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Profiting from the Sjuggerud "Natural Rate of Return" TheoryBy
Tuesday, December 21, 2010
Oh man, the Hotshot loved to hear himself talk.
"I own a couple restaurants, and I own a couple beach houses I rent out..."
He kept talking. People around me were hanging on his every word.
But I tuned out. I know chances are GREAT this guy won't keep the fortune he's made.
Why? It all comes down to my theory about the "Natural Rate of Return."
Today, I'll explain how this little "mental model" works... and show you how to use it to increase the return on your money.
This'll take a few paragraphs. So bear with me. Here we go...
This theory starts with the idea that there's a "natural" interest rate for money. And there's a "natural" rate of return on your money.
The natural interest rate is where lenders and borrowers meet in a free market. (Let's call it 6% for now, but it doesn't have to be 6%.) I believe that, over the long run, the natural rate of return on money EQUALS the natural interest rate.
Some investors will earn much higher than 6%, and some will earn much lower. But balancing it all out, the natural return on money equals the natural interest rate. (It's just a theory here... But stick with me a little longer and I'll show you how it works with your money.)
Only a few things tilt this equation. One of the most important is the "Enjoyment Factor"...
For example, most people don't own a beach home for the rental income alone. There's a certain Enjoyment Factor (bragging rights... a great vacation spot... whatever) that doesn't have a monetary value.
Once all is said and done – after property taxes, insurance, damage, maintenance, and so on – a beach house rental might actually be a money-losing business. But a lot of people are willing to sacrifice investment return for the Enjoyment Factor of owning a beach rental.
The same might be true of a restaurant...
To some people, there's no greater thrill. They're hosting their friends, and they're the toast of the town. The Enjoyment Factor of owning a restaurant can be so great, people are willing to sacrifice investment return. But like the beach house, once all the bills are paid, a restaurant might just be a money-losing business.
The actual rate of return on a beach house or a restaurant is the natural interest rate (our hypothetical 6%) MINUS the Enjoyment Factor. So the return can be very low... or even negative. It's the price of the enjoyment.
So if you don't own a beach house or a restaurant, what does this have to do with you? How do you use my Natural Rate of Return theory to maximize your gains?
Well, the theory works on the flip side, too. Guys dealing in things perceived to be unsavory (like toxic waste disposal, for example) will earn the natural rate of return PLUS a reward for managing something nobody else wants to.
Let me show you with an example...
I've written about gold coins for about eight years – but I've been too embarrassed to talk about 'em. At cocktail parties, they didn't turn heads like the latest beach house "knockdown."
But who is better off today? The guy who bought my recommended gold coins? Or the property flipper?
Now, gold coins were hardly toxic waste. But they sure weren't popular when I first started writing about them. And they absolutely made a higher return than real estate.
In short, if you want to be like the Hotshot above... if you want investments you can brag about at a cocktail party... go ahead. But realize you're swimming upstream – you're on the losing side of the "Natural Rate of Return."
If you actually want to make money, invest in things you're embarrassed to talk about... The more you have to "hold your nose" to make an investment – the more the "Enjoyment Factor" is negative – the more money you'll likely make.
In my career, "holding my nose" to buy has worked out fantastically better than buying what was hip. I didn't have to subtract the Enjoyment Factor out of my returns.
This is just a little "mental model" I use to help increase the rate of return on my money. Keep it in the back of your mind the next time you're stuck talking to the Hotshot.
Good investing,
Steve
Further Reading:
Another "toxic waste" investment we've shown you here in DailyWealth is tax deeds: buying super-cheap lots because the owners didn't pay their taxes. Some readers have e-mailed saying that's a terrible thing... that we're taking advantage of distressed property owners.
But the county gives owners plenty of chances to save themselves. When they don't, the county sells the property on the courthouse steps. That's what happens. And you'll end up making a much higher return on those tax deeds than the Hotshot will see from his restaurants or beach houses.
Market NotesTHIS COMMODITY IS BACK TO "SUPERCHEAP" Now that stocks, gold, and oil have soared in the past few months, it's getting harder and harder to find unloved, "contrarian buys." Which is why we're still interested in natural gas...
We've profiled natural gas many times in DailyWealth. New extraction technologies have produced a surplus of oil's "clean cousin"... which has resulted in a 66% wipeout in "natty" prices since 2007. This wipeout has left natural gas darn cheap compared to its more popular cousin.
Today's chart puts this cheapness on display. It shows the "oil to gas ratio." Since oil and gas are both used as fuel, they tend to trade in an energy-equivalent ratio.
During the late 1990s to the early 2000s, an oil-to-gas ratio of 12:1 or 14:1 meant natural gas was cheap. But "post supply surge," we need to see an oil-to-gas ratio of 20:1 or 24:1 to say gas is cheap relative to oil. This ratio reached a "supercheap natural gas" reading of 24:1 in the fall of last year. This extreme reading kicked off a more than 100% rally in natural gas...
Nowadays, this ratio is back to a "supercheap gas" reading of 22:1. While this is no reason to expect a big bull market in gas, it's enough to say you're buying a darn cheap fuel... one politicians will want to burn more of in the next few decades. Our advice: Accumulate natty.
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