Doug Casey is emphatic that a downturn will affect us all. When it comes, we want to minimize the damage. That’s particularly challenging for baby boomers and seniors who may be at, or past, the end of their careers.
In the past I’ve shared some experiences from speakers who had real world experience with hyperinflation. It is not pretty. They were quite candid that many previously wealthy seniors and savers ended up penniless before things got under control. That’s the ultimate catastrophic loss.
So how can you test your safety through diversification?
Start by posing a series of hypotheticals: If this were to happen, how would it affect my portfolio?
Let’s go through a strong sample portfolio, by way of example.
#1. What could happen with a 40% or greater downturn in the market that did not recover for a decade or more?
A good portfolio has good sector diversification; however, even the best would not be immune to an overall market drop. If you have 50% of your portfolio invested with a 20% stop loss, the most you could lose is 10% of your overall portfolio. Diversification is the first step in protection. Additional circuit breakers like strict position limits and stop losses help too.
By using trailing stops, you can enjoy profits from the rising market and protect yourself from a sudden, sharp downturn.
The worst-case scenario: You get stopped out of your positions and have money to invest in a down market—while protecting yourself from catastrophic losses. While no one wants to take a double-digit drop, you would be breathing a sigh of relief for being well diversified and having stop losses and strict position limits in place.
#2. What could happen if we saw a significant jump in interest rates?
This could have an effect on the market, so some of your stocks might be affected. For bond positions with short-term maturities and very low durations you could either hold them to maturity or take a small loss.
#3. What could happen if our government instituted currency controls in response to runaway inflation?
We have written extensively about why part of your portfolio should be invested internationally, which is another form of geographical diversification. If the government followed currency controls with emergency taxes like they did in Cyprus, we could be faced with serious losses. The best hedge against this type of government action is to have some of your nest egg out of the immediate grasp of a predatory government. Many investors in Cyprus fared well because they had some investments outside the country.
#4. What happens there is a rapid jump in inflation?
We are adamant that everyone should keep a good portion of their overall portfolio in core holdings—about 10% or so. Core holdings are a necessary foundation before going into the market. Their purpose is to combat inflation and ensure survival. History has shown that people living through hyperinflation go into survival mode. Hopefully, we never have to experience that… and tap into our core holdings to eat.
Our investment recommendations at Miller’s Money Forever correspond to the portion of your portfolio you want to invest with maximum safety while earning enough to supplement your retirement income. A well-diversified portfolio will also include ample allocation to your core holdings and a smaller allocation to speculation.
#5. What happens if our government decides to confiscate gold again like President Roosevelt did in the 1930s?
We would all comply with the law. Those who saw fit to protect themselves by diversifying and owning metals internationally may be better off. With the world as it is today, however, there is no guarantee our government would not try to confiscate metals you own in other countries or perhaps levy a huge tax on those holdings.
The Foreign Account Tax Compliance Act (FACTA) requires investors to report all of their foreign holdings in excess of $10,000 each year. It would be much easier for the government to try to tax or confiscate foreign holdings than it was in the 1930s.
Many wealthier investors are investing in foreign real estate. That is one thing that is impossible to repatriate (although I wouldn’t be shocked if they tried). There are many experts who specialize in international asset protection.
Why is internationalizing so important? With history as our guide, if the government confiscates gold, it would then peg the dollar to gold at a much higher than current market price. The purpose is to stop runaway inflation, which is, in effect, a pseudo default on all government debt. That would dramatically reduce the value of the dollars held by all citizens, making them dramatically poorer almost overnight.
These are just some examples of events that could have a dramatic impact on seniors and savers. Do we want to handicap the probability? Not me. If any of them did occur, an unprepared investor could incur catastrophic losses. Some might be unable to ever recover.
If none of these hypotheticals ever come to pass, great! I have never complained when a home fire extinguisher had to be replaced because it expired. I hope I never have to pull the pin and use one. There are just prudent safety precautions you have to take. Better safe than sorry.
Diversification is indeed the holy grail of asset protection, if done properly. This includes investment vehicles, currencies, locations, sectors, and timing, to name a few. The next level of protection is position limits and appropriate stop losses. If there is a downturn and it affects only a portion of your portfolio, you may take a loss. Don’t forget the overriding goal: to avoid catastrophic losses.
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