"Should I invest in stocks, real estate, or put money in reserves?"
“Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve.” (Written in the Talmud, a record of debates among rabbis about Jewish law dating as early as 1200 B.C.)
Asset allocation is an art and a science.
It’s also the MOST important skill an investor needs to execute a successful strategy for growing and protecting their wealth.
Let’s go deeper into the philosophy of the wise Jewish Rabbi who wrote the verse above (it’s been a strategy followed by successful investors for centuries).
When you are building your overall asset allocation strategy, you have to start with a base mix of assets. I use base mix referenced in the opening quote: 1/3rd real estate (primary residence, REITS, rental properties, etc), 1/3rd business (this includes stocks), and 1/3rd reserves (historically cash, bonds, gold...and now with new technology bitcoin).
Then you decide to overweight (put more money than the base asset mix) or underweight (less than the base asset mix) based on expected return of the asset classes over a time period (I like to use 5 years as my expected return time period...longer time frames strategies don’t rely on perfect timing).
How do you calculate the expected return?
You have to understand how to do a discounted cash-flow analysis (or some other valuation equation model) ??. That’s an entirely separate blog post, but here’s a link to a good post on the discounted cash-flow formula: Discounted Cash-flow formula
For sake of example, let’s assume you determine that the real estate bucket has the highest expected return over the next 5 years and stocks have the lowest expected return over the next 5 years.
(Important note: When stocks or real estate have a lower than expected return than the reserve bucket, it typically means it is due for a price correction down some time in the future. It’s very hard to time when that correction will come which is why I like to use expected return and a 5 year time frame. Based on my research, 5 years is a long enough time-frame for asset prices to correct, but sometimes it takes a little longer and sometimes it happens a lot sooner than 5 years.)
You might decide to put 50% of your money into the real estate bucket (overweight), 33% (1/3rd) into the reserves bucket, and the remaining 17% into stocks (underweight) in order to increase the probability of your portfolio earning a better rate of return than the base allocation.
You might have also noticed that gold/bitcoin, cash, and bonds are in the reserve bucket.
There are periods of time when stocks and real estate have a lower than expected return which signals time for a correction in both and wise investors overweight reserve assets (where my analysis shows we are today).
The question becomes, “which reserve asset do I want to overweight, cash, bonds, or gold/bitcoin”?
That’s also an expected return (discounted cash-flow calculation). So let’s assume you do the math and you come to the conclusion that after you adjust for inflation (cost of living increases) that bonds and cash will lose you money, then the natural conclusion is to want money to go into scarce assets, gold/bitcoin.
The opposite is also true. If bonds and cash won’t lose you money after the inflation adjustment, then you want to put your reserve assets into scarce assets, gold/bitcoin.
Now I know the next question you might be thinking is, “what’s better gold or bitcoin”?
That’s also another blog post, but here’s a good read for you from a blog post citing an interview from Michael Saylor (a billionaire who has a similar view as I do) until I write a follow up: Coindesk post
I hope this helps you become a better asset allocator in the future.
Phillip Washington Jr. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.