Wednesday, September 29, 2010

Investing For The Next 5 Years

¹²Investing For The Next 5 Years

By Larry Laborde | 27 September 2010

Even though perhaps as many as 20% of the working age people in the US are unemployed, 80% are still working. Young people fall in love, babies are born and the inevitable funeral awaits us all at the end of our earthly journey. But what a joy life can be if you simply make the right choices and choose to enjoy them. One of my favorite sayings is happiness is not about getting what you want but simply wanting what you get.

Many people are uncertain about just exactly how to invest in these troubled economic times. Private capital seems to be fleeing the stock market as it not only seems to have gone nowhere this last decade but has even lost ground when considering the steady erosion effects of inflation as it devalues our dollars. Even though we may hold the same amount of dollars in our accounts at the end of the decade as when we crossed over into the year 2000 those dollars have shrunk quite a bit when considering their purchasing power.

Many of those dollars that have left the stock market have rushed into the supposed safety of bonds. With the falling revenues and increasing expenditures of municipalities and state governments (especially in lavish defined benefit pension funds) default cannot be far off. US bonds are not much better but will last a bit longer before the inevitable default occurs; either through outright default or the slow painful type that pays off in 'future' dollars that buy less and less than the past dollars that purchased those same bonds.

Bonds may realize a further gain if the interest rates drop further— but how much lower can they go? If the interest rates go up (more likely than going lower) the value of [[a pre-mature: normxxx]] bond will drop. Bonds just do not look as good going forward as they have in the past.

Most investment advisors will tell you that you should only invest in stocks and bonds. Invest heavy in stocks when young and change the mix to a heavier allocation into bonds as you get older. This is looking to be a less and less promising strategy as we go forward into this economic storm.

There are 7 classes of investments out there; stocks, bonds [[and other 'fixed income' investments: normxxx]], cash [[and cash 'equivalents': normxxx]], precious metals, commodities, collectibles, and income-producing real estate. Real estate still seems like it has lower to go (especially commercial real estate). Cash is not bad, but there is a cost to hold it as inflation exceeds ordinary interest right now. Commodities are becoming more and more popular [[altogether too popular: normxxx]]. People had made fortunes in agricultural commodities as of late due to the Russian drought, a growing world population, and third world prosperity that is hungry for a better diet. Precious metals have been in a bull market (when priced in fiat currency) for the last decade and will probably continue to be a good investment going into the next decade, as they are increasingly recognized as the premier form of cash. [[But beware of increased, stomach-churning volatility going forward.: normxxx]]

Economic storms are not about smooth sailing or even about passing other boats in the race. They are about survival. Storm sails and sea anchors are not about speed. They are about surviving through the storm, then taking stock of the horizon afterwards and then adjusting our sails and continuing onward.

Preserving our capital in this economic storm should be our number one priority. Making money should be secondary. The time for great profits will come a bit later after the storm. However, if your boat has capsized and sunk then you are out of the race, and when the storm clouds clear and the sun does reappear, you will be unable to take advantage of fair winds and favorable seas.

So how exactly do we rig for storm? Only invest in what you understand. If you do not understand the business plan of a company you are invested in then read up on it. If it does not make sense to you then get out. If the prospectus looks like an old Sears and Roebuck mail order catalogue then simply pass on that one. Charlie Munger said that at Berkshire they had 3 buckets; good investments, bad investments and just too hard to understand investments.

[[Look for "World Dominator" stocks [1]; ie, whose customer base is geographically distributed, which seems to have an assured future— including revenue growth during "up" periods and no significant loss during "down" periods, which is providing an essential/needed product/service (which is not likely to become obsolete in the foreseeable future), has an investor friendly, innovative management (this may be hard to judge; but use the opinions of several gurus whose advice you have come to respect; in particular, look for the capacity to 'expand' its current franchise into seemingly unrelated or tangentially related fields— such as google or microsoft— and/or can quickly match or usually anticipates the new products of competitors— such as intel), has a high 'moat' against new competitors, a very consistent profit margin (preferrably over several years), pays a reasonable dividend (in-line with industry) with a good history of ever increasing dividends (very few or no "bad" years), etc.

Remember to be especially on the lookout for 'future' world dominators, ie, medium-sized companies with seemingly unlimited potential to grow, eg, in the attributes described for the WDs (most such are relatively 'boring' companies, like Wal-Mart or Exxon; Microsoft and Intel are probably two of the most 'exciting' stocks in this group, but are not any better than the rest).
: normxxx]]

Even the best of investments should be shied away from if they are too hard to understand. Stocks are not altogether poor investments if you are a good picker and are willing to do your homework, but by and large most are overpriced right now. When P/E ratios get back around 5 to 7 and good dividends are being paid out then it will be time to re-enter the market with the capital that we saved from the storm.

Lazy stock investors will have a hard time surviving this storm. Municipal bonds should only be invested in when you have knowledge of the individual municipality and feel comfortable with their fiscal position. (I know of few to none right now.)

US government bonds are simply a bet that Washington DC has the right answers and will guide us through this mess with responsible policies (It is hard to type and laugh at the same time.) If you feel that you must invest in bonds then try only short-term bonds or long term bonds that mature in 1 year or less. Just remember to be out of them at least one day before they default.

There are simply no shortcuts in this process. You simply have to grow up and do your homework on your investments. My father used to lament that it is hard to make money but it is even harder to invest it wisely enough to hang onto it. I now know exactly what he was talking about.

I have always recommended a 10% investment in precious metals (metals that you own outright and hold in your hands) as portfolio insurance. In these uncertain times a 20 to 25% allocation is not too much. Don't look to others to take care of you.

Social security will probably not be around for those of you under 45 right now. Social Security has just gone into deficit spending 6 years ahead of schedule. It will be 'means tested', real payments will be reduced through inflation [[the current COLA will be discontinued or discounted: normxxx]], and the retirement age will slowly creep up to where it seems many people will never get there at all (sort of like the carrot on a stick).

Defined benefit plans will go bankrupt after payments are reduced through inflation. Few such plans are fully funded these days, and funding will only get worse going into this storm. Cash, while expensive to hold, is still not bad and probably deserves a 20 to 25% allocation right now. Just make sure your cash is held in the right place.

Most money market funds are paying close to zero and some even 'broke the buck' back in 2008. Many more may head below $1/share as interest payments drop and fees are subtracted. Stay away from the large New York banks as they are all the walking dead. While it is true that DC may bail them out forever it is just possible that things may not work out so well for them into the future.

I also consider it morally reprehensible to deal with them at all. Look at local banks that have a strong bank rating. Also consider credit unions. Just do not keep over $100,000 in any one institution. Spread it around a bit and hedge your bets.

There will be bargains in the future when the storm passes and you must have wealth to be able to play. The stock market will be a bourse with more sellers than buyers as the largest generational demographic enters retirement age and starts cashing in on their investments to live during their old age. Most stocks in the US are overpriced as their P/E ratios are too high and the dividends are non-existent.

Capital appreciation is the only way to profit with most stocks nowadays and that is a long shot with most of them in today's storm. Stock markets in the third world or in the emerging markets will show great promise after the storm, however, they could prove a bit risky just now. Start a list of possible investments for later. Research them and follow their progress through the storm.

It is a bit early to invest but it is never too early to start your watch list with target purchase prices. (This is why you need the cash.) Good agricultural real estate and solid commercial real estate will be great buys at the bottom so start looking around at targets to purchase in the future. Finally, consider opening a family bank or your own venture capital investment company.

Instead of investing in Dow Jones stock consider investing in your nephew, your grandson or another bright young relative. Unemployment is extremely high among the younger generation. Encourage them to learn a trade such as a plumber, electrician, machinist, painter, landscaper or commercial driver. Anything that interests them will work.

If they cannot find a job then encourage them to create their own and start a business. Make a small loan and then mentor them in their business ventures. Help with insurance selection, cash flow, employee relations; all the things that you have learned for the last 30 years in business. Help make them a success. See what the bank would charge for a small business loan and then make that same loan for a couple of points less. The return on your capital will be much greater than the bank is paying. You can control the risk by mentoring them.

Many people complain that the banks are not lending. They are also complaining that the banks are not paying interest on savings. Well just cut them out and make those loans directly through your family bank. It will take honest talk between both parties as well as a little legal work to have everything perfectly understood up front. The results can be amazing for both parties.

Housing will be another area where there will be much more pain to come. Home mortgages will be harder to get and harder to service. While I think we will see inflation in things we need and import such as food and energy, I think we will see deflation in assets such as houses and luxury items that we can do without. I believe we will see 'intergenerational homes' more and more in the coming years.

There is a great opportunity for building contractors to convert the sprawling 5 bedroom ranch house into a modern intergenerational home for the coming decade. A remodel that offers 3 master bedroom suites each with private bath, bedroom and sitting room along with common rooms such as common kitchen, den, dining and laundry rooms will create a powerful economic family unit that will still allow for a certain amount of privacy. Grandparents with their own mini apartment or suite can provide childcare as well as transmit family values to the next generation.

Older adults still working can provide economic stability and allow younger adult children to take risks and open a new business. The key to this new family arrangement is converting the 5 bedroom ranch into a family home with 3 master suites or apartments allowing for private spaces for each generation. Kitchen, laundry and dining rooms are public spaces [[but need to be rebuilt as 'shareable': normxxx]] whereas the master suites are private spaces.

This will allow for families to live together in harmony. The younger generation has been hardest hit in this storm. For those that do not have the luxury of a conventional job, the new economy will work best if they seek several streams of income through contract work at different part time jobs. All three generations working together will allow for flexibility and many different income streams to support the home in case one or more are lost.

Debt will be a killer in the future. If you can pay off your home, credit cards and car then do so. Try to operate with cash as much as possible or at least pay off your credit card every month. Live below your means and save all you can every month. Make sure you have 6 months of living expenses in savings (preferably in a credit union). Also try to have an emergency fund of a few thousand dollars at home or close by.

In these economic times family and neighbors will be more important than ever before. As government assistance and services disappear in this storm, it will be family and neighbors that pull each other through.

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