With globalization 2.0, worldwide financial markets have become so much more intricately connected and symbiotic – literally thriving at the edge of chaos – that seemingly small things can now tip them into turmoil. The events of late 2008 in particular attest to this. For example:
- an economics prof I talk to said “throw your textbooks out the window” because those rules no longer applied in this new type of economic mess
- we’ve heard reports since September 15, 2008 (the day of the Lehman Brothers’ collapse) that if the Fed had not acted as quickly as they did, world markets would have all collapsed within 24 hours. The Fed knew this, in fact, and the quick cash infusion they gave to the money markets actually prevented it (so they say). There was a literal, electronic “run-on-the-banks” in the U.S. that day, with billions being withdrawn from money-market funds all at once.
If the traditional economic rules no longer apply, what about the traditional personal finance rules? Recently we’ve seen a wave of personal finance bloggers starting to question such formerly tried-and-true principles as “buy-and-hold.” The buy-and-holders got badly injured in the past year. But on the other hand, market timing (the process of trying to figure out when is a good time to buy and when is a good time to sell) is also notoriously problematic except for a small few who are able to put in the requisite amount of time and research to succeed at it.
Traditional financial advice also tends to assume that you spend most of your years – from 25-65, say – earning income before you begin to “retire,” convert your portfolio into some more “secure” vehicles and begin drawing upon the interest payments from your safe principal.
Well not only is the “old” retirement dead (we’re all aiming for four-hour work weeks now, aren’t we?), but so is this idea of waiting to start preserving that mass of wealth you’ve stored up.
A better, though still not ideal, strategy is the one where you take your age and make sure you have that same percentage of your portfolio in bonds. So if I’m 32, I should have 32% of my whole financial portfolio in bonds. This would at least assure that you always have some portion of your portfolio in a somewhat more secure vehicle. The problem is that bonds are only ONE way of trying to protect your money. And bonds don’t always perform well in every market. When stocks do well, bonds suck. When bonds do well, its the stocks that suck. Usually.
There are other strategies for mitigating risk and preserving some wealth. For example, take the concept of diversification and extend it into different asset classes; extend it across time (dollar cost averaging); and across purposes (goal-specific savings accounts). But my current favorite model is one that I made up (at least I’m not aware of it existing anywhere else). I think of it as the fountain of wealth preservation.
The Fountain of Wealth Preservation
You can take the concept of rebalancing and shift it onto a “fountain-model” of wealth preservation. Imagine a four-tiered fountain. Water comes out at the top, and spills over into each basin below until it gets to the biggest pool at the bottom. I think this is a good model for wealth preservation. The lowest level is the most stable; the biggest; the most plentiful source. Put your riskiest assets at the top and let their cashflow stream downwards into ever-more secure vehicles. When you invest, add to the top. It has the most chance of future growth (no risk, no reward, right?). But then take a percentage of the earnings from this top tier and let them flow downward to fund a less risky vehicle. And so on. This way you’ll have all your bases covered.
For example, right now I’m taking some dividends from my cash trading accounts and pooling them over into automatic student loan repayments. This way I get instant and lasting benefit from the dividends and their value will never be lost or downgraded, as might happen if I were to simply reinvest them. So far I’ve only got two tiers of the fountain set up, but I’m working on a plan for all four.
What do you think? Do you do something similar? I’ve also posted about how I use my dividends as a strategy for building an emergency fund. This is effectively doing the same thing.
In an era of soon-to-be rampant inflation, wealth preservation is going to be as important as wealthbuilding. In fact it might even be more important, since you can’t enjoy financial wealth you’ve made if you no longer have it.Related Posts
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