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Uncover key differences between Real and Financial assets, and learn why diversifying into real things today is more important than ever.
Do your current investment holdings include any Real assets? For most of us, we've been taught that in order to have a comfortable retirement, it's wise to consistently contribute to a 401k so that when you're 60, you've built a sizable nest egg to live on for the rest of your life. This sounds like a fitting path for some folks, but going this route provides little-to-no diversification or control. For example, the financial crisis of 2008 forced countless individuals to stay in the workforce for years due to having a lack of income-producing assets outside of the financial markets.
At the time of writing this, we're seeing a glimpse of how this is possible. Year to date, the S&P, Dow Jones, and Nasdaq are down 13%, 17%, and 25% respectively. Ownership of any of these indexes or the companies within the index are Financial (or "paper" assets).
Real v. Financial Assets
Real and financial assets are two key groupings of investment classes. Let's start by defining each. At a fundamental level, real assets are tangible things you can see and touch. A few examples could be metals (such as gold and silver), real estate, agriculture, and other commodities like oil. Not only can real assets provide strong overall returns, but they have intrinsic value, the ability to provide cash-flow, hedge inflation, and often provide big tax benefits.
Financial assets, on the other hand, are not physical. These types of assets represent ownership rights in a company - essentially a contract. Examples of financial assets include stocks, bonds, and mutual funds. Since many of us are familiar with it, a 401k is invested in financial assets. What's interesting to consider is that financial assets are considered "traditional" investments, even though real estate and commodities have been bought & sold for far longer. Humans used to barter real assets.
Perhaps I have a bias toward real assets since these are what my company invests in, so I'll do my best to share the unbiased, objective pros & cons of both asset types :)
Comparing Real & Financial Assets
1) Risk Mitigation. In my opinion, and I believe the data will back it, real assets provide more risk mitigation. The way I see it, real assets are an "everything hedge". Okay, I say this a little tongue in cheek, but hear me out. Real assets are proven to be a stronger hedge against inflation. Using real estate as an example, your asset value tends to increase as prices go up, and so does your income (rent). The majority of time, we're also using debt to purchase real estate, so when your debt is fixed and dollars are inflating, it becomes easier and easier to pay down the debt. Other than inflation, let's imagine the U.S. dollar is plummeting and there's an abundance of uncertainty throughout the world. Would you rather own tangible things that have intrinsic value (such as gold and real estate), or financial assets that are losing tremendous value by the day due to the very currency they're denominated in (dollars)?
2) Stability. The graph on the left illustrates the stable climb in rent prices over time. Compare this to the right graph, which is the Dow Jones Industrial Average throughout history. Sure, we see overall growth as time passes in the Dow (which any decent asset will provide), but it looks more like a cardiogram than reliable, steady growth. Just hope you don't need your money during the dip.
3) Market Efficiency. Real estate is what's referred to as an inefficient market. All this means is it takes time to get deals done. They involve vetting, underwriting, acquisitions, relationships, inspection reports, lenders, and the list goes on. The fact that transactions are more complicated means two things. First, the barrier to entry is higher. And two, profitable opportunities are more common. Compare this to the financial markets, which are extremely efficient. For example, open the Robinhood app on your phone and click sell or buy....that's an efficient market. As a result, discounts and "good deals" are hard to come by, because it's priced in. You can speculate that a stock price is undervalued, but the way I see it, that's all it is...speculation.
4) Liquidity. The disadvantage of market inefficiency is illiquidity. Using real estate as a prime example, you cannot click a button to sell - it takes much more effort, time, and attention. This is one area financial assets definitely have a leg up.
5) Leverage. Multifamily assets qualify for some of the best debt that exists...there's a reason you can't take out a 10 year, non-recourse (limited liability) loan with 5% interest to buy $10MM of the S&P 500.
6) Cash Flow. Real assets, more so than financial assets, will produce steady, predictable income streams. Yes, it's true that you can purchase dividend stocks that produce regular income. However, when you own real estate (or participate in syndications) you have more control when it comes to growing the cash flow through value-add renovations.
Concluding
For the sake of this article, I chose to focus on the six reasons above, but it's definitely not an exhaustive list. The majority of my net worth (any many others') is and will continue to be invested in Real assets. I prefer more control over what is happening with my money, and believe this is achieved through investing in tangible things that will always have some level of value and produce income.
If you're interested in learning more about real assets and how to get involved, let's chat!