"No man can become rich without himself enriching others"
Andrew Carnegie

Tuesday, May 14, 2013

How to Invest for an Uncertain Financial Future

The Snowball: Warren Buffett and the Business ...
The Snowball: Warren Buffett and the Business of Life (Photo credit: Wikipedia)
By Investmet U

Chicago, May.14, trading stocks .- In Friday's column, I laid out what I believe is the greatest threat facing financial markets today: the propensity of national governments to tax, spend and regulate too much. The unintended consequence is to suppress economic growth, discourage risk-taking by entrepreneurs and investors, and crowd out private borrowing.

How will this all end?

The truth is no one knows, although opinions abound. Some predict an inflationary spiral. Others call for a deflationary depression. Still others argue that we will muddle through relatively unscathed.

However, your financial well-being is too important to stake on some talking head's worldview or economic theory. Government profligacy has us sailing in uncharted waters. As an investor, you need to gird yourself for anything and run your portfolio accordingly. Here's what I mean...

Are we headed for an inflationary spiral? If we reach a point where the U.S. government tries to repudiate the debt by accelerating the borrowing and devaluing the greenback - not a foregone conclusion as some gold bugs would have you believe - the answer may be yes.

This means a generous portion of your net worth should be invested in real assets like gold, silver, Swiss francs, TIPS (Treasury Inflation-Protected Securities), commodities and real estate.

Own your home instead of renting, and sock money into bullion and coins, numismatics, foreign currency accounts either overseas or at financial institutions like EverBank, and own TIPS and commodity ETFs like iShares Barclays TIPS Bond Fund (NYSE: TIP) and iPath DJ-UBS Commodity Index (NYSE: DJP).

Of course, the champion spender among major governments is Japan, whose debt-to-GDP recently surpassed 250%. That's more than twice our own rate. Yet Japan's problem is not inflation but disinflation.

What thrives in a disinflationary environment is bonds. So you should also own a slug of high-grade and high-yield corporate bonds and munis. Individual bonds and low-cost ETFs are your best bet. Avoid leveraged bond funds - which will get killed when interest rates tick up - and be sure to ladder your maturities to insulate yourself from interest-rate risk.

Positive Signals

Of course, we may have neither an inflation or a deflation problem. We may well experience continued prosperity. (Warren Buffett recently opined that he is "an unbridled optimist about America's future.") This country has always rallied in times of crisis. Never forget the words of Winston Churchill: "You can always count on Americans to do the right thing - after they've tried everything else."

I know it's hard to imagine members of either party saying no to spending - including Republicans who tend to be rhetorically conservative but operationally liberal when it comes to fiscal policy - but there may be enough men and women of courage in Congress to eventually pass bipartisan legislation that puts the country back on a sound fiscal track.

That won't happen this year.

But if it occurs down the road, you can expect stocks to press higher, especially those that are posting positive surprises in market share, sales and net income. You want to own great companies, especially those in the top 10% of earnings growth or under heavy accumulation by corporate insiders. Both are overwhelmingly positive signals.

Please don't make the mistake of listening to investment advisors and other pundits who suggest you sit out the current rally in cash. If you've done so until now, you've already missed a substantial move in the market. With interest rates as low as they are, you can't risk missing even more.

But what if the market tanks?

This is the risk every stock market investor faces. But if you've stuck with my advice to here, you already are diversified beyond the stock market and into real estate, precious metals, commodities, corporate bonds, munis and inflation-protected Treasurys.

You need to own equities too... but with downside protection.

That means you should run a trailing stop behind each position. That protects both your principal and your profits, offering you unlimited upside potential with strictly limited downside risk.

There’s Plenty Right, Too

Follow this advice and you are asset allocated, diversified and risk protected. Deviate from it and you are just guessing... because you don't have a crystal ball and neither does anyone else.

I spoke to a gentleman the other day who said that with all that's wrong in the world today he didn't understand why the stock market didn't just crash.

Well, there is plenty wrong with the world. But there is plenty right too.

Let's not forget that we are in a period of low interest rates, low inflation, rising productivity, expanding markets overseas (especially in Asia and Latin America), and record corporate profits. You don't hear enough of this from the national media, which delivers the news through a prism of negativity designed to attract viewers and please advertisers.

Government profligacy may indeed lead us into a financial crisis down the road. But the stock market only looks out six to nine months. It can't - and won't - discount a financial crisis that might arrive in, say, 2019. In other words, don't expect to see a fire until investors get their first whiff of smoke.

In the meantime, you have financial goals to meet. But you won't meet them sitting in cash, overinvesting in gold or kneading your fingers. Successful investing is about managing risk. You do that by asset allocating, diversifying, sticking to quality and running trailing stops to protect your positions.

That's why you should do just that....

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