Productive v. Unproductive Assets
If you want to grow wealth, you need to own productive assets.
The whole point of investing is to grow your money. Some people do this by investing in a diversified portfolio of stocks and bonds. Others like to speculate and buy things they hope will increase in value, like gold, cryptocurrencies or collectibles.
You need to own assets to grow your money. But not all assets are created equal. The difference between an asset that you can reasonably expect to increase in value and one that is purely speculative comes down to what it can produce.
First, what is an asset? It’s theoretically anything that holds economic value. Assets can include stocks, bonds, currencies, crypto, real estate, farmland, commodities, artwork and more. Some assets will increase in value and some will decline in value. But most importantly, assets can broadly be split between those that are productive and those that are unproductive.
Productive assets generate profits through cash flows or the promise of future cash flows. A classic example is a business. Businesses take investors’ money and use it to create more products to sell. In return, investors have a right to a piece of the business's profits in proportion to the number of shares they own. When you buy stock of a company or shares of an index fund, you own pieces of that company or the underlying companies.
Another example is real estate. When you buy a home or an apartment complex and rent it out to tenants, you’re taking a piece of physical property and putting it to productive use by generating income. Similarly, farmland produces crops, meat and other products for consumption or use in the economy.
What these assets all have in common is they’re producing something. They’re taking capital and transforming it into something somebody wants and is willing to pay for. Companies that succeed take those profits and reinvest them to create even more profits, hopefully attracting more investor capital along the way. Of course, not all business ventures succeed. But as long as a business is attempting to turn capital into something useful for society and create profits for shareholders, there’s a rational reason for thinking it could be a wise investment.
Then we have unproductive assets. These things might hold economic value to someone, and they might even grow in value. But unlike companies, they don’t grow because they’re producing useful things that people want. They simply grow because someone out there is willing to pay a higher price for them.
There are lots of unproductive assets: gold, silver, currencies, crypto, artwork, collectibles, wine. And plenty of investors have reasons for wanting them in their portfolios. But they don’t produce anything. There’s no rational reason why their value should grow. Simply parking your cash isn’t a good long-term investment. The money needs to be doing something useful.
A business can start as an idea in someone’s head and one day grow to be among the largest and most profitable companies in the world. If a company generates cash flows, investors will want a share of them. But a bar of gold produces nothing. It will always be just a bar of gold, and the only hope gold investors have is to buy it at a lower price than someone else down the road is willing to pay.
Unproductive assets are often the focal point of speculative bubbles. Think of tulip mania in the 17th century Dutch Republic, the Beanie Babies craze of the 1990s, or more recently, the NFT bubble. Speculative assets often feature a period of intense interest and rising prices, followed by crash and burn.
Assets that don’t produce aren’t sustainable. Productive assets are the only reliable way to increase your return on investment. Speculative investments can and do deliver returns, especially over short periods, but there’s often no logical reason for them to do so and growth can reverse in an instant. Speculation is risky, and doing it successfully mostly comes down to timing and luck.
Another downside to unproductive assets is holding cost. This is particularly true for precious metals and collectibles like artwork and wine. You either need to own the space necessary to store these things or you need to pay someone else to do it. Then there are other costs like insurance and security that come into play.
One unproductive asset most Americans own — 65.6% to be precise — is a home. This may come as a surprise to those who view their homes as their biggest and most important investment. People spend years saving up for a down payment. Homeownership is a critical part of achieving the American dream. It’s the ultimate marker of financial success. And yet your home produces nothing, only consumes. Any increase in price beyond inflation should be seen as speculative or a result of supply failing to meet demand and must be offset by the cost of ownership, including maintenance, taxes and insurance.
While there are plenty of good reasons to be a homeowner, your home just isn’t a good investment.
Another unproductive asset people own is cash. Yes, there are interest-bearing accounts like savings accounts and CDs, but even the best ones will barely beat inflation. Bank accounts are for short-term purposes, not for growing your money.
If you want to build wealth, you need to put your money into productive assets. Doing this:
Protects your money from inflation
Grows it for future consumption
Reduces your reliance on human capital (i.e., your job)
When you invest, your money should be working for you, not sitting in an asset that does nothing to actively produce value. Sticking to productive investments is your best chance to grow your money.
The best way for the average person to accomplish this is through index funds. Holding a globally diversified portfolio of stocks through index funds is a hands-off approach to investing in productive assets with a minimal barrier to entry.
Following this framework can ensure you put money into assets that have a real chance of growing rather than those that give you false hope. Understanding the difference between productive and unproductive assets will help you avoid bad investments you’ll later regret.