I have a confession. I’m not an investment advisor.
That’s a deliberate choice. Many years ago – October 19, 1987, to be exact – I watched global stock markets fall more than 20% in one day. The Dow Jones Industrial Average (DJIA), an index of the most widely traded stocks on the New York Stock Exchange, fell by nearly 22%.
In the carnage that followed what became known as Black Monday, I decided the last thing I wanted to do was to manage other people’s money. Managing my own was hard enough.
Over the years, I’ve managed to save some money, hopefully enough to secure a comfortable retirement. This issue describes what I’ve done right – and wrong. I hope you’ll find it useful, especially if you’re a beginning investor.
Let’s start by focusing on what I did wrong.
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Letting others manage my money. There are some outstanding money managers in the world. Unfortunately, all the ones I’ve worked with personally have lost money. One investment manager trading options and futures in a managed portfolio lost one-third the value of the funds I invested in three months. Another manager lost 20% over five years. A third who focused on junior natural resource stocks lost 30% – during a bull market in commodities, no less.
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Buying stocks. Money managers will tell you that the long-term performance of stocks beats virtually every other investment. For instance, between 1928 and 2011, the DJIA rose at an average rate of 9.3% annually. That’s impressive, but unless you have a very long time horizon, much of your return depends buying at the right time. For instance, if you bought DJIA stocks in 1929, you wouldn’t have broken even until 25 years later, in 1954. More recently, from 1998 to 2008, the DJIA lost an average of 0.6% annually. As a result of these trends, and my personal experience losing money on most stocks I’ve purchased, I’ve cut my exposure to stocks anywhere in the world to less than 1% of my portfolio.
- Not paying enough attention to fees. Many types of investments require that you pay stiff fees when you buy, sell, or redeem an investment. In many cases, those fees are poorly documented or can change without notice. A few years ago, I purchased a foreign annuity. There was a 3% front-end fee, which I paid with some reservations. I paid another 2.5% annually to have the investment “managed.” And when I sold, I had to pay liquidation fees amounting to about 5% of what I had left. Without the fees, I would have come close to breaking even. With them, I lost 25% of my initial investment.
Fortunately, not all of my investing experiences have been bad. Here’s what has worked for me.
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Holding cash. By cash, I mean cash in all of its forms, starting with physical cash. A great way to start investing is to keep a stash of physical cash in a safe place at home. I recommend keeping enough physical cash on hand to pay the bills for at least two or three months. What’s more, if there’s ever a financial collapse that causes widespread bank failures, you may not have access to your bank account for weeks or even months. Your account might even be bailed-in. Instead of getting your money out the bank, you get worthless stock back. That’s what happened to bank depositors in Cyprus in 2013. And bail-ins could be coming to the US as well. Keeping physical cash close at hand means you can avoid the worst effects of this type of calamity, at least temporarily.
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Buying gold. In 2003, I inherited some money from my father. I used half of it to purchase a substantial position in gold, at an average price of around $400/ounce. After my purchase, gold prices rose to nearly $1,900/ounce and subsequently fell below $1,200. Gold is worth just over $1,200 today. I was lucky. Despite purchasing a large quantity of gold all at once, the value of my investment tripled. A safer strategy is to dollar-cost average your gold investments; buy it in installments over an extended period, not all at once. For instance, if you plan to purchase $10,000 worth of gold, invest the same amount each month until you get to $10,000. This is a great strategy to purchase any investment, because you automatically buy more when prices are lower and less when prices are higher. It’s the exact opposite of what most other investors do.
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Buying real estate debt-free (or with a small mortgage). In 2007, I used the other half of the money I inherited to purchase a townhouse in Phoenix. My timing was terrible. Within 12 months, the value of the townhouse had tumbled more than 80%. But I didn’t care, because I was living in it and had paid for it with only a small mortgage, which I soon paid off. When I moved out in 2015, the value of the townhouse still was 30% less than what I’d paid. I still didn’t care, because I was able to rent the property to generate a nice income.
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Peer-to-peer lending. With the rise of peer-to-peer lending websites, it’s become easy for anyone to become a lender. These websites match borrowers and lenders, and even the lowest-risk loans generate returns that exceed 4% annually. That’s not a huge return, but it’s been a consistently profitable strategy for me. I diversify my risk by never putting more than $50 into any one loan. If one borrower defaults, I have a fractional interest in hundreds of other loans with borrowers that are still paying.
If you’re just starting to invest, or you’re looking for ways to mitigate risk, I’d focus on these asset classes. But keep in mind what investment gurus call “counterparty risk.” In a nutshell, that means when you invest, you often expose yourself to the possibility that the person or company you invest with – the counterparty – could experience financial difficulties.
For instance, part of your cash position will inevitably involve keeping money in a bank. But once you turn your money over to the bank, it’s no longer your property. It’s the bank’s money. All you have is an unsecured claim against the bank.
If the bank collapses, your account might be protected by deposit insurance. Or it might not, since the FDIC has only enough cash on hand ($90.5 billion) to insure about 1.3% of the more than $7 trillion US depositors have in US banks. Basically, the FDIC has only enough money to bail out depositors at one medium-sized US bank.
Sure, the Federal Reserve could always create more money out of thin air to bail out depositors up to the limit of $250,000 per account. But if it doesn’t – or if you have more than $250,000 in any one account – your money could become subject to a bail-in.
Counterparty risks also abound in gold investments. To avoid them, take personal possession of your gold investment, and keep your coins or bars in a safe place at home. For larger investments, keep your gold in a safe deposit box in a private vault – not a bank.
If you purchase gold that you don’t store yourself, make certain it’s kept in “allocated” storage. With this type of storage, a custodian (e.g. a bank or warehouse) has specific coins or bars that you own set aside. Your gold isn’t part of your custodian’s balance sheet, and if the custodian becomes insolvent, its creditors can’t grab your gold.
Unallocated storage means that you have an ownership interest in a gold pool maintained by your custodian. But you don’t have title to individual coins or bars, and if the custodian becomes insolvent, in most cases you’re just another unsecured creditor. Good luck getting your gold.
If you’d like to learn more about what I’m investing in, and what I’m trying to avoid, please consider a risk-free membership in our Nestmann Inner Circle. In an upcoming interview exclusive to Inner Circle members, I’ll reveal a low-risk strategy that actually allows you to earn income on your gold investments. It’s not for everyone, but it’s a great strategy you should know about.
