Over the past 30 years, the S&P 500 and the Nasdaq—both productive assets—have surged almost fivefold and eightfold, respectively. In contrast, gold, a nonproductive asset, has only risen 2.5 times in value.
“Gold is a way of going long on fear. And it’s been a pretty good way of going long on fear from time to time,” remarked Warren Buffett in a 2011 interview, highlighting how people often turn to nonproductive assets such as gold for safety during economic downturns, even though these assets do not generate income.
Additionally, Buffett famously noted, “The stock market is designed to transfer money from the active to the patient,” emphasizing the significant potential of patient, long-term investing in productive assets for building substantial wealth over time.
While the returns on any investment are driven by multiple factors such as the performance of the underlying assets, economic conditions, market sentiment, etc., which are beyond our control, we can make informed investment choices.
Productive Assets
A productive asset is an investment that generates income or appreciates in value over time. The key characteristic of productive assets is that they are not merely speculative.
They have inherent value and are expected to generate returns independently of the selling price on the market, either through generating revenue, providing rental income, earning interest or increasing in intrinsic value.
Examples of productive assets include commercial and rental real estate, stocks, business ownership, investing in trade financing, intellectual property and royalty interests.
Nonproductive Assets
A nonproductive asset is one that doesn’t generate income or increase in value through its own productivity.
Instead, its value typically comes from selling it at a higher price than it was purchased at.
The investor buys the asset with the hope of selling it to someone else at a higher price in the future, relying on the belief that there will always be another investor (“a greater fool”) willing to pay more—a concept known as the “greater fool theory.”
Precious metals, collectibles, speculative real estate, cryptocurrencies, luxury goods and unproductive land all fall under the category of nonproductive assets.
Factors Influencing Asset Performance
Productive and nonproductive assets react differently to economic, political and social factors, which often distinguish their financial performance.
For instance, the Nasdaq-100 experienced a significant decline in 2022, ending the year with losses of nearly 33%; however, it made a strong recovery in the first three quarters of 2023, due to the boom in the AI sector.
Here are some other major factors that influence an asset’s performance:
Economic Downturns
Productive assets, such as businesses and income-generating real estate, exhibit greater resilience during economic downturns due to their ability to generate income and preserve value.
In contrast, the value of nonproductive assets is closely tied to consumer sentiment and disposable income.
Time Horizon
Productive assets shine when investors have a longer investment horizon. Over time, the compounding effect of income generation and asset appreciation becomes more pronounced, which can result in substantial wealth accumulation.
In contrast, nonproductive assets may not offer the same long-term growth potential. Their value may remain stagnant or even decrease over extended periods, making them less suitable for long-term wealth-building strategies.
Crisis Or Geopolitical Tensions
In times of uncertainty, nonproductive assets such as precious metals and certain currency-based investments, seen as safe havens, often experience increased demand as investors seek to preserve wealth.
However, such shifts in asset allocation might not offer significant returns or income, besides causing investors to miss out on potential market rebounds when tensions ease.
For example, after Covid-19 began, gold prices reached a then-record high in August 2020, acting as a hedge against uncertainty. But with vaccine rollouts in 2021 reducing uncertainties, gold had its worst start to a year in a decade, showcasing its volatility in response to shifting market sentiment.
Risk Tolerance
In a 2011 letter to Berkshire Hathaway shareholders, Buffett defined investment risk as the potential to erode the owner’s purchasing power over the holding period, (i.e., the same amount of money may not buy as much as it used to) and not merely as the fluctuation in the value of an asset.
By this definition, nonperforming assets are high-risk because they offer no purchasing power during ownership and often come with significant idiosyncratic risks, such as collectibles’ vulnerability to market trends.
In contrast, productive assets typically allow for risk management through diversification and active management.
Inflation
Productive assets can provide a hedge against inflation by offering income that adjusts to counter rising costs, while nonproductive assets may not offer the same protection against the erosion of purchasing power.
Changing interest rates, liquidity and labor dynamics are other factors that affect asset performance.
Why Productive Assets Stand Out?
Besides income generation and resilience to most factors influencing investment value, here are some other compelling reasons that make productive assets stand out:
• Active Management: Productive assets can benefit from strategic decisions such as improvements, innovation or operational changes. This active management can boost yields and increase long-term value, distinguishing them from more nonproductive assets.
• Value Appreciation Potential: The potential for capital appreciation is significant. While nonproductive assets can also appreciate, productive assets often offer both income and appreciation, enhancing total returns over time.
• Tax Benefits: The tax advantages associated with certain productive assets can significantly impact net returns. These benefits can include deductions, credits and more favorable tax treatment on income or gains.
In Closing
Securing your financial future begins with informed choices. To help you make decisions that maximize your asset performance, make sure you’re keeping up with market trends and exploring tax-efficient investment strategies. And when investing in productive assets, building a well-diversified portfolio is key. Lastly, due to the nature of productive assets and their growth potential over longer investment horizons, it’s important to adopt a patient, long-term perspective.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
