What is the role of real assets in preserving your wealth?

March 22nd, 2009

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In our previous article, we made a case for gold in your portfolio. Today, we will talk about the role of real assets. Before we begin, let’s get our basic definitions right.

There are broadly two types of assets:

  1. Financial asset – This is basically a piece of paper (e.g. document or certificate of title) that represents a physical asset. A financial asset has no intrinsic value because it is an intangible representation of a real asset. In the ancient past, most assets are real, physical and tangible (e.g. land, gold, silver, etc). The rise of the modern economy allows people to hold assets in conveniently intangible forms. Examples of financial assets include: money in the bank (bank liabilities), government bonds (government debt), real estate mortgages (household debt), shares (company shareholders’ funds).
  2. Real asset – This is basically tangible and physical things that provide economic value. Real assets include real monetary assets (e.g. gold, silver and other precious metals), commodities (e.g. copper, iron, oil, grain, wheat, corn, etc), real estates (e.g. properties), farms, mines, factories and (for the paranoid), guns, food, water and so on.

Interestingly, the word “credit” comes from the Latin word “cr?dere,” which has the meaning of trust (“to believe”). Therefore, the credit crisis implies a crisis in trust in the global financial system. Without trust in the financial system, the value of financial assets becomes suspect. Thus, as we said before in Fading glory of the financial services and ?wealth? management industry, the reality of this new world is that,

Thus, the global credit crisis is a return back to reality as the masses wake up their idea that all these ?wealth? are illusionary.

As far as we can see, the bull market (in real terms) on financial assets is over.

This generation is so used to the idea that the financial system can be trusted. Unfortunately, this trust had been abused and exploited. It takes a Global Financial Crisis (GFC) to expose the fact that this trust is unfounded.

Hence, the extent of your diversification towards real assets will depend on the extent of your distrust in the financial system. It will also depend on your expectation of the state’s legal and administrative infrastructure to enforce and define your rights. Obviously, weak states cannot provide such infrastructure. Therefore, if you really distrust the financial system and is very pessimistic about the global economy and geo-political situation in the days ahead, you will be switching some of your wealth into real assets.

Within real assets, you will have to allocate between (1) real monetary assets (e.g. gold and to a certain extent, silver) and (2) real non-monetary assets (e.g. commodities, land, farms, etc). How should the allocation be made?

We cannot advise you on that. But here are some pointers to take note of:

  1. Both types of real assets serve different functions. The former functions as money. The whole purpose of money is to exchange for things that you want. The latter are things that are (I) directly wanted  (e.g. commodities, food) or (II) means of production for things that are directly wanted (e.g. mines, farms, factories, timber land).
  2. Without money, the only way to get things that you want is by (a) force or by (b) bartering. Since we do not advocate violence, we will rule out (a). For (b), it is highly inefficient. That’s why human society evolved away from direct bartering to using money.
  3. The only way for you to completely do away with money is for you to be (i) completely self-sufficient or (ii) have the energy and will to engage in bartering. Otherwise, there will be a need for exchange using money.

Real non-monetary assets have their risks too. In particular, ownership of farms, lands and properties requires a functioning legal and administrative infrastructure to enforce and define your property rights. In states like Zimbabwe, the government abandoned the rule of law and enforcement of property rights by allowing war ‘veterans’ to take away the land of the white farmers. In Russia, the government nationalises the real assets of foreign businesses- no wonder investors detests Russia.

For the ultra-pessimists, a shot-gun is an asset too. But let’s hope the world wouldn’t degenerate into that.

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