Friday, February 8, 2013

2013 Outlook: Part 12: How To Invest

2013 Outlook Part 1: Introduction
2013 Outlook Part 2: What Is A Bond?
2013 Outlook Part 3: How Did We Get Here?
2013 Outlook Part 4: Can You Lose Money In Bonds?
2013 Outlook Part 5: Global Debt Binge & Policy Response
2013 Outlook Part 6: United States Bubble Bond Prices
2013 Outlook Part 7: Residential Home Prices Have Not Bottomed
2013 Outlook Part 8: Commercial Real Estate Cap & Interest Rates
2013 Outlook Part 9: Chapter 2 Of The Sovereign Debt Crisis Begins
2013 Outlook Part 10: Japan's Government Debt Bomb Goes Off
2013 Outlook Part 11: Should I Buy US Stocks Today?
2013 Outlook Part 12: How To Invest

The scope and structure of a portfolio should always begin first with a plan. In order to know where you want to go you need to figure out where you want to end up and then work backwards. I believe this strategy should be used in all aspects of life, not just investing. In simple terms, you need a goal.

Most people have no goal in mind or know where they want to end up, and if they do have a goal they give very little thought on how to get there or the potential road blocks that may occur along the way (something that I try to help with here). I cannot tell you what your goals should be because you could be someone that is in their early 60's with $2 million saved for retirement, or you could be someone in your mid 20's with $15,000 saved for retirement, and the ultimate desired finishing point for each person could be starkly different.

Therefore, I have to talk in generalities when discussing actual investments, and you always need to speak with both a professional financial advisor and a tax specialist before making any investment decisions.

We live in a world today where almost everything feels overvalued. The dangers in the global economy and financial markets have been masked by the temporary illusion of artificially low interest rates. Investors have once again become drunk on liquidity and credit. There is a belief now that even if something goes wrong that the central banks can immediately "fix" the situation. This simple and incorrect assumption, when it is proven to be false, will trigger a massive dislocation across all assets.

During periods of severe complacency to borderline euphoria the first and foremost strategy is capital preservation. This means that you want your capital out of harms way when the euphoria fades. Markets have a tendency to climb slowly over long periods, pulling as many people as possible into the madness of the crowd, before reversing quickly and crushing those caught off guard.

In very general terms, around the world I would avoid these assets:

Most Real Estate
Most Bonds
Most Stocks

99.9% of investment advisors tell you that you should have 100% of your investments in a diversified portfolio composed of these three asset classes. Maybe you own a $200,000 home and have your 401k, which contains $400,000, in a "retire in 2035" fund." That fund may contain 50% bonds and 50% stocks to give you $200,000 (33%) in real estate, $200,000 (33%) in stock mutual funds, and $200,000 in bonds. This is a dream portfolio for most advisors.

If someone I knew was in the situation above and asked me what percentage I thought they should have in each of the three categories, it would be 0% in all three. Based on where they lived in the world, the economic environment, the supply/demand statistics, and the rent/own data I would most likely tell them to sell their home. The 401k situation becomes a bit more difficult and needs careful consideration. Some 401k plans allow you to move money over to an IRA type fund where you can invest in whatever you like (which occurs automatically if you ever decide to change jobs). If you cannot move your funds you must decide if you should sell and incur the taxes and penalties or if you should try and locate the safest possible fund type within your options. I cannot give advise on how to proceed there, only let you know that if you are in a "retire in 20XX" fund you are most likely in the maximum amount of danger.

The safest possible fund in a 401k would be one that has a description like "prime money market fund" that has treasury bills or investments with very short term maturities as its primary holding. The return on this fund will be close to 0% annually.

Let's now look at a strategy if you have freedom outside of a 401k.

After you have your final investment goal in mind, we can now look at strategies on how to get there. The first thing you want to do is remove as much risk as possible from your portfolio (the assets listed above). Then you want to make sure you have cash available when buying opportunities emerge.

"Safe cash" would be a fund that invests only in short term t-bills rolling about every 3 to 6 months (or less). The best fund I know available for this strategy is the American Century Capital Preservation Fund. This type of fund will protect you on interest rate risk (the bonds can just be rolled over at a higher yield), but while you wait you will earn close to 0% on your money. There is a price to pay for safety, the short term return you miss out by not investing in longer dated, higher yielding bonds or stocks, that I believe will be well rewarded as we move through this storm.

The second part of protecting your portfolio is through the purchase of physical precious metals: gold and silver. I believe you should start your investment in this area with physical coins in your possession that you can either keep at home or in a safety deposit box. My favorite option to purchase physical coins is through the Northwest Territorial Mint. When you feel comfortable with your initial physical ownership then you can begin to accumulate metals through services that will store physical metals for you. My favorite option for this is through Goldmoney, which allows you to purchase physical metals electronically and then store them in different vaults around the world. You can then sell them at any point and have the funds transferred back to you or you can request physical delivery of your metals. I will provide a link to goldmoney at the bottom of this page.

Your "safe cash" and "precious metals" part of your portfolio should make up the lion's share of your total investments based on the current economic environment. How much of your portfolio should be allocated to metals? It depends on your personal situation, but I would recommend that everyone have at least 10% of their total net worth in precious metals to start, which can be considered an insurance policy.

Now that you have your assets protected you want to make a list of investments you can purchase when they go on "sale." You determine this list first by getting an idea of what assets you believe are in long term secular bull markets and have long term positive fundamentals. For example, my list looks like this:

Gold Mining Shares
Chinese Stocks
Certain Asian Currencies
Canadian Dollar
Australian Dollar
New Zealand Dollar
Brazilian Real
Rare Earth Stocks

I check in with these asset groups and specific stocks/ETFs within each group every day. I recommend you create your own list and when an asset goes on sale, which usually coincides with a massive drop off in sentiment, it will create a buying opportunity and the ability to exchange some of your safe cash for that asset.

For example, which asset or assets on my list currently have the two most important determinants I need before making the purchase?

1. The price has recently fallen and the asset has gone on sale
2. Sentiment toward the asset is at extremely low levels

The only two on my list as I write this morning are gold mining shares and rare earth stocks. Right now gold mining shares are hated by by investors who do not like gold, and they are disliked by investors that do like gold. They have performed miserably over the last three years. As gold has recently risen, gold shares have fallen by 30%. The fundamentals are fantastic, the prices are low, and the sentiment is a rock bottom. I love them. Rare earth stocks currently share the same traits.

Once you have determined that an asset group is on sale then you need to dig a little deeper to determine the best possible investment options within that category. In order to do this I use the service of professionals that study that specific category on a full time basis (I don't have the time or ego to think I can personally track the fundamentals or management of every individual stock on the planet nor would I ever want to).

For gold stocks I subscribe to John Doody's Gold Stock Analyst newsletter. If you are thinking about making a purchase in this area I would recommend using his excellent research. I also invest in the Tocqueville Gold Fund managed by John Hathaway. These two men have decades of experience tracking gold stocks. I wait for stocks to go on sale and then I invest in their specific recommendations.

For rare earth stocks I use the services of James Dines and his monthly Dines Letter, which has been tracking the market and the participants within the rare earth industry for over a decade. His newsletter provides a monthly analysis of the top rare earth stocks and the story behind each choice.

I'm not recommending that you invest in gold mining shares or use any of the services just discussed, I'm only trying to walk you through the process I use for investing.

Gold stocks could be a bad investment for me personally this afternoon or tomorrow (prices and sentiment rise), and another asset on the list could become a buying opportunity (prices and sentiment fall).

If oil were to go on sale and sentiment were to plunge, I would then use the resources of a specialist in that field to determine the best stocks to purchase within that asset class. The same with agriculture or water or Chinese stocks.

I used the example in the previous section of this outlook of how I felt Chinese shares went on sale a few months ago and I recommended readers look at it as a buying opportunity. The shares since then are up close to 20%, sentiment is rising, and investors are starting to pay attention to their market again. Do I want to purchase shares now? Definitely not. If prices crash again and sentiment falls then I'll make another purchase. If they don't then I'll just hold on to my shares.

It is important to note that buying when prices fall and sentiment is low sounds easy at first blush, but it is pyschologically one of the most difficult things for an investor to do. People move subconsciously in a herd behavior and if you are not focused on it every day you will automatically begin to drift mentally back in line with the herd.

I can't tell you what I will purchase (or not purchase) this afternoon or tomorrow because I don't know where prices or sentiment will be. Maybe silver prices will crash tomorrow and everyone will hate silver. That would be amazing. I would be buying with both hands. Over time, if you make strong purchases within an asset class that has long term positive fundamentals, if you buy when everyone is afraid and hold when everyone is euphoric, then you will be rewarded in full.

People get upset when their favorite assets fall in price. I cannot figure out why. Their reaction should be the exact opposite. Would you get upset if the television or computer you wanted to buy went on sale? Your portfolio should be prepared (with the safe cash just discussed above) for market sell offs and they should be greeted with a welcome smile.

I will continue to update you as we move forward when specific asset groups have gone on sale and sentiment has reached levels that I believe warrant an investment.

Let me re-state that 99.9% of financial advisors you speak with tell you to do the exact opposite of what I am recommending here. I fully understand that, and you need to take that into consideration before making any investment decisions.

I don't know if the coming change, the paradigm shift, discussed in this outlook will occur in 2013, 2014, or 2015, but I know that it is coming. I really don't care when it occurs. I have my plan on where I would like to end up and I have my vision on how the world will change as I move toward that destination. I work relentlessly every day to prepare myself to be ready to invest in asset classes that will be on sale in this future world, after the dislocation has occurred.

I will elaborate on my personal preparation more in the future, and the opportunities that will emerge after the coming shift in interest rates, but that is looking further ahead than the scope of this outlook.

For more information on getting started with goldmoney, where you can open an account in just a few minutes, click on the following link:

GoldMoney. The best way to buy gold & silver


  1. I agree with the majority of your premise on most real estate however i would like your thoughts on parking money in High Quality real estate. If i have fortune 500 companies such as walgreens, Home depot, fedex etc sell their real estate to me and sign a 15 year lease with a 7% cap rate on a triple net basis where is my risk. In an inflationary environment the land and building acts as a hedge and in a deflationary environment my 7% rate protects me. Am I wrong in my thinking? I would love your thoughts on where my thinking is flawed. Thanks

    1. That's an excellent question. From what you are asking it sounds as if you are interested in purchasing a retail commercial building with Home Depot, Fedex, and Walgreens as tenants. Each of these tenants plus potentially others of equal or greater financial strength would sign a 15 year triple net lease. What would be your risk?

      First let me say that if you are thinking about such a purchase you will need a significant down payment, or a financial partner who can provide a significant down payment. You will also need to have an understanding of how to manage such a building or have a strong management company handle those details for you (perhaps this has already been factored in to your analysis to bring you to a 7% cap rate purchase price).

      Let me also say that all things being equal, income producing real estate is by far the best asset class in the world based on the tax advantages, leverage, and ability to purchase an asset far under market value if you have an understanding of what you are doing (unlike stocks and bonds and even commodities where professional and high frequency traders destroy even the most knowledgeable market participants).

      So what is the problem?

      I think that if interest rates were to just normalize, not taking into account that the US government is bankrupt or the possibility of inflation actually impacting assets, just NORMALIZE up to the 5 to 7 percent range, it would have a dramatic impact on your 7 percent cap rate.

      Let's say that in 5 years an investor can purchase a 10 year U.S. government bond at 7 percent. Your building has 10 years remaining on the leases and those leases provide an investor a 7 percent return (a 7 cap).

      Do you think someone will pay you a 7 cap for the building if they can get a risk free rate from the government at 7 percent? I don't think they will, and I think cap rates will rise.

      Let's say that under this 5 years later scenario your building is now valued at a 10 cap. If your annual NOI is $100,000 at a 7 cap your building is worth $1,428,571. At a 10 cap this building is now worth $1,000,000 meaning you have lost $428,571 over the 5 year span.

      Now, many people say that it is impossible for US government debt to move to the 7 percent range (the 10 year treasury rate was above 7 percent almost the entire time span between 1968 and 1996). That makes it seem possible to me, but my views are considered crazy.

      I would rather wait until rates rise, cap rates on commercial real estate fall, and THEN make the purchase (I spend most of my personal working hours during the weak preparing to buy commercial real estate for when this time comes).

      I hope that helps.

  2. If you had followed this and invested in gold in Feb 2013 - you would now have lost 35%.