005 Using money to make money

Chapter 5 of 'There are no grown ups'

If you have some money, and want to ‘make it work for you’, your main options are:

1. Lend it to a government, company, or person, who will pay it back to you with interest.  The interest may be paid every year/quarter/month, or ‘rolled up’ and paid when the loan is repaid.

2. Put it into a business in return for owning some (or all) of the business, in the hope that the business will make a profit that EITHER can be paid to its owners OR, can be used by the business wisely to make even larger profits in future.  (alternately, a speculator, may invest in a company in the hope that positive market sentiment in future will make others prepared to pay a higher price in future, an approach often dubbed the ‘greater fool’ strategy)

3. Buy something (A house, office, land, vehicle, or equipment) that can be rented to a person/company/government that has a use for it but does not want (or can’t afford) to buy it themselves.

4. Buy something for which there is usually a ready market (wheat, oil, wine, a foreign currency etc) and which appears to represent good value (for example because a bumper wheat harvest has depressed the price of wheat) and which you think will rise in value (In the case of wine this could simply be because you think it will improve with age and that the improvement will be reflected in the price).

5. Buy something to which you can add value.  For example, a plot of land on which you can build a house, or a financial instrument involving a series of payments which, if split up and sold separately to people wanting a particular result, has a higher total value than you had to pay for the whole security.

Futures, options, swaps, and other derivative instruments, which can be very useful in managing risk, and in making speculative bets, are covered in another chapter.  They are not listed separately in the above as they are second (or nth) order instruments whose value is driven by an underlying asset/value, typically one of those above (they can also be affected by interest rates, volatility, etc, but the most important variable is usually the underlying asset’s value and/or movements in that value).

Although the rest of this book looks at largely passive investment, spending all your ‘investment time’ choosing / analyzing is not the only option.  Spending some of the time adding value through your own work can help.   If you are young, or retired, and have lots of time on your hands, this time can be your competitive edge, especially when dealing with smaller amounts of money.

When I was nine, I asked my grandfather, who was a director of the Bankers Investment Trust, about investing my Christmas money.  He suggested that with a very modest sum, rather than buying shares, I would be better off putting the money into wine.  At the time, wine did not interest me, or seem nearly as interesting as shares.  I was rather miffed, but he was right.  Not only because, in the 1970s, before deregulation of the city (‘big bang’ in 1987), and long before the internet, dealing costs would eat up a big chunk of a £100 (or less) investment, but also because half a case of good claret would probably perform quite well over six to eight years.  Big name French wines, such as Chateau Petrus, Chateau d’Yquem, etc have since become highly tradeable speculative assets, selling ‘en primeur’ for thousands or even tens of thousands of pounds a case.  The problem with wine (even, or, perhaps especially, lesser known and more affordable ones)  is that, if you are the sort of person who finds the subject interesting enough to not mind spending dozens of hours on research, you may well also be the sort of person whose ‘wine investments’ turn into ‘wine consumption’, at which point it really does fall outside the scope of this book.

Gold is loved by many, though dammed as irrelevant by Warren Buffett.  It is difficult to define Gold as an investment, as it yields nothing, and costs money to store. Let’s consider investing £35-45,000.  At the time of writing (prices are volatile), this would buy about 1kg of Gold, 5 Acres of prime farmland (Yield c186 tonnes of wheat a year), a Treasury bond yielding c£1,000 per year, a property producing rent of £1,000-£2,000 per year, or Equities producing a return of £1,000-4,000 a year.  Over a 30-40yr investment horizon, the effect of compound interest (see on) makes gold look very unattractive, even more so, if you are Warren Buffet and have averaged c20% annual returns (ie £7,000 pa in this example with a £35k stake) on your investment.  If you put money in Gold, you are doing one of two things:

EITHER speculating (betting it will become more valuable) which is more betting than investment (see on for ‘Fundamental’ Vs ‘Greater Fool’ approaches to valuation).

OR taking out insurance, because you want to have a cash-equivalent in the event that there is a financial breakdown, in which case you need to have the physical coins/bars readily accessible.

Putting up to 5%-10% of your investible assets into gold as insurance may make sense, just as having insurance on your house may make sense.  But, if doing this, don’t expect a good return.  As with your house insurance, you want the house not to burn down and your insurance premium to be ‘wasted’.  But if the house does burn down, having that insurance is mighty comforting.