Business | Investment
Investment is about risk navigation
Deciding where to put your money boils down to a personal appetite for loss.
- By John F. Wasik, Bloomberg
- Published: 23:41 October 3, 2008
Dishing out advice on fin-ancial staples in times of crisis used to involve three servings: precious metals, US Treasury bills and real estate.
With the tumult on Wall Street having changed the financial world - investment banks are going the way of rotary-dial phones - the usual recommendations aren't adequate.
As Congress seeks to leaven the risks of under-regulation, toxic debt and systemic collapse, traditional hedges may not protect your nest egg.
Let's assume any bailout legislation will put only a modest dent in the US home foreclosure crisis and won't dramatically lower mortgage rates.
Interest rates are more likely to rise in the long term as the government peddles $700 billion or more in debt to pay for this Faustian rescue. The final tab is unknown, but it's always more than what officials in Washington project. That casts a pall on home values, sales and the industry's recovery.
That leaves assets such as stocks, bonds and metals. Unless inflation soars, the conventional wisdom may be perilously wrong on how to best insulate your portfolio.
I'm always perplexed with the first crumb of conservative investment philosophy: Precious metals are the best haven in times of calamity.
That has always puzzled me. Metals such as gold and silver bullion don't pay dividends, aren't backed by anything and are mostly held in large quantities and traded by huge institutions. Individuals usually don't stand a chance trying to successfully time the metals markets.
Metals fallacy
Gold bugs have always touted precious metals as the last immutable store of value in a crisis. In Wall Street's most terrifying week since late 1929, during a brief shining moment, gold was once again favoured as a haven.
As a volatile commodity, though, investing in gold isn't for sissies. After the spot price reached a record this year of almost $1,000 an ounce, it fell to $736 on September 11. Then it gained more than $100 an ounce during the week ended September 19.
You need a strong stomach to buy something that fluctuates more than $200 in price in a short period of time.
Most people can't buy bullion on the spot market, so they might invest in a vehicle such as the SPDR Metals & Mining exchange-traded fund, which samples several metals mining stocks. The fund has fallen about 20 per cent this year.
Active management can help avoid volatility in the metals markets. If you believe that, then consider the First Eagle Gold Fund, managed by perennial fin-ancial-system sceptic Jean-Marie Eveillard.
Although it has beaten all but four per cent of its peers, it's not a perfect hedge. It's down about 11 per cent this year.
If gold doesn't work as a stable retreat, should you be jumping out of common stocks into another asset at all?
As an individual investor, it doesn't make sense to me to leapfrog from one asset class to another.
Just when you thought you had made the right decision, the market turns. Most people guess wrong, time badly and lose money consistently. They hold on when they should be selling, praying for a comeback. We are hardwired to be optimists.
The same reasoning applies to buying even more skittish investments such as metals. So let's try another strategy. A mix of metals and Treasury securities, which are backed by the full faith and credit of the US government, may be the way to go.
Safe money
US Treasury securities are usually thought to be the best receptacles for safe money. Yet, when institutional investors retreated to Treasury bills in auctions during the week of September 15, real returns were negative after you subtract inflation.
While you got government guarantees on your principal, T-bill yields were less than one per cent.
Of those fixed-income mutual funds that weren't inflation-protected or leveraged, only 30 out of the roughly 1,000 surveyed were beating the Consumer Price Index through September 15, according to Morningstar, the Chicago-based financial information company.
If you are looking for a little diversification, you could combine Treasuries with other traditional fin-ancial refuges in one portfolio.
The Permanent Portfolio has been doing that for decades. Designed for fin-ancial ostriches, the fund invests in Swiss francs, metals, real-estate stocks and Treasuries. Beating 98 per cent of its peers, it is down less than 1 per cent this year.
If most of your holdings are in dollars, you'll also need to hedge currency risk. Non-US stock and bond funds, and oil and gold stocks will help. I have previously advised against buying metals, but if you are bearish on the dollar, gold can be a hedge. Buy and hold it in a mutual or exchange-traded fund.
Since no single fund can give you insulation from systemic market risk or inflation, consider adding a commercial real estate index fund such as the Vanguard Reit ETF and the Pimco Commodity Real Return Strategy fund, which combines inflation protected securities and commodities in my portfolio.
Diversification
Diversification is important. It doesn't concentrate your portfolio risk in one country, asset, market or property.
The Pimco fund, for example, hedges inflation and credit risks. It has risen almost five per cent in the past year.
The most important issue isn't what will happen to the leading financial institutions in the coming days. Although unbridled avarice is at the core of the current mess, each time a financial crisis surfaces, the knee-jerk reactions attract far too much attention.
One reality always registers: If you need money within the next five years, you have no business being in volatile and uninsured assets. All risk is personal, no matter how you slice the investment pie.
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