The most common investments are stocks, bonds, CD’s, and real estate. For the average investor it’s hard to tell the difference between an asset that’s artificially inflated and real investment gains.
A simpler way to phrase this would be to ask, is a bubble really a bubble?
Price of $1
Let’s start with the US dollar. If I hand you a $1-bill then you know what you can buy with it – so you know both the price and the value of the dollar. You don’t know much about its future value but you know the price will always be $1.
It can purchase a pound of apples but you don’t know if it will be able to purchase an apple a few years from now.
I complicated this problem now because I also introduced the price of an apple. And whenever we talk about price, we are considering value as well – this will become quite relevant in a bit.
So now I give you one individual stock unit, let’s say it’s one individual Netflix stock which is trading at $300 as of this writing.
Stocks are so different from a dollar even though there are many investors who invest in the US dollar – it’s called currency trading. So how can we tell if this stock is inflated in price? What does it have to do with the value of the stock?
I’m not an economist nor do I have insight into the streaming media market. I certainly don’t understand the many legal issues regarding net neutrality. It’s nearly impossible for me to determine the value of this stock when the price goes up.
Price & Inflation
A can of Coca-Cola or a burger from McDonald’s are good examples to use to demonstrate inflation. They have the same ingredients, use the same production methods, and so their purchase price goes up because the value of our currency goes down with time.
That’s normal. Every economy experiences this and it’s a bit too involved of a topic to cover here. But just know that the purchasing power of your $1 bill will always decrease in time.
I used to be able to buy $0.60 cheeseburgers and now it would cost me $1.85. That’s inflation. It’s safe to say that the value of a cheeseburger has remained the same.
Value of $1
The value of something is different from its price. The value of the dollar-bill is however much I can buy with that $1-bill. If I can buy a cup of coffee with it in 2008 but would need $2 to buy that same cup of coffee in 2018 then the value of that dollar-bill dropped by 50%.
But value doesn’t exist in a vacuum. I don’t have to buy the same cup of coffee for $2. I might be able to brew my own cup of coffee at home and pay only $0.50 per cup.
Economist would laugh at this because to them it’s a science. To me it’s life. When it got too expensive for me to own a vehicle I decided to move to a city like Portland with great public transportation and get rid of the car.
If the same Netflix stock was $100 only a decade ago then is the stock price inflated or is the company producing more value as a business? A very hard question to answer.
A cafe with a strong patronage and $150/hour of sales is a more valuable cafe than what it was when it first started. It has a higher value. Therefore, an investor would pay more for this business.
Netflix has too many moving parts for the average consumer, even an economist, to determine its real value. This is the problem with the securities market, it’s made up of a bunch of complex companies such as Netflix, Amazon, and Berkshire Hathaway.
Sometimes the price of something will rise and so does its value.
Real Estate Value
If I buy a condo in an industrial part of town for $100k and then some builders and businesses decide to move to that neighborhood after a decade then not only will the price of the condo go up because of inflation alone but the value will go up as well.
If all home prices in your country are up but there is no serious change in the country as a whole then the prices are inflated but the underlying value is likely unchanged.
Cause for Price Inflation
Popularity. Prosperity. Herd mentality.
These are common causes for artificial price inflation.
Looking at the entire stock market in 2018, everything is up in price and probably even value. Sure, technology and healthcare is leading the pack but that’s generally the norm of an industrialized economy.
There is no active war going on that the US is involved in, people feel prosperous. More people are buying stocks, more people are buying homes. More people buying drives the prices of these items up.
The Underlying Value
Did the US invent a new form of democracy in the past decade? Did they suddenly allow people to live in tiny homes? Did they massively drop taxes? Did they figure out a way to cut healthcare spending while improving outcomes?
Sure, there has been some progress but nothing major. The US still has a very strong presence in the world and continues to support entrepreneurship more than other nations with acceptable levels of corruption and bureaucracy. Otherwise, there is nothing majorly different about the US economy.
Therefore, it’s unlikely that the underlying value of stocks and bonds and homes have appreciated as much as their prices. This is why everyone is screaming artificial inflation or pointing to a bubble or whatever other term that’s popular.
Supply & Demand
If people are willing to pay $1M for a home in Portland then the demand is there. Not only is the demand there but there are plenty of sellers who are willing to supply the homes for sale to meet the demand.
The same poor people crying that they were ‘priced’ out of their neighborhoods were the ones who sold their homes for fat profits to the yuppies.
Is it silly? Is it wrong? Is it inflated? Is it artificial? Is it a bubble? Is it a good time to get in or a good time to get out?
For better or worse people will always buy land and stocks. By land, of course, I mean homes and by stocks I mean businesses. Unless the entire society collapses there will always be businesses and land to buy and sell.
The Individual Factor
I see the beaming eyes of homebuyers in Portland, sitting at cafes meeting with their realtors, signing papers. They are talking rapidly with excitement as they are purchasing their $700k homes. I congratulate them and hope that it’s a good choice for them.
I also reflect on our decisions and behaviors as individual investors in such economic times. Stocks are at an all-time high and so are real estate values. Every cafe and restaurant that’s halfway decent is packed on evenings and weekends. People are prospering.
We’re not talking about PTSD of Iraq War veterans anymore. The stock market crash and housing crash of 2008 is behind us. And Bin Laden is dead.
Since 2013 everyone has said how inflated everything is, what a bubble we are in, and that it’s all going to come crashing down.
The Big Crash
So what does it actually look like for this giant crash to take place. Remember, we don’t live in a vacuum, we can make choices, move, dodge, and weave.
Are your home payments more than you can afford? Are you about to cash out all your stocks in the next 1-2 years because you need to live off of them?
If either of these things are true then it matters little whether you’re at the bottom of a market crash or at the peak of a manic market. You would be advised to downsize your home and get the fuck out of stocks.
I have a net worth of a little under $900k right now. I have ways of earning an income and I am not living beyond my means. I am also able to cut my spending even more if I wanted/needed to.
If I wake up tomorrow with my condo being worth $15,000 and my stocks and bonds portfolio worth $100k then nothing would change. I would still pay my HOA dues, my property taxes, and I would continue contributing money towards retirement accounts to lower my tax burden.
Should You Stop Investing?
I think investing is more of a habit and a skill than a timing strategy. The more you do it the better you get. And if you do it long enough and invest in both the down markets and the up markets then chances are you will come out ahead.
I still invest in my earning-abilities. It has gone up from $100/hour to $250/hour. I will also keep investing in stocks and bonds because it’s a system which has done well historically and it makes sense to me. Okay, well, it at least makes as much sense to me as relationships.
I won’t invest in real estate anytime soon only because it’s too much work for me. I might change my mind down the road but babysitting an investment property right now doesn’t excite me.
I am an Inflator
I am an inflator of stock market prices because I buy stocks and bonds which drive up the prices of the securities market. The more I buy the more I contribute to the inflated prices.
I blow bubbles.
Let’s say the world as a whole agreed that the US stock market is inflated and that we all should stop buying stocks. It’s obvious what would happen. But no such thing will ever take place. The nature of a human being is individualistic which is why our society functions the way it does.
The Baby Boomers Phenomenon
When the right time comes and all the baby boomers cash out of their stocks and bonds and flood the market with shares then prices will bottom out.
The value will drop as well because there is much more supply than demand. But this is a temporary value flux phenomenon.
When that happens – who knows when – will the stock market be fucked for good? Or will our society once again lament over this massive tragedy and then forget all about it after 5 years and buy into it again?
I don’t believe in the stock market because it’s a magical creature but because I know how well it feeds into the psyche of a US consumer. For that reason I lean towards the latter scenario and will continue investing.
My Individual Net Worth
So is my net worth inflated? Yeap.
Should I stop claiming that it’s $900k because it’s in fact much lower? Only if someone knows of a way to calculate the exact value of my portfolio.
Should I stop investing because I know for sure that at some point in the future the stock market will drop again? No.
Nobody would ever invest in the stock market if they believed that a drop in the stock market signaled the end.
Am I screwed if the stock market or housing prices crash? No.
My lifestyle has very little to do with my net worth. I’ll still go to a coffee shop. I’ll still write. I’ll still earn money one way or another. I’ll still teach at the college. I’ll still go to the gym. I’ll still make delicious homemade bread and yogurt.