Wednesday, January 17, 2018

The longer you keep it the less its worth! About drains and financial plumbing


We have been busy thinking about money lately. I would like to put up another money idea or concept. Money is a means to temporarily store wealth. But if you keep your wealth too long in cash you are going to lose it because overtime most money, in particular fiat money, loses purchasing value.  In fact, economists and their buddies at the central banks all over the world get really panicky if money doesn’t lose value. If inflation is not around two percent the economy probably is not  growing fast enough they say. Well, whatever.
So here are all those governments and corporations and home owners. If the purchasing value of money - I mean fiat money-  falls, then they benefit. Well, most of the time.  You see governments print money out of thin air and through issuing government debt they withdraw funds from the real economy as well.  They are just borrowing from their citizens and whomever else needs a way to park cash.  The lenders earn interest; but in times like today, especially on an after-tax basis, they receive hardly any interest.  To top it of, each year the face value or the principal of the loan loses purchasing value (if the central banks make their target of every year 2% less purchasing power). Of course, this is a compounding loss for those poor lenders. Over a 10 year period their ‘principal’ loses 18.3% in power and over a century the principal is worth only 13% of its original purchasing value.  So if government pays only (on an after tax basis) 1%x(1-50%)= 0.5% interest while there is 2% inflation then in under a century the debt has gone to virtually zero. But it gets worse: because historically inflation averaged 4%. i.e. the principal on debt is reduced to 10% of its original purchase value in under 50 years, who benefits?

Yes not the lenders.  If you have a 50 year mortgage and you just pay the interest but don’t pay the principal what happens?  Your house increases in value with inflation and with population growth. Your house appreciated 3 to 6% per year while your mortgage principal is going down the drain in purchasing power. So banks ask for a premium over inflation when setting up mortgages rates but in times like these those (interest) rates are virtually zero and when you invest in real estate the interest is even tax deductible. Well for you but not for your tenants, of course.

When large corporations go into debt, they play the same game. The longer they keep the money, the less debt in terms of purchasing power. Insurance companies do it even better. All their clients pay insurance premium, i.e. give that insurance company an interest free loan and when the bad times come, the insurance has plenty of money to pay for the damage while investing free money during all those years they collected the premium. Why do you think that GEICO owner Warren Buffett is so rich?  And you thought he was just a good stock picker?  No, oh no! Warren is a lot more than that!

Of course, if interest rates fall, the price of bonds go up; but if interest rates rise those same bonds drop in price. So is it a zero sum over the long term? In some ways yes. That is the trouble with lending other people money. In many cases, unless you’re a math whiz, you'd likely lose money and you help borrowers to invest using leverage to make lots of money at your expense. Now, it is not quite that simple because if you borrow too much you are likely to end up in the poor house as well.

But when all is said and done, money is only a temporary means of storing your wealth. In the end, if you don’t do anything productive with your wealth others will suck it away from you. So really, you should accumulate assets. An asset is anything that earns money for you – real earnings after tax and inflation that is. There are ways that you can benefit more than just from the appreciation of your money.

You can get even with the government and ‘borrow money’ from it. The smart crowd calls that ‘tax deferral’. One of the easiest ways to ‘defer’ is by not selling an asset that has gone up in value such as a stock. Because the moment you sell (assuming a 50%) tax bracket, you have to pay the government 25% in ‘capital gains taxes’. So you have 25% less money to invest in another asset that may appreciate and sometimes not even as fast as the one you sold!  In fact, the government is more like a partner than a lender, because as long as your investments are held outside a RRSP or a TSFA and the deal goes sour, you get a capital loss tax credit. Don’t 'boohoo' that because if you lost all your investment money, your partner the government gives you 25% back. That can be sweetness at a bitter moment. What do you think ‘tax-loss selling’ at the end of each year is about?

As my regular readers know, I don’t like government, but you have to give (tax) credit where credit is due! 😎  Then there is the term inflation. When talking money, especially fiat money, there is always inflation. So rather than saving money, accumulate assets and hardly ever sell. All those assets will create day-in and -out cashflow and you use that to buy even more assets. You have to be aware though that not every asset is created equal. 
We just learned that lending money is often not working in your favor. Buying gold is better because people think it does keep its purchasing value.  But I really question that!  Yes many years ago you might buy stuff that today is the same in price when expressed in gold. But if you look closer that accounting ledger is a lot trickier than many think.  You may have felt wealthy owning 100 ounces of gold in the early 1900s and you could live from that for quite a number of years. Today if you’re lucky you could live well from that gold too and also for many years. But really, a 100 years ago you'd bought a news paper. Today you get the news in this world a lot faster and from far away and often for free on the internet. Yes, I prefer to sit in my modern car with heated seats and a heated steering wheel rather than in a Ford T.  Today, I don’t have to walk into the freezing cold hauling coal and getting a dust-lung to heat my house that is finely tuned with a nest-self-learning thermostat. Oh and my robot is vacuuming the house. The world these days, how amazing that may sound, knows much less poverty than a hundred years ago and we all eat avocado and watch local wars on the TV rather than fight in the trenches of World War I.  So are you telling me that the average person now leads a worse life than if he was working on the land a 100 years ago? Yes, in our way we were then and today probably just as happy; but we’re talking wealth and purchasing power here; not happiness.  Having been around for a while, I can tell you that there is no doubt in my mind that life has never been so good; so how is that for purchasing power?  How would you express that in gold coins?
We listen always to the doomsayers and are scared by the newspapers. We believe statisticians who tell use that our wages haven’t gone up in 50 years and that it is all the fault of the Central Banks and fiat money. Look around you rather than always watching the TV and the internet!  Numbers are lying; all the time!
But yes, if you believe in the depreciation of fiat money and you want to fight it or better take advantage of it then you will have to think and buy real assets. Economy is based on scarceness. That which is rare and that doesn’t get used up or, or better, that what produces money to buy even more assets; that is real. If you buy a house, you use that house up (we call that depreciation) but the underlying land we don’t use up and with a growing world population chances are it will become even more scarce and more valuable. If you buy an ETF that tracks the Dow Jones Industrial or some other index that is real. The indexes are managed by very smart people who often select the best and most valuable companies in a country or in the world. Over time old companies fade away and get replaced in the index by new ones. Over time those indexes , when chosen wisely,  will increase in value and pay dividends. Individual companies start-up, grow, boom and fall back into oblivion. But hopefully they produce enough wealth for you to keep on accumulating more assets.
It is not about money; it is about using money as a temporary storage of wealth so that you can do your due diligence and select the assets or investments that make money for you rather than sucking it up and sending it down the drain. And it doesn’t matter what kind of a drain – a government drain or one in the private sector! Caveat Emptor – Buyer be aware and always ask yourself: is this a money maker or a drain?. Because if it is the latter, you probably do better to become a plumber and stop the leaking!

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