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Investing 101: What Is Value?

16 February 2009 One Comment

Value is an interesting term.  What is value?  How is it measured?  In this article, I aim to challenge your beliefs on how to measure value.  Let’s get started.

Why is it important to define value?

First, we need to discuss why it is important.  To achieve gains in wealth, you must be increasing the value of your assets.  When investing, we must have an accurate way to value an asset in order to determine its return.

Value in dollars

Most of our assets are given a value in U.S. dollars.  If you live outside of the United States, your assets are likely valued in your local currency.  The problem with this is that what if your currency loses value?  Let’s look at a couple examples to illustrate this better.

First, let’s look at real estate.  The U.S. government is doing everything possible to stabilize home values.  Can you really artificially stabilize home values outside of affecting supply and demand?  Well, yes and no.  Yes the government can stabilize home values with regards to U.S. dollars.  Your home value may even start to rise in dollars.  But, is it actually gaining value?  If the increase in dollar value is simply because of inflation (or more dollars in circulation), then it has only increased in nominal value, not true value.  You would have to weigh the loss in purchasing power of the U.S. dollar over the same period of time to determine the true change in value.

Second, let’s look at the stock market.  The stock market is down with regards to dollars.  However, with regards to gold, its down even further.  Currently, the Dow is trading at approximately 8.5 ounches of gold.  This is a very important metric to keep an eye on as our government runs the printing press to re-energize the economy.  The government might get the Dow back to 14,000 through government intervention, but what if gold rises so much that the Dow at 14,000 is the equivalent to 3 ounces of gold?  Well, although the Dow would gain in nominal value, it would lose true value.

Why don’t we price everything in gold?

If the above examples prove anything, it is that we should price everything in gold, right?  Well, maybe, maybe not.  It may also be constructive to determine the value of an asset in other currencies, a basket of currencies, other commodities such as silver, oil, etc.

The main thing to remember is that although dollars are used as the mainstream metric of valuation, if the dollar’s purchasing power is lost (which we’re likely to continue to see), then you might want to compare the asset’s valuation with regards to gold or other measures.

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