Hedge against commodity dips and grow personal wealth
Think long and hard about your reasons for buying a neighboring piece of farmland, even if you can swing the deal. Does the investment enhance your financial portfolio?
Producers are adept at growing the farm business and making money, but they are far less skilled
at growing a diversified portfolio focused on personal wealth, says Mike Boehlje, a Purdue University ag economist.
A wise strategy includes on-farm and off-farm investments, advises David Kohl, Virginia Tech professor emeritus of ag economics. Off-farm investments can include the stock market, CDs and other instruments.
Kohl recommends setting aside cash—and lots of it. "Producers should maintain 33% of revenue as
working capital, which can readily convert to cash," he says. "This can be used to hedge against volatile times and as a funding source to invest in less expensive assets, if an opportunity arises."
Kohl explains that large corporations have historically held 3% of profits in cash as a hedge against
future uncertainty but as of late are keeping 6%. "This should tell producers something," he says.
History shows that when commodities are up, the stock market is down, and vice versa, which is why it’s good to invest outside of agriculture, Kohl notes. With off-farm investments, farmers can hedge against commodity dips.
Kohl acknowledges that investing in stocks requires a lot of study. "It’s important to take the time to learn about firms, including their management, before investing in them," he says.
Risk Rewards. The fear of "stock picking" holds some producers back from diversifying their portfolio, but there are all kinds of mutual funds that justify a riskand-reward philosophy, Boehlje
notes. "These funds give you a greater chance of holding onto your wealth," he says. "Of course, with greater risk comes greater reward."
Boehlje advises producers to assess their risk comfort zone before developing an investment
strategy. The safest investment is probably government bonds; however, a less than 1% yield curve on a five-year note means investors aren’t being rewarded with a high rate of return, he explains.
Mutual funds, which carry more risk, aren’t always great either. From 2000 to 2009, the S&P 500’s
average annual return was 1%. That’s the 500 largest, most stable companies on U.S. stock exchanges. Clearly, cash was better off parked in farmland, which rose by 2% to 4% between 1994 and 2004 before seeing double-digit spikes.
The S&P average from 1992 to 2011 was 9.07%. For 2011, the return was –1.12%. Since the S&P
500 has been in existence, it has averaged an annual growth of 12%.
It’s not just the stock market. For producers who are more comfortable in real estate, Boehlje says, options exist for packaged commercial investments. If you look at real estate as an investment, you can consider farmland, which you would buy to rent, outside your state.
Boehlje cautions that specialized investments carry more risk than diversified investments. Producers need to ask themselves whether they want to protect wealth or grow wealth. "Do you want earnings or capital gains?" he asks. "Making diversified investments is a completely different way of thinking to that of being a low-cost producer."
- Mid-November 2012