Real Wealth Vs. Paper Valuations
May 31, 2015 Leave a comment
Sam is a painter. He has about $50000 in cash and no particular income source apart from small gigs here and there. He is very savvy in his expenses and doesn’t waste any of it, painting most of the time.
He shows his paintings to one of his friends, who happens to be a consultant. The friend on seeing a particular painting, stops and wanders in exclamation, “Dude, you should show this to art galleries, they would pay 100s of millions for this”.
Sam gets excited. He gets some more consultants to do the review for his painting and they too tell him that they can sell the painting easily for 50 million dollars. He pays the consultants $500 each in fee and they are off.
Sam is very happy. He is going to be a millionaire. He decides to celebrate. Spends 1000 dollars on dinner and wine. Next day, he meets a lot of people, “They say, yeah, this is a really wonderful painting. Congrats, you’ve come up with your masterpiece.”
Overjoyed, Sam starts partying often. With money on display, he is able to get a really hot girlfriend. Life is good.
Six months pass by. Sam gets very good reviews and keeps on celebrating quite frequently. Sam realizes, he has only $10,000 in his bank account – he is running short of capital now and needs to raise some. He tries to raise a loan, but the banks refuse, “We only give loans to people who don’t need it”.
Frustrated, Sam puts up his painting for auction over a period of three days. The highest bid which he gets on the first day is $100. People are not really willing to pay for the painting.
Sam is puzzled. He calls up the consultants quoting the valuations they gave him. The consultants explain to him how the markets are different now than they were six months back. If only he had sold the painting six months back.
Couple of days later, Sam sells the painting for $265.
“The downturn wiped off 50 million dollars of wealth”, he messaged his girlfriend. She never called him back.
Be careful what you classify as your assets. The best assets will give you a fairly predictable, inflation indexed and tax-advantaged income on a periodic basis. Most often an asset is worth nothing more than what someone else will pay for it and finding a Greater Fool is not so easy and involves effort and expenses. Cash is King. Don’t be fooled into parting with it too easily on the basis of big talk.