In the last blog on often ignored portfolio risks we discussed custody, fiat and concentration risk, that every investor needs to be acutely aware of. Now it is time to analyze the various asset classes in more detail, and to determine what should be included in a balanced and crisis-proof portfolio.
Real Estate
Most people aim to live in their own home, be it a small apartment, a house or a mansion. Fully paid, your own home is certainly a great asset that protects you against inflation and provides a decent place to live, if you lose your job. Real estate that you buy to rent out, can also be a good investment, but the risks are higher.
Over the past decade property prices around the world have risen substantially. Price increases of 100 % and above are not uncommon. The housing markets especially in metropolitan regions of Canada, New Zealand, Sweden, Norway, Australia, and China are in bubble territory, and prices in other countries also give reason for concern.
Many families have to borrow money several times their annual income, just to purchase a small home. This is a big bet that the future will be fine. But mortgage rates will most likely go up in the next 10-20 years, especially in Denmark where you can already obtain a mortgage with negative interest rates. Your job prospects might also not be as good, as you currently think. If you can’t afford your monthly mortgage payments anymore, your bank will have no qualms about foreclosing. And if the property bubble bursts, which is becoming increasingly likely, your mortgage could be “underwater”, i.e. the value of the outstanding debt will be higher than the market value of your property. This occured in the aftermath of the Great Financial Crisis (GFC) 2007-09 in the USA, where many families lost not only their homes but also all their savings, and some of them are still paying off their debts today. Expect it to happen again.
If you, and not your bank, own your home it makes sense to keep it. The same applies, if you have bought a house many years ago at a low price, and if you have mostly paid off your mortgage. However, if you are renting and considering buying not only at the current inflated prices but also with a very large mortgage, then it is probably better to wait. After prices have corrected to a realistic level in relation to incomes, there will be fantastic opportunities to buy, even though interest rates are likely to be higher.
In case you are lucky enough to have too much cash and want to acquire physical assets, buying now is an option provided that you find an investment property that is not grossly overpriced. You should consider searching in a stable jurisdiction outside your home country (or outside the EU if you live there). This gives you a plan B in case the situation at home becomes intolerable. However, buying assets in markets that are not familiar incurs elevated risks. Many people who have bought a villa close to the beach on impulse during a holiday trip, have learnt this the hard way. Intensive prior research is mandatory if you don’t want to lose a lot of money.
Stocks
A second asset class that is high on the purchasing list for many people is stocks. They can be great investments, as they offer potential price appreciation and also annual dividends. Unfortunately, stock prices in many countries around the world are in a bubble. Since 2009 the MSCI World index of large- and mid-cap stocks has gone up by 128%, whereas the corresponding GPD only went up by 37%. This means stock values have grown 3.5 times faster than GDP. The highest divergence is in the USA where the S&P 500 index has grown 5.4 times faster than GDP. Stock values in Europe have also grown sharply, with the STOXX Europe 600 rising 3.6 times quicker than GDP. Only in emerging and frontier markets has stock index growth underperformed GDP growth.
Contrary to what many financial advisors are telling you, stocks don’t always go up. The Japanese Nikkei 225 Index peaked at almost 39,000 at the end of 1989. In the following years it collapsed to a low of 7,800 and is now trading at close to 24,000. This means that three decades later it is still 38% below its historical peak. Even if a stock market takes off spectacularly, this does not necessarily mean that you will get richer. The Venezuelan IBVC went up 2,950 % in the first 9 months of 2019. However, at the same time inflation peaked at 340,000 % (this is no typo). Keep that in mind, the next time you hear someone say, that the Dow Jones – currently around 28,500 – will go up to 60,000 in the next few years, or even to 650,000 within 50 years, as billionaire Ron Baron recently predicted. Nominal gains do not necessarily equate to real gains.
As stock prices are at extremely high levels caution is required. That doesn’t mean that equity prices can’t go up further. As part of a “blow-off top” prices can rise another 20%, 40% or more within a short time, followed by a sharp and rapid drop that might test new lows. Alternatively, our desperate central bankers can (or most probably will) intervene to keep the casino going by directly buying shares. Based on what has happened in Japan, where the central bank owns almost 70% of the country’s ETF and is a Top-10 shareholder in over 50% of all listed companies, such a scenario is not far-fetched. Welcome to the Communist Republic of the USA or EU, where all listed companies will be managed by enlightened bureaucrats and selfless politicians. We have seen it before in several countries around the globe, and we know how it ended.
Big money managers can easily make money in the stock market regardless of its direction, by using insider information, high-frequency trading and other (legal or illegal) investment techniques. The average retail investor does not have such tools. He or she usually gets in too late, when the market goes up, and is unable to get out in time, when the market drops. Embarking on binge-buying in the hope of a central bank bail-out every time the market is turning, has been a very successful strategy over the past decade. But with stock valuations increasingly detached from the real economy, risks are growing. Will central banks be willing to rig the stock market forever, thereby stifling real growth and causing huge market distortions? And will they continue to be able to control the markets, or will they eventually lose control? Nobody knows for sure, but we certainly won’t bet the house that the current mania will continue indefinitely.
Nonetheless, there are still companies worth investing in. Look for “value” firms with a strong balance sheet (i.e. little debt and high liquidity), a durable competitive position in their market, low exposure to economic downturns and an acceptable price level. Some specific sectors such as emerging markets, mining, commodities and new technologies will offer great opportunities until they are discovered and promoted by the financial media. On the other hand, be extremely careful with “growth” stocks, whose prices have skyrocketed over the past few years (the NASDAQ Composite, which represents technology and other growth stocks, is up by over 400% since 2009). Definitely avoid companies that pay for growth with mounting losses and/or exhibit questionable corporate governance. Most of them will see their stock prices collapse, once the downturn gets underway.
Most retail investors don’t buy stocks directly, but rather put their money in mutual funds or ETFs. Mutual funds are professionally managed financial vehicles, that pool money from many investors to purchase securities like stocks. Though this is in theory a great idea, the data shows that most fund managers can’t consistently beat the reference index. In addition, fees can be substantial. Purchase or “load” fees can be as high as 5% and annual management fees usually range between 1% and 2%. At the end of a business cycle, the average retail investor usually finds out, that most of the generated profit has gone in fees to the firm offering the fund.
Exchange Traded Funds (ETF) are financial vehicles that pool the money of many investors and try to track an index such as a stock index. Unlike mutual funds, ETFs are traded on exchanges and can therefore be bought and sold faster than mutual funds. Their fees are also much lower. You just pay a brokerage commission for the purchase and sale and the annual management fee can be as low as 0.03 %.
But low cost comes with a risk. First, ETFs just replicate an index and don’t engage in fundamental analysis and active stock selection. This is fine when the market goes up, but is likely to lead to higher losses compared to actively managed funds, when the market goes down (at least if the management of the active fund is worth the money that it charges). Second, most ETFs engage in securities lending, some of them up to 50%. This generates additional income for the ETF, but also increases counterparty risk, as the borrower of the stocks (usually a short-seller) might default and the provided securities won’t be insufficient to compensate for the value of the loaned stocks. Third, there are synthetic ETFs that don’t own any assets of the underlying index directly. Instead they use derivatives such as swap agreements, in which a counterparty – often a bank that owns the ETF provider – agrees to pay the ETF the return of the index. This can cause heavy losses once the market reverses and counterparties start to default. Fourth, ETF prices can deviate significantly from those of the constituent securities, especially if the ETF contains many illiquid assets or if there is high stress in the financial system. If retail investors lose faith and overreact, this can result in fire sales and a disproportionate drop in the price of the ETF. In summary, despite their low cost, ETFs carry much more risk than most financial advisors will admit. Carry out your own research before investing.
Shares of many companies are currently trading at record prices. Great caution is therefore required when investing in today’s stock market and the overall share of equities in your portfolio should reflect this. Nonetheless stocks belong in every portfolio. The best way is to buy them directly. If you lack the time or expertise to select individual stocks, purchasing mutual funds or ETFs is an option, provided that you are fully aware of the associated costs and risks.
Bonds
Many people consider stocks to be a risky investment. On the other hand, they see bonds from private companies as low risk and government bonds as risk-free. This might have been the case in the past, but not anymore. With their low/negative interest rate policies and their extensive bond buying programs, central banks have created a bond bubble. As higher bond “prices” mean lower bond “yields”, this has allowed governments and corporations to borrow money at very low or even negative rates.
Bonds with negative yields: At its peak in August 2019 there were bonds worth more than USD 17 trillion (equivalent to more than 20% of world GDP) that carried negative yields, among them over USD 1 trillion from private corporations. Negative interest rates mean, that you need to pay someone to borrow money from you. Such an investment only makes sense if you i) are forced to invest in the respective bonds as some insurance companies are, ii) expect a further drop in interest rates, or iii) are convinced that you can sell the bond before maturity to someone else at a much higher price than you paid. In the event that you can’t sell it, you will have a guaranteed loss.
Junk bonds: Bonds of companies with a credit rating below BBB are called “high-yield” or “junk” bonds. In the past they could only be sold, if the issuer was willing to pay much higher interest rates than successful companies with strong balance sheets. This is not the case anymore, as investors have scrambled to buy anything, that still generates a positive yield. Consequently, the spread (= difference in yield) between junk bonds and so-called investment grade bonds has dropped to below one percentage point and there are even junk bonds that carry a negative yield. Considering that many issuers are likely to go bust in the future (some even before the next downturn), current yield levels hardly compensate for the huge risk.
Investment-grade bonds: Bonds rated between AAA and BBB are deemed to have at least adequate capacity to meet financial obligations and are therefore deemed as “investment-grade”. For bonds rated AAA to A this might be true, but BBB rated bonds are not what they used to be. Traditional requirements for strong loan covenants and adequate financial disclosure have been diminished to the point, that most of them are now covenant-lite. In addition, in view of their level of debt alone, the majority of BBB bonds should have a junk bond rating already. Based on their track record prior to the GFC, it can safely be assumed that our venerable rating agencies will only start to downgrade many bonds to non-investment grade, once the next recession is in full swing.
Government bonds: Most Western governments are highly indebted. If they were companies, their bonds would hardly be investment-grade. Nevertheless, most European countries were able to issue at least some bonds, that are now carrying a negative yield. Even the 10-year bonds of crisis-prone countries such as Spain, Italy and Greece only yield 0.4%, 0.7%, and 1.5% respectively. Austria was even able to launch a 100-year bond at 1.2%. Does this sound attractive to you?
The situation in the USA looks a bit better. But even here 10-year treasury notes yield only about 1.9% which is certainly insufficient in view of the growing debt pile and other risks. Only if you need to park your money temporarily, does it make sense to invest in short-term treasury bills (T-Bills), that currently generate around 1.6% for a duration of between one and six months.
Emerging Market bonds: Many bonds from issuers in emerging markets have attractive yields. But they entail high exchange rate and default risks and therefore require thorough research. Better leave them to the professionals who are used to getting burnt. Franklin Templeton Bond Funds just lost USD 1.8 billion on its exposure to Argentinian government bonds …… who could ever have foreseen that.
Over the past few decades, investing in bonds has been profitable. But with current prices at very high levels, even institutional investors are finding it difficult to make money. For the normal retail customer, bonds carry substantial risks but offer at best very low returns. Purchasing bonds of allegedly solvent companies and governments is hardly attractive, as their return is well below the rate of inflation. To invest in junk bonds and low rated investment-grade bonds carries the risk of heavy losses, that are not compensated by their low yields. Buying negative yielding bonds is gambling and will end badly for most investors, except if interest rates go much further into negative territory and cash is made illegal. Derivative products are even worse. Run as fast as you can, if someone – probably the nice relationship manager at your local bank – offers you a Collateralized Loan Obligation (CLO), a security that is backed by a pool of loans and sold to investors in various “tranches”. They are very reminiscent of Collateralized Debt Obligations (CDO) that were at the heart of the Great Financial Crisis.
Central banks have created the current bond bubble. Investing in bonds is therefore a bet, that they will continue their current policies and, if necessary, buy all outstanding bonds at inflated valuations to prevent any sharp drop in price. However, if central banks reverse their policies or lose control of the market, the prices of bonds are bound to crash. We would not bet the house, that central banks will forever be able to prevent the bubble in stocks and bonds from bursting. Considering the high risk and low/negative return of bond investments, we think it is better to keep money in cash or buy assets with higher potential profits such as gold.
Life insurance
Many people have bought a life insurance policy as an allegedly safe investment that offers decent returns. In the past such policies might have had some justification, provided that they generated high tax savings. But nowadays their disadvantages prevail. To begin with, life insurance policies are highly inflexible: It is easy to get in, but costly to get out. The latter applies particularly to investment-fund-related products, that have been aggressively promoted by offshore financial advisors. Management fees and insurance costs (for insurance that is often not needed) are another reason for concern. They are hardly ever properly disclosed and can be excessive. Finally, thanks to the ultra-low interest rate policies of our central banks, interest payments for the money that is actually saved hardly compensates for inflation. Even for insurance companies this business is not as interesting as it used to be, and many companies are trying to sell some or all of their policies to financial intermediaries. This adds another level of risk to the policies, that many customers are not aware of.
Most life insurance policies will only provide small nominal capital gains. Adjusted for inflation, the return will most likely be negative. This applies particularly to Europe, where insurance companies have been forced by state regulators to “invest” in government bonds with negative yields. To compensate for the expected loss, their managers have shifted the remaining money into increasingly risky “investment-grade” bonds and some bond related derivates. Insurance companies don’t publish details, but we must assume that a growing share of their assets are in – existing or soon to be – junk bonds. As Warren Buffet remarked: “You never know who’s swimming naked until the tide goes out.” Expect it to be an ugly sight and don’t be surprised, if several large insurers go bankrupt or are rescued just in time at the expense of the insured.
Everyone with a life insurance policy should carry out a thorough analysis of the policy (including all the fine print), the expected return that it promises, the financial strength of the insurance company and whether the company plans a sale of its life insurance business and to whom. If there is any doubt, it makes sense to sell the policy as quickly as possible. If you have a family to look after, just keep the death benefit part and get rid of the savings part. If that is impossible, consider selling it and getting a new policy just for the case of your death.
We fully understand that there is a mental barrier, that prevents many people from getting rid of their life insurance policies. But it can be done and if you invest the proceeds in more lucrative projects, it can be a life changing decision.
Bank accounts and cash
Almost everyone in the Western world has a bank account. Many maintain accounts with several banks, but the majority of their funds are usually held with a single bank in their home country or even home town. It seems that most of us are either not aware or don’t care about the risk of capital controls and bank defaults. Both should not be underestimated in view of the dismal situation of our financial system.
If there is a liquidity crisis, a bank or the government can implement a partial or full freeze of your account for a few days, weeks or even months. This happened in Greece in 2015. If a bank faces default, it can use bail-in regulations enacted in the USA and the EU, to give you a “haircut” (i.e. cancel part or all of your deposits without compensation) or convert your money into worthless bank stock. Cyprus, a member of the EU and the Euro area, provided a testing ground in 2013. Expect more such cases in the future, which might also cause the various deposit guarantee schemes to collapse. Better don’t count on your government to bail you out.
Maintaining several bank accounts is a must. At least one of the accounts should be held with a strong financial institution in a safe offshore jurisdiction. A multi-currency account is preferable, as it allows you to easily shift assets between various sub-accounts to alleviate the effects of “currency wars” that have already started. Some of you might counter, that banks outside Europe, Canada, Australia and the USA are not safe. The opposite is true. We rather keep our money with some banks in Asia, than with most failing banks in Europe. Thereby we also have a great currency hedge against the inevitable decline of the Euro.
Holding some cash at home or in a private safety deposit box outside of the banking system makes sense, as long as inflation isn’t high and cash is widely used. Just be aware that keeping large denomination banknotes (e.g. USD 100 or EUR 500/200/100) might not be a good idea, as they can be withdrawn from circulation overnight. It happened to 500 and 1,000 Rupee banknotes in India in 2016.
Don’t plan to keep cash as a long-term investment. As governments have already started their “war on cash” (allegedly to counter money laundering and terrorism, but truly to further control the populace and spread negative interest rates) and most people are more and more using electronic forms of money, cash is rapidly becoming a thing of the past. To store millions of USD or EUR banknotes in your basement, might therefore not be the best idea. Some drug lords, despots and corrupt officials with unqualified financial advisors will most likely be in for a big surprise. Serves them well.
Precious metals
Cash, bonds and life insurance policies are directly dependent on the value of fiat currencies. Even though stocks and real estate have intrinsic value, their current inflated prices are a direct result of excessive central bank money creation. Once trust in fiat currencies evaporates (which will happen at some time), the value of real estate, stocks, bonds, life insurance policies, and cash will plunge (at least in real terms). On the other hand, the value of gold and silver, that has been systematically manipulated down by commercial “bullion” banks with the tacit approval of central banks and governments, will soar.
We are certainly not gold bugs, but in view of the current monetary insanity everyone should consider investing in physical gold. Although fiat currencies are not backed by the yellow metal, it has always retained an influential role within the monetary system. Since the GFC, central banks have added many tons of gold to their balance sheets and a recent article by the Dutch central bank (DNB) states: “A bar of gold always retains its value, crisis or no crisis. This creates a sense of security. A central bank’s gold stock is therefore regarded as a symbol of solidity ….. Shares, bonds and other securities are not without risk, and prices can go down. But a bar of gold retains its value, even in times of crisis. That is why central banks, including DNB, have traditionally held considerable amounts of gold. Gold is the perfect piggy bank – it’s the anchor of trust for the financial system. If the system collapses, the gold stock can serve as a basis to build it up again.” If central banks still trust gold, why shouldn’t you? And it also makes sense to own some silver, which is often called the “Poor Man’s Gold”.
How and where should you hold precious metal? An easy way is to purchase shares in gold or silver ETFs, which are available through most brokerages. But if you read the fine print you will realize, that you don’t really own the metal, but rather have a claim to an equivalent amount of money. The same applies if you use the service of a bank or a provider of unallocated and non-segregated storage. There is a high risk that no precious metal was ever bought, or that the metal was lent to a third party without your knowledge. The latter is standard practice. It took the German Bundesbank 4 years to repatriate 583 tons of gold from New York and Paris back to Frankfurt, an endeavor that could have safely been accomplished within a few months. Imagine how long it will take you in a crisis, to “repatriate” your own gold and silver.
The only way to really own gold is to buy it in a physical form and store it at home, in a safety deposit box outside of the banking system, or in a private vault that offers fully allocated and segregated storage and keeps your assets in bailment. Be aware that a lot of fake gold is sold today, and that many vault operators don’t fulfill minimum standards regarding asset security and the safety of your personal information. There are also many middlemen with questionable background, who are after your money. It is therefore mandatory to conduct proper due diligence.
It is prudent to store at least some of your precious metal outside of your home country, or outside of the EU if you are living in one of its member states. Private ownership of gold was illegal in the USA between 1933 and 1974 and future gold confiscation in Western countries can’t be completely ruled out, even though modern fiat currencies are not backed by gold anymore. To store gold and silver abroad will also enhance your global mobility, in case the fiat currency system collapses in your home country or globally.
Cryptocurrencies
Gold and silver have three main disadvantages: They need to be physically stored somewhere, they are expensive to transport in larger amounts and with adequate security, and it is difficult to transfer them across borders (try to take a kilogram of gold on your next international flight and see what happens). Cryptocurrencies or “cryptos” such as Bitcoin don’t have these restrictions, as they are digital and borderless. If you have access to the internet and the private keys, you can trade them anywhere in the world.
Whereas gold has been used as money for thousands of years, Bitcoin was launched only in 2008 and other cryptos even later. Prices of cryptocurrencies have fluctuated even more than the prices of gold and silver. For instance, in 2017-18 Bitcoin went up from USD 1,000 to almost USD 20,000, then dropped to USD 3,200, reversed to USD 13,000, crashed again to USD 6,700 and is currently trading above USD 7,000. Cryptos are without doubt speculative investments at this stage. They can go up by 1,000 % and more, but they can also crash to zero.
Many people argue that cryptocurrencies have no value, because they are backed by nothing. The latter is certainly correct. But are fiat currencies backed by anything? Even gold does not have a real intrinsic value, apart from the fact that it feels good in your hand and looks nice on beautiful women. Eventually the value of a good depends on what others are willing to pay for it. And if there are people, that are willing to buy fiat currencies, gold or cryptos, then these items have value, irrespective of whether it is intrinsic or not.
Bankers and politicians also claim, that cryptocurrencies are (only) used for drug trafficking and money laundering. This is a ridiculous argument. If we take it seriously, then we would have to ban all fiat currencies and also close down governments and banks. Just remember that Denmark’s Danske Bank is accused of laundering EUR 200 billion through its Estonian branch. This is a lot more than the current market capitalization of Bitcoin, which stands at about EUR 120 billion. Despite what many officials claim, cryptos are not fully anonymous, as they are based on a public blockchain that contains all information on previous transactions. Therefore, better report the profits of all your crypto trades, as the U.S. IRS and other tax authorities have ways to track you.
A valid argument against cryptocurrencies is, that their technology is new and not time tested. They might get hacked due to poor programming or by the sheer computing power of quantum computers, that are currently being developed. Another risk is, that governments will declare private cryptos illegal and/or launch their own state-backed cryptocurrencies (China has already declared, that it will soon introduce a digital yuan). A more detailed analysis of these and other risks is a topic for another blog.
Arguments in favor of cryptos are, that they are borderless and that transactions can be carried out cheaply in minutes or seconds, whereas traditional bank transfers might take days or weeks and can cost a substantial amount of money. Another advantage of cryptos is, that you can avoid custody risk, provided that you control your private keys. As with gold and silver, the value of cryptocurrencies is mostly independent of the value of fiat currencies. Whereas central and commercial banks can increase the supply of fiat money without limitations, the supply of many cryptos is finite. For instance, there will be no more than 21 million Bitcoins, of which over 18 million have already been mined. Would you rather believe in cryptos or your home fiat currency? Citizens of Venezuela and Zimbabwe have already answered this question. Without access to Bitcoin or some other cryptos, many of them would not have been able to buy food and medicine.
Despite the many ups and downs, cryptos are still around and the number of users is growing, particularly among the younger generation. We would rather invest in cryptocurrencies, than in Austria or Argentina 100-year bonds, obscure Collateralized Loan Obligations (CLO) or synthetic ETF sponsored by failing banks in Europe.
Consider acquiring some Bitcoin and/or some other well-established “altcoin”. Avoid buying most of the several thousand tokens, except if you are into gambling. Many of them lack a sound concept and implementation team, or are outright scams. They can certainly generate huge profits in the short-term, but are likely to crash to zero in the not too distant future. Don’t keep your cryptos on an exchange, as most of them have been hacked in the past and quite a few even have gone bust, creating huge losses for their customers. Instead store them in a hard wallet and ensure, that you are the only person who has the private keys.
Buying cryptos is without doubt risky. You can generate exceptional returns but also severe losses. Therefore, only invest money that you are prepared to lose. If you are lucky, you might experience life changing profits that you will never achieve in the stock market or with real estate.
Other assets and debt
To hold other physical assets makes sense, provided that you bought them at a low price and that you can easily sell them in the future. Some websites are suggesting that you purchase vintage cars, pieces of art, wine or whiskey. This might be a good suggestion for specialists in their respective field, but for the average citizen it is a high-risk investment. Not only can prices fluctuate widely, but you also have to provide secure storage. Only wine and whiskey seem to be safe bets. If the economic crisis causes a shortage of food and water, you have an asset to survive on. And you will probably be the only one in your neighborhood who is constantly in high spirits.
Most people not only have assets, but also debt. To increase debt in an era of low or even negative interest rates seems to be straightforward. This is the reason, why the top management of big corporations and hedge funds has been keen to increase their levels of debt. Nowadays the average citizen can get a mortgage at very low rates, but we have already warned above about the associated risks. Car loans, student loans, consumer loans, credit card loans and bank overdrafts still carry high interest rates, some of them in the double digits. In addition, interest rates can go up substantially, if central banks reverse their policies or lose control of the market. Of course, there is a possibility, that future governments will cancel all debt or that hyperinflation will eliminate your debt burden. But there is a much higher probability, that you will end up as a debt slave before that happens (many of us already are). Therefore, it would be better to pay off debt quickly, even if it means, that you have to reduce your standard of living.
Crisis portfolio
Only fools, charlatans and soothsayers claim, that they know exactly what will happen in the future. We certainly don’t make that claim. The economy is far too complex. Its direction depends on the future actions of a large number of people, be they politicians, central bankers, hedge fund managers, high net worth individuals, CEOs, middle managers or consumers. But in view of the huge pile of debt in our global economy and the increasingly desperate behavior of politicians and central bankers it is obvious, that trouble lies ahead.
Several scenarios are possible, such as a gradual decline mostly affecting the middle class (as is currently the case) or a sudden collapse. We can neither rule out deflation, nor hyperinflation, nor a combination thereof. The response of governments is likely to differ between countries. Some governments might just increase taxes and implement capital controls. Others might expropriate assets and severely curtail economic freedom. The emergence of civil wars and dictatorships can’t be ruled out.
You need to build a portfolio, that can withstand all kinds of future developments. If one asset class loses value, other asset classes must compensate for it. This is easier said than done.
Many middle-class families have invested most or all of their money into their family home. This is certainly understandable but also very risky, especially if the property is mortgaged up to the roof. It is better to allocate your total assets to various investments with different or even opposite risk profiles.
Your financial advisor will tell you, that the investments he/she proposes have different risk profiles, based on the latest and most sophisticated statistical models. The use of such models is widespread nowadays, even though they are usually based on a limited set of data and also don’t consider what scholar and writer Nassim Taleb calls “black swan” events. These are occurrences, that are far beyond the realm of normal expectations but still happen (take for instance a Turkey, that is fed and coddled over a period of a 1,000 days, just to be butchered on day 1,001 to become the main ingredient of a delicious Thanksgiving dinner). Most investments models developed by financial advisors and hedge funds will not work in times of severe economic stress. Think twice before you invest all your money based on a model, that you either don’t know or don’t understand.
In summary, the following should be considered when building a crisis-proof portfolio for the uncertain times ahead:
General principles:
- Invest in 5 – 10 different assets, that you fully understand and whose value you can track regularly. Focus on “return of assets” and not “return on assets”. Once the worst is over, you will have the opportunity to invest in wonderful assets at very low prices
- Diversify away from fiat assets, as there is a high risk, that the main fiat currencies such as the USD, EUR, AUS, CAD, JPG will fail. Consider investing part of your money in assets, whose value is independent of fiat currencies, such as physical gold/silver and cryptocurrencies
- Diversify between custodians as every service provider is vulnerable to bankruptcy, confiscation or fraud. In particular don’t keep all your money with a single bank, all your securities with a single broker or all your precious metal in a single vault
- Diversify internationally by holding assets around the world as the situation will likely differ between countries. Having assets away from home will help you to move abroad, if the situation in your home country becomes intolerable.
Assets that derive their value directly from fiat currencies:
- Bonds: Evaluate your bond portfolio. Dispose of high-yield “junk” bonds and investment-grade bonds that are BBB rated. Stay away from negative yielding bonds and derivative products such as Collateralized Loan Obligations (CLO). Use short-term government bonds with a yield above 1% to park money temporarily
- Life insurance: Conduct a thorough analysis of your life insurance policies. If anything looks suspicious, sell them immediately. If you want to protect your family in the case of your death, get a policy that only provides death coverage
- Bank accounts and cash: Maintain several bank accounts, among them at least one offshore account in a stable jurisdiction. Keep a sufficient amount of cash at home or in a non-bank safety box for emergencies.
Assets that have an intrinsic value, but whose current inflated prices are the direct result of excessive fiat money creation:
- Real estate: Try to pay off your mortgage quickly. Refrain from buying overpriced real estate financed with large debt. If you just bought an apartment or house at inflated prices, consider selling it as long as prices stay elevated
- Stocks: Reduce your exposure to stocks, if equities make up a large part of your portfolio. Sell loss making “growth” stocks and instead invest in value stocks with low debt and high cash reserves. Avoid mutual funds and ETFs that lend out a high percentage of their assets or use derivates to prop up performance. Stay clear of synthetic ETFs and derivate products that nobody can explain to you in a few sentences
Assets with no or very low exposure to fiat currencies
- Precious metals: Buy physical gold and silver and store it at home, in a non-bank safety deposit box, or in a vault that offers fully allocated and segregated storage on bailment. Sell all paper gold such as gold ETFs and gold bought from and stored at a bank
- Cryptocurrencies: Invest some money, that you can afford to lose, in cryptos with a sound track record. Keep them in a hard wallet and ensure that you are the exclusive owner of the private keys
It would be unprofessional to go further into details regarding the appropriate share of each asset class in your portfolio, or even the single components in each class. This depends on your citizenship, your residency, your professional background, your international experience, your age, your family, your risk aversion and many other factors. If you have specific questions, please contact us at info@livebeyondborders.com.
Disclaimer: The above is for informational purposes only. It is not an offer or advice to buy or sell any products or services. LBB and its owner do not provide investment, tax, legal, or accounting advice. Neither the company nor the author is responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any content, goods or services mentioned in this article.
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