Risky Business (Part 3)

Is that all there is?

Yesterday I gave a pretty narrow definition of a financial asset. A financial asset is something that is expected to produce future cash-flow. Bonds are senior claims on that cash-flow. Equities are claims on the residual, or left-over cash-flow. And real-estate is a claim on the operating cash-flow.

Of the three, equities are the most risky because they get the leftovers. Sometimes there’s lots, sometimes there isn’t any. Bonds are the least risky because the payments are usually set by a fixed contract. And real-estate is in the middle, because rental payments can rise or fall with the economy.

But what about commodities? What about art? Jewelry? Stamps? Coins? Doesn’t their value rise and fall? Aren’t they investments? If you buy something and its price goes up, you can sell it for a profit. The thing is, the price can go down, too. If there’s no cash flow apart from a sale, it’s not a financial asset. It’s just a speculative purchase.

But what about your home? Your home provides an essential service—shelter—that you’d have pay rent for anyway. Owners essentially pay themselves rent (tax-free). The economic value of a home is the discounted value of those phantom rental payments.

But the other stuff? Hobbies, mostly. Some people get lucky with their hobbies and make money, but most don’t. If you want an investment, buy a stock or a bond. And if you want a friend, get a dog.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-05T20:04:14+00:00 August 10th, 2010|Global Market Update|0 Comments

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