The Value of Long-Term Savings Products and Assets
Part II of The Value of Financial Products and Assets
Part II of The Value of Financial Products and Assets
Previous Parts
In the previous part, we illustrated the value of short-term saving products such as bank savings accounts and money market funds. In this part of the series, we will analyze financial products and assets that make up long-term savings to see if they hold any intrinsic or instrumental value.
Long-term savings are typically savings for retirement or investments in assets for a potential high return on investment. The money used for such long-term investments is usually allocated with the expectation that this money would not be needed in the short term for any emergency or unexpected event. With that, long-term saving products typically consist of a diversified set of asset classes. The most common asset classes held in those accounts are stocks and bonds – it must be noted that long-term saving accounts often allocate capital into mutual funds or ETFs, but at the end of the day, those mutual funds and ETFs typically consist of stocks and bonds; therefore, we will focus on the intrinsic or inherent value of stocks and bonds. After discussing stocks and bonds, we will briefly touch on other assets that can be part of a long-term savings or investment portfolios such as real estate and commodities.
To reiterate, we are focused on instrumental and intrinsic value as in what value-add or function do those assets provide beyond their financial potential and the price attributed to them. What is inherent in the nature and utility of those assets that allow them to have a financial value in the first place? Do they have any inherent attributes that make them valuable in and of themselves?
Financial Securities: Stocks and Bonds
At the surface, from an investing or trading perspective, a stock seems to be a ticker with a price that goes up or down. It seems as if it exists in and of itself for the sole purpose of being traded and for the sole purpose of bringing about profits by its capital appreciation and, in some cases, a distribution of dividends. This description, however, is a very surface level or shallow approach to viewing what stocks are.
Stocks were developed for the purpose of financing activities of corporations and businesses. With companies expanding and conducting large scale operations, they needed a means beyond loans to raise sufficient funds for specific objectives. To get a broader number of potential equity owners and investors to allocate capital into such companies, stocks were introduced. The first company to issue public stocks was the Dutch East India Company. The public stock we know today standardized the capital raising process and allowed the broader public to participate in the stock market. This development allowed corporations to raise capital in a more efficient manner and from a broader set of investors. That said, it is important to distinguish between primary and secondary markets: primary markets are where companies raise initial capital, and secondary markets are where the shares of those companies are traded. Nonetheless, the point here is that a stock exists due to the capital raising function it serves in the primary market, with the secondary market allowing for more efficient markets, liquidity, and risk management. In fact, with a robust secondary market, investors are more willing to participate in the primary market for the capital raise of a company knowing that they can exit the position later through the secondary markets. With that function of a stock outlined, it is clear that a stock has instrumental value since it is a tool for companies to raise needed capital to conduct specific operations, which enable the provision of goods and services that are of added value.
Of course, if stocks are being used to raise capital for companies that do not offer valuable products or services and actually do more harm than good, then one can argue that the function of the stock would be considered harmful, or more accurately, corrupted. In that case, we would not be able to ascribe instrumental value to that specific stock since the stock would be a means to a “bad” or harmful end as opposed to a valuable end. Nevertheless, this point is beyond the scope of this article, and we are assuming that companies are providing a valuable good or service that is needed and are acting with moral standards.
In addition to the capital raising function that a stock serves, a share in a company represents a claim on the company’s assets and profits. Owning a stock of a company is a representation of economic ownership in the entity. Evidently, it is the activities and operations of the company that eventually provide the financial returns that shareholders seek from the stocks they own. Since the activity and profitability of the company is what eventually leads to returns for stockholders, it is the underlying activity of the company that makes stocks valuable. While stocks were established to finance operational activity, they also represent the value of the service or the product that the company provides, and the value is reflected by the company’s growth, profits, and cashflow, which influence its stock price and the dividends that the company can distribute from its earnings. From this perspective, one can argue that a stock holds intrinsic value since it is a claim on a productive entity that provides valuable products or services. In other words, the stock is a reflection of the intrinsic value of the services, goods, and operations of a company.
From a long-term savings perspective, it is valuable for savers to be able to invest in stocks of companies as they grow since a company’s success and value grows over time. As for the companies raising money through issuing stocks, it is important to have long-term investors who hold the stock for the long-term potential of the company, since a company does not become successful overnight and might experience ups and downs. Moreover, the stock price of the company may be affected by the trading of the stock itself, so having investors invest and hold a stock of a company with a long-term orientation is crucial since the stock price is an important aspect in the financial health of the company even after the initial primary capital raise – having long-term investors typically results in more stability.
As mentioned, investing in stocks is typically considered a long-term strategy because the price of the stock fluctuates over time and typically needs years to sustainably appreciate in price and/or to be able to distribute dividends as the companies invested in become more valuable and mature. The risk varies based on each company or stock, and given the risk and the volatility of stocks, this is why they are typically considered for long-term savings because it takes time to fully achieve the expected sustainable returns and because the volatility can be stomached if the cash invested is not needed for short-term requirements. A long-term investor can withstand a steep decline in the stock price on a specific day if their time horizon on this investment is ten years and there is strong conviction that the company has potential for success based on the fundamentals. That said, there is always the risk of a company failing; hence why a typical long-term savings portfolio consists of a diversified set of stocks and assets, and it is advisable to invest in an index that represents the market. Investing in the market is another way of saying to invest in the economy of a country since the market, which is typically represented by an index which tracks the stocks of several companies (the S&P 500 for example) represents the economy of the country and the productivity and potential of those companies which contribute to the economy. The point here is that a stock’s price is linked to actual economic activity that is valuable, and volatility is a function of the fundamentals of the company and the macro environment.
At the end of the day, the stock is a contract that benefits both parties – the party that raises capital via the shares it issues and the party that invests in those shares for economic ownership in the entity.
As for bonds, they were introduced as a vehicle to lend a large amount of money, usually with a long-term timeline or maturity, to fund activities that governments and companies want to undertake. Rather than representing ownership, they are a type of loan, which allows for the return of the principle of the money lent with interest and can also be traded on the secondary market. Like a stock, the purpose of the bond is to finance activity. It is a vehicle that allows for a broader base of investors to allocate capital that a specific entity is looking to raise for a specific purpose. As opposed to owning a share in the potential earning of a company though, bonds allow investors to make a profit from the interest earned on the principle lent out while maintaining or preserving capital until maturity of the bond or by selling the bond at a profit on the secondary market. The secondary market for bonds allows for more efficient and liquid markets – similar to the point mentioned above in our discussion regarding the role of the secondary market for stocks.
While a stock’s value is linked to the activity and operations of a company and its potential growth, a bond is typically linked to the health of the entity and how likely it is to keep its promise of distributing the coupon or interest and return the loan at maturity. Nonetheless, the health of an entity is also linked to its operations and activity which grant it its healthy status and allow it to return the money it had borrowed with the interest owed.
Bonds are valuable for long-term savers because they are more predictable and less risky than stocks and allow for some profit and income distribution from the interest distributed over the lifespan of the investment. It is also a means to maintain or preserve capital since the money would be returned at maturity. Bonds are typically an important part of a diversified portfolio from a risk-reward perspective.
Since bonds are instruments used to finance or raise capital for specific activities by entities, they evidently hold instrumental value. They are another instrument that allows organizations to raise capital for specific operations that is of added value and that typically allows for the provision of goods and services. If we want to look at the intrinsic value of a bond, however, it would be different than a stock. Instead of offering ownership claims to the investors as stocks do, bonds provide a contractual agreement in which the entity pays interest on the loan amount and returns the principle once matured. While stocks represent ownership claim in an entity and typically perform based on the performance of the underlying entity or company, bonds are just a fixed claim on the entity that the entity is obliged to pay back, independent of its performance or future growth prospects. The point here, as mentioned above, is that while a stock is a reflection of the operations of the company, which one can argue lends it its intrinsic value, a bond is not an asset reflecting the operations of an entity, but is rather an independent claim on an entity that the entity is obliged to pay. Its intrinsic value isn't necessarily reflected by the operations of the company, but by the terms of the bond itself. However, one can argue that the intrinsic value of the bond is still reflected by the health and cash flow of the entity it has a claim on, and the health and cash flow of the entity is tied to its fundamental operations. In any case, bonds or fixed income securities have instrumental value as discussed and have some sort of intrinsic value since they are a claim on an entity that is of value due to its operations, even though the claim isn’t on the future growth prospects and potential of the entity, but is rather a claim that the entity is obliged to pay.
At the end of the day, stocks exist to finance businesses, and holding a stock represents economic ownership in a company producing goods and services. The value of a stock, a financial security, is clearly beyond just its ticker price on a screen. Similarly, bonds are vehicles that allow businesses and governments to borrow money for specific purposes. As opposed to having ownership in the entity, a bond allows investors to lend money to those institutions to help finance their activities with the expectation of getting their money back with a profit – it’s a contractual agreement that the borrower is obliged to pay.
Overall, stocks and bonds which make up most long-term saving portfolios have valuable attributes that are useful for individuals, organizations, and communities. They are tools that are a means to raise capital that is then allocated into productive and needed activity. Being a vehicle that enables a capital raising function that represents a sort of claim on a productive entity is what lends them their instrumental and intrinsic value and why they have developed into assets for long-term savings. While stock and bond performance and price movement can deviate from their fundamentals, it is the foundational functions and value-add discussed here that makes them valuable in the first place – these are the main features that resulted in them being financial assets for long-term savings and investing.
As illustrated, the value of stocks and bonds is evident by the functions they serve and by the economic use case they are tied to.
Real Estate
Real estate is another asset class that ca be part of a long-term savings portfolio. The value of real estate is straight forward. Land is needed for almost everything we do. Through real estate we farm, build commercial and residential buildings, build factories, build infrastructure, and more. Evidently, the value of real estate is not necessarily tied to its price alone. Real estate is valuable in and of itself given how crucial it is for all our activity. Afterall, we are beings that occupy space and rely on land for almost everything we do ranging from personal, economic, and political use cases.
Since real estate and land have inherent attributes, it can be argued that land has both instrumental and intrinsic value. Instrumental value since we use land to farm and produce crops and foods, to build houses and factories, and more. It is the basis of almost all our activity, and we rely on land for almost everything we do. As for its intrinsic value, it can be argued that the land is valuable in and of itself; it holds inherent features that make it valuable. Those inherent attributes could be the land’s fertility, the space and structure of the land, the natural resources contained in the land, etc.…
It is important to highlight that real estate is considered a long-term investment since financial returns on real estate take time to materialize. Renting-out property allows one to accumulate wealth through the stable cash flow generated via rent. To make a worthwhile return from rent, one needs to hold the asset for the long run. Also, growth in a specific area might allow for the value of the property in that area to increase in value throughout the years, so one can exit an investment in real estate if the price of the property increases due to fundamentals and the macro environment; this typically materialized in the long-term. Moreover, real estate isn’t as liquid as financial securities, for example, and so the money allocated into it is tied up and can’t be accessed at any time needed. That said, financial products such as REITs are available to allow investors to allocate capital into a fund that invests in real estate, and such products are typically liquid. The underlying of such funds are the real estate assets held and the operations involved to maintain these assets, so the instrumental and intrinsic value of the real estate assets held in REITs are the same as the attributes discussed so far regarding the value of real estate and land.
With that, it is evident why real estate is valuable and why it is considered an asset for long-term savings. The important points here is that real estate is used for specific functions that we rely on and value (it has instrumental value), and that certain lands naturally hold inherent attributes (it has intrinsic value). It is those features of real estate that make it valuable and why it has developed into a financial asset that is typically a good investment for long-term savings – the price attributed to land is typically tied to the instrumental and intrinsic value it has, and its use cases is what allows it to generate cash flow or appreciate in price.
Commodities
Commodities such as oil, base metals, and agriculture products are sometimes included for long-term savings, but they act mostly as a hedge or a sophisticated strategy in a portfolio. What we are talking about here are the forward and future contracts and other derivatives based on those commodities. Holding the commodity itself is rare, especially since those commodities are used for consumption and productive purposes. To be clear, we aren’t talking about precious metals and gold in this section. The commodities being briefly discussed here are commodities such as oil, agriculture crops, base metals, etc...
It is important to highlight that futures and forward contracts on commodities were founded to enable farmers to manage the risk of future prices of their produce. Such contracts allowed sellers and buyers to lock in a price on a sale or purchase of a commodity, such as wheat or rice for example, that they would be happy with at a later date. Such contracts and agreements provide farmers with certainty and predictability as to the sale/purchase price of their produce and provide protection against adverse price fluctuations in the market. That is why commodity forward and future contracts exist. It is this function that makes those contracts valuable – those contracts thus have instrumental value.
While many traders participate in the futures and forwards markets for speculation, the basis of the instrument was founded for the use case mentioned above. Also, one can argue that the speculators in commodity markets allow for liquidity, which results in better pricing and a more effective market overall. That said, there is criticism as to heavy speculation around commodities, but that discussion is beyond the scope of this article. The point here is that futures and forward contracts in the commodity markets were developed as a tool for risk management as discussed above, hence the instrumental value of those financial assets.
As for the commodities themselves, it is evident that they are the natural resources we need to sustain our lives and hence why they are valuable. There’s no need to go into detail to prove why we value crops such as wheat and rice or metals such as iron and copper.
Again, what we are talking about here are commodities that are typically used for productive use cases and that are part of our everyday lives through the food we eat, the infrastructure we rely on, and the energy that lights up our buildings and powers our transportation. Gold, a precious metal, which is also commodity, will be discussed in more detail in the following part of this series, since it deserves a dedicated section for the purpose of this discussion given its complexity and that bitcoin is often labeled as “digital gold” and is said to resemble gold.
Cash and Cash Equivalents
While we discussed cash and cash equivalents as part of short-term savings, they can also be considered as part of a diversified long-term savings portfolio for risk management purposes and as a war chest. We already illustrated the value of cash and cash equivalents here (Part I - The Value of Short-Term Savings Products).
The Value of Long-Term Savings Products and Assets
The value of the products and assets that make up long-term savings is thus clear. While we discussed a variety of different assets that hold different features, they all share a common theme – they have foundations by either providing an instrumental use case that allows us to achieve something of value, or they inherently hold attributes that lends them their intrinsic value. While all provide some sort of instrumental value, a few of the assets discussed could be argued to have intrinsic value in and of themselves as illustrated. The point of this analysis is to show that while many of those assets are looked at in terms of their price in the market and as a means to accumulate profits, they all have a basis that provide either instrumental or intrinsic value beyond the price attributed to them and beyond their financial characteristic. The price and financial characteristics attributed to such assets and products are due to the foundational value they provide as illustrated.
As mentioned, gold is a commodity and is used for savings and investment as well. In Part III of this series, we will take on the task of evaluating what makes gold valuable and to see if it holds any instrumental or intrinsic value.
