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 There was a literal, electronic “run-on-the-banks” in the U.S. that day, with billions being withdrawn from money-market funds all at once.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.
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{ 12 comments }
Great article with a great message. I started making long term wealth creation and preservation decisions in my early 20’s, and it has made all the difference.
What I would add though, is that if you are 50, it is never too late to start making good financial decisions.
Rock on!
-B
I REALLY like the fountain image. Seriously, I may use it sometime :)
I’ll credit you, though!
@MLR – glad you like the fountain idea! thanks. I’m excited about it myself.
@Almost – good for you, getting started so early. But I’m not surprised knowing how successful you are already! and good point, definitely if you’re 50+ that’s no boundary – I admit I randomly kind of picked that number – now is always the time to make better financial decisions, there’s always room to preserve and grow your wealth.
My wife and I started saving in our twenties and it is the best financial decision we’ve made. I wish we had put back more and wasted less though….
Great Article.
The fountain idea is a nice metaphor, but I’m not sure if it applies to all situations. I’ve realized recently that my business can give me enough income to cover all my expenses while decreasing my time involvement a lot sooner than I’ll be able to live off of investments in regular securities – accordingly I plan to divert a good portion of that income to separate investments, stocks, and bonds to create a more stable income. In a way it’s similar but the top will outweight the bottom by far for a long time :)
@Ryan – congrats to you both, just make sure you capitalize on that early time in the market – maybe keep it all reinvesting.
@Silicon – wow, it sounds like you have met the basic definition of being almost financially free! I think you’re right to try to create a more stable income; this is what I’m working towards, too – self-employed income can be volatile/sporadic sometimes.
I’m not quite there yet, but my plan has changed a bit since I figured out that any way I look at it there will be a big turning point between now and the time when I actually make a significant income from public securities. At that time it won’t be an income based on daily time input but it will still require some involvement. I’ve divided my income into three categories: money earned from the time I put in each month, money earned based on work that’s already done, and interest/dividend payments. I guess it does make a good fountain, with the second category filling up now and a few drops making it to the third one.
@SiliconP – that actually makes a nice addition to the fountain metaphor, the image of a “renewing flow” like royalties that keep coming even though you’ve already done the work. I’ll have to think about how to fit that in. Another thing I thought of in regard to dividends is that although there is de facto risk involved, the nice thing is that you know they’re regular. Unlike some other self-employment income, dividends and interest always come in on time, and that could be important too.
I like the fountain analogy. I’ve always been critical of the “rules of thumb” like your age in bonds. I’ve written a post on similar thoughts if anyone would like to check it out.
Nice post!
A business is similar to royalties, even though the arrangement isn’t as clearly defined. It’s easier to put in a bit of time working on long-term income streams when your immediate income gets high enough that you no longer need to work on it full-time, although having a bit of extra money at the ready can help too. Although the money might not go directly into the long-term income activities it does help.
I enjoyed the article-made my brain hurt a little as I had to actually think. I am 53 and struggling to pay off debt that is a result of years of poor choices. I have very little in the way of long term investments (I do have a rental property.) I feel a bit of panic, at my age, that i do not have more invested. I often wonder if I should take a dive and go bankrupt and begin investing more–building more for the future. If only I had that crystal ball..
Thanks for the post, Morgan at TheDebtDance.com
@Bootstrap – thanks!
@Silicon – I can’t wait to get to that point of critical “income” mass, when the work you’ve already put in becomes high enough to keep supporting you so that you can take more time to do even more quality work on your own schedule.
@Morgan – congrats on having a rental property! I would definitely hold onto that – that can be one of the best investments ever. I’ve seen people become very wealthy very quickly just from real estate. So don’t disparage that you don’t have much in the way of “paper assets”. In fact you could argue you were much safer from the storm that happened over the last 8 months. Ultimately I can’t advise you on bankruptcy since that’s out of my purview but I would definitely make sure to fully research your options, get inspired and motivated again and try to work it out. Don’t give up! I’m glad you got something out of the article!
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