Here are three economic risks.
#1: A crashing stock market.
#2: Ultra low interest rates.
#3: High inflation.
These three economic events can rob the purchasing power of your wealth.
Now we may have all three conditions… at once!
The ultra low interest has been with us for some time. We can see this in a chart at advisor.visualcapitalist.com/us-interest-rates
As inflation rips upwards, interest rates should rise, but as the chart above shows the government can keep rates lower than they should be.
Watch the stock market closely now. We can see how the danger is brewing everywhere.
A Wall Street Journal article yesterday entitled “Inflation Poses Risks of Faster, Less Predictable Fed Rate Increases” warned “Promises or clues about rate plans are growing harder to deliver”
A New York Times article “Wall Street’s losing streak stretched into a fourth week, and the S&P 500 has fallen 10 percent since early January”. reinforced the risk.
A drop of this scale is known as a correction — and is seen as marker of a shift in sentiment as the market adjusts to a new outlook on the economy and corporate profits.
Another Wall Street Journal article, “Tech Rout Fueled by Bond-Market Turn” helps explain why: Rising yields, particularly on inflation-protected Treasurys, are often viewed as close indicators of borrowing costs for businesses and consumers
Shifts within the bond market are removing a key pillar of support for Wall Street’s more speculative bets, dragging down major stock indexes as investors flee everything from tech stocks to cryptocurrencies.
Spooked in large part by rising bond yields, investors continued to dump stocks last week, extending early-year losses that have taken many off guard with their speed and severity. Once again, tech shares were at the forefront. Selling also broadened to include sectors such as banking and energy, sending the S&P 500 to its worst stretch of declines since the onset of the Covid-19 pandemic.
We need a new wealth protection plan.
We are living in times like we have never seen. There’s huge differences and change in the economy so we need to rearrange how we think and act.
Embrace risk! Everything is risky now. Live with this fact and rewire your work, your investing and your thoughts. Planned danger is as safe as we can have.
Let me share how I’m doing this.
My approach might work for you. It might not. After all a 75-year-old must plan differently than someone who is 20, 30, 40, 50 or more.
But as we share, I’ll give you the tools to adapt this thinking to your own set of needs and desires.
My plan might be good one. Or it might not, because what we face is a known unknown. We need to think of our plans as short time starting points, that we monitor and adjust as we move ahead.
We start with knowing that we are in the unknown. Previously we might have been fooled into thinking that we knew what’s ahead. The 50 years of stability we enjoyed obscured the longer trends.
Now we know better. We are acutely aware that we are guessing more than usual about “what’s next”.
Locking our money in a safe is not safe, because safe is unsafe in our current turbulent world. Risk is our friend and we have to learn how to protect with risk.
The first and foremost step in my plan is to continue to be of service in creating wealth. In other words at the age of 75 I am still working and that’s OK. I love what I do and in the “Live Anywhere, Earn Everywhere” scheme of things, I can be at work wherever I choose to be.
After all 65 was created as a retirement age when the average lifespan was still in the 50s.
My own personal skills are where I am putting my greatest effort, because our ability to serve and be of value is the ultimate asset. All the other promises that our human hierarchy offers can fail, but having something to offer in the marketplace of mankind will always be an inflation-proof asset.
Next, I focus on investing to protect the money I have and any extra monies I save and to make these monies grow.
Second, I track and for equities invest only Index ETFs in good value stock markets.
I recognize that I no longer have decades to let my portfolio recover if we see a major long-term market correction.
I make sure I know how long will I need this wealth I am trying to protect?
I can use a system offered by the US Social Security Office. It says I have 12.2 years to go.
I like the “How Long Will I Live” system created by some professors better. (This is the first tool to use in your wealth protection plan).
This system asks questions.
The “How Long Will I Live” system gives me an extra eight years. I’ll take that!
My mom made it to 96 (though dad did not make it to 60) and I believe a Welsh forefather reached 106. So I can let hope spring eternal and plan for at least 20 years.
Next I can go to (your second plan tool) another US government system, www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator and do some compounding math.
My research found that the average long-term return for a global growth equity index strategy was 8.36%.
So I’ll calculate, how much wealth these strategies will create in 20 years.
If the return I get is 8.36% I’ll have $498,172.70 in 20 years for each $100,000 invested.
Still I have no idea what will really happen, but I now have a time parameter and some numbers based on earning (8.36%) over the 20 years.
The chances of just getting positive results in a straight upwards motion are highly unlikely. In tho 20 years I am planning for (or however many years you have), we’ll likely see some volatility.
The question is how long do we need to hold an investment to get the best return?
Here, we can turn to an 88 year Keppler Asset Management study on the probability of a positive and top return. (These numbers are the third tool).
The study shows that a diversified portfolio invested in US markets had a 74% chance of at least breaking (above) even and after 15 years, 100% chance that there will not be a loss.
After a year the odds are 63% that I’ll have the highest return on that portfolio and after 20 years I can be pretty sure that I’ll have the highest return, if I leave the portfolio alone.
This gives us some odds to work with so I can now look at the risks of a draw down. The stats below (the fourth tool) show that longest losing streak (if we have the Top Value Portfolio) might be seven months and the largest draw down from the previous high is 54%. What we do not see in this information is how long the draw down might be and how soon the recovery.
So far my planning has looked at all the ups. I also have to consider the downs.
History suggests that if I invest in good value stock markets, given the passage of time, an inner calm, ample diversification and a minimization of transactions and fees, every $100,000 I invest with grow to somewhere around $498,172.
According to CNCB article “Here’s how long stock market corrections last and how bad they can get ” (1) which is the fifth tool I use, there have been 26 market corrections (defined as a 10% decline in one of the major U.S. stock indexes) since World War II with an average decline of 13.7%. Recoveries have taken four months on average, if the correction did not fall into bear territory (defined as a 10% decline in one of the major U.S. stock indexes).
Bear markets are the worst glitch
The CNCB article states that there have been 12 bear markets since World War II with an average decline of 32.5% as measured on a close-to-close basis.
These bear markets have lasted 14.5 months on average and have taken two years to recover on average.
During the October 2007 to March 2009 bear market, there was a 57% drop and the recovery took four years.
This downside information provides me with two data points.
The first point, the four months average recovery for corrections in the market. To cover this, I’ll make sure that I always maintain four months’ worth of immediate liquidity so I never have to liquidate holdings when markets are down during market corrections.
The second data point is the depth of loss and time for bear markets. I want tactics that allow me to maintain my portfolio for two years without requiring any liquidation.
In my case, I have created a balanced portfolio that includes income-producing real estate that generates enough cash flow so I don’t have to sell equities during bear markets . Assuming my plan holds together I can leave my equity portfolio undisturbed.
One other way I can reduce the risk of a forced sell-off is to increase the dividend income-producing element in the equities I hold. We’ll look at this tactic in an upcoming message.
That’s the basics of my plan I use. Hopefully it works. If so, I might sleep better at night (though there are other health and well-being plans for that we’ll review another time), never have to worry about day-to-day costs of living, and 20 years from today there will be something nice for the children and grandkids.
If my plan does not, ideally it’s because the time element was wrong. “Hey here I am, 94, thriving and active. Kids, you get me, not cash, for now”. They’ll be happy.
Yet I keep in mind that there are still risks of pandemics, civil disturbances, weather disasters, perhaps even a war or even something worse. I hope not, but that’s why my plan is a starting point, not an inflexible map.
We have all lived most of our lives in an era of relative stability. To keep society together and moving forward, many promises have been and are being made (pensions, Social Security, stable currency, insurance, health care, physical security, economic stimulation). Not all of these guarantees, maybe none of them, can be kept.
There are plenty of problems for humanity to solve. For example, 75 years after WWII, Western society is still at odds with Russia and China. Good grief. How can it be we have not settled this.
Yet here, we are 75 years later, more people, more material wealth with some amazing day-to-day stuff we could barely dream of in science fiction just a few decades ago.
My starting point is based on an optimism that mankind will evolve along lines based on humanity, compassion, friendliness, and recognition that cooperation blended with friendly competition might be the most productive, successful model.
Yet the plan is day to day short term in the sense that history suggests we’ll see obstacles and roadblocks that require adjustment.
I’m ready. I have a plan, flawed in many ways, but workable because it is meant to evolve and I’m ready to adapt because I recognize that risk is our friend and I have to accept more risk than before to be safe.
I hope the thoughts and the tools here can help you prepare a well protection plan that suits you.
Gary is an entrepreneur, author, and investment publisher who began writing about multi-currency portfolios five decades ago when many thought he was crazy.