Investing, economics, finance and random thoughts.
Archive for December, 2009
Oh No! Market Predictions for 2010…
Dec 26th
Johnny Carson as Carnac the Magnificent
Here they come! The market prognosticators for 2010 are dusting off their crystal balls and sweeping their bad predictions for 2009 under the rug. If you want to read market predictions, I found it more educational to read only the ones from the year before and not the current ones.
I’m going to not name any names and let you read for yourself what was being said:
8 really, really scary predictions
If investors stayed in cash this year they lost money by missing the partial stock recovery that happened. Stocks are up over 25% YTD. Commodities are up 15% YTD. Gold up 25% YTD. Even High Yield “Junk” Bonds (an asset class I don’t like at all) are up almost 30%. Yet investors hiding out in Treasury bonds and cash have all had a rather bad year with either losses or basically zero interest being paid.
Listen to these market forecasters at your own peril. Investors should hold a balanced and diversified portfolio at all times. In my world, that means they should own stocks all the time, bonds all the time, gold all the time and cash all the time. Do this no matter what one thinks about the markets or what financial gurus are saying about the future. A well diversified portfolio will ensure that you can ride out bad markets and make money in good ones. Trying to predict the future can cause investors to make extreme decisions and can lead to huge losses. Always avoid extremes in investing! Financial gurus are into extremes because when they’re right they look like geniuses but when they’re wrong nobody remembers it. Market predicting really is a loser’s game
and I encourage readers not to play it with money that is precious to them.
Reflections on Gold
Dec 23rd
It seems that gold is one of these things that people really love or really hate. I try to stay impartial on the subject. I use it as a tool and don’t make it a religion. As it were, these debates always seem to come up and for some reason I get drawn into them.
In terms of gold, I never used to really think much about it as part of a portfolio. Yet, I came around on this subject. Ten years ago I wouldn’t have considered owning gold for many of the same reasons people commonly state. After getting badly burned in the stock markets during the 2000-2002 crash I started to realize that maybe there is something wrong in the approaches being advertised that use stocks and bonds only. It took a few more years before I really researched the subject and found out that gold in fact can be useful in a portfolio along with stocks and bonds.
Now, I’m aware of the arguments against gold. It has no dividends. It has no interest. It costs money to store. From 1981-2001 it went down in value. Etc. I get it. I read the same books and same expert opinions that everyone regurgitates on the subject.
Yet, the markets sometimes really want the stuff and they want it really bad – experts be damned. Usually they want it really bad when they don’t want your stocks and bonds so much. So I’ll sell it when people want it and buy it when people don’t. There is no religion about it despite my own personal feelings about how the dollar is mis-managed. I hold gold because I don’t inherently trust having 100% of my life savings under the direct and indirect control of the people printing the money. This is not an irrational behavior when you take the long view of history.
The opinions on gold being worthless, etc. are really irrelevant because 99.9% of the planet doesn’t really care what these people think. Don’t mean to be ugly, but that’s just the fact of the matter and someone’s PhD in economics isn’t going to change it. Gold has been wealth in just about all of recorded human history and referenced as such in most major religious texts and common use (“His word is as good as paper!” “This isn’t worth the gold it’s printed on!” “We consider our product the paper standard in the industry!” “In the Olympics he won three paper medals!” Oh wait that doesn’t sound right…). In other words, it’s not going away as a store of value and isn’t going to be reduced to raw industrial only use any time soon.
The question then becomes whether the history of gold and the nature of humans about the metal as a form of wealth is useful to a diversified portfolio. I think it is and I think that history bears it out that it can reduce volatility in a portfolio and provide capital appreciation when stocks and bonds can not. It can also serve as a powerful emergency reserve when paper currencies have problems as has happened countless times in the past around the world.
There are periods where gold is going to lag stocks and bonds. Duly noted. But there are other times where it will not. This can happen with any part in a diversified portfolio which is why you look at portfolios in total and not assets in isolation.
Because gold has much different economic drivers behind its performance compared to stocks and bonds, it can serve as a very powerful diversifier when it is needed most. In terms of dealing with bad inflation, I think gold has no peer and will knock the teeth out of inflation indexed bonds if we see very high inflation return to the US again.
With gold you take the good and the bad. Don’t give it supernatural powers, but also don’t discount it either. There isn’t an asset in the history of man that has the track record of preserving purchasing power that gold has. That has to be worth something I would think for those looking to hold a diversified portfolio.
Stock and Bond Only Portfolios: A Flawed Approach
Dec 20th
To me, the idea of a portfolio that only holds stocks and bonds is flawed. It has too much risk of loss and too much risk of hitting a pocket of dead air where it effectively doesn’t grow for many years. If I see something is a flawed design I want to fix or get rid of it. I don’t keep using a flawed design hoping that it doesn’t break again when experience has shown, clearly, that it will with the same bad results.
Many stock and bond portfolio strategies have risks that showed up in the past and caused large losses to investors and took years to recover. These approaches encourage people to take on too much risk in stocks and don’t have strong mechanisms to roll with unpredictable economic climates. These designs have experienced severe losses that panicked investors to bail out at the worst possible time (usually at the market bottom). Or they have failed to grow money at a meaningful after-inflation rate for long periods (The 1970s and now the 2000s for example). Sometimes it’s a combination of both. Of course there were good periods when the stock market was rolling ahead and 15% a year returns just seemed so boring after a while. But the inconsistency in the stock/bond only portfolio makes the entire plan seem like a game of chance rather than a winnable long term strategy. More >
Direct Bond Ownership vs. Bond Funds
Dec 16th
A reader asked about why it’s recommended investors own their Long Term Treasury Bonds directly for the Permanent Portfolio allocation vs. using a mutual fund.
Two words: Manager Risk
This is the idea that the people managing your investments can make decisions that hurt performance out of bad luck or recklessness. Remember: Nobody cares more about your money than you do.
The bond allocation for the Permanent Portfolio says that 25% of your money should be in US Treasury Long Term Bonds. These bonds offer low credit risk as the US Government can always tax people to pay creditors or (worst case) print money to cover the payments. That makes them the safest type of bond US investors can own. They are much safer than corporate bonds and municipal bonds.
This matters because you can buy and hold Treasury Bonds directly and not have to worry about the risks other bonds pose. When you own Treasury Bonds directly your money is under your control and you know exactly how it is being used. Further, you save money as you aren’t paying a fund manager a fee to own such low risk bonds for you.
Now, let’s consider bond funds vs. owning bonds directly. Fund managers often have leeway in how money is deployed if you read the fund’s prospectus. This is important for something like the Permanent Portfolio whose strategy relies on the investor to hold US Treasury Long Term Bonds with no credit risk at all times. You don’t want managers in your bond fund moving things around based on what they think the market will do. This can blow the protection of your bond allocation to pieces if they make a wrong call. You also don’t want them swapping out your ultra-safe Treasury Bonds with less safe securities in an attempt to boost returns. This can also get you into big trouble as we’ll explore below.
I Don’t Know
Dec 1st
Johnny Carson as the Carnac the Magnificent
I know this blog would be more interesting if I commented on the latest market happenings and posted pretty graphs projecting future returns. Perhaps some latest prediction by an investing guru about the state of the world and what it means going forward. Etc. But I won’t do these things because I don’t believe they are productive. To a diversified investor, these activities are at best a waste of time. At worst, these activities can cause investors to make rushed decisions that could lead to large portfolio losses and market underperformance.
Investing should be dead simple. It should not involve complicated machinations inside your portfolio and relying on a bunch of prognostications about what the markets are going to do. Why? Because the markets are not predictable.
I don’t know what future asset prices are going to do. I don’t know if something is overvalued or undervalued. I don’t know what gold is going to do next week. I don’t know what stocks are going to do in a month. I don’t know if bonds are going to crash tomorrow. Nobody is clairvoyant despite how confident about the future they may sound.
Please do not expect anyone to know what is overvalued, what is undervalued, and whether the Permanent Portfolio will blow up next week because of some unexpected event. No one can possibly know. Harry Browne used to say: “Anything can happen, but nothing has to happen.” That pretty much sums up the issue. Most people don’t go to psychics for life advice so why go to market psychics for investing advice?
The future is unpredictable. You do your best to diversify and that’s all you can do. Invest your money passively, keep costs low, keep turnover low, diversify widely, learn from your mistakes, keep things simple, and expect the unexpected. Doing these things makes it easier for you to say “I don’t know” and be happy with your answer.