—————————————————————————
Prosperity on Purpose Newsletter

October 2008
—————————————————————————

This month’s Prosperity On Purpose presents a fictitious story about John, a novice art investor, as he makes erroneous assumptions about the value of his investments.

As he experiences emotional highs and lows along with his misguided valuation of his art collection, his plight teaches us three main lessons about real dollar value, wishful thinking about investment values ‘always’ increasing, and asset stability.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Art Lessons

LISTEN: Art Lessons [mp3 audio] (11:18)

READ: 1,766 words (Just over 7 minutes to read)

Here’s a story with a lesson:
On a trip to Europe, John bought a painting. He really didn’t know much about art, but he shelled out $25,000 because one of his trusted friends told him it was a good buy. “Hold on to it for 10 years or so, and it will probably triple in value,” the friend said.
It seemed like the friend was right. A few years later, John started seeing reports of similar paintings selling for $50,000 or $60,000. Out of curiosity, John had an art gallery owner appraise his painting. The appraiser gave an estimated value of $65,000. “Imagine that,” said John, “I’ve got $65,000 hanging on my wall. That’s pretty cool.”
As John considered the $65,000 hanging on the wall, another thought occurred to him: Why not buy a few more paintings? After all, he’d made a nice profit when he didn’t know a thing about art. Now that he was starting to understand the market, he’d probably do even better. Over the next few years, John dipped into his savings and bought a few more paintings.
Pretty soon John’s home had become a small art gallery. Not that he was bragging, but his art collection was valued at over a million dollars! “Wow. This really changes my net worth and gives a boost to my retirement plans,” said John. “And since the price of art just seems to go up, imagine what the values will be 10 years from now!” But while John might have paintings worth one million dollars, he didn’t have a million dollars. And there was a difference.
As his net worth continued to grow, John had an opportunity to buy a summer home for $250,000. It was a great deal, and on paper, John could afford it. The question was how to pay for it. “Hey,” thought John, “One of my paintings is worth about a little over $250,000 right now. Maybe the homeowner would consider a trade – I’ll give him my painting for the house.”
John was slightly surprised when the homeowner declined his offer. “I want my settlement in cash,” said the homeowner. “A painting hanging in my living room can’t pay for groceries or a vacation.” John really wanted the house, so he decided to sell the painting. He called the art gallery owner and made arrangements for a sale. The gallery owner agreed that John’s asking price was reasonable, and began soliciting some of his patrons.
A month went by, and the painting remained unsold. In fact, John didn’t receive a single offer. “What’s the story?” John asked the gallery owner. “Why isn’t the painting selling? Is it overpriced?”
“The price isn’t the problem,” said the gallery owner. “I’ve had several people say the price was fair. It’s just that they weren’t interested in buying right now. You have to remember, buyers of high-end art represent a very small percentage of the populace. Just because something is worth the price doesn’t mean there’s a buyer that will pay it.”
John considered his options. Even if he cut the price, there was no guarantee he would find a buyer. So if the painting was really worth $250,000, he would be better off waiting until he found a buyer willing to pay it. And since good art just seemed to keep increasing in value, he might as well hold the painting. He told the gallery owner to continue listing the painting, but stay firm about the price. John also told the owner of the summer home that he couldn’t meet the cash terms.
And then something completely unexpected happened. The painting he was trying to sell was found to be a forgery. It still looked nice hanging on his wall, but the painting was worthless as an investment. John was stunned and frustrated. He’d paid quite a bit for that painting. Not that he wanted to pass off the forgery on anyone else, but he couldn’t help thinking he would have been better off accepting any offer in the past year instead of deciding to keep the painting.
Disillusioned, John decided he was done with art as an investment. He contacted the gallery owner and arranged to auction his entire collection. Unfortunately, the general economy was in the tank; housing values were down, the sub-prime mortgage mess had squeezed the financial markets, and gas prices were up. The gallery owner called the night before the auction to say there simply wasn’t enough interest to justify holding the auction.
John faced a sobering reality: For all the money and time he’d invested, all he had to show for it was some canvasses on his walls.

Lesson 1: Dollar value is not the same as money.

In any society, money is a commodity or token that serves as a medium of exchange. This could be anything from shells and beads to coins or cattle. While there are many items or commodities that can serve as money, the best kind of money is something that everyone will accept in exchange for the things they have to sell.
The official “money” that everyone accepts in the United States is Federal Reserve Notes, denominated in dollars. And while there are many assets that can be valued in terms of dollars, very few of those items can serve as money. A single share of stock may have a current value of $10/share, but you can’t pay for lunch at a fast food restaurant with a stock certificate, and a bank isn’t going to allow you to make your monthly mortgage payment in baseball cards or bottles of wine. Most of the time, transactions will require the purchaser to pay in dollars.
If you look behind the curtain of the art analogy, you can make an application to the stocks, real estate and other financial assets. On paper, the dollar values are there. But it’s only when the assets are turned to money that you can determine their real value.
This distinction between dollar value and money is receiving increasing attention as a critical issue in individual financial programs. It’s not enough to accumulate an impressive portfolio; there must also be the assurance that those assets can deliver a consistent source of money when needed.

Lesson 2: If something can’t go on forever, it’ll stop.

The statement, “If something can’t go on forever, it will stop” is known as “Herbert Stein’s Law.” (Stein was an economics professor, senior fellow at the American Enterprise Institute, and chairman of the Council of Economic Advisers in the 1970s under presidents Nixon and Ford.) His statement is often rephrased as: “Trends that can’t continue, won’t.”
At various times, some financial commentators observed a trend, then decided it would continue uninterrupted into the future. There was a certainty about their opinion, as if the outcome, while not guaranteed, was still a sure thing. It was the realtor who said “the residential housing market is a great investment. Homes will always go up in value.” Or the stock market analyst who said “stocks will fluctuate on a daily basis, but the general long-term trend is always up.”
This certainty provided the justification for financial experts to make financial projections about fluctuating assets:

• Because homes would “always increase in value,” it was possible to justify making loans for 100% of the purchase price; the future appreciation would negate the risks taken by both the borrower and the lender

• Because savvy investors had been able to deliver double-digit annual return from the stock market, it became reasonable to think it was possible to retire sooner and receive more income; the inevitable upward trend would make any concerns about stability irrelevant.

But as certain as the experts might have been, there were never any guarantees. The trends in real estate and the stock market were influenced by other variables – interest rates, baby boomer demographics, tax laws, etc. When those variables changed, the trend could not continue. The result of ignoring Stein’s Law: Often a bad case of SWILS – Sudden Wealth Loss Syndrome, a term coined in a March 18, 2008 Wall Street Journal article. This isn’t just a “bad year” – it’s a wipeout; so we have to watch our thinking!

Lesson 3: Asset stability is important.

For perhaps the past two decades, “safe” in the financial world has often been associated with “boring” and “stupid.” The thinking was “Why settle for a 5% annual return when there’s an opportunity to earn 15%?” But in light of the recent financial turmoil, the stability that is a primary feature of safe financial instruments has taken on a new luster.
When the fluctuations are minor and you don’t need the money, it’s psychologically and mathematically possible to ride out the downturn. But when the losses are huge and you need the money, it’s a different story.
The ultimate objective of any investment decision is to acquire more money. Nobody buys shares of stock so they can hang the certificates on their wall. They don’t invest in real estate because they want their mail delivered to a different address. The end result of all investment is to have more money – the kind you can spend, not the dollar values that add to your net worth.
Some asset classes are well-suited to delivering money in a reliable fashion. Their dollar values are fixed, and they can be quickly converted to Federal Reserve Notes, the kind of money that’s accepted everywhere.
The knee-jerk reaction to recent events in the financial markets might be to swear off all investment opportunities and keep your remaining money in a safe at home. That’s probably an overreaction. But because of Lessons 1 and 2, it’s important to understand the place asset stability has in your personal financial program. If the ultimate goal of any financial program is to deliver money, there must be a consideration of stable, liquid financial assets. Otherwise, you run the risk of acquiring a lot of financial “art” that might look impressive on a balance sheet, but in the end, isn’t worth what you paid for it.

CONSIDERING THE EVENTS OF THE PAST MONTH, DOES YOUR FINANCIAL SITUATION NEED A BETTER PERSPECTIVE ON MONEY vs. DOLLAR VALUES? If it does, let us help.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

To your prosperity!

Kim/Todd/Ron/Theresa/Jill/Jessica
Partners for Prosperity, Inc.
(877) 889-3981

Thanks guys! Another great newsletter for all of America’s financial needs!

Bill Lyons, LEI Financial