When I invest my dollars and allocate my money I’m looking at Five Investment Goal Categories.
A given investment may be in all of these categories or maybe just one.
Preservation of Purchasing Power
Prices go up each year due to inflation.
Older relatives might have told you stories about being able to buy “penny candy”, candy that cost just one penny! Well you can’t buy candy for a penny anymore thanks to inflation.
If you saved a jar of pennies in your basement for 50 years, you wouldn’t lose a single penny, but what you could buy with those pennies would be substantially less, in other words you’ve lost purchasing power. So the first goal of any investment should be to preserve purchasing power.
In other words I’m not only interested in just preserving the number of dollars I have, if I have twice as many dollars, but a dollar only buys a third as much, I’ve still LOST.
I want to preserve my purchasing power, which means I want investments that retain their value in real terms, even while the value of the dollar (or other global currencies) goes down.
What does this fancy word mean? If I invest 100 dollars today and in a year it is worth 110, my investment has appreciated by $10 dollars. The invested capital has appreciated, it’s now worth more.
I don’t just want to keep pace with inflation and preserve my purchasing power. As important as that is I also want to take some calculated risks to gain capital and gain purchasing power.
Passive Income is definitely a favorite because it allows me to leverage my time.
I like to contrast passive income with active income. Active income is earned by trading time for money.
Let’s say you’re a in a highly paid profession that bills hourly such as a medicine or consulting. Even if you’re at the top of your field and people are willing to pay you more than your peers there is a certain market rate that effectively caps your earnings. Plus you can’t work more than 24 hours per day.
Passive income can scale independently of the amount of time in the day and how much someone is willing to pay.
Lets say you own a rental property. There are still market rates that effectively cap the amount of rent people are willing to pay. But because rental property income is passive you’re not trading time for money. This means you could buy a second rental property and double the amount of rent you bring in, buy a third to triple the earnings, etc.
Examples of passive income include: dividend paying stocks, bonds, rental property, and privately owned businesses. These investments tend not to go up dramatically in value (although capital appreciation (and loss) is possible!), but provide stable, regular income.
Geopolitical Risk Protection
Bankrupt governments tend not to treat their citizens very well. Places like cypress have had banking holidays during which money cannot be withdrawn, or a percent of bank account balances are taken from private individuals and “given” to the government.
I want assets that will retain and grow even in the face of Geopolitical risks. Risks like bank bail-ins, high taxes, terrorist attacks, wars, plagues, famine, etc.
At the end of the day, the purpose of wealth is to be able to buy things that meet my needs. I want to be able to afford housing, food, clothing, and entertainment. In order to buy these things I need assets that are liquid, that can be quickly sold to make purchases or can be used to directly make purchases.