Maintaining A Balanced Portfolio


May 2008
Vol 31 No 8

          This newsletter usually addresses the trials and tribulations of the little guy who is either starting, or in the midst, of the long journey to the top of the financial heap.  But this month’s letter will be different.  It is aimed squarely at those who have “arrived” and who are looking for alternative investments that, while not providing the thrill ride that housing has over the past few years, will provide a steady, safe, reliable income stream and capital preservation


          A long time ago, I said that making a million dollars was a lot easier than hanging on to it.  If you doubt this, ask lottery winners, or highly leveraged builder/developers, how much they have left of the millions they made. 


           Now seems a pretty good time to revisit Portfolio Strategies.  We offered a number of seminars on this subject in the decades of the 70’s, 80’s, and 90’s when the markets began to become less reliable, and when confronted with dramatically changing governmental policies.  Admittedly today’s market seem a little wild, but to those of that era who saw gasoline prices quadruple, price controls, dollar devaluation, abandonment of the gold standard, 12% unemployment, 17.5% FHA loans, and 20% inflation, today’s market and economy seem comparatively tame.


           When it comes to building truly inflation-hedged wealth, for the majority of the past ten years, there has only been one game in town; single family houses.  Oh, the securities markets have had a couple exciting years in the sun, along with the mortgage markets, but now all of that is changing.  Consider the following:


1. In many areas, housing is flat and promises to remain flat for a few years.

2. The costs of holding single family rentals are rising much faster than rents.

3. Political remedies for the Sub-Prime meltdown will add to market uncertainty.                                                

4. The stock market is suffering from desperate surges and relapses as speculators try to time wild swings to jump in and out to harvest its volatility.                                            

5. Internationally, the dollar is under attack on all sides; and falling fast.                      

6. American industries continue to lose market share to foreign competition.      

7. Financial markets are rocked by scandals while bank stocks continue to fall.                                                                             

8. Rising layoffs are causing fear of recession to once again stalk the land.                             

9. The lame-duck Bush Administration seems more focused on justifying its ruinous policies of the past 7 years than on solving health care, immigration, crime, education, economic, and failing infrastructure problems.                                                          

10. Just to keep things hopping, Americans are faced with a Hobsen’s Choice for the next 8 years of an economically illiterate aging Republican President who vows to cut taxes while maintaining the two front war; or a liberal Democrat with a Robin Hood complex who can be expected to reverse most of the tax benefits of the past 8 years; to leave a power vacuum in the Mid-East; and to dramatically expand government control over the lives of Americans at many levels. 


          What does an investor invest in for the long term when cash is deflating at about 8% per year and the American dollar is going down in comparison to other currencies?  A special report issued by FED economists shows that annual gross real estate rents are at a record low of only about 3.5% of the current market values even while home prices continue to decline.  Those who sold their houses and bought stocks saw the values of their equities lose billions of dollars in the first few weeks of this year while gold reached record highs.  When it comes to the economy, Government is like a bull in a china shop. Every time the FED cuts interest rates to save homeowners, it drives the dollar down and alienates foreign investors whom we count on to lend us money by buying U.S. Bonds.  It also drives up the cost of oil that is so crucial to our economy; making everything we buy just a little more expensive.  It’s time for everybody to focus on asset preservation



          Don’t tell this to those who are struggling in the trenches trying to survive the current economic cut back, but ultimately, wealth represents less opportunity than obligation.  If you think being responsible for the care of a pet dog curtails a lot of fun, try being responsible for taking care of the life savings of someone who relies upon you.  I’m not talking about some doddering old aunt; I’m talking about your immediate family.  If you suddenly became dependent upon your parents, or your kids, for food, shelter, clothing, medical attention, and personal care, this could be a crushing blow for your family to sustain.  That’s what portfolio strategies is about; protecting your family from needing to support you.


          A wise multi-millionaire once gave me ten principles on which ultimate success in life will depend.  I’ll paraphrase them below:


1. Personal savings and liquidity to insulate you from distress sales to raise cash.                                                               

Success books over the ages have stressed living far enough below your means to be able to save 10% or more out of each pay check, and to keep enough cash around to meet emergencies.  Being forced to sell or pledge valuable assets robs security.


2. Protection of your assets, purchasing power, and income from inflation. Everybody on a fixed income understands how rising prices can destroy security.  Part of every portfolio should be inflation hedged so that asset values can pace inflation.


3. Faith in your own judgment and in the successful outcomes of your decisions.  Beware of strangers bearing advice.  If you were smart enough to amass a fortune, you should be willing to continue to learn so you’ll be smart enough to manage it.


4. Understanding the investment principle that your money must earn a fair return.                                            

How much is your IRA earning?  If you want to see a financial epidemic, check out all those poor souls working for a fixed rate pension plan, or those putting money into IRAs who know that their yield is not even keeping up with inflation.  The difference between a 2% Money Market Fund and a 10% mortgage isn’t 8%, it’s 500%; or over $62,500 MORE for each $4000 per year invested 30 years in your IRA. 


5. Better to pay a fair price for a good investment than a good price for a fair one.  I once bought 20,000 shares of gold penny stocks in the 1970s because they only cost $2000.  That was my IRA contribution limit at that time.  The money is still there.  If I sold them all, they wouldn’t net enough to pay the commissions.  On the other hand, that same year a new company called Microsoft was selling for about a dollar a share.  That same $2000 could have been worth about $70,000 today.


6. Understanding, and being able to use, compound interest and time value of money.                                 

Einstein said the greatest single concept of man was compound interest; the process whereby interest earns money on itself.  $1000 invested for 10 years at 100% would add up to $11,000, but if compounded at the same rate would add up to $1,024,000.


7. Growing an estate by using prudent leverage with no personal liability for debt. 

Millions of people are in distress today because they guaranteed to pay their loans.  Had they not done this, they could have simply walked away from ruinous their debt


8. Methodically and systematically eliminating debt to increase income and safety.                                                              

Paying off debt creates equity, safety, and cash flow.  One way to commit financial suicide is to refinance equity to get spending money.  It destroys all compounding and cash flow while increasing risk.  If you want to be rich don’t borrow lifestyle!


9. When you know you’ve got it made, stopping taking chances to make more.  If you’ve got enough, you don’t need more.  Risking your security to make money that you’ll never spend is the sheerest kind of folly; especially when you lose it.  The homeless shelters are full of people who bet their winnings one time too many!


10. Understanding diversification is the only defense against all the unknowns and   uncontrollables in every investment situation.  I’ve saved this final principle for last because, compared to the foregoing rules, which are fairly easy to ingest, diversifying your portfolio to touch all the above bases, and being able to keep in touch with it to manage it, can be really complex.  In a nut shell, diversification is a big word that means not putting all your eggs into one basket.



         Warren Buffet, who’s been able to average about 23% compound yield for almost 4 decades by keeping his money hard at work has two rules:  Rule #1 is: Don’t lose money.  Rule #2 is, Don’t forget Rule #1.  He also said that diversification is for those who don’t know what else to do.  That pretty well describes me and I suspect most of my readers.  Let’s face it, Buffet is a financial genius by any measure.  Nobody has ever equaled his investment performance.  Those of us who are cut from more common cloth can only hope to keep a little ahead of inflation while replacing the money we take out of our investment yields to pay for lifestyle


         You may hear people bragging about their investment yields, and a few of them may even have enough money on then to pick up an occasional tab; but most are talking about a relatively small sum of money.  When you start trying to earn high yields on larger sums of money, you’ll find it’s a totally different game.  If you don’t agree, check out any investment manager of any mutual fund, insurance, company, or bank.  Their vaunted yields barely keep up with inflation on a good day.   


         A major threat to your financial security is posed by so-called investment advisers who brag about their investment prowess, but for some reason or other, still seem to need their salaried or commissioned job.  When I was a kid, there was an old saying, “If you’re so damn smart, why ain’t you rich?”  Here’s some advice you can take to the bank; there may be a lot of people who made lucky guesses over the years and made money, but absolutely nobody can see around curves and into the future to tell you what is going to happen to any particular deal or investment.  How many people were caught unaware when 9/11 triggered a stock market panic? If people really knew what was hot, why would they share this knowledge with anybody?  


         Diversification is like playing every horse in the race.  Some will lose, some will win, place, or show.  It’s not very exciting and you won’t win very much, but you won’t lose very much either.  So what are these horses?  There are a lot of them, so let’s sort them into piles:  Pile #1 is comprised of investments that are related to real estate such as Houses, Leases, Land, Farms, Partnerships, Real Estate Investment Trusts, Mobile Home Parks and Land/Home Packages, and Mortgages;  or Options on all of them.  Pile #2 consists of non-real estate related investments such as cash, gold/silver, stocks, bonds, institutional debt and derivatives, T-Bills, CDs, Notes, Insurance, commodities, and interests in small businesses.


         I array these on a circular pie-chart that I call my wheel of fortune.  The objective is to try to have a few dollars on each slice to maintain some kind of balance between them; understanding that even a modest free and clear house could be a bigger investment than a big stock investment.  Start investing in things you know the most about.  For me that would be a free and clear personal residence.  This would much more act as a store of value than a source of liquid funds.  To enhance the growth aspect of my portfolio, I’d toss in some long term Options and Remainder Interests on better properties where high rates of growth are the norm


         For income, I’d plug in some better than average good rental houses in solid middle class neighborhoods, and good quality Mobile Home packages.  Houses might be a little low on income, but high on inflation protection.  To enhance my income, I’d add discounted seller carry-back high quality mortgages and Deeds of Trust; and Sandwich Leases.  Today, if I could buy some timberland and in-fill lots in a high grade subdivision at deep discounts from lenders, I think these will lead any economic bounce-back while requiring minimum management.  I think I’d hold all of these assets in Land Trusts or LLCs for liability protection, and privacy.



         What about non-real estate investments?  Because of all the financial scandals and bogus accounting statements, I don’t know how to discriminate between good companies, bad companies, and those on the verge of bankruptcy.  I was one of those eager lads that invested a bunch of money in Enron and World Com. As of today, in spite of all the law suits and recovered funds, I’ve never had a penny returned to me.  That doesn’t mean that I’m going to turn my back on the stock market; it just means that, when I don’t know anything about a market segment, I prefer to invest in groups of companies rather than on any particular one


          The problems with stocks is that good company prices are bid up so high that the yields are miniscule.  New cheap companies promise a lot but deliver little.  For years I invested in Mutual Funds, but those wizards who manage these funds don’t do well when a hot market cools down.  Instead of betting on a pool of stocks held by a Mutual Fund, I’d bet on Exchange Traded Index Funds whose value is pegged to the companies they emulate.  You can hold E.T.I.F.s in groups of companies in almost every industry group and country where a securities exchange operates.  From among hundreds offered, you have a choice of domestic or international companies, medical companies, landholding companies, and various R.E.I.T.s that own Mobile Home Parks, Mining and Energy Exploration companies, etc. 


          These are ideal for a market morons like me who not only doesn’t trust corporate financial statements, but doesn’t understand them.  By betting on a lot of companies, I spread my ignorance across them all and let them do what they will.  Some go up, some go down, and I get a few pennies in dividends each year.  Why invest in them at all?  First my funds are liquid; unlike a Mutual fund that only invests and sells at the market closing price on the day an order is placed.  In contrast, I can buy in, or get cashed out of, an Exchange Traded Index Fund at the next bid price within minutes with just a telephone call.


          Why not put cash into the bank?  I do keep “walking around” money in banks, but sweep them into stocks or other investments when balances get very high. Even though bank deposits are protected by FDIC, things can get pretty sticky when a major bank fails, and I don’t want to get caught in the mess.


          What about gold and silver.  These are great, highly liquid inflation hedges but they aren’t much fun.  You’ve got to store precious metals somewhere where they’ll still be there when you want to raise some cash.  This costs money and all the while that you have them they’re like vacant lots.  Gold and silver don’t pay any interest.  That’s not so bad when they’re going up 30% like they did in 2007, but not much fun over the 27 years since 1981 when they weren’t going up.       


          One advantage stocks will have between now and 2011 is that dividends and capital gains will be tax free of federal income taxes to those in the 10% and 15% income tax bracket while bank interest will be taxed at ordinary income tax rates.  It may pay you to switch your liquid cash over into high dividend paying investments.  Value Line publishes a book monthly that you can review free in your library to find companies that never miss paying high dividends year after year.


          Let me say just a few words about CDs, Bonds, and T-Bills:  With the spectre of Jimmy Carter style inflation looming on the horizon, I’m leery of tying up money for years in Bonds or CDs.  As interest rates rise to offset inflation, the value of fixed income investments plummets.  For this reason I prefer to buy 91 day T-Bills.  Their interest is paid in advance and isn’t subject to State Income Taxes. Moreover, yield tends to increase with inflation, so they don’t lose value like long term Bonds.  The safety of T-Bills is guaranteed by the government.  They can be bought easily by contacting the Fiscal Agent at the nearest Federal Reserve Bank and finding how to take advantage of the weekly T-Bill auctions.  By spreading T-Bills purchases over successive weeks, you’ll be able to liquidate some every week too.


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