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Keeping your currency, current

To hold wealth in any country one needs a good command of currency as a tool, so this month I wanted to share some insights into currency that can really help both the novice investor and spark up debate for improvement in the more seasoned investor.

The word ‘currency’ is derived from the Latin word ‘currentum’, meaning the ‘condition of flowing’. For some, having currency at hand means choices. For me, currency represents an agreement at a point in time backed by confidence. It is a means to obtain something of value. The important thing in all of these meanings is that currency is not a fixed item, it changes over time. A dollar is not necessary the dollar of yesteryear. This concept of changing value once well understood, can have a profound effect on future investment decisions to most individuals.

Remember those copper/bronze 1 cent and 2 cent pieces we all used to use? I remember a time when they were an asset that could be traded for a few lollies on the way home from school. Now they are nothing, but just a rounding issue on a screen. When the devaluation that fell upon the one and two cent pieces is put into context, it is harder to fix items value to the price they are now – as where before I had some lollies now I have none ☺.

If we take a look at the cost of things in shops at the earliest time we can remember buying them: say the Newspaper; a Mars bar; Petrol; a bottle of milk; or some bread. Remember the cheapest you bought any one of these items? – if you look at the price, how have these changed for you if we come forward to today’s cost? For me a newspaper was 20 cents, a Mars bar 30 cents, Petrol was 28 cents a litre, a bottle of milk 40 cents, and bread for 1 dollar. How incredibly have they moved in price? Compared to the declared rate of inflation of around 3 percent per annum over 2 decades, it is shocking how much more they have increased in price.

Okay so now it’s clear, prices go up, but values often remain the same. The main message in the movement we see in the prices of things is that they are not increasing the value of our assets, or things we may be buying. The currency we are buying them with is becoming worth less.

It’s a worrying finding for the savers out there who choose to just bank their cash, because prices are increasing so much. By the time most kids reach mature age and their parents hand over what they’ve been saving for them in the bank, it will likely be worth a hell of a lot less than the actual currency they’d forgone spending for the sake of their children’s futures. This certainly doesn’t mean to give up and stop saving, but it really does mean we need to buy something that can battle against the tide of price increase.

So how can we do something about this? One sure way to increase the chances of this is to buy things that keep pace with the money supply in the nation where you plan to retire. Otherwise if you don’t, as the money supply increases, the price of goods increases and any currency you have will likely decline in value while prices continue to rise.

In trying to maintain the value of your assets, a smart investor takes to tangible things, such as real property and businesses or shares. These things adjust in value and price promptly as buyers factor in values regularly. As proof of this, let’s look at the chart below. It shows money supply, or increase in currency against the price of the median home. As an example, a person may buy a home in 1990, for say $110,000, and hold it through to 2010 where it would be worth $520,000. All in all it is the same house however. At the end this investment would lead to no ‘real’ dollar gain, if they had bought the median house at the median price 20 years ago following the below chart if they used only cash to buy it. They would in affect have what they started with, but at least they didn’t lose.

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In the above example, we’ve assumed the investor had enough capital to buy their home with no debt.

Now I know we are playing this investing game to ‘NOT LOSE’. We have all seen what happens to football teams that do that. We are playing to ‘WIN’. Well the winners’ corner is where a person would have purchased with a debt that they serviced on an interest-only basis. Using this facility they would have reduced the debt in proportion to the asset by fourfold without even making a principal repayment on the loan, just by servicing the interest and holding on to the asset. In other words, the debt may have started out at say 80% Loan to value (of a $110,000 purchase price they may have borrowed 80%). Then, without repaying any of the principal of the loan, the debt would have reduced to something like 20% (or $100,000 debt against an asset of $500,000) by 2010. Which equates to a repayment of 60% of the loan in the 20 or so years of holding the asset without a dollar paid off the principal, while only servicing the interest. This is an example of why Warren Buffet – one of the world’s most successful share investors – maintains a level debt at around 20-30 percent of the value of his assets. The borrowed money acts to hedge (protection) against the actual effects of governments increasing money supply. Buffet has discovered this and used “good debts” for many years now, as he knows the value of a good debt to his currency ☺.

Let’s not be complacent. We must do something if we want to carry our wealth forward into tomorrow and beyond. This means us taking some calculated risk, having some currency insurance and getting down to the business of long term investing in assets that we know can work for us using workable means. If you need help with working on this or some other financial issue we have a team ready to help here. Just send me an email at mail@investorsdirect.com.au.

Until next month happy investing.

Adam Carmody

Director

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