In my investment learning journey, I have come to classify assets into two types: Income Generating Assets and Speculative Assets. Income-generating assets produce an income, so you can still make money regardless of whether the asset’s price is up or down. Speculative assets, on the other hand, don’t generate an income, and you can only make money if the asset price moves in the direction that you want.
Examples of income-generating assets are real estate, stocks and debt instruments. Real estates generate rental income. Stocks represent partial ownership of a business that generates profits, which are either paid out as dividends to shareholders or re-invested into the business. Debt instruments such as bonds and mortgages allow their owners to collect interest income.
Examples of speculative assets include precious metals, commodities and most crypto assets. They don’t generate any income organically, and you can only make a profit if you guess both the direction of the price movement and the timing right. Between the two, timing is the harder one to grasp.
Warren Buffet once famously said that he would rather own farmland than gold. You can buy 100 ounces of gold, look at it, fondle it, cajole it, and after 100 years, you will still have 100 ounces of gold. In between, it doesn’t do ANYTHING for you (in fact, gold COSTS money to store and secure).
Conversely, 100 acres of farmland can produce crops continuously, generating an income. After 100 years, you’d still have 100 acres of farmland, AND you would have collected 100 years’ worth of harvests.
Thus, Buffet believes that over the long term, a good productive asset will outperform any speculative asset.
For conservative investors like myself, it is also a lot easier to value an income-generating asset, because we can use concrete numbers to do a Discounted Cashflow analysis. But with a speculative asset, it is extremely difficult. You first have to guess the direction of the asset price correctly (which is already difficult). And even if you got the direction correct, did you get the timing right?
The price of speculative assets is very much dependent on sentiment; it’s only worth as much as what the next buyer is willing to pay for it. Thus, it is very fickle and unpredictable, because market sentiment can flip within minutes.
But for income-generating assets, their price, over the long term, is mainly going to be determined by the amount of income they generate. And the amount of income it generates usually has NOTHING to do with its price.
Tesla’s share price may fluctuate every second, but it doesn’t affect how many cars it is going to sell. I own (at the time of this writing) an industrial property and a condo which are both rented out at market rates. I bought them at a good price, so I don’t expect them to drop in value before I sell them. But even if the price drops, so what? I can just hold on to the properties and enjoy the rental income until the price recovers.
Thus, income-generating assets offer baseline protection for conservative investors like myself. Such assets offer you the chance to make speculative profits (i.e. from buying low and selling high), but if you guess wrongly, you still get some returns via the income stream.
And because I am a conservative investor, I prefer the bulk of my investment portfolio to be in income-generating assets.
In fact, the returns from income-generating assets can be as mouth-watering as speculative assets. I am lucky enough to own 3 profitable businesses which generate pretty high returns on investment (ROI), enough to beat most speculative assets out there.
As a shareholder, I get a share of profits, which are either paid out as dividends or reinvested into the business as equity. As the business manager, I also get a salary from these companies. Adding the two sources of income and dividing them by my initial investment (ROI = (Profits + Salary) / Investment), this is the annual ROI I’m getting from each company:
Company A: 175%
Company B: 60%
Company C: 20%
Even the worst company generates a 20% ROI for me. That is the power of an income-generating asset.
Real estate forms the biggest chunk of my investment portfolio (>80%). The rental income is very stable and only fluctuates in response to demand and supply. Furthermore, rental contracts are usually between 1 to 3 years in length, so my income doesn’t change at all while the contract is in force. I park most of my income and business profits here.
My next biggest class of investments is my share equity in the businesses that I run. These are riskier than my properties because business income can fluctuate. But, if I use book value as a measure, the value of my businesses increases gradually over time as each profitable year adds to shareholder’s equity.
My third biggest asset category is stocks of a handful of companies and ETF (exchange-traded fund) which I believe have the potential to grow 5x to 75x in the next 10 to 15 years. While I am expecting mostly speculative profit from this, this is still based on my assessment of how I think the income of these assets will grow over time. Thus, I still view stocks as mainly income-generating assets rather than speculative assets
Next is a very small tier consisting of debt instruments. I am invested in two crowdfunding platforms, which help private investors like myself earn interest by giving business loans to companies. Returns from these debt instruments are quite low (5 – 6%, after factoring default rate of 1%).
Unlike most other income-generating assets which also have the potential for speculative profits, these crowdfunding platforms are fully income-generating assets with zero potential for speculative profits, because the principal lent does not fluctuate in value based on demand and supply.
Finally, the riskiest of all, crypto assets. There is very little or no income return, but these have the potential for the highest speculative returns of any asset class. However, the risk is also the highest, which is why I only dabble in it with a minuscule amount. In fact, as of this week, I have liquidated all of my crypto holdings to push funds into the stock market. It’s not because I don’t see a future for crypto; it’s because at the moment I see more opportunities in the stock market (and because I love income-generating assets).
Thus, my entire investment portfolio is currently fully composed of income-generating assets or income-generating assets with speculative potential. Nothing is allocated for pure-play speculative assets. Even if I do invest in speculative assets, my rule is to never let that exceed more than 5% of my portfolio, which is money I can afford to lose.
An income-generating asset is like the goose that lays golden eggs. You can sell the golden eggs for money, and you can also sell the goose (please don’t kill the goose like the story goes!!).
If you bought the goose at the wrong price (i.e. too high), you can still sell the eggs for income for years to come. But if you managed to buy a goose at a discount, you can sell the goose for a profit in future. And while waiting for the right price to exit, you can continue enjoying the income produced by the goose.