What if everything you’ve heard about diversification is wrong?
What if your strategy is about to break you?
Most investors have been told diversification means spreading risk among different asset classes – stocks, bonds, real estate, commodities, etc. Some wealth advisors even recommend having some foreign assets and gold. But they all have one thing in common- they believe that inflation is inevitable.
But what if they are wrong? Wonder if we are facing a deflationary depression, just like the other three depressions in American history? Well, it means investors will lose most, if not all, of the assets they own, and yes, that means gold too.
The key word here is risk. Before you can manage or reduce it you have to understand what the true risks are. We live in a probabilistic universe and knowing what the probabilities are is the first step in managing risk.
Financial institutions and funds (80% of financial market participants) have only 3% cash in their portfolios, the lowest in history. They are saying there is virtually no risk owning assets like stocks and real estate. To them ‘cash is trash’.
They are betting on the Fed to keep interest rates low and inflation causing asset prices to rise. Investors think they are diversified when what they really are doing is betting on one thing- asset prices going up.
Not only are they betting one way, they are doing it with the highest level of margin (debt) in history. Right now, margin levels are at the same level they were just before the Great Crash of 1929, and margin debt is what caused the 1929 stock market crash and the deflationary depression that followed. In 1974, total margin debt was $4 billion, 40 years later it’s over $400 billion, a 100 fold increase!
Here is a recent quote from the legendary Robert Prechter, president and founder of the world’s largest and most respected market forecasting company:
Man, oh man, what a change is high. Almost no one has a clue about what’s about to transpire. When the tide turns, the burdens that optimistic, careless people have placed on the economy will finally crush it. The downturn will seem to come out of the blue, but it has been germinating for a long, long time.
In 1999, an academic economist published an editorial in the Wall Street Journal predicting that there would never again be another recession. Last week we read an editorial proclaiming that the S&P will never again experience another 10% correction.
The ebullience of 2000 was amazing, and the indulgence of 2006-8 was flabbergasting. Now words are insufficient to convey the breadth and depth of the financial insanity that exists. The stock market is overvalued but no one thinks it matters, the economy is dying, yet economists think it’s fine, real estate is weighed down by debt, yet institutional investors are buying tens of thousands of homes, to flip. The amount of risky debt is so huge that it can never be repaid and the public is gorging on it at a record pace. Corporations can’t find any traditional areas worth investing in, yet they are buying their own stock. Most people and institutions, including governments, are broke but they don’t know it.
The preeminent economist, Von Mises, said “there is no means to avoid the collapse of a bubble brought about by the expansion of credit”. The last 20 years has seen the largest expansion of credit (debt) in history, many times over.
You need to ask your financial advisor what will happen to your diversified portfolio if there is another financial and economic crisis- or worse. I’ll guess the only answer you will get is something like ‘that’s impossible, there are too many safeguards in place for that to happen. The Fed would never let that happen. There’s nothing to worry about’. Probably followed by – ‘you need to think about buying, you don’t want to miss out on the next rally’!
Today the real risks are more than just financial. True diversification means reducing all probable risks. It’s time for you to start thinking about what the true risks are and what real diversification means. Then act to protect not only your wealth, but your family’s health and safety.
Successful private investors have one thing in common- they don’t rely on financial advisors or managers- that would be like asking a car salesman how to win the Indy 500.