The Cryptocurrency Bust

Cryptocurrencies are down about 75% from the beginning of the year.  See https://www.cnbc.com/2018/08/20/after-the-bitcoin-boom-hard-lessons-for-cryptocurrency-investors.html.  Many investors have taken losses in the range of 70% to 90%.  Those who borrowed to buy cryptocurrencies learned the hard way that investments may or may not work out, but debts have to be repaid either way.  There may be some winners, but clearly there are plenty of losers.

The problem with cryptocurrencies is that they basically have no intrinsic value.  They're only worth what someone else will pay for them.  If buyer interest falls, people holding cryptocurrencies end up holding the bag.  If you want to buy cryptocurrencies, that's your choice.  But understand it's a speculative choice and lots of speculations end badly. 

The reason why stocks, bonds, real estate and a few other things have stood the test of time as good investments is they generally have underlying value.  If you want to build wealth, invest in value.  If you want to speculate, hope to win but don't be surprised if you lose.  If you want a decent retirement, avoid wishful thinking and focus on the higher percentage plays.  See  http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.

Managing Personal Risk

Modern businesses put a lot of effort into managing risk.  They take risks, because that's how they might make big money.  But they also work to mitigate the downsides of their risks, because employee stock options don't pay off real well if the CEO, or someone or something else, blows up the business.

Individuals need to manage risk as well.  Bankruptcies most often result from unexpected problems, like a medical crisis or job loss.  If you don't deal with the ways that life can fall apart, the chances of your life fallling apart increase. The need to manage personal risk may be one of the most under-appreciated aspects of financial planning. While there's no perfect or complete way to analyze personal risk, here are some things to think about.

Age.  As you grow older, reduce risk.  If anything goes wrong, you will have less time to recover, and less ability to recover as your value in the labor force declines (and it eventually will).  There are variety of ways to reduce risk discussed below.  The important point is that as time passes and you accumulate more gray hair, reduce personal risk.

Occupation.  Your occupation can be a major risk factor.  Some types of work can't be performed by older people.  This would include construction, law enforcement, military service, fire fighting and other jobs that demand physical strength and endurance.  It could also include jobs that don't demand physical strength, but do require certain abilities that deteriorate with age, such as flying, working as an air traffic controller, or performing surgery.   If your job has a relatively limited time span, start building wealth at an early age and persist.  You may be able to have a second career when the first one ends.  But then again, maybe not.  Don't count on what's highly uncertain.  Assume your first occupation is all that you'll ever have and base your financial planning on it.

Employment stability.  If your job security is unstable, build up a large pool of savings to tide you over the rough spots.  A year's worth of living expenses, or more, in an emergency fund would be a good idea.  If you work in a boom-bust industry, like construction or oil and gas drilling, or an unpredictable job, like entertainment, your savings account is your best friend.  If you have to take on debts, or lose a car and/or house, because you didn't prepare for a layoff, your long term financial future may be cloudy.

Health.  Factor into your financial planning your health problems, especially any chronic ones you have.  There is no way to avoid having health problems, especially as you get older.  That's why having health insurance is so important--you will definitely use it.  Also have some savings available for health care expenses not covered by insurance--these expenses are one of the leading reasons for personal bankruptcy filings.  If your health is good, save plenty because you may need to finance a long life span. 

Debts.  Debts are one of the most dangerous risks.  Jobs may not be secure, but debts, once incurred, are a certainty.  If you're poor, but debt free, you won't end up in bankruptcy.  Poverty doesn't lead to bankruptcy; unmanageable debts do.  But debts are also one of the most controllable risks.  Avoid taking on debt unless it's really necessary.  Pay off debts as quickly as possible, especially as you get older.  A mortgage-free house is better than a sleeping pill.  There are some financial planners who will tell you to have a mortgage and invest your cash in stocks.  Well, if stocks maintained a nice, steady upward trend all the time, this might well be a smart move.  But if stocks are sometimes volatile--well, some people do manage to eat dog food.  Avoid debt and you avoid risk.

Moral and voluntary obligations.  Lots of people help their kids pay for college--and then help some more when the kids rebound home after graduating.  Many help their aged parents.  Quite a few help siblings, nieces, nephews, friends and so on when the going gets tough.  If you are likely to accept these obligations, manage your finances to be able to meet them.  Being nice can be a major financial risk factor. 

Riskiness of your assets.  This isn't quite the same as asset allocation.  This is preparing for things to go wrong with your choice of assets.  Don't think your allocation is necessarily right.  Almost no one predicted the financial crisis of 2008 and hundreds of millions of savers worldwide got a big tummy ache as a result.  If you really think that you and your financial planner have it all figured out, contact me about buying a very nice bridge in Brooklyn, and at a bargain price, too.

But back to the first point.  Stress test your investments (see http://blogger.uncleleosden.com/2010/11/stress-test-your-retirement.html).  If you are uncomfortable with the potential losses you could incur, change your allocation.  Of course, no matter what you do, you'll end up with some kind of allocation.  The important thing is to end up with something that you can live with on good days and bad.  

Insurance.  Only Congress is less popular than insurance companies.  But having some insurance coverage is important to mitigating risks.  We've already covered health insurance.  Have homeowners or renter's coverage.  Maintain plenty of liability coverage on your auto policy, and buy an umbrella policy if you have a significant net worth.  Get disability coverage (first check to see what your employer offers, and supplement it if appropriate).  If you have dependents, like minor children, buy life insurance.  Think about long term care coverage if you have significant assets.  Granted, writing a check to an insurance company feels like eating sawdust.  But if life takes a u-turn, it's comforting to be able to forward the bill to an insurance company.

Boost your benefits.  Work as long as possible to build up your Social Security credits and any pension benefits for which you are eligible.  Okay, Congress, the White House, City Hall, the boss, or somebody is always threatening to trim or take away these benefits.  But they will very likely survive in one form or another, and you benefit from maximizing them because they may offer the best shelter available when cold economic winds blow.

Aaaaagh!!!!! Insurance!!

Given a choice between visiting a dentist and buying insurance, most people would opt for the dentist. At least, you can get novocaine for the worst moments.

But if you’re serious about building wealth, it's important to protect yourself from risk. We’re not talking about investment risk. You know that stocks, real estate and other assets can decrease, as well as increase, in value. We’re talking about personal risks, and risks to your property.

What happens to your finances if you’re seriously injured and can’t work for months? What if a guest slips and falls in your home? What if you or your spouse dies, and leaves you to raise the kids alone? What happens if the next Katrina heads your way and turns your house into a pile of kindling? These are all examples of situations that could drain away your savings. How do you protect yourself?

1. Get health insurance. The most common reason people declare bankruptcy isn’t reckless spending. It’s unmanageable medical expenses. If you’re uninsured, do your best to get coverage. Be willing to sacrifice a lot of lifestyle in order to be protected. If you’re uninsured and have a health crisis, you won’t have a lifestyle. If you have trouble finding coverage, contact your state health authorities. Some states have programs to assist residents to get coverage.

Also, take care of your health. Avoiding a health problem is better than treating one, even if you have to eat some fruits and vegetables.

2. Get disability insurance. According to the Social Security Administration, something like 8.6 million workers and their dependents received Social Security disability payments in 2006 (www.ssa.gov/OACT/STATS/OASDIbenies.html). This figure doesn’t include people who received private disability payments, but no Social Security. Disability is a fairly common problem. Look for a policy that defines disability as your inability to work in your field or profession (and, indeed, your specialty within your field or profession). A policy that defines disability as your inability to do any kind of work (flipping burgers, anyone?) doesn’t provide much protection.

3. Get homeowners insurance. Make sure the policy limit is high enough to cover the current cost of reconstructing your home. Also have plenty of liability coverage, in case a guest slips and falls on your property--$300K is not too much. And think about whether you should get optional flood coverage--you don't need a Katrina to have a flooding problem (a sewer backup is all it takes).

4. Bulk up your auto policy. Make sure you have plenty of liability coverage--$1 million is rational in these litigious times. And don’t overlook the property damage coverage. Some luxury cars today cost over $100,000. Having $100,000 of property damage coverage isn’t a bad idea.

4. Consider life insurance. If you have dependents, life insurance may be a good idea. There’s no fixed rule of thumb for how much you need. Add up your other financial resources (savings, Social Security survivors’ benefits, any employer’s benefits for survivors, and your spouse’s income if he or she would work even if something happened to you), and then figure out how much insurance you’d need to get the little ones through college. Increase the amount if you want your spouse to stay home and take care of the kids.

5. Consider an umbrella policy. An umbrella policy provides additional liability protection, above and beyond your auto and homeowners’ policies. You can buy millions of dollars of coverage. It’s a good idea if your net worth is six or seven figures.

6. Consider a long term care insurance policy. This type of insurance covers nursing home expenses and other long term care costs (including some care at home). Medicare doesn’t cover most of these expenses. Medicaid does, but you need to spend down your savings to qualify for Medicaid. Long term care insurance is a way of protecting your savings. It could make sense if you have a six or seven figure net worth. Look for a policy with level premiums and an inflation adjustment in the amount of coverage. This stuff is expensive if you wait until your 60s (we’re talking thousands a year). If it seems to make sense for you, buy as early in your life as you can because it's much cheaper if you start when you're younger.

Okay, enough already about insurance. Here’s the story for your inner artist if you’re thinking of a career change. http://www.cnn.com/2007/SHOWBIZ/05/31/lego.artist/index.html.