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4 Steps for Avoiding a Capital ā€œCā€ Catastrophe

October 30, 2014

When the tech and real estate bubbles burst, many of my friends lost 40-50% of their retirement portfolios almost overnight. Whether you’re at the tail end of the baby boomer generation or already retired, lopping 40-50%—or more—off the value of your nest egg would be catastrophic. Which begs the question: is a similar downturn looming?

Take a look at the chart below showing the S&P’s performance since 2008.

Friends, caution is in order. We may see a major correction, a huge downturn, or this bubble could continue to grow for quite some time. I’ll leave the timing predictions to others. As investors, we have to deal with the here and now, with a cautious eye on what might happen down the road.

Don’t Fool Yourself

One of our major concerns at Miller’s Money is investor euphoria. Investors—even those playing with retirement money—often ignore warning signs, thinking the parabolic rise in stock prices is never going to end. However, this time is NOT different.

Look at the Nasdaq’s performance just before the tech bubble crash:

From March of 1999 to March of 2000, the Nasdaq doubled, and investors were euphoric. Are you feeling that euphoria today?

Of course, for retirement investors there’s one key difference between the run-up shown in the chart above and what’s happening now: the Federal Reserve’s low-interest-rate policy has forced them into the market. As one frustrated retiree said to me, “Where else can we go? I rely on my nest egg to help me pay my bills.”

My response: we have to make hay under the storm clouds and protect ourselves from the eventual storm—whenever it might come.

Don’t Let the Next Storm Make You Poor

The goal for a retirement portfolio is to create enough of an income stream that, along with other supplement sources such as a pension or Social Security, you can maintain your current lifestyle over the long haul while the balance grows ahead of inflation. This portfolio should also include enough safety measures to keep you whole regardless of what the market does.

Sounds simple, but it can feel like walking and chewing gum—to the power of 10. Treasuries are supposedly safe… but from what? Sure, you won’t lose your principal, but they won’t protect you from inflation. Certain stocks are solid; after all, many companies survived the Great Depression… but will they keep paying dividends when you need them? Investing in a turbulent market is a gyroscopic balancing act with endless variables.

Our Bulletproof Plan to Keep You Whole

When we built the Bulletproof Portfolio for Miller’s Money Forever subscribers, the first question we addressed was: what’s the safest way we can accomplish our goal?

Pre-2007, the old “100 minus your age” formula worked well. A 65-year-old could put 65% in safe fixed-income investments yielding 6-7% and risk the remaining 35% in the market. Thanks to the Fed’s zero-interest-rate policy, that won’t work today. So we formed a new plan: the Bulletproof Portfolio.

The Bulletproof Portfolio has four broad categories. We call the first Core Holdings. Core Holdings are not investments you intend to sell for a profit down the road. Quite the contrary: they include precious metals, farmland, foreign currencies, and the like, and they protect against a system-wide collapse.

In general, we encourage folks to hold 10-20% of their net worth in Core Holdings. If all goes well, you’ll build up your core holdings and never touch them.

The next three categories are: Stocks, Stable Income, and High Yield. Our Stocks category also includes some funds; it’s designed to appreciate first, and provide income second.

Our Stable Income category is highly liquid. This is where we hold cash that used to sit in our brokerage firm’s cash account earning 4%, or something in that neighborhood.

The High Yield category houses investments chosen for income first and appreciation second (the opposite of our Stocks category). This slice contains carefully selected master limited partnerships, business development companies, and high-yield funds.

We place a heavy emphasis on safety and liquidity. To that end, we’ve set strict allocation limits on our three final categories, which will help protect those subscribers investing along with us during downturn.

4 Lifejackets

While outlining our entire safety system is beyond the scope of this article, here are four of our must-do safety measures.

#1—Set strict position limits. No single investment should make up more than 5% of your overall portfolio. That means rebalancing at least once a year. I have a friend who brags about how well his portfolio has been doing. Turns out, 80% of his holdings are in Apple. While Apple is a fine company and has done well, he should consider locking up most of his gain and focusing on capital preservation.

#2—Use trailing stop losses. We recommend setting trailing stop losses at 20% or less on all market investments. Stop losses can prevent catastrophic damage to your portfolio. As our portfolio grows, a trailing stop can help lock in a gain. While you may still face setbacks from time to time, a trailing stop limits them. You’ll live to fight another day.

I’ve spoken to some retirement investors who limit each holding to 4% of their portfolio and set 25% trailing stops. Whatever makes sense! Just limit the size of each position—and in doing so the potential for catastrophe.

#3—Diversification is the name of the game. This means internationalizing, too. Holding 5-6 mutual funds all in the United States or in US dollars just won’t cut it. You must diversify into non-correlated assets all over the world; so, should one segment or market tank, it won’t bring down a major portion of your portfolio.

You should also review the correlation of the asset you’re considering. What events in the market will cause the price to rise and fall? And pay particular attention to the near term. For example, until recently, utility stocks were considered the gold standard for retirees. Now there is so much capital in this sector, the stocks are correlating much closer to changes in interest rates.

Look for assets that are either uncorrelated to the market or those which may move in the opposite direction (the market goes down, this goes up, and vice versa).

Again, the game is: hold on to as much capital as possible and live to fight another day.

#4—Look for low duration on income investments. Bond sellers tout the safety of US government and investment-grade bonds. They are correct as far as default is concerned; however, a sudden rise in interest rates would mean a large loss for an investor holding these bonds who resells them in the aftermarket.

Retirement investors normally hold bonds for interest income, and they hold them until maturity. While some say bonds are still a good investment, most of these folks are traders. They buy high duration bonds (their market price moves significantly with changes in interest rates), betting on interest rates continuing to decline, and plan to sell for a profit down the road. We are not traders or market timers. Unless you are comfortable holding a bond until maturity, stay away from it.

Protecting Yourself in the Real World

When you invest money earmarked for retirement, using models that were in vogue as recently as 10 years ago will leave you vulnerable. We’ve built a plan that can help protect you in the real world, and we’re eager to share it with retirement investors everywhere.

Right now we have six BUY recommendations in our Stocks category, four BUY recommendations in Stable Income, and seven BUY recommendations in High Yield. You can read up on the specifics by subscribing to Money Forever risk-free for 3 months. Review our portfolio, read through current and back-issues, and take full advantage of our extensive special reports. If it’s not what you had in mind, just call or write within 90 days and we’ll refund every cent you paid.

Also, I should mention one final reason we’ve maximized the safety of our Bulletproof Portfolio: we’re investing right along with our subscribers. Start your risk-free trial now and join us.

On the Lighter Side

We’re always on the lookout for outside resources that can help our readers. My wife Jo and I regularly read The Women’s Financial Edge, a free e-letter from The Women’s Financial Alliance. As the father of daughters, I think it’s important to share tools specifically geared toward a female readership whenever possible. You can sign up for the e-letter by clicking here.

And finally…

The sports update: Are any other NFL fans tired of crazy players celebrating every time they make a play? Score a touchdown, do a dance so the TV camera follows you; make a first down, make a big deal out of it with a first down signal; sack the quarterback, do your trademark dance. Sigh.

The late Walter Payton opposed such displays, telling teammates to act like it was no big deal. “You are just doing your job, and it happens all the time,” he’d say.

What I really don’t like are 9-10-year-old kids in Pop Warner football emulating their heroes by doing the same thing. It’s disrespectful to the opponent.

Recently, Detroit Lions linebacker Stephen Tulloch tore his ACL after celebrating a sack of Green Bay Packers quarterback Aaron Rodgers. Bears defensive end Lamarr Houston signed a $35 million contract at the beginning of the season, and he did the same thing. Houston was quickly mocked by a huge Chicago billboard, pictured below.

When are these highly paid professional athletes going to learn they are paid to play football, not do silly little dances?

Happy Halloween! Until next week…

 
 

About the Author

Over the course of his career, Dennis Miller has consulted with many Fortune 500 companies, training hundreds of executives to effectively communicate the value of their company's products to their customers. Among his many multi-national clients are: GE, Mobil, Shell, Schlumberger, HP, IBM, Corning Glass, Eastman Kodak, AC Nielsen, and Johns-Manville.

An active international lecturer for 40 years, Dennis wrote several books on sales and sales management. He was a contributor to... read more