Thursday March 5, 2009
Emergency Action Plan
We are in the midst of remarkable corrections — a corrective storm that will change how we conduct business, how we invest, and how we buy and manage assets.
Widespread financial mismanagement, spending more than we earned, reckless borrowing and lending, and wanton risk-taking have brought many financial institutions, asset managers, and households to their knees. And the harmful consequences of these actions are just beginning to gain momentum.
Here’s what I see ahead. And here, more importantly, is an action plan that can help you as these remarkable corrections unfold.
First, what can we expect? I foresee the outright collapse of several large banks and insurance companies, and the amalgamation of many smaller banks into larger (and fewer) institutions. Financial stocks of many kinds will be dangerous for years.
But stocks of all kinds are likely to lose more value. The Dow Industrial Average [a proxy for the U.S. stock market as a whole] will, I believe, drop to the 6,250 range this year. I first suggested this 6,000-level in private correspondence and public reports many months ago. As I write this, the Dow is now at 6,950 — far below its 14,164 high point in October, 2007. That’s more than a 50% drop in overall stock prices and I expect that the market will decline further.
So beware. Most stock funds will continue to fare poorly or lose value until the storm is over.
On the other hand, one of the most troubling aspects of this tumult has yet to be widely felt or to draw much media attention. I’m referring to collapse of pension funds and the under-funding for non-pension retirement benefits.
The fact is that many corporate, state and municipal pension funds (and the programs meant to provide other retirement benefits) were dangerously under-funded well before the current Depression took shape. Government regulators gave pension managers free reign to misappropriate pension funds, project rosier-than-possible returns, and generally mismanage and under-provide for these important liabilities.
As stock prices plummet, many pension plans are now completely under water. Many companies, states and municipalities simply cannot pay the pensions and retirement benefits they promise. So many retirees are about to learn that they, too, are victims of Madoff-like ponzi schemes.
Hence, I urge you to be highly cautious when you invest in bonds as well stocks. Many investors are seeking refuge in state bonds and “munis”, looking for high returns and tax advantage. That may prove to be a dangerous strategy.
Indeed, I expect that a number of municipalities will be forced to “declare bankruptcy” and seek federal bail-out assistance. Expect that soon. Expect to learn of monstrous pension funding shortfalls throughout the public and private sectors. And when that news becomes wider spread, many municipal, state, and corporate bonds are going to plummet in value.
So we are in serious financial trouble. Many investments appear to be risky. Many will continue to correct or are poised to lose value precipitously. What should you do?
Here’s my take. It is not, after all, all gloom and doom. Financial history shows that highly troublesome times like these always bring with them highly attractive investment opportunities.
In fact, this is an excellent time to begin looking for high-quality, dividend-paying stocks that are stupendously under-priced. It is an excellent time to invest in the stocks of companies that will benefit from the country’s sundry Stimulus Packages. And it is an excellent time to begin identifying investment opportunities in new companies that will flourish in the alternative energy, health care, and other “emerging market” sectors of our economy.
The great corrections taking place today portend great investment opportunities. There are exciting returns to be earned even if more banks fail, more bonds lose value, and more upheaval takes place in the economy.
So how can you tip-toe through this mine field? How can you capitalize on today’s opportunities without losing more of your capital?
To make positive traction, I recommend this Emergency Action Plan:
1. Divide your savings into three distinct portfolios:
- What savings are you likely to have to draw down over the next two years(to include “emergency back-up money” in the event you lose your job or some other key source of income)? This money belongs in your “I-need-to-keep-this-capital-safe-at-all-costs” portfolio [Portfolio #1].
- What money are you likely to have to draw down during years 3 to 7? You may need to fund a child’s education or begin funding your retirement — but only several years down the road. In that case, you can afford to take on some additional but limited risk. Put this money in your “I-can-invest-this-block-of-capital-cautiously” portfolio [or Portfolio #2]. And,
- What are the savings that you do not expect to tap for at least 7 years? Perhaps you are years away from retirement or do not otherwise need to draw on your savings for years to come. Separate this money. It goes into your “I-can-invest-and-ride-out-the-storm” portfolio. It is the part of your capital that can help you significantly build wealth. But it belongs in a completely different kind of portfolio with different risk characteristics [Portfolio #3].
2. Invest Portfolio #1 money in FDIC-insured deposits. The money you simply cannot lose should go into FDIC-insured deposits. Investing in stocks, bonds, or even Treasury bills opens the possibility of losing principal short term. However, FDIC-insured deposits provide secure returns and protect you from upheavals in the banking sector. So FDIC-insured deposits are the way to go with your “no loss” portfolio.
3. Invest Portfolio #2 money in high-quality corporate bonds, short-term Treasuries, and “bonds with an upside” — meaning [as Jim Cramer first put it] stocks that have a dividend yield of at least 7%. Ask your Financial Advisor for suggestions on specific funds and ETFs to consider, specifically focusing on the stocks of companies likely to benefit from the Stimulus Programs. Put no more than five percent of this money in any single investment. And stay away from bank and financial company stocks — even if they pay attractive dividends — until their derivative and asset-backed exposures are disclosed and until much more rigorous transparency and “health” regulations are enforced by the government.
4. Invest Portfolio #3 money in a mix of high-quality domestic and international stocks that pay dividends. In your third portfolio, focus primarily on the dividend-paying equities of telecommunications, alternative energy, raw material, and mining companies. Expect losses until the current crises are over. They are bound to happen. But we cannot “time” the markets or find exactly the “best time” to invest. So even if you experience some interim loses, there are nevertheless very exciting returns to be had when the world’s economies and stock markets rebound. In fact, it’s a remarkable opportunity to build wealth!
I hope your personal finances permit you to put a good chunk of your savings in Portfolio #3. Begin buying low-priced, dividend-paying stocks, investing about a quarter of Portfolio 3’s money into such stocks once every five months. Make the investments gradually. Look for dividend-payers with P/E ratios of 14 or lower. Broadly diversify by (1) kind of investment, (2) industry exposure, (3) geographic exposure, as well as (4) asset manager. And, again, ask your Financial Advisor to recommend specific funds, ETFs, and allocations to help you achieve broad diversification. The diversification tactics explained in my book Cash-Rich Retirement will also help you.
So let’s put this all together: We are, I’m afraid, likely to experience a lot more financial upset and pain, but you can take action to profit while others remain paralyzed. The great investor Warren Buffet says that the economy will be “in shambles” in 2009. However, I also hold to a modified version of Mr. Buffet’s strategy for bad times: Be fearful when others are greedy and invest skillfully when others are fearful.
It’s time to invest skillfully, not buckle with fear. Divide your capital into three different portfolios. Invest cautiously and prudently. Get professional help. And expect more turmoil ahead with — if you invest non-speculatively with a prudent time-line focus — a silver lining long-term.
The information and views contained in this column do not represent a recommendation or solicitation to buy or sell any particular security or fund.
At the time of publication, the author may or may not have held any of the investments cited. His holdings may change from time to time. The opinions and recommendations expressed in these articles may likewise change from time to time without prior notice. Hence, readers are urged to conduct their own, independent research and consult their personal investment counselors before making any investment decisions.
Past results are not a guarantee of future outcomes. Investments of any kind can result in losses. When considering any investment, you should independently judge the content, management, fees, tax implications, historic performance, and risk factors of the investment and, in particular, read its prospectus and/or other offering materials.
The communications, comments, and opinions contained herein are intended solely for informational purposes. Mr. Schlagheck and this blog are not responsible for the accuracy, timeliness, or soundness of the information provided. All of the above commentary comes without warranty or guarantee of any kind. Neither Mr. Schlagheck, this blog, nor any other party can be held responsible for the validity, accuracy, or efficacy of these views or for the investment performance resulting therefrom.