Investment strategies have become extremely popular in the financial news, especially during the last several years. The down economy and more frequent job loss has forced many Americans to take a hard look at their finances, especially in regards to retirement planning. Millions of Americans have relied on social security and a 401(k) or IRA to get them through their golden years. This is the traditional approach, and it seemed to work out well during the decades in which American industry was still productive. It even appeared to be a good idea in the 90s and early 2000s before the tech and housing bubbles burst.
Today’s world is much different, and much less stable. Can you afford to keep all your eggs in only one or two small baskets? Unless you’re already extremely rich, or you’re expecting a bailout, you’ve got to consider more diversified investments. One of the best strategies I’ve read on diversified investments comes from the late Harry Browne. He was a financial advisor and two-time presidential candidate who specialized in keeping it simple and secure. His philosophy (and mine) was that you should divide your assets among many diversified investments, and build up that retirement fund through hard work and persistence. Leveraged or other highly managed asset funds typically do no better in the long run, and may lead you to lose your life savings.
Types of diversified investments
There are many types of investments out there, but the Browne method of diversified investments breaks them into four categories:
Cash Stocks Bonds Commodities (specifically precious metals)
Cash is simple. This is the money you have in your bank right now, as well as any funds you might have in a money market fund. Stocks are well-known, and include any you have in a 401(k) or IRA account, plus any you own individually. Bonds are title to the profits received from a loan being paid back, either to a government or private corporation. Commodities can include grain futures, oil options, etc. For the sake of this article, however, we are focusing only on the commonly traded precious metals. I’ll explain why this is later.
The point of having diversified investments is that if one type of asset loses value, you still have one or more that are doing well enough to offset that. The four above were chosen because historically, at least one of these has been up when the others went down. In other words, unless there’s a complete global financial meltdown, you will probably survive. You may not be living it up, but you won’t be dying on the street either. Who knows, you might even do really well. The goal is always to keep your eye on the ball, and not get distracted by shiny-looking get-rich-quick schemes. Your retirement is too important to risk!
The four kinds of economy
There are four different types of economic situations in which you can find yourself. Each has its own unique set of pros and cons, which is why there are four different types of diversified investments, as shown above. These conditions are:
Prosperity – There is a lot of growth in the economy, and almost everyone has a job. incomes are rising, and interest rates tend to go down. Inflation – A period in which a government-owned or licensed central bank (The Federal Reserve, in the US) increases the money supply, which results in higher prices when you buy something. Recession – A period in which economic growth slows, or even goes slightly negative. Individuals have less money to spend, and banks are unable or unwilling to loan money to people and companies as liberally. People begin to lose their jobs over time. Deflation – The opposite of inflation. This is a time when a central bank reduces the money supply, either through intentional policy, or because large asset classes have been wiped out due to unintended consequences. The depression of the 1930s was caused by this scenario.
Which diversified investment is best in which circumstances?
Now that we’ve seen the four main types of diversified investments, and the four main economic trends, let’s play connect the dots. Real or imagined prosperity leads to higher prices in stocks, as well as better bond prices. This is because stock traders feel that companies are doing well, and will continue to grow. Bonds go up because interest rates tend to go down, making lenders as well as bondholders believe that said borrowers will be able to pay the loans back.
Times of inflation benefit commodities, especially gold and silver. As the dollar weakens due to oversupply, people turn to alternatives which hold their value better. Gold and silver have been used for thousands of years, and have never been worth nothing. In fact, they have largely maintained their value over the centuries. These precious metals are hard to mine, yet have always had good consumer demand, either as money, an investment, or in industry. If you already have the gold, then you’re in a good spot. Now you have it, and they want it!
The other two popular choices are platinum and palladium. I like all four, simply because it makes my investment even more diversified. I don’t touch other commodities with a 10 foot pole for two reasons. First, foodstuffs and energy are consumable, and are heavily dependent on how well the rest of the economy is doing. If we fall on bad times, demand for these goes down, and a bad crop or a BP style drilling accident can lead to a temporary or long-term loss of production. In other words, all other commodities are too risky, in my opinion.
Bonds also tend to do well in deflationary periods, as well as in times of prosperity. How is this possible? Recall that in good times, rates go down because investors assume that the borrower is going to be able to pay on time. In a deflation situation, many unstable businesses have filed for bankruptcy during the recessionary period, meaning that the remaining ones tend to be the credit-worthy ones. Also, when there’s less money in circulation, each dollar is worth more, meaning that interest rates go down because trustworthy borrowers couldn’t afford to pay anything more. The bottom line? Lower interest rates = good bond yields.
Finally, cash is king in recessionary periods, simply because the other three investments aren’t doing well as the economy readjusts. Recessions are uncertain times by definition, which leads consumers to hold off on purchases until they know what kind of financial situation they’re going to be in long term. Fortunately, recessions can’t last forever. Either the bad investments collapse and the economy gradually returns to prosperity, or bad economic policy gets worse, which drives us into either an inflationary or deflationary period.
How to balance your diversified investments
The key to safe investing for retirement is to avoid trying to “fix” what isn’t broken. Frequent trades can not only result in expensive trading fees, but can also lead you to take unnecessary risks. Do you want to gamble with your future? If you feel that urge to gamble with investments, do so only with the money you can afford to lose. Set up a separate “play fund,” and allocate only a very small percentage of today’s income into it. Have maybe 5% of your paycheck direct deposited into that e*trade fund, and go crazy. If you make some money, take it out and put it into your “real” retirement fund, and if you get wiped out, oh well you’re only out a few hundred bucks, not hundreds of thousands.
The easiest, and most effective way to allocate your diversified investments is to only revisit it once in a while. Harry Browne recommended doing so only once per year. Personally, I look at my portfolio between one and four times per year, depending on what’s going on. The point is, make it infrequent enough that you’re not tempted to gamble and lose sight of the long term. How should you break the asset classes up?
The best way to rebalance your investments is to focus on not how many units you own (shares of stock or troy ounces of gold), but rather look at the dollar value they represent. To start, purchase enough stocks, bonds, cash, and precious metals such that each asset class is worth about the same. For example, if I had $10,000 to invest, I would put $2,500 into stocks, another $2,500 into bonds, etc. Let your investments run their course, and check up on them this time next year. You’ll notice that some have gained value, while others have declined. For example, in a year, my portfolio might look like this:
- Precious metals – $3,000 Stocks – $2,700 Bonds – $2,000 Cash – $2,300
At this point, you would sell off $500 worth of your metals, and $200 worth of your stocks to buy enough bonds and cash that everything is an equal $2,500 again. In an ideal world, your total investment would be more than the initial $10,000 after a year, but I decided to make this simple for demonstration purposes. Resist the urge to sell the bonds or cash to buy more stocks or metals! This might a good idea short term, but may cause you to lose out over the long haul. Remember, the name of the game is to do everything you can to guarantee slow but consistent growth for the entire portfolio over the period of several decades.
I have personally been following this advice for almost a decade, and have found it to be sound. I’m no millionaire, but I have realized gains of 10-15% per year in an environment when a lot of people are getting wiped out. I used to have a “play fund,” which eventually lost everything. I hadn’t put much into it, and I haven’t added more in several years. And guess what? I don’t really miss it.
What are your best strategies for diversified investments? Feel free to post them below.