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Investing to Minimize Risk and Beat Inflation

IMG Auteur
Published : November 06th, 2012
2800 words - Reading time : 7 - 11 minutes
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Category : Investing

 

 

 

 

Between the spooky holiday and that even spookier hurricane, it was almost easy to forget for a moment or two that we citizens of the "land of the free" have a presidential election coming up in a matter of days. What sweet respite it was, if only for a few hours. But with only days left in this advertising blitz, it is about time to start thinking about the cold realities this political economy will face regardless of the outcome of the pseudo-choice at the polls on Tuesday.


The implications of the economic storm building up power off the coast as I write are enormous for us as individuals – the weight of the global sovereign debt bubble, the continued obscured insolvency of the big banks, and a sputtering economy with massive (albeit unreported) underemployment. Will this election change anything? Does the choice of a flag-pin-wearing donkey or elephant have implications for the stock market?


The long-term picture may be crystal-clear, but in the short term, there is much to be discussed. The folks over at Mauldin Economics – particularly concerned with the impact of everything from the pending capital gains tax increase as a result of the expiring Bush tax cuts to the massive shift into bonds – have put together an outstanding faculty for an upcoming seminar to discuss exactly that:


Mohamed El-Erian, CEO and co-CIO at trillion-dollar bond management firm PIMCO;


Gary Shilling, one of the most recognized market analysts of our time and publisher of the widely read Insights letter; and


Barry Ritholtz, market strategist, author of Bailout Nation, and editor of The Big Picture, which is among the most widely read economics blogs with market insiders.


And others to be confirmed. That's quite the lineup John has managed to arrange... but we rarely expect much different from arguably the best-connected independent analyst we know. I'm certainly looking forward to watching. If you are too, you can sign up here.


In today's edition of the Daily Dispatch, we have Dennis Miller, a lone voice of sanity in preparing your finances for retirement, weighing in on what's scarier – being all-in in the stock market or letting inflation eat away your bank accounts and CDs. Then Vedran Vuk touches on some shoddy research coming out of some major financial institutions. Thanks to all of you, our dear readers, keeping us honest, Vedran also offers a minor correction to his recent dividend article and uses the opportunity to make a few notes on ex-dividend dates and record dates that will be useful to anyone chasing yield in this low-interest-rate world.


And of course, we have some Friday Funnies for you.


Last, I want to call attention to a fascinating train of thought from the folks over at Stansberry Research. Like Doug, Porter Stansberry is among the most controversial of our peers in the independent research space – his big-stakes bet with Marin Katusa about the future price of oil and assertions that America ended already and we're all just now finding out being not the least among them. This time around, Porter paints a thought-provoking picture of a new political dynasty. As busy as I find myself lately, I'm not much for these longish videos, but this one kept my attention when it landed in my inbox yesterday morning.


Filling big shoes for David and Vedran this week, I hand you over now to the good stuff,



Alex Daley
Chief Technology Investment Strategist
Casey Research



Damned if I Do, Damned if I Don't


By Dennis Miller, Money Forever


David F., a Miller's Money Forever subscriber, recently sent me a question that hits close to home for many of us.


David F. wrote:


"I have looked at a lot of dividend-paying stocks, but I have been reluctant to buy because my sense is that the market as a whole is overvalued and ready for a dramatic decline. Based on past experience, such a decline will affect all stocks, not just the most overvalued ones. If I buy dividend stocks and there is such a decline, I could be looking at a 40% loss. Even if I defend with stop losses, I could expect a 20% hit. What is your strategy for dealing with this situation?"


Fear of investing is real and understandable. And I can certainly relate to David's fears. As I approached 60, my wife and I had decided on a "magic number" – the amount we thought we needed on top of Social Security to retire comfortably. When we finally hit our magic number, it was a huge cause for celebration.


But then 9/11 happened. We took a huge hit and dropped back down well below our magic number.


We were devastated, both financially and emotionally. The red numbers on our Quicken report sent me into shock. It took such an emotional toll, I promised my wife that once we got back over that number, I would never let us fall back into that position again.


Instead of gearing down to retire, we shifted gears and started working harder than ever.


After a few years, we were back where we needed to be, and I made good on my promise. I took all of our money out of the market and built a CD ladder. It averaged around 6%, and I thought we were home free.


Then the first TARP bill was passed, and the banks called in all our CDs. (You can read the whole story my book, Retirement Reboot.) We were 100% in cash, and I started over. I must admit I felt smug because we didn't lose a dime in the market, as many of our friends had. But what I didn't realize at the time was that I too was putting my money at considerable risk.


It wasn't until the fall of 2011, when I attended the Casey Summit in Phoenix, that I realized how dangerous my "all in CDs" approach really was. There were three speakers there who shared personal stories of hyperinflation in their home countries. Had we experienced any kind of hyperinflation when all our money was in CDs, we could have lost everything. The bottom line was, seniors and savers were wiped out.


So there we sat. The market had just collapsed; my wife and I had more cash in our cash account than ever before; and I was scared to death to put any money at risk in the market. However, since then, I've taught myself how to manage our life savings differently (and better) than I had in the past.


Wading Through the Warnings


People are scared, and that's understandable. There are plenty of sources out there warning us of the dangers –sometimes with conflicting points. I read a report indicating that US corporations are sitting on trillions of dollars in cash, afraid to spend it. When major companies have cash and are reluctant to invest in their own businesses, it should concern you.


I've also come across reports warning investors against investing money they can't afford to lose. Makes sense, but isn't holding it in cash a risk as well?


Then there are the articles about the government printing money like never before. Holding on to a currency that's experiencing high inflation is a sure way to lose money. The Casey Summit speakers who recounted hyperinflation in their home countries convinced me that this is a real worry.


Oh yeah! Let's not forget to add that the entire stock market is a house of cards propped up by the Fed's printing press. Your fear of money-printing should be double-barreled – it can bring both inflation as well as an artificial bubble in the market.


So you want safe investments? I just checked my Schwab account. The best rate they have for a five-year CD is 1.5%. Who'd want to tie money up for five years for an interest rate below the current inflation rate? I sure don't! Forget about hyperinflation – today's tame inflation numbers will still crush your investment.


There are just too many financial warnings for folks to keep track of: "Don't invest money you can't afford to lose; safe investments won't keep up with inflation; invest and compound your growth or you'll have to keep working; enjoy life and sleep well, etc."


We recently completed a subscriber survey, and David's concern was voiced by many. One comment summed up a lot of fears: "I would rather have a lesser return and a guaranteed return of my money than a return on my money."


The real dilemma is how to define a return of our money. In last Friday's Casey Daily Dispatch, we provided an analysis of an investor buying a five-year CD at the going rate of 1.5%. If you believe the government-provided 2% rate of inflation, at the end of five years the net inflation loss would be $9,400. If you believe the true inflation is 6%, as I do, then you will lose $25,750. Neither alternative is appealing. Why would you invest in something that all signs point to losing and the only difference is a matter of how much? Aren't we really looking for a "return of our buying power?"


I'd rather invest in something where at least I have a fighting chance of making a gain. With a CD, I'm almost guaranteed to lose the purchasing power of my money.


So what is the lesser of the evils? My choice is to work with our research team to try to find good businesses that will survive in tough times. Many have dividend yields well above the current rate for CDs and have the potential to not only have capital gains, but for their dividend to grow as well. Even when our research team has found good options, I still recommend modest investments in those picks with only a portion of your portfolio. With such low yields out there, I feel like we are being forced into the market. But at the same time, it's doesn't have to be "all-in" decision. We could put some money in the market and keep some dry on the sidelines.


The trick is finding the right balance for yourself. It's no wonder a lot of older folks have to take pills just to sleep at night! I hope David F. understands that he's not alone; a lot of folks share his concerns.


You Know the Problem, but What Can You Do?


  • The Fundamental Rule. Start with the fundamental rule of investing: Don't invest money you can't afford to lose.

    I have to remind myself that investing in good-quality companies most likely will not make me lose all my money. While they can take a hit in bad economic conditions, you really have to be playing with fire to get completely wiped out.

  • Keeping Perspective. The first big lesson I learned during my own retirement reboot was to put my fears into perspective. You cannot allow fear to immobilize you.

    While I took comfort in not losing a dime in the market in 2008, I shuddered when I realized my "all-in" CD position was putting our entire life savings at risk.

    All in the market, all in cash, or all in anything is dangerous. Returning to the market was scary. It took a long time for me to regain confidence in myself as an investor.

    Having money in the market is like working on high-power lines. While you may have confidence in what you are doing, you'd better take all the necessary steps to protect your safety. We have all been burned.

  • Dividend-Paying Stocks. David F.'s question was a response to my article Twelve Tips for Buying Dividend-Paying Stocks. While I'm not going to repeat all twelve steps, I want to elaborate on a few points.

    I am a strong believer in using stop losses, especially trailing stop losses. They usually work best with heavily traded companies, with millions of shares traded. Also, when I refer to "dividend-paying stocks," I mean stocks bought for the dividend income, not speculative stocks that might happen to pay a dividend.

  • Limit Risk. There are ways to limit risk and still play the game. If you don't put more than 5% of your portfolio into any one investment with a 20% stop loss, the most you could lose is 1% of your entire portfolio.

    In David F.'s letter, he mentioned losing 40%. If you limit your investment to no more than 5% of your portfolio and then get stopped out at 40%, your portfolio won't drop more than 2%. I have had more than one friend say to me they wish they'd had 20% stop losses in place before the 2008 crash. They would have saved a lot of money and would have a lot more confidence in themselves today.

  • Worldwide Presence. Buy companies which have a worldwide presence, dominate their market, and have a history of paying and regularly increasing their dividends. If you buy the right stocks, their dividends continue to grow, and it won't be long before your return can be close to double digits. When there is a drop in the market, you should ask questions like: Do they still have the ability to pay dividends regularly? Can I get a similar or better yield elsewhere with the same or less risk?

  • Keep Enough Cash. If you're being conservative, you should have about 33% of your portfolio in cash. There may be buying opportunities during a market downturn; if you have the cash, you're in a better position to take advantage of them.

  • Go International. International diversification may be right for you; it's an important option to consider. There are many domestic companies that are diversified internationally, and there are also many foreign company stocks (or ADRs) you can buy here in the United States. Shell, a Dutch Company, and Nestlé, based in Switzerland, are both good examples, although I'm not recommending them.

    While all world markets are interrelated and could crash at the same time, diversifying internationally will take some risk off the table, as some countries will always do better than others.

The Value of Doing Your Own Homework


Vedran Vuk, our senior research analyst, has taught me the real value of doing your homework. Vedran was behind the wheel for our upcoming special report Money Every Month, which is targeted for a November 27 release. It's an in-depth analysis of the top-yielding dividend stocks – a virtual encyclopedia of when they pay, how much they pay, and other important parameters. (Vedran and I also work together to produce Miller's Money Forever, a monthly advisory that will help you build an inflation-proof retirement portfolio. Our subscribers will get the Money Every Month special report along with their regular subscription.)


When you find a company you're interested in, go to your online brokerage account, click on the "research" tab, and read up on the company using some of the guidelines I mentioned earlier, such as the 12 tips for dividend-paying stocks.


If you subscribe to paid services, take a really look at the model portfolios. Don't just read the newsletter's in-depth investment write-ups a single time. Go back every once in a while and check to see how companies have done since they were originally added. Are they still growing and paying (and increasing) regular dividends? Are they meeting the goals originally set in the recommendation?


After reading stock write-ups, I usually know a heck of a lot about the company. Many times I ask myself if I would like to be a part owner of the company I'm reading about. Until you can imagine yourself being a happy (and well-paid) part owner, keep researching and looking at other candidates.


And when you find what you're looking for, remember to buy in moderation.


The Risk of Doing Nothing


Do not minimize the risk of doing nothing. The biggest financial risk I have ever taken was holding our life savings entirely in CDs. Honestly, my parents had done that, and it worked well for them. I was under the illusion that our money was safe. And it was safe – if the bank defaulted.


But I realize now that it was at huge risk if we experienced any kind of high inflation. I was 68 when the banks called in our CDs. A "do-over" at 60 – when I had totally left the market after 9/11 – was difficult, but I was still working. Starting over now would be a real disaster. While inflation might not seem like a big deal now, it's something almost guaranteed to be a problem with the rate of today's money-printing. Being all in CDs now is about as smart as being all in stocks in 2008. You've got to find the right balance between the allocations to protect yourself.

 

 



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