How to get Rich (2) - Understand risk and return characteristic of different Investment Products

In the previous post , i introduced the idea of using float to generate return in excess of cost to get rich. Now , it is vital for us to know which type of investment products should we put our money in.

I would classified the investment products available to general public into four types, namely bonds(including fixed deposit with bank), equities (stocks), real estates and precious metals (gold) . The classification is based on
i) how certain you can get your money back (ie, preserved your capital)?
ii) what factors of growth inherited by the product?
iii) what determined the future value of the product?

Lets examined them one by one.


i) How certain you can get your money back? 

The question can be further subdivided into whether you can get back your money in absolute term or relative term (inflation adjusted) .

Investment products denoted in a given currency like bonds and Fixed deposits are safe in "absolute term", which means you are almost certain to get the quoted return. This is good when using floats, where you can invest the float at bonds/FD that give you higher rate of return than its cost, thus taking the excess home. However, investment products that offer maximum protection in "absolute term" offer no protection against "inflation risk". The buying power of one dollar ten years later would certainly be less when price of goods keep soaring. Thus, this investment products are bad place for your own money. 

The rest of the investment products ( equities, real estates and precious metals）are less certain in getting back your money in absolute term, but have more protection against inflation risk. This is because the future price of these investment products are entirely determined by the supply and demand of future market. Thus, an ounce of gold, a house , or a share of equities should exchange the same amount of goods for now and the future, provided the supply and demand of the market remains the same. These are better place to put your own money. 

ii) What factors of growth inherited by the product? 

When growth occurs, you can get more money back following the passage of time. There are three main growth factors: Inflation, Population Growth, and  Market Share Growth  (due to good management).

Bonds and FD offer no growth factors at all.
Precious metals offer inflation growth, but as the supply (ie mining activities）usually growth together with the population, it they offer less population growth factor.
As the supply of real estates is limited, their value grow with population in addition to inflation.
Equities have the chances of additional market share growth, when good management team grabbing business from others while growing along with population and inflation.

iii) what determined the future value of the product?

For Bonds and FD, their future value is fixed. 

For precious metals, their future value is sole depends on market favor. As gold is almost useless to general public, they are bought in the buyer's hope that someone else, who also know that the product will be forever unproductive, will pay more for them in the future. 

For equities and real estates, their future value is not only determined by market favor, but also the underlying cash flow that they can generate for the investor. 

An history overview

Over the last 200 years in America, as this source has showed, the stocks (equities) outperform Bonds in long run, where both outperformed gold in inflation adjusted return. 

http://www.joshuakennon.com/stocks-vs-bonds-vs-gold-returns-for-the-past-200-years/

Looking at more recent data at another source, stock is again outperform the bonds and homes and gold,

http://lansner.ocregister.com/2011/09/11/home-price-gains-pale-vs-other-assets/122448/

However, it should be noted that market favor will changes the rate of return of particular investment products, when more people prefer stocks rather than bonds , there is a chance that investing in bonds can beat the stocks in short term or long term. (see here, and here) 

Source: Bianco Research

Conclusion

If you are using float, it is probably best to invest in bonds/FD that can give you certain excess of return. 

If you are using own money, which type of investment product you choose should be determined by the expected rate of return you can get at the time of buying, which is further determined by the Mr. Market。 

Out of all, the price of gold is mostly determined by the fear of the market of possible economic collapse, no wonder Warren Buffet who always hold an optimistic view on Corporate America, will dismissed it as a viable investment products.