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Warning! Fiscal Hurricane Approaching! Is Your Portfolio Secure? Part 2

In a previous article entitled "The Ominous Warnings and Dire Predictions of World's Financial Experts - Parts 1 and 2", we learned what was probably in store for us short-term and in the next few years. These experts used words like 'Economic Armageddon', 'Financial Apocalypse', 'Financial Disaster', 'Financial Train Wreck', 'Deep Funk', 'Great Disruption', 'Category 6 Fiscal Storm', 'Economic Earthquake', 'Serious Collapse', 'God-Awful Fiscal Storm', 'Debt-Driven Meltdown', 'Major Upheaval', 'Demographic Tsunami', 'Rude Awakening', 'Economic Pain', ' Systemic Banking Crisis', 'An Accident Waiting to Happen', etc. to describe what we are in for. It begs the question "How should we position our assets given the dire predictions of these imminent economists and analysts who are all much of the same mind as to what may well be in store for the U.S and, indeed, the global economy very soon?" Again, we have compiled a detailed and comprehensive summary of what many of these very same individuals, and others, have to say. It is so extensive and informative we have taken the liberty to divide it into 4 parts.

Warning! Fiscal Hurricane Approaching! Is Your Portfolio Secure? Part 2
by Dudley Baker and Lorimer Wilson

Charles Carlson, CEO of Horizon Investment Services and author of a number of books including 'Eight Steps to Seven Figures,' 'Buying Stocks Without a Broker' and 'No-Load Stocks' offers hands-on advice on how to survive - and thrive - in a wildly fluctuating market in his latest book 'The Smart Investor's Survival Guide.' As he says "The storm's eye is an excellent metaphor for what investors must do during stormy market periods. Find the eye. Get to the calm. Play in the space where you won't get hurt.

What kind of investments?

1. Liquid investments: During uncertain market times investors usually migrate toward the most liquid investments because liquidity provides flexibility; the flexibility to respond quickly to changes in opinions about certain investments; the flexibility to raise cash quickly if need be. Such liquid investments include large cap stocks, larger corporate bond issuers and also cash which always works well in volatile markets.

2. Dividends and Interest: During volatile markets, when certainty of returns is an especially prized commodity, investors will migrate to those investments offering at least some modicum of income via dividends and interest. Stocks with high dividend yields, and particularly considerable dividend growth, generally hold up better during down markets than stocks with low yields.

3. Consistent earnings: Certain industry sectors are more conducive than others for weathering volatile markets. At the top of the list is the health care sector, followed by the consumer staples sector. These groups, especially health care, have steady product demand regardless of economic conditions. That consistent demand usually leads to consistent earnings.

4. Low-Volatility investments: In the eye of the storm, less volatile issues will generally weather the fury better than volatile investments. Stocks and stock mutual funds have the most volatility. Cash, bonds and treasury securities have the least expected volatility. Within fixed-income investments short-term bonds are less volatile than long-term bonds and U.S. corporate bonds are less volatile than foreign bonds.

5. Diversified portfolio: Diversification makes perfect sense especially during turbulent market conditions. When you diversify, you buy a bit of insurance for your portfolio against catastrophes. By definition, diversification reduces risk. You don't know with complete certainty what groups will be leading and lagging the market at any point of time. Since you don't know where the next leaders will come from, a prudent approach is to own a bunch of investments a) within a variety of asset classes (i.e. investments with different risk/reward profiles), b) of a variety of different asset classes (i.e. investments that don't correlate with one another), and c) that are appropriately weighted one to the other and rebalanced in relationship to each other every 12-18 months should one or more get out of whack by 5 to 10 percentage points. In that way, you're sure to avoid owning all the groups getting killed and increase your chances of owning groups and investments that are doing well.

6. Proper Allocation:

a) You need to determine the percentage weighting of assets in the total portfolio. The two biggest determinants of asset allocation are risk tolerance and investment time horizon. The more risk-adverse you are as an investor, the greater the portion of bonds/cash versus stocks you should have in your portfolio. Also, the shorter the time horizon the larger the percentage of the portfolio should be devoted to bonds/cash. A good rule of thumb for setting an allocation is to subtract your age from 100 or 110 (depending on how aggressive you are) and invest that number in stocks and split the remainder between bonds and cash. However, if you have an extremely limited investment time horizon, an extremely low tolerance for risk, or a limited need for growth given your financial position, obligations, etc., then consider allocating 15-25% to stocks, 40-50% to bonds (40-45% in a short-term bond fund, 40-45% in a total market bond fund and 10-20% in a high-yield bond fund) and 25-35% to cash.

b) You need to spread the stock component of your portfolio across various industry groups and among 25 to 35 individual stocks or a broad based mutual fund. I think an investor with a 20-or 30-year time horizon would be OK with a single stock making up 20 percent of a portfolio. Conversely, an investor in his or her sixties should keep individual stock weightings to 2 percent to 15 percent of the portfolio.

7. Timing: Smart investors take advantage of volatile markets in two important ways:

a) smart investors step up to the plate to buy, even if everyone is shouting 'sell.' Even if you get nervous and move some of your cash or bonds, make sure that you are putting at least something into stocks or stock mutual funds during the rough patches and

b) smart investors use volatile markets to upgrade portfolios. Smart investors don't miss the future by looking at the past. They take their lumps, learn their lessons, and do what they can to position their portfolios for the market's inevitable upturn. That means smart investors use volatile markets to trim their deadwood and buy those stocks that they always wanted to own if they got cheap enough."

Ibbotson Associates, a Chicago research firm, suggests that "adding precious metals to a portfolio of U.S. equities, bonds, and Treasury bills would modestly improve long-term returns without adding risk to a portfolio. An asset allocation of 7.1% to metals would increase the expected return on a conservative portfolio by 0.2%. A 12.5% allocation in a moderate portfolio would add 0.4% to the expected return. Indeed, the performance of an equally-weighted gold/silver/platinum portfolio is actually closer to fixed-income assets than to equities over the period from 1972 to 2004."

James Shepherd, President of JAS MTS Inc. and editor of the Shepherd Investment Strategist, has stated that "my investment philosophy is based on one simple premise: we must be invested in areas that provide the best returns, with safety, of our core capital. Then, when other opportunities arise that give us the ability to use speculative leverage to propel our overall portfolio higher, we should avail ourselves of the opportunity with a small percentage of our capital in order to take advantage of this potential. Unfortunately for many investors, they never seem to be flexible enough to be in the right things at the right time. I recommend putting 33% of ones portfolio in 30 year U.S. Treasury bonds due to the deflationary pressures that are very much in evidence, although currently just under the surface, which will drive long-term interest rates even lower and 67% in short-term government securities or, for the more aggressive investors, placing 33% in URSA and the balance in short-term government securities.." In addition, when it is evident that a stock market crash is imminent, he intends to "utilize more aggressive means of playing the anticipated decline in long-term rates by using instruments or funds comprised of zero-coupon bonds which move higher in price relatively much faster than regular Treasuries, to take substantial positions in funds that move inversely to the major indices and perhaps even leveraged versions of these derivatives that move inversely in multiples to the underlying index. We will also be utilizing some leverage instruments such as put options. These can increase dramatically in the event of a collapsing stock market. Regarding gold I am of the opinion that if we get rampant inflation at some time in the future, we could confidently expect gold to rise very sharply to well above the $2,000/ounce level. That said, however, the most likely outcome is a deflationary environment. In that scenario gold would not do well, nor would many other 'hard' assets."

Richard Benson, President of Specialty Finance Group, LLC, is of the opinion that "the financial markets are leveraged for a crash. The capital markets have become one massive casino. Very few people believe they are gambling with their own money because borrowing with other people's money to place the bets has become so easy. Money is being made in the leveraged carry trade or in speculating on margin. Even the patriotic homeowner with a variable rate mortgage is borrowing short-term to buy stocks, and to pay bills. What happens when investors want to reduce their risk and need to sell but can't find a buyer? They would be trapped because the markets are just not that liquid, especially when everyone wants to sell! That's why it is important to be in cash before the crash! Short-term Treasuries, bank CD's (but only up to $100,000 per institution), TIPS (Treasury Inflation-Protected Security), I-bonds, and gold coins are all wonderful places to sit out any potential storm. For the average investor who is risk adverse and for any investor who considers losing a dollar worse than making a dollar our advice is to get into cash and be prepared to wait. Good hunters know how to wait and good things happen to those who are patient, like buying what they like at half price!"

It is recommend investors strategically position themselves in a wide variety of assets including precious metals, mining shares and long-term warrants. Nothing like taking what the experts say to heart and investing accordingly.


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