Chapter 15
Exploring Other Investment Vehicles
IN THIS CHAPTER
Checking out call options
Digging into gold and other commodities
Considering cryptocurrencies
Surveying collectibles
Exploring annuities and cash value life insurance
In the earlier chapters of this book, I present and discuss a pretty wide range of investments that are time-tested. You’ve probably already heard of and been pitched other or alternative investments. The vast majority of these alternative investments are flawed due to high fees, lousy performance, or worse.
In this chapter, I discuss the most common of these alternative investments: options, gold and other commodities, currencies and cryptocurrencies, collectibles, and annuities and cash-value life insurance. In each case, I explain each investment’s redeeming qualities as well as its flaws.
Calling on Options
In recent years, I’m finding that some young people are using options, like call options, to try and make big money quickly. If you don’t understand call options, it would probably be better if I didn’t actually explain them to you — I’d rather you stay away from them! But, here’s a simple example to show you how they work.
Suppose you’re intrigued by the field of online gaming software development and you hear about the company Unity Software and its stock. You look and see that the stock is trading at $150 per share. Instead of buying the stock, though, you could buy some call options for the stock. Their $180 call options, which expire in about ten months, are going for $32 per share. Suppose before those options expire the stock zooms higher and hits $300 per share. Your call options would be worth at least $120 per share now so you’d have nearly quadrupled your money — a far greater percentage move than you would have enjoyed in the stock. If the stock instead treads water or goes down, your options will end up expiring worthless and you will have lost all the money you invested in them.
With options, you are making a short-term bet or gamble on the price of a particular stock rather than making an investment for the years ahead. So, you not only have to be right about the specific stock you are choosing, but you also have to be correct about the specific (short-term) timing of your investment.
As you can see, call options can be really exciting because you can make really high returns if you pick the right stock at the right time and it goes up by a large amount. But, that’s more like gambling than investing, and more often than not, you will lose money on call options or not make very much. And, they will likely make you a nervous wreck as they entice you to constantly watch the stock market and the stocks and call options that you own.
Considering Gold and Other Precious Metals
Of all the commodities, gold and silver have gotten the most attention over time, especially in recent decades. Gold and silver are also known as precious metals.
Gold and silver have served as mediums of exchange or currency over thousands of years because they have tangible value and can’t be debased the way that paper currencies can (by printing more money). These precious metals are used in jewelry and manufacturing.
As investments, gold and silver tend to perform well during bouts of inflation, especially when the inflation is unexpected. During the 1970s, for example, when inflation zoomed into the double-digit range in the United States and stocks and bonds went into the tank, gold and silver prices skyrocketed more than 500 percent.
Precious-metals prices have zoomed upward again since 2000. From less than $300 per ounce, gold hit more than $1,900 per ounce in the early 2010s, as some feared the return of inflation due to excessive government debt, government stimulus spending, and expansion of the printed money supply. During this period, silver jumped from just over $4 per ounce to a high of $45 per ounce. After those runups, however, gold and silver dropped dramatically in value and now a decade later, gold is just getting back near its prior highs while silver still has quite a way to go.
Although precious metals may shine for a decade, over the long, long term, they’re lousy investments. They don’t pay any dividends, and their price increases may at best just keep up with, but not ahead of, increases in the cost of living. Consider the fact that even when gold breached $1,900 per ounce in 2011, it was still below the inflation-adjusted levels it had reached more than 30 years ago. To reach those levels, gold would have to rise to more than $2,500 an ounce! According to Professor Jeremy Siegel’s research on investment returns, which goes back more than two centuries (to 1802), gold’s average annual rate of return has been just 2.1 percent, which translates into a return of just 0.7 percent per year ahead of the rate of inflation. So, those who have invested in gold over the long term have just barely kept up with and slightly ahead of inflation.
Although investing in precious metals is better than keeping cash in a piggy bank or stuffing it in a mattress, the long-term investment returns aren’t nearly as good as those of bonds, stocks, and real estate. One way to earn better long-term returns is to invest in a fund containing the stocks of gold and precious-metals companies. Two such funds to consider are Fidelity Select Gold and Vanguard Global Capital Cycles.
Fidelity Select Gold (trading symbol FSAGX) has been in existence since 1985 and has returned 5.1 percent per year on average. The Vanguard Global Capital Cycles fund (trading symbol VGPMX; formerly the Vanguard Precious Metals and Mining fund) invests partially in companies that benefit from increased demand for physical assets such as gold, other precious metals, and minerals. At least 25 percent of the fund is invested in precious metals and mining securities. It also focuses on opportunities to invest in companies with scarce, high-quality infrastructure assets — typically in utilities and telecommunications — that are viewed as irreplaceable and therefore have enduring value. Since its inception in 1984, this fund’s annualized rate of return is 4.2 percent, which is less than half the return you’d expect from a stock-focused fund but is nearly double the annualized rate of return of gold over the long term.
There are numerous other commodities that you can “invest” in, but the long-term data shows terrible returns. Sure, there can be short periods where a particular commodity’s price zips higher, but you will do poorly generally with these over time.
Should You Invest in Currencies and Cryptocurrencies?
Those who frequently predict doom and gloom and the demise of particular civilizations and governments like to highlight the fact that government-created currency, like the U.S. dollar, can be increased and expanded simply by creating more of it. Just look at the large government deficits that occurred during periods like the severe 2008 financial crisis and recession and the 2020 COVID-19 government-mandated economic shutdowns.
Again, looking at historic data going back over 200 plus years, we see that the U.S. dollar has depreciated by a whopping 95 percent after adjusting for increases in the cost of living. That works out to losing about 1.4 percent per year on average. Other currencies generally show similar long-term patterns so “investing” in currencies has been a long-term loser.
When you invest in stocks, you’re actually getting some exposure to and diversification with currencies around the world which in theory reduces your overall stock market risk a bit. When you invest in U.S. companies, especially larger ones, they often do some business overseas. Foreign stock funds, of course, invest in overseas companies which do most if not all of their business in foreign countries and in foreign currencies.
Now, let’s talk a bit about the “newer” currencies that are generating more interest among some younger adults — cryptocurrencies. Bitcoin, the most well-known and highly traded cryptocurrency, has been making headlines as its price climbs to ever dizzying heights. It recently hit more than $61,000 per coin. But there are literally thousands — more than 9,100 at recent count — of other cryptocurrencies.
So, what exactly are these cryptocurrencies? For starters, none of them are actually a coin — that’s a marketing gimmick used by many to make it sound like real currency. Bitcoin and other similar cryptocurrencies only exist in the online world. Bitcoin’s creators say that they have limited the number of Bitcoins that can be mined and put into online circulation to about 21 million.
As its promoters have talked up its usefulness and dizzying rise, many people who have Bitcoins and various other cryptocurrencies continue to hold onto them like shares of stock in the next Amazon, Apple, or Tesla, hoping for and expecting further steep price increases. People don’t hoard real currencies with similar pie-in-the-sky hopes for large investment returns. And for good reason, because as I just discussed, real currencies depreciate over the years, not appreciate!
Outside of Bitcoin and Ethereum, the vast majority of other cryptocurrencies have depreciated in recent years. Many cryptocurrencies have crashed and burned — losing 90 percent or more of their value — as the number of cryptocurrencies has mushroomed over recent years.
Online cryptocurrency transactions can be done anonymously, and they can’t be contested, disputed, or reversed. So, if you buy something using cryptocurrencies and have a problem with the item you bought, that’s too bad — you have no recourse, unlike, for example, a purchase made on your credit card. The clandestine nature of many cryptocurrencies makes them attractive to folks trying to hide money or engaged in illegal activities (criminals, drug dealers, and the like). And hackers create another real danger — your cryptocurrency could be stolen as has happened to numerous Bitcoin and other crypto holders.
So, what is a given cryptocurrency worth? Cryptocurrencies generally have no inherent value; there are a small number of so-called stable coins linked to or backed by another asset or traditional currency. Tether is an example of a stable/crypto coin, which is linked to the U.S. dollar. Digix Gold Token is an example of a crypto/stable coin linked to gold (actually one gram of gold per token/coin).
Contrast cryptocurrencies with no inherent value of linkage with that with gold. Not only has gold had a long history of being used by some as a medium of exchange, but gold also has commercial and industrial uses. Furthermore, gold costs real money to mine out of the ground, which provides a floor of support under the price of gold in the range of $1,200 to $1,300 per ounce, not far below the price of gold at about $1,750 per ounce at the time of this writing.
While the supply of Bitcoin is currently artificially limited, Bitcoin is hardly unique — it’s one of thousands of cryptocurrencies. So, if another cryptocurrency is easier to use online and perceived as attractive (in part because it’s far less expensive), Bitcoin will tumble in value.
Even though Bitcoin has been the most popular cryptocurrency in recent years (it accounts for about 50 to 60 percent of the market value of all cryptocurrencies), few merchants actually accept it. And, to add insult to injury, Bitcoin users get whacked with unfavorable conversion rates, which add greatly to the effective price of items bought with Bitcoin.
I can’t tell you what will happen to Bitcoin’s or any other cryptocurrencies’ price next month, next year, or next decade. But I can tell that it has virtually no inherent value as a digital currency, so those paying big bucks for a particular cryptocurrency will likely eventually be extremely disappointed. There are more than 9,100 of these cryptocurrencies, and the field keeps growing as creators hope to get in on the ground floor of the next cryptocurrency that they hope will soar in value. And, in that respect, they actually share something in common with collectibles.
Contemplating Collectibles
The term collectibles is a catch-all category for antiques, art, autographs of famous folks, baseball cards, clocks, coins, comic books, diamonds, dolls, gems, photographs, rare books, rugs, stamps, vintage wine, writing utensils, and a whole host of other items. In this section, I discuss the appeal and reality of investing in collectibles.
Understanding the allure of collectibles
The best returns that collectibles investors reap come from the ability to identify, years in advance, items that will become popular. Do you think you can do that? You may be the smartest person in the world, but you should know that most dealers can’t tell what’s going to rocket to popularity in the coming decades.
Dealers make their profits the same way other retailers do — from the spread or markup on the merchandise they sell. The public and collectors have fickle, quirky tastes that no one can predict.
You can find out enough about a specific type of collectible to become a better investor than the average person, but you have to be among the best such collectors to have a shot at earning decent returns. To get to this level of expertise, you need to invest hundreds, if not thousands, of hours reading, researching, and educating yourself about your specific type of collectible.
Don’t get me wrong: There’s nothing wrong with spending money on collectibles. Just don’t fool yourself into thinking that they’re investments (more on their actual returns in the next section). You can sink lots of your money into these non-income-producing, poor-return “investments.” At their best as investments, collectibles give the wealthy a way to buy quality stuff that doesn’t depreciate.
Seeing the realities of collectibles and their returns
Although connoisseurs of fine art, antiques, and vintage wine wouldn’t like the comparison of their pastime with buying old playing cards, collectibles generally are objects with little intrinsic value. Wine is just a bunch of old, mushed-up grapes. A painting is simply a canvas and some paint that at retail would set you back a few bucks. Stamps are small pieces of paper, usually less than an inch square. What about baseball cards? Heck, my childhood friends and I used to stick them between our bike spokes (the crummiest players’ cards, of course)!
I’m not trying to diminish contributions that artists and others make to the world’s culture. And I know that some people place a high value on some of these collectibles. But true investments that can make your money grow — such as stocks, real estate, or a small business — are assets that can produce income and profits.
Because collectibles have little inherent value, they’re fully exposed to the whims and speculations of buyers and sellers. As history has shown, of course, and as I discuss elsewhere in the book, the prices of particular stocks, real estate, and businesses can be subject to the whims and speculations of buyers and sellers, too, especially in the short term. Over the long term, however, securities’ market prices return to reality and sensible valuations. Also, a real investment can provide a return to you even if no one ever buys it from you.
Here are some other major problems with collectibles:
- Large markup costs: The spread between the price that a dealer pays for an object and the price for which he sells the same object is often around 100 percent. Sometimes, the difference is even greater, particularly if a dealer is the second or third middleman in the chain of purchase. So at minimum, your purchase typically must double in value just to get you back to even, and a value may not double for 10 to 20 years or more!
- Substantial other costs: If the markups aren’t bad enough, some collectibles incur all sorts of other costs. If you buy more-expensive pieces, for example, you may need to have them appraised. You may have to pay storage and insurance costs as well. And unlike the case with markup, you pay some of these fees year after year of ownership.
- Costly mistakes of nonexpert buyers: Sometimes, you may overpay even more for a collectible because you didn’t realize some imperfection or inferiority of the item. Worse, you may buy a forgery. Even reputable dealers have been duped by forgeries. Also, you may make storage mistakes that cause your collectible to deteriorate over time. Damage from sunlight, humidity, temperatures that are too high or too low, and a whole host of vagaries can ruin the quality of your collectible. Insurance doesn’t cover this type of damage or negligence on your part.
- Terrible returns: Even if you ignore the substantial costs of buying, holding, and selling, the average returns that investors earn from collectibles rarely keep ahead of inflation, and they’re generally inferior to returns from stocks, real estate, and small-business investing.
Objective return data on collectibles is hard to come by. Never, ever trust so-called “data” that dealers or the many collectibles trade publications provide.
Considering advice on buying collectibles
If you want to buy collectibles and can afford to do so, you have my blessing. Here are some tips to keep in mind to make the most of your efforts:
- Do your homework. Use a comprehensive resource to research, buy, sell, maintain, and improve your collectible, such as the books by Ralph and Terry Kovel or their website at
www.kovels.com. - Collect for your love of the collectible, your desire to enjoy it, or your interest in finding out about or mastering a subject. In other words, don’t collect these items because you expect high investment returns, because you probably won’t get them.
- When you know what you want, buy direct and eliminate the middleman where possible. In some cases, you may be able to buy directly from the artist.
- Check collectibles that are comparable to the one you have your eye on, shop around, and don’t be afraid to negotiate. An effective way to negotiate after you decide what you like is to make your offer to the dealer or artist by phone. Because the seller isn’t standing right next to you, you don’t feel pressure to decide immediately.
- Get a buy-back guarantee. Ask the dealer (who thinks that the item is such a great investment) for a written guarantee to buy the item back from you within five years, if you opt to sell it, for at least the same price you paid for it.
- Keep quality items that you and your family have purchased, and hope that someday they’ll be worth something. Keeping these quality items is the simplest way to break into the collectibles business. The complete sets of baseball cards I gathered as a youngster are now (30-plus years later) worth hundreds of dollars, and one is worth $1,000!
Understanding Annuities and Cash-Value Life Insurance
Odds are that if you’re looking to make investments, you’ll be pitched various types of investment vehicles by folks who are licensed to sell insurance products. In this section, I discuss two of the most common vehicles: annuities and cash-value life insurance.
Availing yourself of annuities
Annuities are contracts that insurance companies back. If you, the annuity holder (investor), should die during the so-called accumulation phase (before receiving payments from the annuity), your designated beneficiary is guaranteed reimbursement of the amount of your original investment.
Annuities, like Individual Retirement Accounts (IRAs), allow your capital to grow and compound tax-deferred. You defer taxes until you withdraw the money. Unlike with an IRA, which has an annual contribution limit of $6,000, you can deposit as much as you want into an annuity in any year — even millions of dollars, if you’ve got them! As with a Roth IRA, however, you get no upfront tax deduction for your contributions.
The problem with annuities is that insurance agents try to sell them to many folks who won’t benefit from them — and the vast majority of folks won’t be in a position to benefit from them.
If you’ve contributed all you’re allowed to contribute to your IRA and your employer’s retirement accounts, and you still want to put more money into retirement accounts, you might consider annuities.
Don’t consider contributing to an annuity until you’ve fully exhausted your other retirement account investing options, including all possible Roth accounts. The reason: Annuity contributions aren’t tax-deductible, and annuities carry higher annual operating fees to pay for the small amount of insurance that comes with them. Roth accounts are superior to an annuity because you don’t pay income tax on your withdrawn investment earnings from Roth accounts. Because of their higher annual expenses, annuities generally make sense only if you have 15 or more years to wait until you need the money.
Considering cash-value life insurance
If you have dependents, you may need life insurance. The key question to ask yourself and your family is how they would fare if you died and they no longer had your employment income. You need life insurance if your family is dependent on your income from work and would be unable to maintain its current standard of living with your passing.
Term life insurance is pure insurance protection and the best choice for the vast majority of people. The other major type of life insurance is cash-value coverage, which includes a life insurance death benefit (as does a term policy), as well as a savings and investment feature.
You generally can’t combine insurance with investing when you buy an auto, disability, or homeowner’s policy, so why can you with life insurance? You can thanks to an exemption in the tax code.
Insurance companies and agents who sell their products and earn commissions favor cash-value life insurance. The reasons are pretty simple: Cash-value life insurance costs much more and provides heftier profits for insurance companies and commissions to the agents who sell it.
You should consider getting cash-value life insurance only if your net worth is high enough that you anticipate having an estate-planning “problem.” When you buy a cash-value policy and place it in an irrevocable life insurance trust, the death benefits can pass to your heirs free of federal estate taxes.
Under current tax law, you can leave up to $11.7 million free of federal estate taxes to your heirs. If you’re married, you can pass on double these amounts through the use of a bypass trust. So, most people don’t have an estate-planning situation that warrants cash-value life insurance.