Let's talk about bread. For the sake of argument, let's say you could buy a loaf of bread for $1 in 1985. But suppose back in 1985 you didn't buy any bread and, instead, saved that dollar and put it under your mattress. Today, ten years later, you need some bread. Will you be able to use the dollar under your mattress to buy a loaf of bread?
Of course you know that the answer is no, because today bread costs $1.50. And you know why—inflation. Nevertheless, your dollar saved might have bought a loaf of bread today if, instead of tucking it under your mattress, you had invested it in an asset that appreciated. Appreciation (often called growth) is the difference between what you paid for an asset, and what it is worth on the open market today.
The importance of appreciation, as with the other eight elements of an investment, depends on your own personal circumstances—your age, knowledge and position in the wealth cycle (see Jerry's Corner–The Wealth Cycle). However, as you can see from our bread example, appreciation is a key element as a hedge against inflation.
In addition, appreciation carries certain tax advantages. Appreciation, in the form of capital gains, is only realized upon the sale of an asset; until then, it is tax deferred. The tax rate for capital gains is less than for ordinary income. Furthermore, when you transfer an appreciated asset at your death, your heirs receive a "step-up" in basis, thus rendering the built-up gains income tax-free.
The chart to the right allows us to rate various investment categories on a scale from zero to ten. In this case, a "zero" would indicate that the investment has no ability to appreciate; while a "ten" would be an investment that has the potential to grow in value well in excess of the annual rate of inflation. Now let's look at our individual investment categories.
Bonds and other fixed-income investments are hardest hit during inflationary periods. By their very nature, they have no appreciation factor built-in. Further, when interest rates rise from inflation, these long-term instruments with their fixed amounts of interest actually decrease in market value. And, while falling interest rates will drive up a bond's market price, you will then probably want to hold it to maturity in order to continue to receive its higher interest.
Savings and short-term investments such as Treasury Bills fare better during inflation in that their interest rates can adjust as the market does. However, a dollar invested today is still worth only a dollar tomorrow—there is no appreciation in these investments either.
Stocks and stock mutual funds vary depending upon the assets of the underlying companies. Those that own substantial amounts of physical resources (eg, oil, metals, land) tend to prosper during inflation, as their assets' value increases with the general rise in prices. Conversely, utility stocks, cyclical businesses and financial institutions would experience less appreciation (or a decline in value) as a result of inflation. However, keep in mind that, by their very nature, all stocks have a potential for appreciation.
Tangible assets such as rental real estate and your home are obvious high-scorers on our appreciation rating. In addition to performing well during inflationary periods, appreciation can be achieved as a result of the rise in the value of the particular site (location, location, location).
Limited partnerships should be rated on much the same criteria as stocks—look to the company's underlying assets and the type of business venture in which it is engaged. Commodities, of course, are bought and sold on the basis of appreciation, the anticipated change in the market value driven by supply and demand of the actual commodity.
Finally, remember that appreciation, like the other eight elements, is interrelated to all the others. The prospect of appreciation for any single investment will carry a lower rating if it doesn't meet your needs in the other eight areas. Further, because this is a personalized rating system, some investments will rate higher on your appreciation scale than they would for someone else.
Elements of Investment
Elements
Savings & Money Markets
Stocks
Bonds
Limited Partnerships
Real Estate
Commodoties
Home
Risk
8
6
7
2
5
2
9
Management
8
7
7
9
4
5
7
Flexibility
4
8
7
1
5
2
7
Liquidity
9
8
7
1
6
1
7
Cash Flow
4
5
6
1
7
1
7
Rate of Return
4
7
5
6
7
8
8
Appreciation
0
6
0
5
7
7
8
Leverage
-
-
-
-
-
-
-
Taxes
-
-
-
-
-
-
-
Total
-
-
-
-
-
-
-
|
|
Moorman and Company, an accounting and personal financial management firm based in Palo Alto, serves the San Francisco Bay Area, Peninsula, and Silicon Valley from Hillsborough to Saratoga-Los Gatos, including Atherton, Menlo Park, Los Altos, Los Altos Hills, and Cupertino.