If you live long enough, you get the honor of witnessing some pretty stupid things. And nowhere is this statement truer than in the arena of investing.
In the late 1920s, know-nothing shoeshine boys were giving their customers hot stock tips. Everyone knew that the stock market was a sure thing – an easy path to riches. Only a few years later the Dow Jones Industrial Average crashed by 89% during the Great Depression.
An entire generation of investors was wiped out.
In the mid 1960s, Nifty Fifty companies like Xerox, 3M and Polaroid were widely considered “one decision stocks” – with the only correct decision being to buy (and hold forever). The DJIA peaked at nearly 1,000 in 1966 during the height of the mania…and then proceeded to move sideways for the next 17 years.
The index only irrevocably surmounted the stubborn 1,000 barrier in late 1982. Some of the Nifty Fifty names even went on to declare bankruptcy eventually! So much for buying and holding forever.
In the mid 2000s, people caught house-flipping fever. Many thought they had discovered the perfect wealth building plan: buy multiple houses simultaneously with no money down and then sell them to some other sucker at inflated prices. During this time, Ben Bernanke of the Federal Reserve loudly declared that “we’ve never had a decline in house prices on a nationwide basis [since the Great Depression]”, implying that a widespread housing bust simply couldn’t happen.
Over the next decade, nearly 8 million homes were foreclosed on in the U.S., destroying the hopes and dreams of millions. Ben Bernanke failed upward during this debacle, becoming the Chairman of the Federal Reserve.
In 2017, tech junkies, fraternity bros and anarchists everywhere were enthralled with the idea of crypto-currency in the bizarre belief that all the old rules surrounding money had changed. But as far as I can tell, a crypto-currency is a digital guarantee that you own nothing…nothing tangible anyway. Bitcoin, the undisputed king of the crypto-currencies, peaked in December 2017 at nearly $20,000 a unit.
It now trades for just over $7,500 – down over 61% – with the supply of greater fools running increasingly thin. There will be more losses here for sure.
In 2020, we are grappling with the largest bubble in history – the dreaded Everything Bubble. The coronavirus just popped this bubble, but the stock market still hasn’t gotten the message. When it finally does, look out below.
All of these incidents are historical examples of just how emotionally unhinged investors can be. It is also an object lesson in why you should practice financial self-defense. Participating in a bubble can feel wonderful on the upside, but the dream of riches always gives way to the nightmare of reality at some point.
This is why I heavily rely on historical precedent when constructing my personal investment portfolio. And right now the most undervalued, overlooked asset class by far is portable tangible assets – things like antiques, bullion, fine art and gemstones.
But the concept of financial self-defense also dictates that a portfolio must be well-balanced. One simply can’t load up on a single asset class to the absolute exclusion of all others.
So in my opinion, the best financial self-defense tactic is to tier or layer your assets. In this context, tiering your assets means to diversify across different asset types with different cashflow, liquidity and safety characteristics. This strategy should give you the financial flexibility to buy undervalued assets, while riding out whatever economic disasters may come.
The first asset class vital to the art of financial self-defense is cash. This can take the form of a checking account, savings account, savings bonds or even physical cash. Cash is the most liquid of the asset classes and allows an investor maximum financial discretion. In other words, whoever has a fat pile of cash when a crisis hits will be able to buy investments cheaply when others are forced to panic sell.
Cash is a very underrated asset at the moment. The stock market has done so well since the last recession that a lot of investors believe that “cash is trash”. A corollary to this is the misguided notion that you must always be fully invested, usually in an equity index fund. But this anti-cash stance couldn’t be more unwise. The ideal time to build a strong cash position (if you don’t already have one) is before a crisis strikes. The second best time is right now, regardless of the macro situation.
A word of warning though – don’t rely on credit as a substitute for cash. In a liquidity crisis, common types of consumer credit, such as bank overdrafts, credit cards and payday loans, may very well no longer be available. As the old saying goes, “A banker will offer you an umbrella when it is sunny, only to take it back at the first sign of rain.”
The second tier of assets in a properly diversified, financial self-defense portfolio is conventional investments. These include stocks, bonds, mutual funds and ETFs – paper assets that are commonly encountered in IRAs, 401-Ks and brokerage accounts.
Conventional paper assets are generally very convenient to buy and sell. However, liquidity in this asset class can disappear shockingly quickly in a financial crisis. But because – pre-coronavirus – it had been more than a decade since our last financial crisis, many people foolishly forgot this fatal flaw of the paper asset markets.
Due to the all-pervading Everything Bubble, I have difficulty recommending anything other than token allocations to most stock and bond sectors at this time.
The third integral part of any financial self-defense plan is real estate ownership. This is most commonly recognized as owning your own home. But it can also include owning residential rental properties or raw land.
Unfortunately, due to the Everything Bubble real estate suffers from the same overvaluation problem as stocks and bonds.
That leaves us with the final (and in my opinion best) layer of our financial self-defense cake: portable tangible wealth. As noted above, this asset class consists of antiques, bullion, fine art and gemstones. These are items that have been broadly recognized throughout history to possess substantial value, a large portion of which is often intrinsic.
For centuries the middle class and wealthy relied heavily on portable tangible wealth as a discreet and effective store of wealth that could be passed down from generation to generation. For example, in 18th century Georgian England a house full of art and antiques was considered both a cultural and financial prerequisite for admission into the upper class.
These assets also served as a vital backstop against poverty when all else failed. Many a European noble family resorted to selling the family silver or jewelry when financial bets went wrong. Now this outcome might not have been ideal, but it did put food on the table at a time when there was no social safety net.
However, these historical lessons have largely been forgotten today. Instead, we live in a world where many people put their savings in the stock market, which we are told by the financial media will provide 10% returns from now until forever (hint: it won’t). Others stay 100% in cash, earning a paltry 1% or 2% a year while inflation eats it all up.
Most households are woefully under-allocated to alternative assets such as antiques and bullion. Even a small addition to the average person’s portfolio would go a long way to blunting the risks associated with more traditional asset classes. Financial self-defense counsels us to hold a broad basket of assets, with an emphasis on what is currently undervalued. So you can feel reassured that when you buy a fine Edwardian diamond pin or a set of sterling silver flatware, history is on your side.
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