Investing, economics, finance and random thoughts.
Investing
Investing
Central Banks Doth Protest Too Much…
Mar 25th
An interesting article considering the past two years I’ve heard pundits largely talking about how much gold banks were selling. The IMF announced big sales last year and the gold market didn’t budge. Other central banks snapped it right up at market prices:
Central Banks Stashing Away Gold at Brisk Pace
Central banks around the world added 425.4 metric tons of gold to their reserves last year, the biggest increase since 1964, according to the World Gold Council.
That represents a 1.4 percent gain to put their holdings at 30,116.9 tons in total. The increase was the first since 1988.
A 1.4 percent gain isn’t what I’d call Earth shattering. Yet, when I hear these central banks out pronouncing their faith in the US Dollar it makes me wonder if they really believe it themselves. They’ve got their frontman talking about the dollar being a great reserve currency, yet they’re wheeling gold bars out the back door into their vaults to diversify.
Actually that’s not bad advice. Maybe they’ve been listening to Harry Browne’s shows?
Is this actionable information? No. The Permanent Portfolio holds enough gold that I would just keep things as is. This is more of a piece of knowledge that confirms what many of us probably suspected already with respect to gold and central banks being large buyers.
Safe. Stable. Simple.
Mar 18th
Safe. Stable. Simple. These are the words Harry Browne used to describe his investment philosophy in his October 10, 2004 radio show. He pretty much nails it.
October 10, 2004 Investing Radio Show
Safe
A portfolio that is safe is one that is invested conservatively but also with strong diversification in case things don’t go according to plan. People work hard for their life savings. Why gamble those savings on some get-rich-quick investing scheme that can cost a big chunk of it if things go wrong? A portfolio that is safe does not mean tucking the money under the mattress. What it means is that investors buy things only that they fully understand for a very specific reason. Risks are taken where they should be and avoided where they add nothing to the bottom line. A portfolio invested this way can hold assets that are “risky” but own them in a way where the risks wash out over the long run and produce actually safer and more consistent returns through diversification. Safety also means following some basic rules of investing that will make it much harder to fall into many common investment traps.
Stable
A portfolio that is stable allows an investor to not panic when the markets are in serious turmoil. Stability doesn’t mean investors won’t ever take a loss. What it means is that the losses will be dampened so that the pain is tolerable and not driving the investor to waking up in a cold sweat. These situations, if they occur, can cause investors to make bad decisions about their money usually at the worst possible time. Stability in a portfolio means that investors can focus on their work and savings which is really driving most portfolio returns (especially early on).
A portfolio that is stable also means it is giving out reasonable market returns. A consistent return over the years can grow a portfolio greatly due to compounding. There is no need to reach for the brass ring for double-digit growth because that always means higher risks. Higher risks means less stability and a potential for doing much worse in the markets than what an investor is expecting. On the other hand, a more consistent growth can prove incredibly powerful if just left alone and a stable portfolio means investors will leave it alone. Since long term investment success is related to the ability to stay the course and not try to time the markets, stability in the portfolio is an important ingredient because it helps keep emotions in check no matter what the markets are doing.
Simple
I love simplicity, especially for investing. Complicated investing strategies and products can conceal many risky moving parts underneath. Many times these risks will not be discovered until it’s too late. Not just this, but often financial advisors will sell complicated strategies because it makes sure you keep them around to manage it all for a hefty fee. Investing does not need to be, nor should it be, complicated. There is a strong relationship between complicated investment approaches, lower performance and higher risks – All things you don’t want. Portfolios that are simple have lower management fees, lower taxes, lower chances of hidden risks, and can be managed without the use of a financial advisor with very little time commitment on the part of the investor. All of these attributes ensure a greater chance of long-term investment success.
There you have it. Safe. Stable. Simple. The three words that define the Permanent Portfolio. If you’ve never heard this radio show, you’ll enjoy it. Harry Browne discusses these and other important topics that are the foundation for growing and protecting wealth.
The Dollar is Crashing!!
Feb 23rd
What was this stuff I kept hearing last year about the dollar crashing? In December 2009 this talk reached a fevered pitch. Here’s the dollar index over the last year and you can see how much it’s recovered since the dark days of December 2009:
You can track the US Dollar index at this link.
Since this time the Euro has taken a pounding due to the issues with Greece possibly going into sovereign default. This drove the Euro down and the Dollar was the beneficiary. I’m not a dollar bull necessarily, but I post this just to show (yet again) that reacting to news that everyone else already knows is rarely a good way to invest. The markets are random and things we think must happen may not happen for a very long time (if at all).
Best to ignore all of the financial news and just stick to a simple diversified portfolio that can take care of you whether the dollar is sinking or flying.
Complicated costs. Simple saves.
Feb 12th
I was going through some old investing books today getting ready to dispose of them to make room on my shelves. When paging through the candidates for removal, I saw so many complicated investing strategies. Some of the portfolio recommendations held 10 or more different mutual funds as part of their allocations! I bought these books early in my investment career and during that time they convinced me that only a complicated investment strategy could deliver diversification and performance.
Boy, was I wrong.
After looking back over the many years when I first bought these books it showed me this: Despite the complexity of these various strategies, not a single one of them added anything significant to investor diversification over this time. Owning a bunch of stock funds does not make you diversified. If anything, these approaches were tremendously risky for what you got out of them. Yet, the approaches hid those risks by making you think you had diversification because you owned so many different stock assets.
Well, stocks share the same market risks by and large because of the deep interconnections that exist between them all. Just because an investor owns some small company stocks, large company stocks, foreign stocks, etc. is no guarantee that a bad bear market can’t come up and bite them all at once. I didn’t go back and run the performance numbers, but my quick look predicts that over the period I owned the books they wouldn’t have done any better than a simpler portfolio. With the additional trading and management costs involved, there is a chance they did worse than a simpler approach.
This just reminded me how important it is to keep investing simple. Complicated investment schemes can hide many risks and expenses. The simpler you keep investing, the less chance you have of making a mistake. Investors don’t need to follow complicated investment plans to get good results. Indeed, I’ve found the simpler you keep investing the more likely you are to turn a good profit and not face any wicked surprises.
Why I own stocks…
Feb 11th
After 2008 many people swore off stocks. “Too Risky!” they say and then tell you about their hot new investment in a multi-level marketing scheme or their Uncle’s new franchise opportunity. Isn’t it funny how whatever assets you don’t own you always think are “too risky” when someone else owns them? I’m as guilty as the next guy on this. For instance, I don’t touch junk bonds and emerging market debt. It’s too risky. 
But I think I can make a better case for this position than people who don’t own any stocks for the same reason.
I own stocks and I admit it. I feel comfortable with stocks in my portfolio because they represent an ownership stake in the productive capacity of my country. Every time someone buys a Coca Cola, a computer or any other product they hand me money through the profits. When I’m awake they are handing me money. When I’m asleep they are handing me money. They are handing me this money 24 hours a day and seven days a week across the planet as they make their purchases.
Stocks have risks. Sometimes these risks show up in big price declines. But sometimes these risks cause the prices to climb far higher and faster than any other asset you can own. Over time, stock dividends reinvested can grow capital by large amounts through compounding. This makes it different than assets like gold which cannot grow on its own as it pays no dividends.
While market risks can impact a company’s stock over a period of time, I also realize that most companies are resilient and can adapt to changing economic conditions and survive. Not all of them can do this, but most do. This is why I own a broadly based stock index fund. Such a fund may own over 5,000 individual company stocks. This means any one of company going bankrupt has an insignificant impact on the entire portfolio. Not only this, but stock index funds are cheap. Every penny an investor saves in management fees is another penny in their pocket each year to compound and grow.
I know the markets have proven to be efficient over time. This means it’s almost impossible to outperform the market averages as everyone else on the planet receives the same information you do almost instantly. I recognize that sometimes the markets are not 100% efficient all the time. But I also recognize that it’s close enough that debating the point is academic because rebalancing between assets eliminates these risks.
I admit that all the brokerage houses receive news of major events within seconds and have computers and people that will trade positions just as fast in reaction to it. Therefore, I don’t try to compete with these people by out trading them because someone like me is always the last to know. Instead, I just hold on to my boring index fund that owns everything and profit from the thrashing the professional and amateur traders are doing underneath. Over time, my index fund will beat in excess of 95% of all of them.
The markets are random. The price movements are not predictable day-to-day or even each year so I balance my stock ownership with assets like bonds, gold and cash. I don’t own just stocks because owning 100% in stocks is extremely risky and not guaranteed to bring any more success than a diversified portfolio. I know there have been protracted decade-plus stretches where stocks have performed poorly in real terms (such as the 1970s and 2000s). Therefore, I reject the idea that stocks are the only asset any investor needs. Instead, I diversify just in case the next decade of under-performance happens to be during a period of time when it could hurt me.
I understand that portfolios which do not have any stock exposure face the risk that they will not be able to grow faster than inflation over time. So I accept that stocks have risks of loss in order to ensure I have the chance to take advantage of gains when they present themselves to grow my money. Although assets like gold and bonds by themselves are useful to diversify against certain market risks, I know they may not be enough to beat inflation and grow the portfolio alone. That’s why I own stocks.
Why I own gold…
Feb 10th
Why do people freak out so much when you tell them you own some gold in your portfolio? It’s as if you had just told them you killed a dozen people before lunch. The hyper-ventilation you hear from some when you even mention this topic is just nutty. It usually starts with some juvenile comment involving tinfoil hats. Then they pull out some quote from an economist (usually one that loves inflation to solve all problems) about how useless gold is. They may even hit you with the ol’ “gold is not a form of wealth but just a shiny metal” lecture (ignoring the bulk of human history, and all major central banks, that disagree with them). Then they tell you how “risky” gold is when their own portfolio may be loaded to the hilt with junk bonds, emerging market debt or other complicated investment products. They must think the Nigerian stocks they hold in their Frontier Market fund are a sure thing (assuming they even know what’s in the funds they own).
Well, I own gold and I admit it. I feel comfortable owning gold in my portfolio. I sleep well at night knowing I own gold even though it could drop in value. I understand that in a balanced portfolio gold is a useful tool. I trust gold to protect me in high inflation more than indexed linked bonds (TIPS) ever will.
Gold has no interest or dividends. I admit these things and acknowledge that this is one area that makes gold different than stocks and bonds. However, this does not make gold useless for diversification.
Gold maintains real purchasing power over time and it’s really good at doing this. No other asset on this planet has such a long history. I don’t worry about politicians printing trillions of dollars of gold. This is because politicians can’t print gold. Gold can also be owned directly without any obligations attached to it. These are unique attributes for an asset class when used properly in a portfolio (and properly does not mean 100% gold).
While gold does not have the interest or dividends of stocks and bonds, it has other benefits that can work at certain times to protect a portfolio that does hold stocks and bonds. Gold for instance does very well under high inflation when stocks and bonds do not.
Gold has risks just as stocks and bonds have risks. I understand what these risks are and how they fit in a diversified portfolio. Yet, I do not rely only on gold in a portfolio. I also own stocks and bonds to drive returns when gold is performing poorly. In diversification there is safety which is why I own all these assets and don’t get religious about it. I accept gold’s quirks because I know when it comes time for it to perform it will do so better than all its contemporaries.
The empirical evidence says that owning some gold in a portfolio is not the death sentence academic literature would suggest. In fact, at certain times having gold can be a tremendous help. So, either reality is wrong or the academic theories are. Given a choice between the two, I’ll take reality. That reality is that all portfolios should hold some gold for diversification against stocks and bonds despite what critics state. That’s why I own gold.
Book Review – Books on Risk (and two podcasts)
Jan 28th
A theme you’ll hear on this blog about investing is the idea that the markets are not predictable. You may believe that I’m referring to the idea that you can’t predict returns on investments ahead of time and that’s partially true. The other part though relates to extreme risks that sweep through the markets in unpredictable ways with unpredictable results.
Aside from standard market risks, when you look at your investments it’s also important to always ask yourself: “What if I’m wrong?” Because, odds are, you will be wrong eventually. It’s just a question of degrees on how wrong it will be: A little or a lot.
The Permanent Portfolio has protection against unpredictable market risks and being wrong. If you’re wrong, you’re not going to be wrong so much that you take a crushing blow to your portfolio (because your asset allocation is widely diversified in relatively small chunks). We should also understand though that all investments have risk. Without risk, you will not get rewards. So risk must be taken to grow a portfolio, but it must be done with specific goals in mind. We need profits, but we also need defenses against an unknown future.
In this light, I’d like to share with you some books and podcasts that I think really hit at this problem of risk, uncertain futures and protecting yourself against being wrong. They may help you understand why diversifying and eliminating unnecessary risks in your portfolio is so important and why being wrong does not have to be fatal if you handle it correctly.
First there is John Allen Paulos and his book A Mathematician Plays The Stock Market. This 2003 title is one of a series of excellent books written about his worldly observations as a mathematician. In this case, the book details his own personal story of losing money in the stock market and how uncertainty rules. It’s an interesting look at many concepts you see in the investing world with respect to stocks vs. bonds, efficient market hypothesis, chaos theory, etc. And, best of all, it’s a very easy and fun read with almost no math but high level explanations of many concepts with real-world examples. He has a number of books written in his “A Mathematician” series exploring everything from innumeracy in society to his experiences investing (and losing) lots of money in Worldcom as he discusses in this book. The bottom line is that risk is real, markets are random, and trying to beat it can be very costly. His dedication reads:
To my father, who never played the market and knew little about probability, yet understood one of the prime lessons of both. “Uncertainty,” he would say, “is the only certainty there is, and knowing how to live with insecurity is the only security.”
John Allen Paulos – A Mathematician Plays the Stock Market Dedication
Now that’s a dedication I can get behind! That is the core philosophy of how the Permanent Portfolio is designed to operate.
Next, there is Nassim Nicholas Taleb and his series of books on chance. First there was Fooled By Randomness followed by The Black Swan. Both of these books explore the idea of unpredictability in the world. While his advice is largely being linked to finance today (he was a former trader), his observations come into play in many areas of life. His book, The Black Swan, pre-dated the 2008 crash involving Fannie Mae but said this in one of his footnotes:…the government-sponsored institution Fannie Mae, when I look at their risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deemed these events “unlikely.”
Nassim Taleb – The Black Swan Pg. 225
I’d say he certainly called that one correctly.
I also think you’ll enjoy these two podcasts from Nassim Taleb. One recorded in 2007 talks about his book The Black Swan. The second was recorded in 2009 after the market meltdown as an after-action report on what he had written and said before:
Taleb on Black Swans – April 30, 2007
Taleb on the Financial Crisis – March 23, 2009
One thing about Taleb is while he has disdain for most fields of economics (and especially the very silly Keynesians), he does have an affinity for the Austrian Economic School and their dislike of the over-application of mathematics in economics for what is, essentially, a human behavioral problem (aka. scientism). Why does this matter? For one, you cannot model risks accurately with standard statistical methods because human behavior is not predictable. Secondly, Harry Browne was a firm believer in Austrian Economics and the Permanent Portfolio design, at its absolute core, is based on the Austrian School’s theory on monetary cycles (a lengthy topic for another day) and embracing unpredictability in the world. In fact, I think that one of the reasons the Permanent Portfolio is good at dealing with market risk is because the Austrian Economics school is right about a great many things. This outlook helps to drive the portfolio down the right path over time avoiding serious pitfalls and dangerous assumptions about the future.
With these three books and two podcasts you will understand more about market risk than most professional investors and economists. Seriously. Combine that with Harry Browne’s podcasts, and his own previous books, and you’ll be well versed in the dangers of the unpredictable in the investing world and how to position yourself to deal with them.