how paper assets jeopardize diversificationThe majority of investment portfolios and retirement plans rely heavily on paper assets. In fact, over 61% of Americans make these investment vehicles part of their financial stability. Despite this overwhelming dependence on paper assets, most investors don’t understand the risks inherent to these investments and how these threats could jeopardize their savings.

When understood completely and leveraged properly, paper assets can be sensible parts of a well-diversified portfolio. However, many investors are unnecessarily putting their nest eggs at risk by overexposing themselves to these volatile assets.

What are paper assets?

Paper assets refer to investments that are represented by an electronic or physical document rather than a tangible asset. These pieces of paper (hence, the term “paper” assets) designate the ownership of a particular asset and can come in the form of certificates, contracts, or receipts. Some common examples of paper assets include stocks, bonds, mutual funds, ETFs, and fiat currencies.

When investors purchase these assets, they receive a paper representation of their investment rather than something physical. This makes sense for stocks or mutual funds which can’t practically equip holders with tangible pieces of a company. However, the disconnection between paper assets and their physical counterparts is evident when it comes to ETFs that track a physical commodity such as gold or oil.

You might have noticed that some of the most familiar and common investments are paper assets. That’s because the majority of traditional investments are mere representations of ownership rather than control over a physical asset. Even the US dollar, which underwrites the entire domestic and global markets, has been a paper asset ever since the US abandoned the gold standard. The modern-day economic model is built on promises and receipts rather than real ownership.

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Paper Assets vs Physical Assets

The opposite of paper assets is physical investments. Unlike their paper counterparts, physical assets are tangible. Investors can actually see and handle these investments in the real world rather than looking at digital representations on a trading app or account. The physical nature of these investments comes with a slew of advantages. Generally, physical assets offer investors greater control and more privacy to investors. Their inherent value is independent of market conditions which makes tangible assets reliable hedges against inflation. This also contributes to greater price stability.

This stark difference is perhaps most evident when looking at paper gold vs physical gold. Paper gold assets in the form of mining stocks, gold ETFs, and mutual funds are still dependent upon the health of the overall economy. When the broader economy falls, so do paper gold assets. On the flip side, physical gold investments such as gold coins and bars tend to rise in value as the economy falters. Although paper gold purports to expose investors to the real deal, the performance of these assets proves otherwise. The only way to disconnect an investment from the performance of the economy is to put it into something tangible.

Considerations of Investing in Paper Assets

Volatility

Conventional paper assets are notoriously volatile. A lack of intrinsic value leaves these investments reliant upon unpredictable factors such as market conditions, investor sentiment, and global events. This is reflected in turbulent and unpredictable price swings. The stock market, one of the most popular exchanges of paper assets, is a prime example of this instability. Since 1870, it has experienced 11 crashes with losses amounting to at least 25% and, in some cases, over 50%.

Counterparty Risk

When you purchase a paper asset, you enter into a contract with a specific party or entity that promises to uphold certain obligations. These parties could be mutual fund managers, business owners, bond issuers, or financial intermediaries, depending on the type of asset. The performance of paper assets is dependent upon the actions of these actors. This exposes your investments to counterparty risk which is the potential for these parties to fail to fulfill their commitments.

Inflation

One of the biggest downsides of paper assets is their susceptibility to inflation. Without physical backing, these investments struggle to maintain their initial value. For example, the US dollar has lost 98% of its purchasing power since decoupling from the gold standard in 1933. This inflation is eventually exported to all paper assets because of their link to USD. The cycle of stock market bubbles and resulting crashes is an unavoidable consequence of this non-stop inflation.

Lack of Diversity

It’s useful to think of paper assets as their own investment class. Just because you’re invested in the top 500 companies or a dozen different ETFs doesn’t mean your portfolio is properly diversified. All paper assets carry the same risks, albeit to varying degrees. Meaningful diversification requires investments across diverse asset types, especially tangible assets. Only physical investments offer protection from the exposure of paper assets because of their inherent worth which is maintained independent of market volatility.

Limited Ownership

Another important consideration of paper assets is the restricted ownership conferred to investors. You might have a piece of paper that says you own an asset, but you don’t physically have possession of it. Think of the difference between holding money in a bank account and having the cash on hand. That’s precisely the difference in ownership between paper and physical assets.

Hedging Against the Risks of Paper Assets

These are crucial factors for investors to weigh when investing in paper assets. However, they’re not reasons to avoid these popular investment vehicles altogether. Paper investments come with some advantages including high liquidity and rapid price movement.

The key to building a resilient, high-yield, and properly diversified portfolio is to hedge against the vulnerabilities of paper assets. That’s where precious metals can help. For centuries, savvy investors have relied on gold and silver assets to shore up their wealth from the pitfalls of the broader economy.

With rising inflation, soaring debt, and a weakening dollar, investors are scooping up precious metals at record rates.

“We’ve been seeing a transition from more traditional paper assets into hard assets over the past couple of years.”
– Precious Metals Advisor Damian White

If you’re interested in learning more about diversifying with gold and silver, grab a FREE copy of our Precious Metals Investment Guide. It’ll show you how physical precious metals can protect your wealth from the risks of paper assets and hedge against inflation.