HOW ARE ETFS LIKE MONEY

What is “money?” If you look it up in Webster’s Dictionary you find the words: “-a current medium of exchange in the form of coins and banknotes.” But that does not quite get to the heart of what “money” means today. We can earn money directly, such as with a salary or billable sales, as “proof of work” for the goods and services that we have provided. If we earn an excess, we can save and invest this in stocks or bonds as a way to maintain the value of what we have already earned. Most of us do so with the expectation that what we set aside will maintain or even outpace its inflation-adjusted value over time. Put a pin in the topic of inflation, I will come back to it. First, it is worth considering how you might invest your excess money for future returns.

Stocks and bonds trade every day, so they are subject to vagaries of price fluctuations which result from the confluence of many different buyers and sellers with differing opinions on their value. There are many different stocks and bonds to choose from, and opinions on each vary from one day to the next. An individual security’s price can change more than 50% in a day, a month or a year, so it may be more productive to look at a widely diversified portfolio. Jack Bogle, who started the Vanguard Group many years ago, had this epiphany and created a mutual fund for the S&P 500 index in 1976. He realized that, as a group, large companies got bigger and more profitable over time. Some shrank in value and some grew in value, but these movements tended to cancel each other out and provided an exceedingly good long-term mechanism for aggregating the winners. Today, you can buy an ETF version of the S&P 500 index under the ticker VOO, and it trades throughout the day on the NY stock exchange. This idea of tradable indexes has worked out so well that you can now buy ETF versions of all sorts of indexes: The NASDAQ 100 ETF, Russel 2000 ETF, the FTSI 100 ETF, the GSCI commodities index ETF, green energy ETFs, gold/silver ETFs, crypto currency ETFs, and there is even talk of a baseball card and rare art ETF. As an asset class, however, stocks are unique among this group because they offer dividends with the prospect of growth over time. Stocks do more than just act as a store of value, they become more valuable in terms of money –real, inflation-adjusted dollars – over time.

Anything can serve as units of money; slips of paper, marks in a ledger book, clam shells, cigarettes, tins of sardines, tulip bulbs, etcetera. In theory, as long as a sufficient number of parties recognize its proof of value transference for a sufficiently long enough period of time, the unit itself is not particularly important. Each of these units can have problems because humans can be lazy, fickle, dishonest, and cruel. Thus, fiat currency~ legal tender ~ money. Legal meaning that the money in question has legal enforceability as a means of redress in the conveyance of value for goods and/or services and contracts between parties under the jurisdiction of the administrating and rulemaking authority. Technology has made it possible for us to hold a portfolio of ETF indexes for all the things that trade. ETFs are enforceable contracts that exchange in dollars, and computers have made the dollar intermediation almost meaningless. We can virtually swap the ETF of one thing for another thing in real-time. With so little transactional friction, do we still need our old-fashioned money, the U.S. dollar? What if you could get paid in shares of an ETF? Consider a job that pays in units of the Vanguard S&P 500 ETF. On any given day, you could walk into a grocery store and the shop would accept your VOO ETF shares in exchange for food etcetera. Since computing power is cheap, you would hold the units in a virtual online account, and the store owner would offer you a rate of exchange on that day to the unit of his preference (sounds like crypto currency, no?) Even with the cost of computational power being negligible, the transaction rate is going to move around a bit, and the shop owner would have to have a way to purchase all the goods he put on offer, so he will have to make a lot of calculations each day to pay the wholesaler. Sounds crazy, right? But, in fact that is what occurs with the dollar every single day! Human beings are not computers so they cannot calculate all these changes from one market of things to the next, from one moment to the next. Thank goodness we have the dollar which acts as a relatively smooth medium of exchange. What if you were paid in Game Stop shares (ticker: GME) over the last two months? Wild deflation one moment and inflation the next! Crazy town. Filet mignon and Chateau Lafite-Rothschild one night and Kraft Mac & Cheese (or worse) the next, depending simply on the day or hour that you decided to buy your groceries. The suicide rate would be alarming.

Fiat currencies like the dollar, although far from perfect, allow people to go about their lives in a sensible way. Historically, banks have used their money to act as the intermediaries to make markets in all things all the time. The biggest of these, the Federal Reserve, works hard to keep the relative supply of dollars in circulation, when traded against an index of things we need to live, within a stated purchasing power depreciation rate that averages 2% annually. So, the price for things we need to live in dollars, like food and energy, stays relatively stable. Unlike VOO’s purchasing power which had an annualized inflation rate of around 3600% in March of 2020, the price of things in dollars, like food and energy, stayed relatively stable. The Fed did its job well. However, with that in mind one can also choose their own form of money and behave like their own reserve bank. They can move between dollars, to their own chosen blend of indexed ETFs, and back. Because of the fractionalization of shares you can exchange a broad swath of all the things that trade around the world in the form of ETF’s in a relatively small brokerage account like those offered by the firm Robin Hood. You can choose a highly volatile form of currency, or you can choose the dollar.

The markets may continue to present localized bubbles and price volatility for some time, as shrinking borrowing costs and soaring consumer savings draw new investors into the market, leading to what Charles Munger called “speculative orgies.” With some prices skyrocketing, and market shills touting outsized gains and magical money-making opportunities, it may feel foolish sitting on the sidelines. But if you should be fortunate enough to enjoy some excess cash, it is worth asking what form of money you want to own. Whether your concern is the short-term predictability of purchasing power or the long term performance relative to inflation, would you rather own a unit of GME or a unit of VOO, or just hold onto your relatively stable dollars?

Invest Wisely!