How I determine which assets to invest in
A major part of my investment process is deciding how to allocate my capital to each asset class. I decide this simply by comparing the likely after-tax, real returns of each asset class. In doing so, I am mindful of the following fundamentals.
Business earnings are largely real
The yield from cash or bonds is a nominal return while the yield from a business is largely a real yield. This is because the nominal value of a business’s assets, and its nominal earnings, are both likely to rise by a similar rate to the inflation rate.
Costantini provides convincing evidence that business earnings are largely real. He says:
“Unlike bondholders, shareholders possess a claim on the earnings (of a business) by the dividend and have ownership of the underlying assets, whose replacement value will rise and fall with the level of inflation. Furthermore, the feed through effect of inflation in the profit and loss account has to be taken into account. Faced with rising input prices, businesses will initially accept a certain amount of margin compression, but will eventually pass on this cost inflation to their customers, and all the way to the bottom line. Indeed, our research suggests that there is a 93% pass-through of CPI inflation to earnings growth in the long run.” 
Investing in a portfolio of businesses is likely to provide superior after-tax, real returns than cash
Cash or bonds has, historically at least, yielded poor returns compared to investing in listed businesses (equities). These poor returns mean that it has actually been riskier to invest in cash then to invest in businesses! Dreman provides an excellent example of how risky it has been to invest in cash. He points out that if a US investor, in a 50% tax bracket, invested $100,000 in long treasury bonds after World War II; he would have only $39,200 of his buying power left in 1996. Inflation and taxes would have destroyed over 60% of the nominal value of his investment. By contrast, if the same investor, with the same tax rate, invested the $100,000 in listed businesses (equities) his portfolio would be worth $913,000 in 1996. His portfolio would be worth 23 times more than if he invested all his money in bonds. Thus, Dreman thinks investing in cash, considered by most to be almost riskless, is extremely risky. I agree and I will try to maximise the after-tax real return on my capital by investing in a portfolio of cheap businesses.
Owning a portfolio of businesses also provides better protection from the low risk (but disastrous impact) of high inflation or even hyperinflation. For example, in countries that have suffered hyperinflation, the value of cash or bonds become worthless while the value of business assets kept some value. Moreover, when those economies recovered the value of these business assets recovered while the value of the debt often remained worthless. (See the experience of the German and Japanese debt and equity markets during and after World War II).
There will be price volatility when seeking these better, after-tax, real returns
Despite the long-term advantages of investing in businesses, there will be large short-term swings in their market value. However, I must accept this volatility because in the medium to long run investing in businesses is usually the best way of ensuring that I preserve the real value of my capital, and get a good return on this capital. As Mark Sellers points out:
“Most people equate short-term volatility with risk. So rather than achieving optimal portfolio returns coupled with high volatility, people would rather achieve suboptimal portfolio returns coupled with low volatility.” 
Simply put, I have to accept price volatility to get better long-term returns.
I have to accept the risk of a severe recession or depression
There is always a risk there will be a severe recession, or even a depression, in the real economy. This would dramatically reduce the intrinsic value of most of the businesses I own. I will still invest my capital in businesses, despite this risk, because it is the best way of preserving the long-term real value of my capital. In addition, the cheap price I hope to pay for these businesses will provide a large ‘margin of safety’ from this risk.
 P41: ‘Cash Return On Capital Invested: Ten Years Of Investment Analysis With The CROCI Economic Profit Model’, Pascal Costantini, 2006.
 The best businesses at ‘passing through’ inflation are those with a sustainable competitive advantage. This is because they have a very strong ability to pass input price increases onto their customers.
 P309, ‘Contrarian Investment Strategies: The Next Generation’, David Dreman, 1998.
 Ibid, P309.
 Ibid, P293.
 I refer to the ‘discount’ between a cheap business’s market price and its intrinsic value as my ‘margin of safety’. This term was first used by Benjamin Graham and David Dodd in their hugely influential book; Security Analysis, First Edition, 1934.