Portfolio
Diversification, Risk Management and Baby Boomers
J. Kent Willis
AGAPI Financial
November 18, 2004
A complete
study of Diversification is beyond the scope of our discussion,
but the basic concept is the tired cliché: don't put all
your money (eggs) in one type of investment (basket). The idea
is that at any given time and market conditions some investments
will be "good" or up in value/price while at the same
time some other investments will be "bad" or down in
value/price. This is supposedly a prudent way to smooth out the
ups and downs of an investor's time in the market. Most financial
advisors agree that precious metals are very good diversifiers
to spread risk across several different types of investments.
Never forget this: risk can not be "hedged" away
or eliminated. It can only be transferred to someone
who is willing to take the chance that the "bad side of
the bet" will be on you, not them. For a fee (premium) they
will accept the risk that you were in such a hurry to get rid
of. All risk "shuffling" is based on this concept.
Somebody, somewhere has to be left "holding the bag"
and looking for a chair when the music stops.
We do agree that there are obvious benefits to spreading your
money around in more than one investment idea, but remember
this: The net return, by definition, of a perfectly hedged or
balanced portfolio is ZERO. Suppose you were age 45 and
plan on retiring at age 65. Assume your retirement savings was
comprised of 50% growth stocks, 50% long term bonds and nothing
else, likely held in some kind of mutual fund. In theory,
that's a great start. Now also suppose that over that 20 year
period your portfolio went up in 100% in value in the first 10
years from $100,000 to $200,000 as interest rates declined and
credit was expanded in the economy. Now suppose interest rates
increase and true inflation comes back viciously in a natural,
inevitable cycle which is simply a reaction to the previous 10
years of Federal Reserve policies on market behavior. For the
next 10 years, since you have been "warned" by your
investment advisor to "stay in it for the long haul, don't
try to time the market," your portfolio is not modified
to reflect new trends and drops by only 50% over the 10 year
period. Now guess what, you are 65, your best earning years are
behind you, and you are (if you are lucky), right back where
you started 20 years ago. Think it won't happen? Think again.
The market takes no prisoners. It doesn't care about your situation
and that you don't have enough time to recover. You are retired
now. Bye-bye cabin on the lake. Bye-bye college money for the
grand children. Bye-bye memorial donation to the American Cancer
Society. Adios. Adieu. Farewell. Notice the subtle but often
overlooked mathematical curiosity. Your portfolio went
up 100% from $100,000 to $200,000 but only down
50% to $100,000. You now need a 100% gain to get back
the 50% loss. You are 65; you don't have time to rebuild
your nest egg even if you went back to work full time. If your
health is less than reasonable, well, good luck. You won't be
looking for a cozy fishing spot. You'll be looking for a job.
In a typical mainstream investment strategy you can get killed
following the behavior of the herd. The sheer demographics of
the baby-boomer generation will force the market for stocks and
bonds into uncharted territory. Two excellent books are recommended
for further study which lay out the cold, hard, "spin-free"
numbers and consequences of everyone squeezing for the exits
at the same time:
"The
Coming Generational Storm," L. J. Kotlikoff & Scott Burns, MIT
Press, 2004.
"Financial
Reckoning Day,"
William Bonner & Addison Wiggin, J.Wiley & Sons, 2003.
We will summarize
the basic ideas for you. We hope you are sitting down. The first
wave of the baby-boomers were born in 1946 and will be reaching
retirement age in about 2008. The remaining boomers born through
about 1964 will continue to retire in waves of huge numbers,
literally millions every year, through about 2027. They will
be looking for portfolio safety to protect the nest eggs they
have carefully built up over their working lives. They will be
looking to dump their riskier stocks to raise cash as well as
roll over the sale proceeds from stock/equity investments into
much lower risk bond funds. All at the same time. It is common
knowledge that in great fire-related tragedies many people are
caught at the building exists crushed in the mad chaos to escape
only after smoke or flames are recognized. Everyone CAN'T
go out at the same time. Markets are no different. Every sale
on the stock exchange is also a purchase, someone has to buy
your position from you or it remains unsold. When the markets
are flooded with large numbers of sell orders, the bid/ask or
buy/sell spreads widen. This oversupply in a small time window
overwhelms the available buyers and prices collapse. Finally,
at some ridiculously low price, buyers step in. Maybe a bargain
for the buyer, but a disaster for the selling retiree. If there
are plenty of eager buyers (a so-called highly liquid market),
it isn't difficult to pass on your hot potato stock investments
to all the young turks itching to take them off your hands. They
naively believe they will be doing the same thing 30 years from
now.
This is what contrarians call the GFT or "greater fool theory;"
believing that there is always someone ready, willing and able
to buy a risky investment at a high price anytime it comes on
the market. So now, if we do get out, we receive much less
than we expected. So much for those lovely mathematical graphs
showing the "magic of compound interest" and dividend
reinvestment strategies over "time in the market."
You wonder if Wal-Mart is hiring greeters this month. But wait.
It gets worse. What did we say the retirees were seeking for
safety? Bonds. Well, what happens to bond prices when everybody
is trying to buy the available supply? Competition for what is
available drives the bond prices up. And this means that the
yields (the regular stream of income you were going to live off
of) go down. Yields go down when bond prices go up because you
had to pay more money to get the same face value of bonds. You
get much less income as a percentage of principal than the fellow
who originally bought those bonds at a larger discount. He might
be more than happy to sell them to you at a higher price. But
if the other potential seller is also of the same demographic
i.e., another retiree, he holds bonds for safe income. He isn't
really willing to sell them either. It's a classic dog chasing
the tail dilemma. Massive liquidity problems take shark-sized
bites from your boxer shorts. The double whammy and the worst
of all investment scenarios will be a very real predicament for
millions of US investors. There is no way around it. We did the
math. We wish we weren't mathematicians. Now, like Fred Sanford,
you are clutching your chest, gasping for breath and crying "It's
the big one Elizabeth... I'm coming!."
Still sitting down? Nitroglycerine tablet under the tongue? Defibrillator
paddles at the ready? With so many boomers soon beginning to
draw on their Social Security promises, where will the government
"entitlement" money come from? US demographics clearly
indicate fewer and fewer young people are even in the work force.
America is getting older. Those carrying the burden of senior
citizen support through paycheck taxation are dwindling in number.
Many are minorities in lower paying service-sector jobs with
very little, if any, money available for investing. Day to day
survival has to come first. There will be a massive shortage
of buyers with sufficient resources to take all of those lovely
little stock certificates off your hands. A stagnant or declining
real income environment which forms the tax base for social security
wealth redistribution spells disaster. It won't matter then that
the politicians raided the so-called "Social Security Trust
Fund" today. There is no literal fund; it's simply a bookkeeping
concept. There would not have been enough money in there anyway.
The only options are massive reductions in the promised benefits
along with massive increases in what is confiscated (taxes) from
the poorer working folks who don't have enough in the first place,
or, monetization of the debt. Monthly checks will be printed
and delivered. Mountains of worthless paper money will appear
out of thin air from the Treasury via the Federal Reserve banks.
To prevent meltdown, everything in the economy, including tax
revenue, job stability, interest rates, credit availability and
fiscal policy will have to be exactly right and running smoothly
on all eight cylinders. The mathematics, demographics and historical
precedents are all against every "new deal" and "great
society" that promised more than they could ever possibly
deliver. Either way, fountains of financial blood will be spilled.
At least give yourself a chance by storing a part of your wealth
in something other than paper US dollars. Gold and silver, at
this point in time, are the likely winners.
What actually scares me the most is that the eternal and prudent
warning to "never, never put all your eggs in one basket"
may likely be discredited in the near future. If the worst-case
US economic situation unfolds, the worst thing, in 20-20 hindsight,
will be to have NOT put all of your "eggs" in actual
precious metals. It is certainly no coincidence or accident that
gold and silver have survived triumphantly for thousands of years.
Neither is it a coincidence or accident that every paper-based
money scheme has likewise failed, often catastrophically for
those who failed to heed the warnings on every front. What do
you think about the end of the dynasty of the US dollar? Such
is well named; by definition, dynasties "die nasty."
Remember the 3 Gs of Gold Investing: Trust Governments For
Nothing. Trust God For Everything. Trust Gold Somewhere In Between.
J. Kent Willis
email: jkentw2@aol.com
November 18, 2004
AGAPI Financial
J. Kent
Willis is a Financial Advisor, Licensed General Securities Representative
and the President of AGAPI Financial, LLC. He specializes in
tangible assets, biblical faith-based investing seminars and
balanced life strategies. He has traded gold and silver since
the mid 1970's and resides in Kentucky. He can be reached at
jkentw2@aol.com. This work may be reprinted and distributed freely
to all hard money, gold-bug and related web sites.
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321gold Inc
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