or non-income-producing real estate as a an emergency wealth preservation tool, ideally you want to produce wealth faster than governments can destroy the value of the currency that measures it. The stock market may do this in the long run, but again it can be a long run. The Dow Jones Industrials Index hit a high of 995 on 2/9/1966. It took almost seven years to get back to that level, and then it dropped again, down to 577 by 1974. It wasn't until 1982 that it crossed 1000 for good. Twenty-six years just to break even.

Of course Warren Buffet made money in stocks throughout this time. How? Not by guessing about the ups and downs. He essentially just bought solid profitable companies that were cheap and held them. Of course, he has access to boardrooms that you and I don't and even Mr. Buffet lost tens of billions during last year's stock market wipeout.

Income-producing real estate may be one of the safest ways to both preserve your wealth and grow it. This kind of investing verges on being a business, though, since you have to be a landlord or hire one, as well as engage in other business activities (advertising, going to court to evict tenants, etc.). I personally didn't like being a landlord, and I really don't enjoy dealing with real estate, but I can't help but see the value in it.

Consider a "worst-case" scenario I recently read about. A man bought a house in Detroit over 30 years ago and rented it out. He bought it for $50,000 and now has to sell it for $31,000 because Detroit has been going downhill ever since. But he only invested about $7,000 of his own money at the start between the down payment and closing costs, and the rent has covered the costs over the years. In fact, he owes nothing on it, so now, in addition to the cash flow over the years his $7,000 has become $28,000 (what he clears after costs).

Of course, if you buy in an are that is growing and you have positive cash flow it is more likely that a $50,000 rental house will be worth $150,000 in 30 years, and that rents will be higher so you'll be making much more cash flow each month. When you look at the numbers, and the safety provided by investing in something that everyone needs, it's hard to avoid the conclusion that real estate is still a great investment - as long as you buy with cash flow from the start.

Investing In Crazy Times

These are interesting times. Real estate may fall in value even further, despite the destruction of the dollar. The stock market will crash again at some point. Gold will reach its high for this run, and then fall at some point. What can you do to invest wisely in this environment? If you are young enough you can think very long term and buy good companies in the stock market - but be prepared to see the prices go down at some point. Considering that you can make money on a house that drops by half in value, income-producing real estate might be a good idea too.

More than anything else, though, this is a time to invest in yourself. That might mean going back to school to get a degree that opens up better job possibilities. It can also mean getting self-educated in the ways of money, so you can manage what you have and stay out of trouble. Learning how to do business is another great way to invest in yourself. After all, if you know how to make money you can lose it all in an economic meltdown and still come back.

Perhaps the best approach is a little bit of everything. Invest in your financial education. Start a business. Buy some quality companies in the stock market. Have some silver coins stashed away for worst-case scenarios. Buy a rental house or other income-producing real estate. Maybe even invest in some solid companies overseas to grow your investments and protect yourself from dollar declines. Get out of debt, except for a home and smart investments.

In future newsletters we'll look at other investments, as well as at the issue of ethical investing (should you buy that cigarette company stock?).

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