On investing in digital currencies

Not long after I wrote my previous post, a friend suggested we pool funds to invest in digital currencies. I did not accede but I shared with him my investment thought process that is applicable to more or less any asset class. It starts with understanding where the return and risk will come from. It is better than explaining a child where do mommy and daddy come from. 

Returns in an asset class can come from price growth, asset income, or both. For instance, if you bought digital currencies, your return can only come from price growth. Given they are like cash in your pocket or piece of gold. They do not earn any interest income. In contrast, if you bought a bond your return can from both price growth and interest earned.     

Risk in asset classes can come from permanent loss or inadequate return or both.  Inadequate return will occur if the price growth you expected did not materialise, or worse, the price falls below your purchase price. Permanent loss in digital currencies can occur from theft or some system failure that causes your digital currencies to disappear.  

If you are still thinking of investing in digital currencies, your thought process must be like that of my friend – "the idea of losing $250 doesn’t scare as me much as not risking to $250 to become a millionaire". The point is that if you make investment decisions based on the fear of missing out. You are not investing. You are speculating. 

PS – Richard Feynman said it best, the first principle is that you must not fool yourself—and you are the easiest person to fool.

On digital and physical currencies

Like most things in the financial world, digital currencies are one of those things that many people talk about, but few understand it. Even the taxi driver who picked me up at the Singapore airport wanted to talk about it. In fact, he tried to convince me that I should buy a new digital currency that I had never heard of. He was convinced that he will become a millionaire in couple of years.

I was not convinced but he got me thinking about digital currencies. The question was whether they will replace physical currencies that are still in circulation. After much thinking, I have come to the view that digital and physical currencies complement each other. The best way to explain this is to tell you a story that I came across in the book, The Undoing Project.

During a combat mission in a desert battlefield, soldiers in a platoon refuse to wear helmets due to hot weather. When the colonel raises his concern, they reason that a bullet is going to kill them anyway, if their name is written on it. To which the colonel says – what about all those bullets that are addressed as ‘to whom it may concern’?

Currencies operate in the same way. They differ in whom they are addressed to. Like some bullets, digital currencies need a person’s digital address to reach the target destination. As with some bullets, physical currencies do not have a specific destination to reach. They are just bills addressed as ‘to the bearer’ in an economy.

PS – I tried to explain bitcoin to a man at a bar in Australia. He pulled out a $50 bill and asked me ‘what is wrong with the yellow peril’? His friend added ‘the Sheila won’t accept coins, mate. She wants notes’

On the value of price charts

After reading my last post, a humble soul told me house prices always go up in Australia. He even sent me a price chart to make his point. The problem was that the chart only spanned couple of decades. Surely, Captain James Cook didn’t sail uncharted areas of the globe to reach the eastern coastline because house prices always go up in Australia.

Anyway, the word 'always' got me to thinking; simply, because ‘always’ is too strong a word to be used in finance. Any enquiry starts with a question, which in this case was – Under what circumstances would house prices (or any asset prices) 'always' go up? It took me a while to come up with that question and write this post. For I have been slaving in Singapore.

My view is that asset prices can always go up under these circumstances – 1) buyers compete to pay higher prices i.e., the asset is sold using a bidding system and there are more buyers than sellers; 2) buyers have the capacity to pay higher prices, i.e., they have the money and/or credit to make the purchase; and 3) above all, the buyers have the motivation to pay higher prices.

It appears that these circumstances exist typically (not always) in the housing market – 1) buyers bid against each other compete to pay a higher price and there is only one seller at an auction; 2) buyers can borrow against houses to pay the higher price; and 3) finally, buying a house is closest thing to a religion in Australia; it is an ideology. So much for a price chart.

PS – A geographical map is useful tool for a navigator but a price chart offers no value to an investor.

On house price growth in Australia

Couple of weekends ago I met an old friend who has an investment portfolio of three houses in Melbourne, Australia. Curiously, I asked him about his thought process behind investing in three houses. Specifically, what did he see in those three houses that made him willing to borrow x times his annual income to buy them. His reply – potential house price growth.

That sounded too abstract, so I asked him to explain. He started with the location of those houses and the amenities around them (i.e., school, transport, shops, cafes, parks, etc.). He added how close they were from the central business district including commute time by various modes of transport. And on he went about those houses and their neighbourhood.

After listening for a while, I asked him how does all that lead into potential house price growth. That was followed by silence, which I broke by saying potential house price growth is simply how much more another person in the future is willing to borrow to buy those same houses than him. To borrow a phrase from Howard Marks, he is betting (or waiting) on a bigger fool.

PS - we are still friends and felt our friendship grew stronger with that thoughtful disagreement. 

On negative interest rates in Europe

Creating the Euro created a common currency but not a common language. So when I found myself at a friend’s wedding banquet in Champagne, France, I felt like a foreigner in need of a bureau de change. For all my tongue carried was loose change consisting of Bonjour, Bonsoir, Merci and Bon appetit.

Fortunately, a bridesmaid came to my rescue. She was not only a good translator but also an excellent dinner companion. Someone who can share views on a variety of topics over fine food and wine. As I thanked her for taking pity on me, I added, that is exactly how I feel about savers facing negative interest rates in Europe (clearly, I didn’t drink enough champagne!).

Curiously, she asked me to explain negative interest rates. The real question was how do you explain this to someone who believes in "a penny saved is penny earned". So I improvised – it means paying the bank to keep your money, much like purchasing a wallet to keep your money. She argued, she hardly keeps any money in her handbag. I remarked, so do banks in their vaults.

PS – I didn't bring any souvenir but I left Europe with €50 bill and some loose change in wallet.