Sunday, May 19, 2013

Hoarders vs Investors

How hoarders can make a transition to investors

Enough has been written about investors' obsession with gold and real estate. Hard facts about long-term returns have been published, showing that these assets may not be a good long-term choice. However, investors view such research with skepticism. They continue to prefer physical assets to financial ones, and hold an abnormal amount as cash. Are we mere hoarders of wealth? What does it take to become investors?

First, we are guided by the nominal value of assets. What matters is the real value, after adjusting for inflation, but that is not very intuitive for most investors to perceive. When we are told no one loses money in real estate, we believe it because we have only heard of rising prices. That fact is that with a positive rate of inflation, assets prices move up over time. This is true not just for gold and property, but also for rice, dal, petrol etc. A nominal increase in price does not mean that an asset has become more valuable. As hoarders, we are happy with nominal value; as investors, we will ask about the real value, after inflation.

Second, we like assets even if they do not work for us. Assets are acquired for their ability to earn a return. This should come in the form of a regular  income, such as dividend, interest, rent, or by way of appreciation in value, which we can actually realize when needed. Assets create a sense of security and represent accumulated wealth. They are, therefore, social symbols, which tell the rest of the world that our incomes are far higher, and that we own assets acquired only by the wealthy. Ostentatious display of jewellery and lavishly decorated homes are all social symbols of wealth. When we want to belong to this class, we accumulate assets without caring for the income or the intent to realize gains. We are also reluctant hoarders, unwilling to sell these assets and strip down our social status. As rightly put by ace investor Warren Buffet - "If you buy things you don't need you'll soon sell things you need". As investors, we want the assets to work hard for us and earn returns.

Third, we obsess about the protection of invested capital. The notion is that an asset should have undiminished value dominates our choice. A physical asset, which can be seen and felt, is the obvious choice for the hoarder. Since inflation increases its price, there is a false sense of security about increasing value. The long-term return from assets that do not work cannot be different from the rate of inflation. We see the steadily rising price as hoarders, and expect this from all assets. As investors we know that what goes up will certainly come down and vice-verse. As hoarders, we fail to see the economics of asset prices.

Fourth, we do not understand the dynamics of markets. We prefer an oversimplified version of the way prices should behave since we seek a linear growth in the assets we hold. Assets prices are not influenced only by demand and supply and could also be distorted structurally. The real estate and gold markets in India are dominated by holders of black money. The unaccounted for cash invested in these assets is generated and stored outside the banking system, and is not sensitive to the changes in borrowing costs that the RBI tries to manage. Large-scale tax evasion, ill-gotten bribes and payoffs, and unaccounted for incomes hidden from the taxman feed these assets purchases.

It is a combination of these factors that turns several investors into happy hoarders. When the government says it wants to do something about this preference, it needs to work towards ensuring that the large hoarders and evaders stop distorting these markets. Before blaming the small hoarder, who is unable to make the transition to an investor, we need actual asset builders who will guide. That is the missing link

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