Virtual to Real Dollars

What is your net worth, REALLY?

I recently likened the money in my Vanguard account to Shroedinger’s Cat and though I entitled the post Quantum Portfolio Management I merely introduced the metaphor that your invested money is in something like quantum superposition.

Apologies if you’ve heard me say this before, but it bears repeating. There are only two times when the value of your shares of any equity is real:

  • on the day you buy them, and
  • on the day you sell them.

That’s not very helpful for planning for retirement. You need your investments to throw off income to cover expenses so you can quit working.

A securities analyst could probably devise a probability density function quantifying predictions that the market will go up, down, or sideways within a time window. You could then multiply that probablity by your current market price to derive a normalized net worth. This seems too hard.

Alternatively, you can plan on selling your equities on a regular basis. Doing so is the opposite of dollar-cost averaging. In the extreme case, without cash in hand you must sell shares to buy groceries. Sadly, on the day of a bad market you’ll either sell too many shares, buy the cheaper catfood, or go hungry. (Fasting for the win!)

In this extreme case, your paper net worth (less commissions and taxes) is exactly equal to your true net worth. No quantum superposition for you! Congratulations, but now you’re at extreme risk of impoverishment/starvation after the inevitable stock market meltdown.

Adding income-generating assets to your portfolio pushes out the have-to-sell timeline. This mitigates risk. At the opposite extreme all expenses are covered by stock dividends, annuities, pensions, rents (less expenses), and Socialist Security. This happy alternative makes you completely indifferent to stock price swings, but your net worth lives in the quantum cloud of unknowing.

Cash doesn’t throw off income and it is subject to inflation. Inflation is a stealth government tax. Turn on the printing presses, spend government money on cronies, and every dollar-denominated cash account is diminished imperceptibly.

This argues for cryptocurrencies. If you don’t trust your government not to inflate away your savings, you can buy gold. But gold is heavy and hard to move. Bitcoin is predicated upon nothing but math and the faith of Bitcoin owners in its value. And it is designed to be deflationary in nature.

This suggests hedging a cash position with gold or cryptocurrency. Of course, that raises questions of liquidity and price fluctuations that we see in the stock market. Hmmmm. It seems we’re back in the quantum soup.

The magic bullet of financial planning is a productive asset that’s price-anticorrelated with the stock market.

Financial planners insist that you must balance your portfolio with a mix of stocks and bonds. They believe bonds are the best asset to balance stocks against. The rule of thumb is your age minus 100 should be the percentage of equities in your portfolio. I think this is too conservative.

Maybe. I once asked a financial planner dude whether rental real estate was a viable alternative for balancing an equities-heavy portfolio. His answer surprised me. He said that rents are another form of bonds.

That took me a while to grok. Each rental is a contract between me and the tenant. Like clipping a coupon on a bond each month, the tenant sends me rent.

There are major differences of course. Rental real estate is subject to infrequent “capital expenses”–things like furnaces that age and need to be replaced. Bonds don’t have that worry, but their risks are less visible to the investor. I can readily examine rental property and hire an inspector to delve deeply. Yup, the roof is old or the house needs painting. Conversely, I need a securities analyst to grok the fine print of a prospectus.

Suppose rental property is a form of bond investing. Since you aren’t collecting rent from it, you should exclude the value of your principal residence. Now total your bond plus real estate portfolios and compare it against your equities portfolio. In a rocking economy, we should tilt toward equities. When the economy is going into a recession, tilt the other way.

Of course, there are strange situations like the housing bubble of 2008. In that case a real estate bubble took down equities, too. You might expect a real estate bubble to wipe out my rentals. Maybe it hurt their paper value, but it dramatically cut vacancy rates and rents went way up. Go figure. Likewise, a drop in equities prices will not hurt dividend income.

Nevertheless, the 2008 crash hurt both real estate and also equities prices. So much for balancing. If a rising tide lifts all boats, a tsunami hurts every asset class. My big mistake in 2001 and 2008 was overlooking the bargains all about me. I had the cash to snap up bargains from others forced to sell. Cash is high ground and a hefty cash balance is the best thing to have in a crash.

There’s nothing quantum about cash.

Steve Poling

Masters degrees in math and computer science. Poet in several computer languages. I write stories about Sherlock Holmes' brother Mycroft, steampunk, and SF.

Grand Rapids, Michigan