I’m 28 and just came into some money (8 figures). About 70% is invested in stocks and the rest is cash. I don’t want all the money tied up in stocks. Should I buy apartments or land and build my own apartments?

First of all congratulations. You have achieved something most of us just dream of and cannot achieve in a lifetime. Because both stocks or real estate are assets with fluctuating values your money is not guaranteed but needs to be invested. And wisely so.

Now is the time to do some serious soul searching. What is your long term goal with your money? Do you want to preserve its value long-term or make a decent return? It may sound as a trivial question, but it actually holds a little bit more substance than first anticipated.

At first it may be a good idea to read some books on what you want to do with your money. Even if blogs like this may give you a short description, we cannot do your due diligence. You have to do that yourself.

If you come up with an answer where you want to preserve the value of your capital you should invest in tangible assets, like precious metals, farmland or fine art.

The reason for this is the current regime of central banks where quantitative easing is slowly diluting the value of money. One of the facets of precious metals is its “moneyness” and the reason people buy it is that it preserves buying power over the long haul.

The fundamental reason the gold price got higher in the period between 2008 and 2011 was the negative real interest rates. The negative real interest rates is defined as the differential between the nominal interest rate and the inflation rate. In other words, it is the interest rate that businesses and people are experiencing at any given time. During the three years between 2008 and 2011 the real interest rate was negative which drove prices higher.

The trouble with gold is that its value fluctuates wildly and that when its price in dollars goes up, it soon blows out of proportion. For instance, in 2011 when gold had its last peak at over 1900 $, it had gone up from 1100 $ a year earlier. The hype around it made it very expensive very fast. Similarly, it fell from 1900 $ to 1150 $ over two years. These wild gyrations are attributed to the size of the gold market. If you compare it to the size of the bond market, it is minuscule.

In this sense farmland is a better investment since it also is a tangible asset that preserves its value. Over the past few years farmland has increased in value of an average 8 per cent a year.

My own preference when it comes to investments in tangible fixed assets is fine art. For instance, if you had invested 100$ in a work of art by the French artist François Boucher in 2001, it would be worth 197 $ by now. Similar gains can be seen with other artists.

Compound interest

It is however important to stress that this strategy of preservation only makes sense if you believe that “money” as we know will be diluted and eventually die at some point in the future. It does not make sense to preserve value like this if you believe that the central banks are doing the right thing .

The difference between between buying something tangible and investing in a return-yielding stock or bond is called “compound interest.” This does not take place if you invest in tangible assets. What “compound interest” means is that if you have an interest rate of 10 per cent and you reinvest those 10 per cent each year, you will be building on your capital much faster than if you did not reinvest the surplus. The longer your investment period is, the higher the return.

In real terms this means reinvesting your dividend each month or each quarter or whatever the dividend period is. If you just stick to reinvesting your dividends in a disciplined manner your money will soon grow much bigger than any doubling or tripling of prices that you occasionally see in the stock market.

Value investing

If you do not believe central bank policy being a problem then you want to shun precious metals and fine art and invest in good cash generating stocks instead. I would take a look at small-cap stocks in your own country with good cash flows, dividends and interesting business ideas.

The idea may sound like a dangerous approach, but is less so once you know the companies that you invest in a little better.

It does not really matter where in the cycle we are – what matters is how these stocks are valued at any particular time. Try to go for stocks with a positive free cash flow (the free cash flow is calculated by taking the operational cash flow and subtracting the CAPEX spending which is found under investing activities in the cash flow statement.) The free cash flow is the amount of money that the company has available for paying out dividends. If the company is not generating a free cash flow it has to borrow the money.

Another thing to look for is a low price to earnings ratio and a high dividend yield. Ideally, for a good investment, the P/E should be around 7, but a higher number may be acceptable. It depends on the business. When it comes to the dividend, of course the higher the better.

The next thing is of course to reinvest your dividends in the same stocks and see your capital grow, slowly. The key will always be to be patient. In the short-term there is no guarantee of financial gains at all and anything might happen, but if you have chosen good value eventually the market will reward you.

Conclusion:

In today’s post we have been looking at a (presumably) young man or woman who has inherited a fortune. Allegedly his or hers fortune is an 8-figure dollar inheritance which apparently is invested in stocks and bonds. The person then asks how he/she should invest his/her money.

We have divided our answer in two. One which is based on tangible fixed assets if you don’t believe in the current central bank policy and another if you do.

Our suggestion would therefore be based on your current thinking. Remember that it is not a question of prudence – we are always prudent.

If you believe in the current central bank policy we would invest 10 per cent of our portfolio into tangible fixed assets and the rest in small-cap stocks. That way you are hedging against a really bad outcome whilst at the same time earning a more than decent return on your money.

If on the other hand you don’t believe in the central banks you can increase those 10 per cent into tangible fixed assets to 25 or even 40 per cent.

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