Photo: Viktor Hanacek. Source: Picjumbo
Cheese, bread, tomato sauce, spices, and a little basil can make an outstanding pizza. Bake it just right, and it forms the base of a delicious meal. We don’t need a lot of fancy ingredients whose names we can’t pronounce from countries we’ve never heard of. Nor do we need to grow the wheat in our own back yard or use cheese from our own cows, although fresh basil is nice. What’s important is to combine what we have and bake it just right.
Our finances don’t have to be that complicated, either: cash for emergencies, bonds for stability, stocks for growth, real estate for both growth and income. Our investments should match our needs. If we have a long-term need, we should use a long-term investment. Stocks are long-term investments, because their earnings and cash flow grow over time. The revenues of the four largest American companies last year were greater than the entire US economy 50 years ago.
Bonds provide stability because their cash flow is contractual. Unless there is a default, we know what bond issuers will pay us and when they will pay us. And if there is a default, bondholders typically get something after all the moving parts are sorted out. Lehman’s bankruptcy ten years ago was the biggest default in history, and their senior bondholders were paid almost 50 cents on the dollar. That’s not great, but it’s a lot more than their shareholders got, which was nothing.
Real estate fits between stocks and bonds. Land has no intrinsic value by itself, but in the right location it can be worth a lot. School children read that Manhattan was purchased from the Lenape almost 400 years ago by Dutch settlers for 60 guilders ($24) worth of goods. But the Native Americans hadn’t developed the land, they merely travelled over it. They didn’t think air, water, and earth could be owned, and the kettles, axes, shovels, and drilling awls they received were immensely useful. After New York became the principal commercial and financial hub of the New World, though, its location meant that the real estate could generate a growing revenue stream, no matter whether it was the Dutch, British, or Americans who managed it.
“The Purchase of Manhattan.” Illustration: Alfred Fredericks. Source: Wikipedia. Public Domain.
(Notably, that $24 would now exceed New York City’s current GDP of $1.6 trillion if it had been invested and compounded at 6.5% over the intervening 400 years.)
Cash is just a very short-term bond. Our checking accounts are obligations of the bank where we deposit our money. The bank has to pay us on demand, whenever we ask for the funds. It doesn’t pay us very much, because the money needs to be available. Cash-equivalent investments, like money-market funds or short CDs, are just very short-term bonds.
Stocks, bonds, real estate, and cash are essential elements of a diversified portfolio. Everyone should have them, in some combination. The proportions may vary, but like a good pizza, the right ingredients assembled in the right way and baked just right can give you a result that’s timeless.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”