During periods of higher inflation, hard assets will generally outperform soft assets, such as the stock market. I have been able to earn 10-15% returns using certain hard assets, which is a rare rate of return in typical Wall Street based soft assets. Hard assets typically provide a better investment hedge against inflation than soft assets. This isn’t a universal truth, and it doesn’t mean all hard assets are good and all soft assets are bad. I use both types of assets to invest, and diversification of both hard and soft gives a better overall performance than being heavily downloaded with one or the other. Unfortunately, most people are only familiar with Wall Street-based investments that a financial advisor will recommend or purchase for you, typically for your retirement plan.

Economics 101

All countries have economic cycles that go up and down over time, and other variables like higher or lower inflation during those cycles. Once the government implemented the concept of Central Banks and removed their currencies from the gold standard, our money supply became fluid. It can be expanded or contracted by the Federal Reserve raising and lowering interest rates. This has triggered multiple periods of inflation during our history and removes discipline from investors and businesses that will chase returns on what often turn out to be poor investments. A gold standard will return this discipline to the market and do a much better job curtailing inflation. The concept of a gold standard is a foundational principle in the Austrian School of Economics.

When you have no gold standard, bubbles will form and eventually pop which creates widespread economic hardship. Understand that these bubbles can develop in any market, including hard assets, but today, most people are used to seeing skyrocketing stock market gains, which is a soft asset class. Therefore, it is essential that, as an investor, you understand that picking great investments isn’t as easy as always selecting hard assets over soft ones. That is simplistic and will lead to poor returns over time.

Investors should be looking for the right investments at the right times in the economic cycle and moving from one to the other as opportunities present themselves. I admit this is often easier said than done; you will get it wrong occasionally. Also, please understand, I am not talking about timing the market, which most investors will tell you is a sucker’s gambit, and I would tell you they are right.

An investor named Howard Ruff who hit his stride back in the 1970s during the period of high inflation described the economy as “malarial” with periods of fever and chills. As the economy boomed inflation would eventually creep in and the Fed would raise interest rates to try and stop it, which would eventually pop the bubble and cause the economy to go into a recession. His strategy was to purchase certain assets during the fever and when the bubble popped, and the chills set in to buy other types of assets.

Hard Assets

So, precisely what is a hard asset? In short, it is a tangible rather than an intangible asset like a stock, bond, mutual fund, ETF, or CD. My philosophy is that hard assets are things you can put your hands on, things you physically own, and, more importantly, control. If you ask your financial advisor to put you into hard assets, they will likely stare at you blankly, not understanding what or why you are asking for such a thing, or suggest things like a gold ETF or commodities ETF. They might suggest a real estate investment trust. They will likely do their level best to talk you out of this type of investing and show you piles of charts of why these investments are terrible. The way they implement the strategy, it probably is. The problem with all these investments is that they are still paper assets sold in the stock market. True hard asset investing involves YOU owning and being able to touch and control them. Here are some examples of hard assets:

Rental Properties

If you are a reader of my blog, you know I am a real estate junkie to the core and a huge advocate for owning rental properties. You must understand I am referring to you owning and managing these properties and not offloading the responsibility to a real estate investment trust or syndication. I won’t say those investments don’t have a place in an investment portfolio, but it is not what I would call hard asset investing because you have very little control over it. Rental properties should be single or multi-family homes that you manage, maintain, and collect monthly rent. You control these properties in an entity like an LLC, land trust, or self-directed retirement account.

As I have mentioned in other articles, owning physical real estate gives you incredible benefits. You get tax benefits, appreciation, equity, and income from owning and managing rental property. Real estate should be a cornerstone of your hard asset investment strategy.

Rare Coins

Gold and silver coins, as well as numismatic (collectible) and non-numismatic coins you physically own and control. These can be gold coins such as American Double Eagles, Canadian Maple Leaf, and South African Krugerrands. These types of rare coins are classified as bullion coins. Rare coins can also be numismatic coins, which are collectible due to rarity. They might contain gold or silver, but they don’t have to and can still be collectible. You can also buy silver coins, which gives you a bit more diversity because it can include newly minted silver coins like American Silver Eagles (bullion) or what investors call “junk silver” coins, which are silver dollars, half dollars, quarters, and dimes that were minted 1964 or before and were circulating currency. After 1964, coins no longer contained silver and were minted out of base metals with no intrinsic value.

Most hard money investors I know, including myself, generally stick with bullion-based coins or junk silver as it is a relatively easy, hard asset to get into and out of, even for newer investors. Numismatic coins require a lot of expertise to be good at and can be a high bar to get over for new investors without this knowledge. However, if you like coins and enjoy learning about them, numismatic collectible coins are a fine, hard asset.

Understand that rare coins are long-term assets. They don’t throw off income or come with tax benefits like real estate. Over time, they generally keep up with inflation. Note that I said over time. In the short term, it is possible to have inflation outstrip the value of rare coins, but over a long investment horizon, they typically will hold their value. I like this asset class for savings rather than growth. You won’t get much growth, but over time, it works better as a savings vehicle that isn’t eroded as badly by inflation as a dollar stuffed under your mattress or even in the bank earning a pathetic rate of interest would be.

Natural Resources & Raw Materials

This is a broad category of hard assets. It can include oil, natural gas, water, timber, agricultural products like wheat, corn, beef, etc. The first problem with this category is the difficulty of owning and controlling it. Unless you are a farmer, having tons of grain stored is impractical. Getting into oil and gas is only possible with an industrial firm. However, You can own timber if it is combined with real estate or even as raw material, but it is impractical to most people without vast amounts of storage. I know some real estate investors who invest in timber in South America by owning the real estate and hiring a professional company to manage it. This combines real estate, hard assets (timber), and foreign investments. You can tap into these investment categories through the stock and commodity markets. Many investors access this category through master limited partnerships, ETFs, or stocks. It isn’t a hard asset you can touch or control and, therefore, not my favorite way to access it. Depending on how you invest in it (limited partnership), you can access tax benefits, income, and appreciation like real estate, but that is a topic outside the scope of this article.

Physical Precious Metals

Similar to the rare coin investing I mentioned above, I am referring more to bullion bars of gold and silver. However, it can include some of the coins I noted above, like the American Double Eagle, Krugerrands, Maple Leaves, and Silver Eagles. You can own and control these investments, but as with my comments above, you don’t get income and rarely growth from owning these investments. Again, these investments are a long-term hedge against inflation over a long investment horizon. Don’t expect to purchase these investments with dollars; have them rise in value over a year or two and sell at a profit. You should stay out of this category if you have that expectation. These investments are savings vehicles that, over time, hold up against inflation.

I once heard an old-time investor say that during the heyday of Rome, a man could purchase a fine set of clothes with an ounce of gold. If you had an ounce of gold today and cashed it in for dollars, it would be about enough to buy a nice suit, hence it held its value for over 2,000 years. It was an interesting observation. The same investor gave me another example. In the 1920s and even before, people would use paper money and gold coins for everyday transactions, and nobody batted an eye when they wanted to pay in gold. Today, your average cashier would probably call the cops if you tried to use a 20-dollar gold piece. In 1920, a man could go into a clothing store and purchase a nice suit, shirt, shoes, tie, and hat for either a $20 dollar bill or a $20 gold coin. Today, a $20 dollar gold piece would still get you the same thing, but a $20 dollar bill wouldn’t even purchase the tie. That is the effect of inflation, or more appropriately called monetary debasement, on purchasing power over time.

If you follow my example and invest in real estate, you might find that precious metals and real estate can become interchangeable. I once met an investor who purchased rental properties with bags of junk silver coins! I am not talking about an investor from 1750, either. I am talking about an investor who did this during my lifetime. His story is fascinating, and you should take a few minutes to read it.

O Gold! I still prefer thee unto paper, which makes bank credit like a bark of vapour.

— Lord Byron

Classic Cars

My friends and I used to buy and race around in old muscle cars in high school and early college. We often paid only $3,000 – $5,000 for most of them back then. I am not talking about pristine vehicles here, but they were decent and fun. We would buy, sell, and even trade them. For us, it was fun. None of us ever thought they would become as valuable as they are today. I routinely see old Chevelles that have been restored being sold for $100,000 dollars! Collectible classic cars have gone through the stratosphere in terms of value. I wish I had hung onto a few of them when I was younger, but alas, I had no idea they would be so valuable in the future. This is a perfect example of a hard asset you own and control. However, as with precious metals, they don’t throw off income or have tax advantages, but you can certainly gain appreciation for them over time.

Paintings & Art

I will admit right now that I know nothing about this investment class. However, I have encountered more than one hard asset investor who considers old classics and other artwork to be a perfect hard asset investment. I have seen artwork traded for real estate and vice versa. Marcia Christoff-Kurapovna, has written an interesting article on Mises.org about hard asset investing in a negative interest rate environment. She also discusses old classic master paintings as a type of hard asset, which before her article I had not seen before. In a real estate exchange meeting in Florida, I saw an art dealer negotiate a deal to swap real estate and artwork. Again, there is that concept of trading one hard asset for another, as in the example above of real estate for bags of silver.

Hard Money Loans & Notes

These are technically paper assets because you don’t own the actual real estate it is backed by, but I still consider these hard assets because they are backed by hard assets (real estate), which you can take possession of if someone defaults on the note. When a real estate investor buys a property to either flip it or keep it long term they typically need to borrow money to complete the purchase. Another real estate investor with cash will often step in and lend the first investor this money to make the purchase. The lender, just like the bank, will secure their loan with a lien against the property.

Hard money loans typically don’t exceed 24 months in length and earn interest rates many times higher than a typical bank mortgage. As I right this most hard money loans are at 15% with 4 points (a point is 1% of the total loan). That is a great return over a 24 month time frame and it is backed by a hard asset you can put your hands on. Hard money loans and notes are interchangeable terms, but notes in fact, can be for different lengths of time. Some investors will buy longer term notes that are in default from a bank, modify the loan and get it performing again and make an incredible return. I am a big fan of notes and hard money loans as a form of hard asset investing.

Real Estate Options

A real estate option is the right, but not the obligation to purchase a piece of real estate at a fixed price over some period of time. For example, my IRA owns an option on a house about 8 minutes from my house. I can exercise that option in 10 years and purchase the house for what it is valued at today. I purchased this option from a homeowner in return for a replacing her roof and some other repairs to the home due to water damage. The house is in a nice area of town and will easily appreciate over time. She didn’t have the money to make the repairs and couldn’t borrow it. This was a good arrangement for both of us. She wanted to stay in the house for the next 10 years, but didn’t have the money to repair it. I had the cash and would like to own the home in about 10 years, but at today’s prices.

I (my IRA) stepped in and offered to make the necessary repairs in return for the option noted above. I hired the roofing contractor to make the repairs and the funds to pay them came from my self directed IRA. She didn’t plan on living in the house past 10 years due to retirement and wanted to eventually move out state near her daughter. In 10 years I can exercise my option and purchase this house for what it is worth today. Given how fast house prices are climbing do you think this house will be worth more or less in 10 years. Estimating what I believe this house will be worth in 10 years I expect to make a 15% return on the money over those 10 years. The option is backed by the real estate itself so I am well protected. Technically an option is a paper asset, but due to the fact it is backed by real estate that I can take possession of I classify it as a hard asset.

Soft Assets

Most people think of these when they think about investments and include paper assets like stocks, bonds, and mutual funds. Wall Street sells these, which make up 95% plus the investments in retirement plans. If you ask a financial advisor about these types of investments, they can talk for days on the topic. Ask them about hard assets, and their knowledge drops to near zero. To the degree they understand the topic, it is usually only in terms of Wall Street products like REITs (Real Estate Investment Trusts), which hold commercial real estate, precious metals ETFs, and commodity contracts. Again, I am not saying you should never own these investments, but it is not hard asset investing. These types of investments act more like stocks, and you have very little control over the investment or management of them.

Benefits of Soft Assets

The benefits of soft investments are numerous, but they also have severe shortcomings. First, they are easy to buy and sell. You can do so with any brokerage account from your laptop. That means you can go from an investment into liquid cash very rapidly. This is not the case with most hard assets, which take some effort and possibly time to return to cash. However, it can also be a weakness because, in a moment of emotional overload, you can dump good investments at the push of a button.

The paper asset world has a large pool of investment vehicles and choices. You can buy individual stocks and bonds or diversify with funds. You can buy technology companies or industrial companies. Every diversified investor should have some assets in the soft asset category. I own all the above and even enjoy researching stocks and bonds for purchase.

These investments are easy to own in retirement plans. Any self-directed IRA or 401(k) plan can easily hold these investments and be set up at all brokerages. They are highly regulated and standardized for a broad base of investors. Depending on your comfort managing your investments, most people will find them easy to understand and manage.

Shortcomings of Soft Assets

The shortcomings are numerous. First, you have very limited control. If the Government or Fed makes an announcement that the market doesn’t like, you can see the market crash in a day and have very little control over your investments. For example, as I write this, inflation numbers came in higher than expected, and the market fell 500 points in a day. The only thing you can do when this happens is either hang on for the ride or sell while the market is crashing. Both choices can turn your average investor into a pile of jelly on the floor in no time. You are at the mercy of the market and need to wait until it recovers, which is completely outside of your control. I am not saying this never happens in hard assets, but the volatility isn’t quite as wild in most cases, and there are still a variety of things you can do if you are creative and in control of the asset.

The second major shortcoming in my book is that soft assets are often not very well diversified. Most are part of the Wall Street complex. While you can diversify within the market, all your investments are ultimately still in the same basic basket and subject to stupidity violations from the government, The Fed, and other investors. Your average financial advisor often recommends diversifying between large, medium, and small companies and throwing in different categories like real estate (REITs), bonds, or foreign investments. This does create some diversification, but not enough in my book. Typically, when the market goes to shit, ALL these investments feel some pain. Some more than others.

True Diversification

My philosophy is to be genuinely diversified over hard and soft assets in various buckets. I am talking about rental real estate owned and managed by you and other hard assets like precious metals and some of the other hard assets I discussed above, such as the paper(ish) assets of real estate notes and options. In addition, you also have soft assets in the market. I know investors in the alternative investment space that wouldn’t touch a stock if you gave it to them for free! They stick strictly to real estate and other hard assets. They don’t trust or care about Wall Street products. I don’t share this single-minded devotion to hard assets. That type of focus can be as harmful as not including any hard assets in a portfolio.

I also diversify by keeping some assets outside a retirement plan and some inside retirement vehicles like IRAs and 401(k) accounts. Retirement plans offer tax advantages to both hard and soft assets held inside of them. Yes, you can hold hard assets in retirement plans. Most investors I know do it through self-directed IRAs, but you can also have a self-directed 401(k) plan if you have a freelance business without employees. Using self-directed retirement plans with alternative investments is like adding plutonium to your investment portfolio.

You can also diversify by holding paper(ish) assets that are still alternative and not Wall Street products. I refer to real estate-backed notes, options, and private lending. Those are all paper assets and can be held inside and outside retirement plans. They are also outside of the Wall Street environment and generally not affected by crazy volatility in the market. They can still be affected by the economic environment as real estate was during the 2008 recession, but even when devastating economic conditions like that come along, being in control of your hard assets or paper assets that are outside of Wall Street that you control give you a lot more room to maneuver and still come out with a profit.

In addition, a skilled exchanger can turn those paper assets into currency that can be traded for hard assets. My mentor and friend, Pete Fortunato often talks about how real estate backed notes and options are a currency that he can trade for property. Another alternative investor, Dawn Rickenbaugh refers to a concept of the dance between paper, property, and cash where she routinely moves from one to the other increasing her returns and profits along the way.

Know what you own, and know why you own it.


- Peter Lynch

Conclusion

A truly diversified portfolio combines hard and soft assets that are both alternative and traditional Wall Street. The hard assets are an excellent hedge against inflation and can come with various benefits such as income (rental properties) and/or appreciation. You have a lot of control over them. You can further diversify by holding them inside and outside tax-advantaged self-directed retirement plans. If you are an exchanger, you can trade hard assets and real estate backed paper assets like currency to move from one investment to another increasing your returns and profit at each turn. Unfortunately, you can’t do this with traditional Wall Street investments. Even though they call it “trading” you are really going from paper to cash back to paper and often paying taxes in the process.

Intangible assets such as stocks, bonds, ETFs, and mutual funds can be easy to get into and out of. Provide rapid liquidity in the event you need to raise cash quickly. They are widely understood, and regulations ensure that most everyone plays by the same rules, making them far more approachable for new investors. Your returns on these assets are often not as high overtime as hard assets, if done correctly, and one of the strengths of this asset class is also a weakness. The ability to rapidly dump these investments can be done by jittery investors during a period of high emotion when more prudent strategies are called for.

Combining hard and soft assets in your investment strategy gives you true diversification and a stable base to work off. Hard assets, soft assets, and cash comprise three legs of a solid investment portfolio. Suppose you combine this with self-directed retirement plans for tax advantages. In that case, you gain a fourth leg that gives you superior performance in the absence of taxation and further diversifies how you hold and control them. During economic downturns, having these legs on your investment portfolio will give you a lot of room to maneuver and profit if you know what you are doing.   

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