Sunday, June 10, 2018

Small-scale Income Trade That Works Similar to Income from Real Estate Property

Part I: Upstream against Currency Devaluation

For all practical purposes, 1964 marks the last year when regular quarters minted in the USA were suitable for storing value by a regular person. 54 years later, in 2018, 1964 Washington silver quarter costs about $3. Isn't it an interesting and dangerous question - to whom  11/12 of the original value was transferred? 

Another important observation is that those- before 1964- folks were paid interest without losing the principal value. A modern investor has to operate in the monetary environment constructed to deplete the principal value of a cash account by virtue of the hidden currency devaluation. Let us estimate the rate of USD devaluation using the value of 1964 Washington silver quarter -  (1-x) ^54=1/12.  The answer x = 0.045. It means that 

No matter what they say in their official reports, the above calculation showed that the value of $1 decreases with the rate ~4.5% per year.

Now, the formula to calculate a real return on a cash account reads :

Real ROI = (1 - Tax Rate/100) x ROI - Currency Devaluation Rate,

where ROI stands for return on investment. Say if your tax rate is 25% than Real ROI for the cash account becomes positive if you make > 6% per year.

Part II:  Residential Real Estate Investing. 

Middle-class individuals often choose to invest in real estate as a way to receive interest without losing the principal value. For example, currently a 1400 square feet, 2 bedrooms, 2 1/2 bath condo in Miami-Dade, Florida costs ~$200,000. If rented out, such property generates cash flow, $1300 per month, minus management fee, $200-300 per month, and minus property tax, ~$2,000 per year. Altogether it is about 5% ROI.

Real ROI = (1 - Tax Rate/100) x (ROI - Depreciation Rate), 

Let us use IRS allowed number, 3.636%, for the depreciation rate. In this case, if your tax rate is 25% than Real ROI in the above described residential property is ~1% per year.  For investors in Miami-Dade residential properties, it means that in 2018 all future rental incomes are nearly priced in. Well, at least the wealth is protected from the silent erosion by $ devaluation. Investing in Miami-Dade residential properties was attractive back in 2010-4 when the same condo yielded between 6 and 4%.

Part III:  Small-scale investment in equities.

Real estate investing is a capital-intensive business while according to recent publications in media,  many people in the USA have no $500 of free cash. Now let us think of a person who wants to accumulate wealth by small-scale savings while collecting interest. Since this individual has to beat $ devaluation (see Part I), small-scale investing in a dividend-paying company looks like a natural choice here. This choice, however, creates an additional risk cause companies tend to lose business and at some point, nearly all of them will go bankrupt.
Thus it is better for our small investor to buy a dividend-paying index fund.  For example, in 2018 before tax SPY pays ~1.8% of interest.  Similar to real estate, the problem here is the overstretched valuation which goes hand in hand with debt expansion cycles. A debt expansion cycle is usually followed by a prolonged stagflation period. From 1970 to 1980 SP500 dropped from ~$700 to $300 while, for example, WTI oil skyrocketed from $20 to ~$120. It is difficult to predict when and at what price the next top in SP500 will happen, but the phenomenon of lost decades is amply demonstrated by the historical chart of SP500.

Part IV:  Small-scale investment in commodities.

Commodity investing is another way to fight currency devaluation. Beware that the entry point has to be close enough to the lows of a commodity cycle. Typically a long period of oversupply and of depressed prices is followed by a period when the demand becomes larger than mining supply. The price will stay depressed until the overground stocks are depleted. Usually, there is enough time to gather information and make an investment decision. 

At the beginning of 21st century, the rise of digital photography had eliminated about half of industrial demand for silver. After it, the investment demand was oversaturated in the bubble of 2011. The price of silver was depressed since then. With the widespread adoption of electronic gadgets the situation has changed and for the first time in many years, the total demand for silver is larger than mining supply. Silver ETF, SLV, is an ideal choice for a small-scale investment. Interest can be collected by selling out of the money calls against SLV stocks (SLV has liquid options) and at the same time to allow price appreciation against currency devaluation. Here is an example of the above-described investment in SLV using $3600.

"In 2018 U supply is getting short, demand is growing while the number of active mines is dropping worldwide. When the overground stocks will go, the price will explode. Here one can get a solid return on investment while participating in the liquid market.  Indeed, for the next several years, aggressive trading strategies like stock replacement by debit call spread may yield abnormal returns ...."

URA ETF is suitable for small-scale investments in this market. Again, the options market here can be used to collect interest. Unlike SLV, URA is not a pure commodity ETF. As a collection of mining stocks, this ETF pays quite significant dividends.  

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