personal investment blog

Big picture

Rule 7: Big picture

All investment assets compete for your money, subject to liquidity and risk. By “investments” I mean anything in which one can plausibly invest with the intention of making a return through yield or capital gain. Some people distinguish between pure financial assets and “real” assets as if there is some profound difference. There is not, in my view. Physical assets tend to be degradable and more complicated to buy and sell (e.g . property, farms, art, fine wine, vintage cars). As such, they might be appropriate for investors who can afford to tie up capital for a long time and who can, for the duration, afford the cost of storing and or maintaining their assets. For these reasons, like long-dated bonds, they should offer better returns in recompense.

My most fundamental investment thesis is: the bigger the picture that an investor can see, the better the investment decisions.

To try to demonstrate what I mean, let’s start with the smallest picture.

As I wrote in the rule called Value, the easiest – and ultimately least useful – way to judge the cheapness of an asset is by comparing it with itself. Those of us who bought a share for X or a house for X5 will want to see either as cheap if it falls below our purchase price. This is human nature and may even be a rational approach depending on personal circumstances but as an investment philosophy it sucks.

A slightly bigger picture, which we are all capable of seeing, is the one that takes account of the price performance of other shares and other houses. Share X is down by 10% by the overall stock market is down by 20%. My house is seemingly worth 5% less than I paid for it but the national house price survey says that the average property is -12.5%. Most publicly available financial investment analysis ends at this point.

The much bigger picture, which is very difficult to visualise, is the one that takes in different kinds of assets. Should I invest in shares, company bonds, government bonds, property, precious metals or oil paintings? You will struggle to find independent advice that takes this kind of broad view.

Most financial research is written by experts about a single asset class for people who have decided to invest in that class. Equity analysis is written by equity analysts and is addressed to committed equity investors; ditto bond research; ditto property analysis. I have two objections to this state of affairs:

First, that the most important investment decisions are those that choose between classes of assets, not those within asset classes.

Secondly, that the esoteric nature of the debate within each asset class creates communities of advisors and investors with a mutual interest in being bullish. If Fred gets paid for giving advice on investing in equities and Ed’s job is to invest in equities, they may well have a heated debate about whether Tesco shares are better than J Sainsbury’s, but they are likely to die of old age before either starts to argue that equities as a class are a rotten investment.

All investible assets should be judged according to the same two criteria: liquidity and risk. Assets that are relatively illiquid or relatively risky should merit a higher return for the investor. Assets that are both illiquid and risky should offer a higher return still.

Judging when an asset is good value is more of an art than a science but, like other kinds of artistic endeavour, it can benefit greatly from good technique.

The value of everything is relative to the value of everything else. Keeping this in mind, our starting point should always be the price (from which we derive the yield) of very liquid, low risk assets. As it happens, low risk is currently very strongly in demand. If you lend money (i.e. invest) to the Polish government overnight, you will get paid an annualised interest rate of 4.25%. If you decide that Poland is too risky (because of its government or its currency) then you might prefer to lend to the Swiss government. Such is the popularity of the Swiss government and its currency, you will be charged for this. In fact, negative interest rates in Switzerland go all the way out to five years. Yes, if you allow Switzerland to have use of your money for five years, at the end of the period you will get slightly less than all your money back.

From a starting point like this, every asset would appear to have a chance! But the truth is that a return of nearly zero over five years might turn out to be an excellent investment relative to others in the big picture.

Always be thinking about how and when you are going to get paid out. Always be thinking about the big picture.