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Options Theory: Thoughts on Valuation and Gold

February 15, 2021

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Normally I pen this blog on Thursdays, but life conspired against my timetable. So you’re getting it a few days late. Apologies. To make it up to you, I’m going to share a few thoughts that have been rattling around my head of late.

Valuations

Let’s start with valuation. P/E ratios are pumped and markets are anything but cheap. Some would say investing at these levels is risky. But what’s the alternative for a conventional investor that doesn’t want to trade? If they’re investing money for retirement or some far off goal, then why should it matter if market valuations are stretched when they start investing? Take me, for instance, I’m 36 years old and suspect the market will experience 5 to 10 major bear markets between now and when I’m 65. Rather than fretting about the volatility, I should embrace it. It’s the price I pay for stocks’ higher returns. And, in the long run, they’re all temporary anyway.

Time bails out ill-timed entries. Just ask the investors who bought the S&P 500 in 1987, 2000, or 2007.

Am I supposed to sit in cash until a crash arrives? What if it takes three years? Furthermore, what if the long-awaited bear arrives and I’m too shell-shocked to pull the trigger? Spectators looking for an excuse not to buy stocks will always find one. If the valuation problem fixes itself, then I guarantee they find something else to harp about.

In today’s low rate world, stocks have become the only game in town – regardless of valuations. Cash is trash, bonds yield nothing (though long-term rates are creeping higher), and real estate isn’t exactly cheap. On a side note, foreign stocks aren’t as juiced as their American counterparts, so you could diversify afield if you want.

In my experience, valuation is a terrible timing tool. Rather than worrying about the next bear, your time is better spent building a durable portfolio with risk characteristics you can handle through all markets.

Gold & Silver

I like the idea of gold and silver to diversify a portfolio. And I own some. But do you know what I’ve come to realize? They suck as long run inflation hedges compared to stocks. And it’s not even close. One of the biggest reasons for the difference is the ability of stocks to compound your growth through reinvested dividends. Every quarter the S&P 500 pays a cash dividend that you can use to buy more shares. As your share count increases, you get paid more dividends. More shares capture more dividends which, in turn, buy more shares.

It’s a virtuous cycle that puts lighter fluid on your wealth building in equities.

To the detriment of many a gold bug, such a phenomenon doesn’t exist with precious metals. They’re inert, shiny rocks. Historically, they’ve been far better than holding cash, sure. But owning stocks has been best.

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