4 Ways To Protect Your Wealth During This Recession
Emanuel Balarie, October 3rd, 2008
Protecting Your Money Portfolio In A Recession
It is often in the midst of economic despair that wealth is both made...and lost. While history often focuses only on the financial loss that transpires during recessions, it is also important to point out that these types of market environments have also provided individuals with the opportunity to make money.
Consider, for instance, some of the biggest companies we have today. Microsoft was started during the recession of 1975, Hewlett-Packard was born during the Great Depression, Disney was founded during 1923, and GE started during the panic of 1873. The founders of these companies were all able to thrive during times of economic turmoil.
Not an entrepreneur? No Problem. Recessionary environments also provide investors with investment opportunities. There will be opportunities to buy real-estate at undervalued prices, shares in companies at historically low P/E ratios, and perhaps even invest in start-up or emerging companies that might become the next Microsoft or GE.
But, before you start counting the wealth that you can possibly make during this recession, it is best to first start thinking about how you are going to protect it. Indeed, while a recession provides opportunities, it also creates an environment where many investors are often afraid to invest in value opportunities, or simply do not have the cash to participate. This, of course, makes perfect sense. After losing money in the stock market, real-estate or other investments, not many people will have the "contrarian" courage to purchase value investments. Additionally, many investors that have stubbornly held on to their present portfolio will simply not have the means to re-allocate their wealth.
As such, it is important to re-evaluate your financial situation and focus on protecting your wealth. While many pundits might still advocate buying into this market, I firmly believe that we are still in the early stages of a deep and long recession. The first step is to focus on protecting your wealth. Once you protect your wealth, you allow yourself to invest in potential value opportunities that will inevitably arise.
Is Cash King?
So how exactly do you protect your wealth? Well, for many investors, the answer is simply to liquidate their positions and move everything into cash, money markets, or treasury bills.
The basic logic behind this move is simply that "cash is king". In other words, while the stock market and real estate markets are declining substantially, keeping one's money in cash will at least preserve what they currently have. It will also allow them to have money to invest in opportunities down the line.
While this logic makes sense in a non-inflationary environment, it fails to address the de-valuation of purchasing power that occurs during rising inflation. Simply put, rising inflation erodes at the purchasing power of cash or cash equivalent investments. In other words, while you might think you are preserving your wealth...you actually are not.
Not convinced? All you have to do is take a look at your current costs and compare them to your costs from 5 or 10 years ago. You will quickly realize that you dollar does not buy what it used to buy. Consider, for instance, this hypothetical scenario.
Let's assume that 10 years ago you retired from your job. For the previous 40 years, you worked hard to put enough money away so that you would enjoy a comfortable and relaxing retirement. In preparation for your golden years, you put together a financial plan, calculated the potential costs of goods and services (using core CPI numbers), and decided that you had enough money to simply keep your wealth in a money market equivalent investment.
If you fast forward to today, you will quickly notice that the costs of goods and services are substantially higher that what you or your advisor had initially calculated. While you received some interest on your money, it by no means made up for the rising costs that have occurred around you. In addition to record food and energy prices, you are now paying for your prescription medication, your cable bill, recreational activities, and travel costs. You had even planned to help pay for your grandkid's education, but are now noticing that tuition costs are also rising at quick pace.
If are your living this above scenario, you are quickly understanding that cash- or any type of fiat money- does not preserve your wealth. Your wealth has eroded at a faster pace than you initially projected, and your purchasing power of your money has declined substantially over the past decade. Why is this? Well, a big reason has to do with the exponential growth rate of our money supply. While the Fed no longer reports the growth of the M3, the following chart can still give you an idea of the exponential increase of money that the fed has injected into our economy.
What is the result of an increase in the money supply? More money floating around. What is the impact of more dollars bills floating around? It dilutes the purchasing power of the dollar that you have in your pocket. There is now too much money chasing too few goods.
The Fed has cranked up the printing press since the mid 90's and the recent turmoil in the markets is forcing them to crank it up a notch higher. In fact, this is why I believe that the government's current bailout package misses the point. Flooding the market with liquidity is simply robbing Peter and paying Paul. Investors who did not participate in the speculative investments of the last several years are now forced to pay for them, whilst inflation will continue to erode the purchasing power of their savings. You can read my comments here:
So how exactly do you preserve wealth? And how do you keep your wealth so that you can participate from these potential value investments? Here are some ideas:
