How to Always Know Where to Place Your Money

I am often asked a seemingly simple question but to the complex answer: “How do you know where to place your money?”

The answer being variable depending on the period of time you read this article (just as the answer is variable every time I ask the question), and knowing where to place his money is a useful skill in all circumstances, I would like to discuss Here in detail the basics to know and the criteria to be considered in making a smart investment decision.

In the first part we will detail the main investment choices accessible to individuals, and in the second part we will talk about the macroeconomic factors to consider in order to know where to place his money intelligently.

Where to put your money: available options

If you immediately put aside all the doubtful investments (i.e. unreliable, very speculative including binary options, Forex and pretty much all ads you can receive in your Inbox for “miracle Investments”), you have following 4 options, liquid and existing for centuries:

Stocks:  Should we still introduce them? This is the kind of asset that has historically offered the best returns. This comes at the cost of a high volatility, i.e. you have to have a strong stomach to deal with the violent fluctuations of the value of your securities (or have a good strategy). That said if you can tolerate this, you will be rewarded with big returns.

Bonds: A more “quiet” investment in terms of volatility. And very profitable since the 80’s because of the continuous interest rate cuts (when rates fall, bond prices increase, and therefore the value of your portfolio increases, read here if you want more information about bonds).

Commodities: This asset class includes all tangible assets that are, well as their name implies, raw materials. That is, among others, precious metals, oil, cereals, but also more exotic things like live cattle (or dead) or frozen orange juice. As you can imagine, each sub-market of raw materials responds to conditions of supply and demand which are its own, besing that said, the asset class “raw materials” generally reacts in its entirety to certain macro-economic factors (detailed In the next point).

Real Estate: This is a class of tangible assets as well. However, the real estate market is not a centralised market, i.e. there is a large amount of local “sub-markets” and there is no global electronic rating of the “Real Estate” asset class (although some funds offer The real estate “paper” that comes to replicate the course of physics). However, you must understand that the environment will not be the same for an individual who wants to invest in New York, as for an individual who lives in a a village.

There would hypothetically be a fifth class of assets that I do not list: Cash. This includes cash stored in checking or saving accounts & CDs. If the economic conditions are disastrous, this category can sometimes prove to be the best option (but it is very rare and it does not usually last, there is always an opportunity somewhere). Which brings us to the next point.

Economic conditions and the impact on each asset class

Each of the vehicles mentioned above knows periods of good yields and periods of poor yields, which is why it is generally advised to build a balanced portfolio spread over several assets, in order to take advantage of the Diversification. This also means, among other things, that you may be the best stock investor in the world for example, you will not make any money if you invest in a period where the general (macroeconomic) conditions are strongly against you. The good news is that the economy is cyclical and that each phase of the cycle tends to favor an asset class in particular, so there is 90% of the time, “always an opportunity somewhere”. Let’s see in detail the main macroeconomic conditions to be taken into account, there are 4 which are important to understand the mechanisms.

Growth: The one that everyone is eagerly looking for. In times of growth everything is generally good for everyone. The economy is doing well, consumers are consuming, companies are doing well and stocks are going up. Growth is positive for all asset classes, and generally promotes actions in particular. Real estate is also well in general because people have money to pay rents or to become homeowners.

Recession: There it is, the opposite (necessarily) everything goes wrong. If you hold shares from the beginning to the end of a recession, you usually find yourself with significant capital losses. However, recessionary ends often mark major opportunities for the savvy Investor (2008 for example). During a recession, stocks and real estate are generally bad. The solutions to be preferred are defensive, i.e. state bonds or extremely strong companies, or cash.

Inflation: Here it becomes more complicated. Inflation is by definition a monetary phenomenon which results in a general price increase. That is to say your $100 will allow you to buy less tomorrow than today. You will understand that cash is highly discouraged during these periods. On the contrary, tangible assets such as real estate and raw materials tend to be very good during these periods (since there is a rise in generalized prices). Fixed rate bonds are generally to be disadvised during these periods (your coupon being fixed and the prices of tangible assets only going up, you constantly lose mechanically of purchasing power).

Deflation: This is the inverse phenomenon (and it is bad for the economy). Your $100 will allow you to buy more tomorrow than today: there is a downward pressure on the general price level. You guessed it, raw materials and real estate make bad performances during these periods, since the prices of tangible assets fall (and rents also, because they are indexed on inflation). The asset classes to be preferred in this case are the cash (since you buy more tomorrow than today with, your purchasing power increases mechanically by keeping your cash), as well as fixed rate bonds (the coupon received allows you to Consume more and more because of the decline in general prices while the amount of the coupon does not decrease).

To conclude on concrete: raw materials such as gold and precious metals have had a very bad performance in recent years because of almost zero inflation pressures, and for this same reason the bonds have made a good Performance (not in terms of performance, but as a price increase). The actions also made good performances, especially in the United States, as a result of the economic recovery (and the policies of the central bank). And real estate prices tend to deflate slightly because of the lack of inflationary pressure (to be relativized according to the local real estate market you are in). As you can see, there is no mystery and the returns on your investments are largely explained by the economic conditions (and the policies of central banks also at this time).

Now that you have a better view of the economic factors, we will move on to the next step.

where to place your money?

Let’s say you know pretty well what the general economic conditions are, but you still hesitate between several investments. Or you’re not sure about the direction of the economy, we are at a crossroad and the future looks unclear. How do I know where to invest? It’s simple, compare each of the large asset classes with the others, and then go to the most profitable and less risky.  I will give you an example: Today bonds are very expensive and offer very low returns. For example, you will have 2% return on very safe bonds.

Then, let’s observe the raw materials. First of all they don’t pay a return (which by nature does not please me very much), but in addition to that, their courses are extremely volatile. The risk/return ratio does not play in favor of this asset class, so I leave it aside.

So I still have the stock and the real estate. We will arbitrate between the two in a simple way by asking us the following questions: is the stock market currently too expensive? (which means, overvalued stocks and low yield?). Does my local real estate market offer high returns?

Let’s say, I can find lots of stocks that are somewhat undervalued and are supposed to bring me 6 or 7% return. And that my local real estate market has an average profitability of 3% at present with a very high price of square meter. Naturally, I will go to the stock market. If, on the other hand, I can find very easily 6 to 7% yields by buying a studio in my neighbourhood, I’ll have no interest in paying too much risky shares that will only bring me 2 or 3% return.

You will understand that it is fairly easy to know or position yourself simply by observing the general economic conditions, and by applying a little common sense. No need to make complicated predictions at 10 or 20 years, or to have a PhD in economics, because anyway no one can predict the future (and you don’t need it to be a good investor).

Take a fair and objective look at the world around you, and ask yourself where the opportunities are. Once you’ve spotted them, don’t get lost in abstraction and act. Stay in the present and do not conjecture. That’s all you’ll need to be a good investor.