Which of These Options Would You Choose?

Imagine someone came up to you and offered you a choice of investments.  Also assume you happen to have an extra $8 trillion dollars laying around that you are actively looking to deploy!  I know, I know, that’s ridiculous, but this is just a hypothetical example.  This person offers you the chance to buy a bunch of vacant land, approximately half of all the vacant land in the U.S., for your entire $8 trillion.  Alternatively, the person offers you the chance to buy ~40% of the $19 trillion dollar S&P 500 index for $7.6 trillion.  You would also have an extra $400 billion dollars lying around as spare change.  Which would you choose?

With the vacant land, you would have something tangible.  You could drive by it, look at it, touch it, but at the end of the day it doesn’t earn you anything.  Unless you are able to ground lease it, you would be paying some hefty property taxes every year.  If you had to pay an average of 1.5% of the value of the land every year in taxes, that means you would have to come up with ~$120 billion dollars each year to continue to own the land. Most likely, you would have to sell land each year just to meet the tax obligation.  The other problem with selling is that you would have to pay somewhere between a 1-3% commission to a broker as well as any capital gains taxes.  Basically, your large holding of land would have to shrink each year to meet tax payments.  You would hope for some hefty appreciation every year, but you wouldn’t be able to count on it.

On the other hand, if you owned 40% of the S&P 500, you would be entitled to roughly $460 billion in earnings, to which roughly $135 billion is paid to you as a dividend every year.  Not only that, but historically the dividends have grown roughly 5-6% every year.  Of course, your holding isn’t tangible and you can’t drive by to see it, but you own a very large slice of some of the greatest businesses in the world that deliver cash to your bank account every year, which should grow at roughly double the rate of inflation long term.  These businesses also retain ~$325 billion each year to pay down debt, pursue acquisitions, buy back shares, or reinvest into their businesses.  The one negative for some people is that this holding will fluctuate in value, sometimes by great deal.  Your starting $7.6 trillion dollar stake might be worth $9 trillion next year, or it could be worth $5 trillion.  Over time as the U.S. and world economies grow, it should represent this growth with a higher value.  In the short term, anything can happen and volatility will be expected.

So which of these options would you choose?  To me it’s a no brainer, the S&P not only pays you money in the form of a dividend every year, but also will increase in value at somewhere around double the rate of inflation long-term.  The land may keep up with inflation, but growth much above inflation isn’t likely.  Many people would choose the land, because they just don’t trust the stock market.  They just like owning something they can see and touch.  That’s fine, but in exchange for not having to se their net worth fluctuate in value, they are giving up a lot of long-term wealth.

For another example, suppose this same man offers you the opportunity to buy all the supply of the world’s gold for $8 trillion, or you could buy a large chunk of all multi-family real estate in the U.S.  You would pay cash and not use leverage (where would you get a loan of that magnitude!), but you would own an obscene amount of apartment units at an average capitalization rate of 5.5%.  You would receive about $440 billion per year in income, but you also are going to leave a little bit of that in reserve for capital expenditures.  Your buildings will need things over time such as new roofs, hvac units, water heaters, appliances, etc.  You decide that you will leave $40 billion per year in an escrow account to handle all of these replacements.  The good news is that part of your $440 billion is shielded from taxes due to deprecation.  You would be allowed to use the depreciation write-off to shield somewhere around 25% of your $440 billion, or $110 billion from taxes.  All told, after taxes and reserves you would have around $235 billion leftover for spending, charity, or whatever you wish.  Not bad!  Also, rental units should prove to be an excellent hedge against inflation, as rents should rise along with inflation in most areas.  Not only that, but people will always need a place to live, so your odds of becoming obsolete are extremely low. Unless people figure out how to live without shelter in the future, you investment should prove to be very wise.

Instead of owning apartments, you could own all the gold in the world.  You would have to find some gigantic vaults to store the gold, after which you could open them and stare wondrously at the gold, but that’s about it.  It doesn’t produce anything, you will have exactly $0 every year flow into your bank account.  The only way to turn it into money would be to sell some.  This could work really well if it could grow at 10%+ per year over the long term.  However, gold has only grown in value over the long term at roughly 4% per year on average.  You would slightly beat inflation, but that’s about it.  It would probably be better to hold than raw land, but vastly inferior to the S&P or the apartment buildings.

Many people in life tend to choose the raw land or gold for the perceived “safety” of the holdings due to less volatility, or they have a doomsday mentality and feel the world’s economic system is due to collapse.  That’s fine if it makes a person feel secure, but I think that is very suboptimal to wealth building.  It seems pretty obvious to me, but you want to own productive assets such as income producing real estate, or stocks.  Not only will they likely increase in value over time, they will put cash in your bank account as well.  While owning raw land or gold will feel good in times of economic distress, over the long term it won’t build the kind of wealth that income producing real estate or business ownership can provide.  Every once in a while someone will sell some raw land they bought twenty or more years ago for a small fortune to a developer.  This does happen occasionally, but I would argue that it was due to luck more than skill.  Over a long time period such as ten years or more, productive assets will win almost every time.  Choose to allocate most of your wealth to productive assets and you will look back and smile over 10+ years.

 

 

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