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.

…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.

Formerly, I was in the Internet security field and part of my work was as a security auditor hired to break into computer networks as well as doing network attack tool development. So, it comes naturally to me to look for ways in which something may not go according to plan and deliberately push further until it breaks in unexpected ways. That’s what security auditing is at its core.

Therefore, as my research in investing and economics widened, I thought it would be an interesting exercise to depart from looking at optimistic scenarios and instead look at financial disasters. I already saw all the unrealistic hockey stick charts where people project their 15% annual returns for the next 50 years and retire by buying a Carribean island somewhere. Instead, I wanted to see how things worked when the train really sailed off the tracks. What assets held up, what didn’t, how long did it take to recover, etc. And, as it turned out, one of the more recent financial disasters was Argentina in 2001. During that year, the Peso was devalued from 1:1 with the US Dollar to a market exchange rate peaking around 4:1 Pesos for US dollars (that’s around an 80% loss of value kiddies). In the end, the overall damage to Argentina’s citizens was to lose more than 2/3rds of their wealth almost overnight as the government implemented extreme policies that made the situation worse.

Inflation in Argentina 2002 - Wikipedia

Now it’s one thing to read about losing so much of one’s life savings under an extreme event like this, but it’s another thing to actually live through it. Yet, during my reading on the subject it just so happens that I came across a report from an Argentinian Architect student (now Architect Professor) living in Buenos Aires:

Lessons from Argentina’s Economic Collapse (Read all four parts at your leisure, it’s well worth your time)

He also published a book (and keeps a blog) that is a collection of his advice on what really happens when an industrialized country hits a very bad economic climate.

Unlike other survivalist-type books that operate under the idea that all you need is a bunker and some bullets, this book actually covers realistically what to expect. It details the events of 2001 and the aftermath. This includes the very high unemployment, crime and poverty (as high as 57% under the poverty line at one point). He also talks about what things you probably should have to prepare for this situation (hint: It does not include an armored personnel carrier, but does include things like LED headlamps and a moderate amount of food supplies to ride out some initial disruptions). Finally, he goes into great detail about what happens in a country when a currency really does hyper-inflate. For instance, did you know that vendors and banks will happily buy gold and silver but are not interested at all in bartering with ammunition? Do people really think you’re going to walk into a store and say:

[CraigR]: I know that pack of Coca Cola costs a half-dozen .308 caliber, but all I have are 10 rounds of .338 Lapua Magnum. Can you give me five 30-06 caliber softpoints for change? Oh, and I’ll take two gallons of napalm. I need to refill my flame thrower because I have a death match at the Thunderdome tonight.

Ignoring the fact for now that gold can diversify a portfolio without any financial disaster at all, one of the criticisms of gold is that for financial Armageddon some say you’re better off with bullets, razor blades, etc. However if you read accounts of what actually happened in developed countries like Argentina and Iceland it’s a total myth. In Surviving the Economic Collapse the author goes into detail about how and why barter systems must fail eventually and how they did exactly that in Argentina. As it turns out, gold and silver in fact are great assets to have once you move beyond the basic sustenance items for your family. People are always happy to exchange gold and silver for either real items or local currency. Moreover, there is not some magic button that’s pushed where everyone turns into rabid murdering lunatics roaming the countryside looking for the razor blade bazaar to trade their wares. In the book the author explains:

Survivalists spend countless hours discussing what product to stock specifically for post SHTF [craigr: Shit Hits The Fan] barter. Tools, needles, candles, shoes, and sometimes the most ridiculous suggestions are considered the wisest statement. This or that item, ‘will be worth its weight in gold’.

Well, no.

Only gold is always worth its weight in gold. Bar none.

- FerFal – Surviving the Economic Collapse

And on bartering with ammunition:

How about Uncle Bob’s ammo stash. He read somewhere that .22 Long Rifle would be the new currency after the SHTF, and the best barter item, so he bought a few 500 round packs.

Again, his surprise was big when the egg guy told him that he didn’t need .22 ammo, he doesn’t even like guns, he simply needs a plumber.

Since he was at the ‘Barter Club’ he checked around to see what was the actual market for his .22 stash, and was sort of disappointed by the few offers he got. Seemed that each person wanted a different item, and those that were interested…they looked like people from the wrong walk of life, and Bob wasn’t sure he wanted to give ‘them’ ammo. Ammo that would end up being used in delinquent’s guns and possibly against him and his family.

- FerFal – Surviving the Economic Collapse

Besides the above, he covers many other topics with an insightful outlook. Here’s a short list:

• Common myths about what happens during an economic crisis
• Why preparation is a good idea
• How to prepare
• Importance of being physically fit
• Crime and unemployment
• Risks of living in rural areas
• Risks of living in the city
• Security in your home
• Security in your vehicle
• Gear to keep on your person, car and at home
• What kind of gun to buy first for protection
• Self-defense skills – unarmed
• Self-defense skills – armed
• Finances under economic calamities
• Making money in bad economies
• Bartering
• Gold and other foreign currencies in a crisis
• How to expect your government to respond
• Bribing, looting, riots and relocating
• Having multiple plans in case things don’t work out where you are

Lastly, the author reflects a bit on what he’d do differently if he knew what was going to happen ahead of time. This involves what items he’d buy, what he’d avoid, how he’d diversify his money and other small but important details that you may not have considered.

Overall I really enjoyed this book for the practical details inside of a financial crisis and what really happens as opposed to theories. The author apologizes for the writing in the book as English is not his first language, but I found his writing style humorous and blunt with no sugar coating. From his descriptions and acknowledgements of what he did right and wrong you can tell that he’s someone with (unfortunate) experience in these matters.

For $24.95 I think this is a great buy. It’s a book that offers practical advice for anyone who wants to be better prepared in case any type of emergency should arise that affects where they live whether natural or man-made. I give this book five stars. It’s a great read.