5 buckets for your savings...
DIVERSIFICATION and asset allocation can help you reduce your risk as an investor, writes Dan Denning, co-editor of the Bill Bonner Letter.
For your kids and grandkids, a depression could be just the tonic they need. In a world where real wage growth is stagnant and the robots are taking all of our jobs, your best chance to build a fortune is to buy assets when they're cheap. You can only get them at that price after a crash.
Do you think it's a coincidence that famed investor and economist Benjamin Graham wrote his investment classic, Security Analysis, in 1934, just five years after the Great Crash of 1929?
The Dow Jones Industrial Average fell by 89% between September 1929 and July 1932, dropping from 386 points to 41.
Stocks and bonds weren't just cheap...they were destitute and unloved.
If you have any skill at reading a balance sheet and doing a bit of math, you stand a good chance of being able to buy future earnings at a deep discount. Most investors find that emotionally hard to do.
For most investors, expectations are high when prices are high, and expectations are low when prices are low.
If you teach one thing to your kids and grandkids – or if you hope to come out of this market with your wealth intact – remember that it should be the opposite: Your expectation of future returns should be low when prices are high, and high when prices are low.
This is another way of saying, "Be fearful when others are greedy, and greedy when others are fearful."
By now, you're probably wondering what the plan is. So let's get on with it. I'll take you through my proposed Permanent Portfolio, asset class by asset class.
The cash allocation is 25%. Now, if you believe the market (or earnings) is going to go up, your cash is going to underperform (be very lazy). In a low-interest-rate world, your cash won't be earning you any money.
True, it won't be at risk in the market. But inflation won't be kind to your purchasing power.
Still, the biggest benefit of cash is what's called "optionality". If you have it, you can trade it for something you want when that thing becomes cheap.
A 25% cash position assumes you'll be able to put it to better use when assets become cheap. Your risk is that assets may stay expensive for a much longer time.
It may not naturally occur to you that you also have options about what kind of cash to own. I'm not just talking about whether you want to own 100-Dollar bills, 50-Dollar bills, or 20-Dollar bills. I'm talking about which cash?
The US Dollar? The Swiss Franc? The Singapore Dollar?
Everyone should own cash denominated in foreign currencies.
It's not hard to do. You can exchange your Dollars for Euros or British Pounds at major banks.
Obviously, you'll want to do so when exchange rates are favorable. But it shouldn't be too difficult to accumulate $5,000-$10,000 worth of cash in a foreign currency.
Bill and I weren't sure about this one. The widely held idea that government bonds are risk-free is one we fundamentally disagree with.
Don't ever forget that, despite all their assurances, governments can and do default on their debts. And with huge unfunded liabilities to go along with their official debts and deficits, the situation is far more dangerous than the feds would have you believe.
That's why the bond market is ground zero for the explosion in global debt since 2007. In an inflationary scenario, bonds will be consumed in a hellfire of wealth destruction.
So why own bonds at all if we think the world will inevitably enter another debt reckoning?
Well...we can't entirely rule out the possibility that central banks will continue to purchase bonds for years.
And even if the Fed reduces its bond portfolio by $15 billion a month, it will take nearly 25 years for it to clear off the bonds it's already purchased. That's assuming that, in the next crisis, it doesn't resume adding bonds (funding Washington's ever-expanding deficits).
There is no theoretical limit to how big a central bank balance sheet can get. When you're the one printing all the money, you cannot be insolvent. And the Fed isn't a "going concern" anyway.
For that reason, we reluctantly suggest you keep some bonds in your portfolio. You should own some inflation-adjusted bonds or short-term bills and notes.
Those instruments are quickly and easily redeemable for cash but still have the perception of safety (and liquidity) for most investors. Hold your nose and buy.
The worst advice I could give you is to sell everything now and go straight into cash.
Emotionally, it's tempting. But we usually make our worst decisions when we invest emotionally. That's why most investors tend to buy high and sell low. Even in bull markets, research shows that investors underperform the indices by trading too much.
Unlike bonds or cash, a stock is a claim on a for-profit enterprise. That enterprise can increase its earnings, even (or especially) in challenging circumstances.
Think, for example, of a company that sells generators during hurricane season. Wall Street is full of "factor investing" models today that aim to slice and dice the market by investing style (momentum or value), market cap (small or large), or volatility (beta, so-called "smart beta," or alpha).
If you were going back to basics, you'd look for companies selling at less than one times book value. You can find them in the US But many of them are financial stocks (like banks). Those are precisely the kinds of investments we want to avoid in a financial crisis.
That means you have to be willing to buy foreign stocks or exchange-traded funds that give you access to foreign markets.
Tangible Assets: 30%
What about other tangible assets? Gold is one possibility. What about oil? What about silver? What about real estate? Aren't those tangible assets, too? And does buying a real estate investment trust (REIT) for income qualify as buying a tangible asset for the purposes of the portfolio?
That's why we've broadened our version of the Permanent Portfolio...
And you can see that we recommend a 30% allocation. We believe tangible assets – a claim on something real – will be more valuable than purely financial assets (claims on future cash flows) as the stock market mean reverts.
The bulk of this position will be made up of real estate which you either own and occupy or rent and generate an income from.
As real estate values are local and affordability depends on your income, interest rates, and the size of the mortgage, we don't have anything specific to say about where to buy. That is up to you.
Of course, precious metals and collectibles are included here, too. What about art? Explore your options. You have them.
Perhaps controversially, we've added a fifth "asset class" to the plan: cryptocurrencies.
I'm a crypto novice. And Bill is neutral on the subject. Neither Bill nor I are prepared to say we fully believe that cryptocurrencies are actually money. But then, the definition of what money is and who gets to produce it is one of the recurring subjects of the Diary.
Cryptos are a speculative position. But they're one with potentially huge upside – several cryptos soared thousands, even tens of thousands, of% in 2017. And even with the crypto bloodbath in 2018, several of our world-class crypto experts are still very bullish on the crypto market.
And remember, no investment or allocation strategy can protect you from the worst type of financial calamity.
However, maintaining a diversified asset portfolio is one good way of reducing how much damage you sustain when the next calamity occurs.