The Best Asset in a Time of Volatility

All markets are volatile these days.  Stocks are gyrating, bonds are falling as interest rates increase, oil is bouncing up and then down, bitcoin has fallen all year, and even the real estate market seems to be going wobbly.  Gold and silver have been slipping away.  And foreign markets look even gloomier.

Investors naturally look for opportunities when prices fluctuate.  Whether you're a buyer or a short seller, price movements create the potential for profit.  Volatility is gut wrenching if you're taking losses, and can stimulate panicky selling when prices are low.  But it can be exhilarating if it looks like a lucky break.

That's why cash is often the best asset to hold in a time of volatility.  It gives you the means to take advantage of fortuitous price movements, while its stability insulates you from the emotional roller coaster that often drives people to sell when prices are dropping.  Don't think that you have to remain fully invested all the time.  What you have to do is remain unemotional, as emotion is the enemy of careful investing.  A nice, comforting cushion of cash can prevent an unwanted flood of adrenaline.

Cash may appear to have a low rate of return, with greedy banks still paying miserly rates of interest on deposits even though interest rates have been rising.  But cash also offers the potential to profit from price volatility.  You can dive into an asset when its price is low and make a bundle when it rebounds.   That potential makes the effective return from cash much higher.  So don't be afraid to hold a lot of cash in a time of volatility.  That's when it's an investor's best friend.

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.

To Manage Your Money, Manage Your Emotions

Building up your wealth is simple:  spend less than you get.  But it's hard for many people even though it's simple.  Put a little money in their hands and it's gone as quick as a flash.  Put a lot of money in their hands and it's gone quicker than a flash.  This is no way to get rich.  If you spend everything you get, how will you put together a down payment for a house, college costs for your kid(s), or retirement?  Sometimes, you can borrow.  But loans have to be repaid, so you'll enrich banks, not yourself.  Retirement on just Social Security can be okay--if you move to Panama or Cambodia, places where your only option may be McDonald's if you want a taste of America.

Controlling your spending is the first and most important step to building wealth.  Don't begin by reading the vast array of materials that discuss how to invest.  It doesn't matter how you make money investing in ETFs, mutual funds, S&P 500 futures contracts, or covered stock options if you don't have any capital to invest. 

First, learn how to save.  This means getting control over your emotions.  Learn how to deny yourself immediate gratification.  Learn how to value long term rewards.  Learn how to ignore the latest trends.  Learn that keeping up with the neighbors could mean you're just as foolish as the neighbors.  Aside from basic spending for food, shelter, clothing and transportation,  essentially all spending decisions are driven by emotion.  The latest smart phone?  Designer clothes and accessories?  The trendiest restaurant?  A luxury nameplate on your car?  An extra 500 square feet in your house?   These things are marketed to people with impulse control problems.  Status won't give you a comfortable retirement.  You need money for that.

You've probably seen the news stories reporting that half of all Americans have no retirement savings and most of the rest don't have very much.  How could this be when America is one of the wealthiest nations in the world?  The hard truth is most people don't have the emotional composition to get rich.  And they don't have the willpower to get control over their emotions enough to begin the process of saving.  Sure, an illness or layoff can wreck your financial plans.  But they're not an excuse not to try.  If you don't try, you'll fail for sure.  Those who try actually succeed in many cases.  Give yourself a chance.  Get control over your spending impulses and save.  The only people who laugh all the way to the bank are people who have money to deposit in the bank. 

For more, see (a) http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html; (b) http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html; (c) http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html; (d) http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html; (e) http://blogger.uncleleosden.com/2011/03/how-to-avoid-running-out-of-money-in.html; and (f) http://blogger.uncleleosden.com/2010/11/how-much-do-you-need-for-retirement.html.

Where Is the Stock Market Headed?

With the Dow Jones Industrial Average having dropped over 2,000 points since its peak a week and a half ago, this is the $64,000 (or more) question.  The recent market surge resulted to a large degree from too much optimism.  Market players have selectively focused on the good news (strengthening economy, big corporate tax cut, rising employment levels), while shrugging off the bad news (growing signs of inflation, rising interest rates, and increasing political discord).  Life is like a rose--pretty petals, but thorns as well.  If you ignore the thorns, you'll get an ouchie sooner or later.

So what happens after today's ouchie (1175 points off the Dow)?  The recent market surge seems similar to the valuation-driven bull markets of 1987 and 2000, which resulted in sizable drops of 25% to 30% in the Dow followed by gradual recoveries that took two to three years.  But we should bear in mind an earlier drop off. In 1973, the stock market (measured by the S&P 500) peaked after a long run up, not unlike the one we've had since 2009.  Then, it declined some 40% or more and didn't recover until some seven years later.  The 1970s were also a time of rising inflation and political scandal (Watergate), with the only resignation of a President.  Political turmoil affects economies and stock markets (look at Venezuela, where a lot of folks can't even get a square meal because of political strife).

Expect more market turmoil tomorrow, the next week, the next month, and maybe the next year.  The market could easily drop some more.  We're running out of good news.  There may be little major legislation coming out of Washington, given the political quagmire.  The Fed may go easy on the tightening, but it's not going to cut interest rates simply to support stock prices.  It's already done that, perhaps too much--and today's drop was likely a consequence.  The economy seems to be slowly gaining altitude.  But there's nothing going on that will provide it a quick major boost.  The federal government can't increase the deficit, given its recent deficit-funded splurge with the tax cut bill.  Corporations seem not to be rushing to increase reinvestment of their tax savings.  The Trump administration may spark a trade war with China and other nations.  And the stability of the federal government cannot, in these times that try our souls, be taken for granted.

History teaches that it's not a great idea to sell your stocks in an effort to staunch losses.  People who try to time the market generally fail to get back in and enjoy the resurge that will likely come (although the resurge could be a long time coming). Instead, try to spend less and save more.  Keep your investments diversified.  And don't stop knocking on wood.

Why You Should Worry About the Rising Stock Market

The stock market keeps rising, setting new records just about every week.  The S&P 500 has risen over 15% since Election Day 2016, and shows no signs of slowing down.  That's an annualized rate of over 20% a year, which is exceptionally good for an aged bull market as we have.

The election of Donald Trump as President was seen as a major reason for the rally.  He promised infrastructure spending, tax reform and other measures that should stimulate the economy.  But his Presidency has sunk into a quagmire of chaos, incoherence and unpredictability. These, coupled with the legal risks emanating from special counsel Robert Mueller's investigation, should have triggered market retrenchment.  But stocks have hardly blinked before levitating some more.  Whatever is driving the market, it doesn't have much to do with the Trump Presidency.

Accommodative monetary policy in Europe and Japan is also said to be a reason for the market's buoyancy.  Foreign central banks have been printing money, and some of it supposedly has found its way into the U.S. markets.  But the dollar has been falling recently, indicating liquidity is flowing out of our markets, not in. That's not a formula for a rally.

Corporate earnings, although pretty decent, aren't dramatically better than last fall.  They don't explain the lighter-than-air quality of stocks today.

So what's going on?  Let's consider that over half of all stock market transactions consist of computerized trading.  Machines are trading with machines, using algorithms known to very few.  These algorithms verge on alchemy.  They rely on statistical correlations that may or may not hold true in the future.  These correlations can be disrupted by unexpected government policy, political upheaval or conflict, economic change (such as the effective collapse of OPEC as a functional cartel), and technological change (such as the fracking that just blew up OPEC).  They also utilize artificial intelligence, seeking to learn from their ongoing experiences in the market and modifying their algorithms as a result of what they learn.  Thus, the humans may have difficulty anticipating what the programs will do tomorrow.  And the programs may produce a positive or negative synergy or other interaction that humans have not foreseen.

Computerized trading is opaque.  That is, in real time, no one knows for sure if a trade or a series of trades involved a machine or two machines or none.  One should avoid anthropomorphism in today's stock markets.  In other words, one should not ascribe human motives, intentions or characteristics to market activity.  There may be no reason comprehensible to humans for today's stock prices.  When computers use artificial intelligence to trade stocks, the valuation of financial assets may be fundamentally changed, and changed beyond human comprehension.  You may think that stock prices are whacked out--and you could be correct from the human perspective.

Homilies like stocks are excellent long term investments and will protect against inflation were derived at a time when people dominated the financial markets and established the asset valuations on which these notions were based.  If machines that function opaquely suddenly become dominant, how can humans understand the valuations determined by the machines?  More succinctly, how can you tell what's a good price and what's a bad price anymore?

There are many more questions than answers in a machine-dominated market.  When the market keeps setting new record highs in machine-dominated trading, be careful.  We are bravely, or not, going where no investors have gone before.  And no one really knows what's going to happen.

Buy Your Retirement

If you're having trouble saving for retirement, think of it this way:  your retirement is a purchase, and the more you spend, the more luxurious it will be.  Retirement is a purchase--you're buying rest, relaxation, entertainment and time to do whatever you want.  You may have to buy a fair amount of health care and other services such as lawn care, housekeeping and so on.  But whatever the case may be, the more money you have for retirement, the nicer it will be.  No need to think of saving as a sacrifice.  You aren't giving up things up.  You're simply spending for a better retirement instead of a bigger TV. 

So, if you can't save for retirement, then spend on your retirement. It will be one of the smartest purchases of your life.  For more, see

http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html, 

http://blogger.uncleleosden.com/2010/11/how-much-do-you-need-for-retirement.html, 

http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html,

and http://blogger.uncleleosden.com/2010/11/stress-test-your-retirement.html.

The Truth About Getting Rich

Wealth is relative.  That is, people tend to consider themselves wealthy by comparing themselves to those around them.  The fact that most people today live healthier, longer and more comfortable lives than King Henry the Eighth is irrelevant to them.  They care more about where they stand compared to the people next door or the colleague across the hall or the persons featured in today's news.

This means you can feel rich only if you have more wealth than others around you.  That, in turn, means you have to be different from most people.  You can't be just like everyone else and yet be wealthier than everyone else.  But if you see yourself as just an ordinary, middle class person, does that mean you haven't got a chance to be wealthy?

No.  You can be wealthy.  While some wealthy people inherit their riches, most millionaires get there on their own by saving more.  It helps if you earn more.  You'll have more money to work with.  But earning more helps only if you save more.   If you spend all your above average earnings, expect to dine on dog food in your retirement.

You have to resist temptation to spend.  An 856 inch big-screen TV and a 4,300 horsepower SUV won't make you wealthy.  The same goes for $700 shoes and $1,200 handbags.  You have to be comfortable with fewer European vacations and plenty of home cooking.  When people laugh at your frugal ways, you have to focus on getting the last laugh.

Most people won't make it.  They won't become wealthy.  That's inherent in the definition of wealth as a relative concept, and it's also a result of the human tendency toward conformity and group think.  But plenty of middle class people end up having comfortable retirements or better.  In part, that's because of social welfare programs like Social Security and Medicare.  But these programs alone don't provide a good retirement.  You must be responsible and save.

What to do?  It's not complicated.  The main thing is save early, often and in significant amounts, like 15% to 20% of your income.  Invest in a diversified portfolio to increase your chances for good long term returns.  (See http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.)   There are a variety of ways to build up your wealth:  http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.  Look at each dollar you receive as a saving opportunity.  Remember that no matter how much money you make,  in the end you will have a finite income (we all do), and what you spend can't be retrieved.  It's gone. So don't waste that opportunity to save (see http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html).  Avoid debt as much as possible (see http://blogger.uncleleosden.com/2010/07/why-you-should-avoid-debt.html).  Don't give up, even if you have financial setbacks.  Like so many other things in life, quitters aren't winners when it comes to building wealth.

You can have a somewhat decent retirement even if you don't save much, by building up your benefits and eliminating debt. (See http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html).  But if you want to climb into the ranks of the wealthy, be different.

We're All Temporary Workers

According to data collected by the U.S. Bureau of Labor Statistics, middle aged Americans are, on average, likely to have held 11 or 12 jobs by the age of 48.  See http://www.bls.gov/nls/nlsfaqs.htm#anch4.  The same group will have, on average, experienced 5 or 6 periods of unemployment by the age of 48. See http://www.bls.gov/nls/nlsfaqs.htm#anch42.  Only about 10 percent of these workers will have had between 0 and 4 jobs by age 48.  In other words, the long lasting, stable employment that we anticipate for adulthood is mostly a mirage.  Few of us enjoy that kind of certainty.  Indeed, it's fair to say just about all of us are temporary workers.

Of course, there are differences among workers.  Some are considered full time, others part time.  Some are permanent--either full time or part time--and others are temporary--either full time or part time.  But the average American, with about 12 jobs by the age of 50, is realistically a temporary employee, just with better benefits if he or she is considered "permanent" and is working full time.

The impermanence of employment means fewer employees qualify for defined benefit pensions, even in the few jobs that still offer pensions.  It also means that in the real world, workers have trouble building up their 401(k) and IRA accounts, because they're periodically hit with a spell of unemployment or have to rebuild benefits at a new employer.  Many workers draw down their retirement accounts during episodes of joblessness.  When they resume working, they have less time to build up their balances again.  The only ways to counteract the temporariness of employment is to save furiously, or, if you're lucky enough to have a job offering a pension, to somehow stay put long enough to qualify for the pension, no matter how boring the job or overbearing the boss.

The wobbly, and sometimes turbulent, work lives of most people place this year's politics in sharp focus.  The debates over Social Security, health insurance, trade policy, jobs programs and wage stagnation become all the more crucial when we consider that, in the end, we're almost all temporary workers. Proprosals that enhance stability for workers, like protecting and strengthening Social Security and Medicare will be popular.  Measures like free trade agreements are likely to be losers.

But don't count on the government to bail you out.  You're not a major financial institution, so assume that there will be no bailout for you.  Save as much as you can--and then save some more.

A Generation of Stagnation; Retirement Walks the Plank

We are now looking at a generation of stagnation.  The recovery from the 2008 financial crisis still wobbles like a drunk.  Even though we now have full employment, wages barely keep up with inflation (if at all).  And recent statistics indicate that inflation is growing as fast as a parched lawn.

Regardless of what this Federal Reserve official or that says, the central bank will raise rates as often as humans walk on Mars.  If you're wondering when rates will return to historical norms, the answer is never.  At least, this is the only rational assumption you can make.  With Asia's growth slowing, Europe's growth nonexistent, South America in free fall, Russia going negative in numerous ways, and the Middle East becoming more unstable with each passing day, and no drivers of growth in America except the Fed money printing presses running 24/7, the only future forecast that seems sensible is to expect stagnation for--well, the rest of your life.

With stagnation instead of brisk economic growth, the government's ability to support retirees will be limited.  While Social Security and Medicare won't disappear, they will likely be parsimonious.  If you drop your porridge bowl, they won't refill it.  And pension fund and personal investment returns are being decimated by low interest rates on bonds and bank accounts.  Your retirement is starting to walk the plank.  What to do, then, about your future?

Spend less, save more.  This is a no brainer.  It's not what the Fed wants, because hesitant consumer demand constrains economic growth.  But the Fed be damned.  Your long term well-being requires the thriftiness of Ben Franklin, and if that results in lower economic growth that makes the Fed look bad, well who cares?  (Or, you can substitute more lively terminology if you wish).  With interest rates so low, you can't use the financial magic of compounding to build much of a retirement (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html). You have to set aside more principal, and hope that the few crumbs of interest income you get will elevate your retirement diet above dog food.

Put some money in stocks.  The inequality of wealth in America has increased because the Fed's easy money policies tend to inflate asset values.  Since the rich own most assets, their wealth  has increased disproportionately from central bank policies.  Realistically, with stagnant wages and a Republican controlled Congress, you can't expect the inequality of wealth to diminish.  (Maybe things would be different if Bernie Sanders is elected President, but both the Democratic and Republican establishments are using all their smoke-filled back room influence and power to prevent that.)  So you might as well join 'em if you can't beat 'em.  Owning stocks can be gut wrenching in times of market turmoil.  But so is a retirement spent eating dog food.  Learn to live with the market's turbulence, and collect the rates of return that the 1% are getting from equities.

Work longer.  This increases your lifetime earnings, which allows you to save more and build up your Social Security benefits.  If you're lucky enough to have a pension, it will likely increase your pension benefits.  Okay, so working longer means a shorter retirement.  But, like we said, retirement is walking the plank.  Just try to avoid having to live in a cardboard box on the sidewalk with a couple of cans of cat food in your raggedy backpack.

Avoid debt.  You can't go bankrupt if you don't borrow.  If you do borrow, some of your future income will go to banks and other lenders in the form of interest payments, instead of enhancing your future lifestyle.  Granted, you may need to borrow for big ticket items like college, cars and a house.  But otherwise, avoid debt.  And pay down the debt you have as you approach retirement.  Especially, lose the mortgage.  Financial advisers may tell you it's okay to have a mortgage in retirement.  But guess what?  If you have a mortgage, that means you may have more financial assets to invest in ways that pay fees and commissions to the financial advisers.  Meanwhile, you have to pay interest on the mortgage debt.  Who's better off?

For more on ways to yank your retirement back off the plank, read http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html, http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html, and http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html.  Good luck.

How the Federal Reserve Destabilizes the Markets and Influences Politics

The Fed is being hoisted on its own petard.  Since 2008, it has suppressed interest rates, keeping them exceptionally low and forcing investors to put savings into risk assets such as stocks and high-yield bonds.  While there were good reasons for taking extraordinary action in 2008 and 2009, the Fed left rates so low for so long that investors, corporate America and borrowers have come to expect that really easy money is the norm, the default.  This dependency has made it virtually impossible for the Fed to normalize interest rates.  If the Fed raises rates, risk assets fall in value (as they did in recent months when faced with the specter of short term rates reaching a ghastly 1% to 1.25% by the end of this year).  The markets simply won't stand for interest rate increases, and the Fed sees itself as having no choice but to do the markets' bidding.  However, as the Fed continues to suppress interest rates, it only increases the markets' dependency, making future rate increases even more difficult. 

The Fed claims its interest rate policy is data dependent, and that it will raise rates as warranted by the data.  The U.S. economy is now at full employment and growing moderately.  Although last month's inflation data show stable prices, the recent rise in oil and gasoline prices will push up inflation numbers for March.  Yet, when it comes to the decision whether or not to increase rates, there is only one data point that matters.  That is the willingness of the financial markets to accept an increase.  With the markets' long term addiction to low rates deeply embedded, and their turbulent hissy fits every time the Fed hints at rate normalization, there is no foreseeable time when interest rates will return to historical norms. 

The Fed is undermining deeply rooted foundations of our society.  Highly rated long term bonds are essential to the stable retirements for which Americans and many other peoples hope.  Shorter term interest rates provide important supplemental income to savers, and promote financial stability and responsibility that mitigate the impact of economic cycles.  When people face lousy retirements (see http://blogger.uncleleosden.com/2015/04/is-federal-reserve-wrecking-retirement.html), and can't count on much of any return on savings (especially after netting out inflation), you can get the political unrest that we see today. 

The Fed is missing an important part of the picture.  People don't just want cheap credit.  They want stable long term prospects.  During the 1950's, 60's and 70's, the World War II generation endured many layoffs and cutbacks, due to recessions, factory retoolings, labor strikes and so on.  But their fundamental faith in the future was unshaken, because they knew they had pensions and Social Security to take care of them in their golden years (which in fact were golden for many of them).  This kind of long term stability isn't evident today.  Instead, havoc permeates today's politics.  Angry voters in America and Europe are upending established political orders because they fear the future.

Personal consumption and wealth have suffered greatly from low interest rates.  From 2008 to 2013, savers lost about $750 billion due to low interest rates (see http://www.cbsnews.com/news/report-low-interest-rates-have-cost-consumers-750-billion/).  Adding in likely losses for 2014 through today, the amount now is probably around $1 trillion.  That's real money.  Take that much out of people's hands, and they feel less secure, less inclined to spend, less inclined to borrow (you borrow less if you have less income), and more angry about the status quo.

What's more, the Fed's insistence on favoring risk assets has exacerbated the increasing inequality of income and wealth.  Rich people have the capital to invest in risk assets, and they become increasingly wealthy when cheap money pumps up the value of those assets.  Those getting the short end of the stick are now turning toward political extremism, because they feel they have no other choice.

The last thing the Fed wants to do is get entangled in politics.  It is supposed to be an independent agency that dispassionately dispenses policy in the public interest.  But the Fed's inability to act independently of the financial markets' short term tantrums is having significant impact on social stability and political trends.  Things will only get worse.  As the fall election approaches, the Fed will find itself in the horns of a dilemma largely of its own making.  If it raises rates because inflation is flaring (which is possible given the recent sharp increases in oil and gasoline prices), it will be accused of tilting the political picture one way.  If it does not raise rates despite an upswing in inflation, the markets will hum along on their cheap credit high, and the Fed will be accused of tilting the political landscape another way. 

The Fed is largely staffed and run by economists.  The economists there have failed to appreciate the diminishing returns of continuing the cheap money IV for the markets.  They have also failed to appreciate the costs of their cheap money policy.  If all they acknowledge is the upside (the return to full employment and moderate growth), and fail to acknowledge the pain they inflict on savers and workers who want to retire, then of course they will continue to inject cheap credit into the markets because they only see the benefits and not the costs.  Economists who don't acknowledge diminishing returns and see only benefits but not costs are bound to get policy wrong. 

The Fed measures its performance by short term metrics--current GDP growth, current unemployment, current inflation.  It doesn't appear to pay much attention, if any, to long term factors.  Long term factors are harder to measure.  But that doesn't mean they aren't important.  By focusing on the short term, and ignoring the long term, the Fed inevitably creates problems.  And we all have to live with the consequences of those problems.

Ask Not What Your Country Can Spend For You

Ask what you can spend for your country.  At least, some folks might like it if you did.  The Federal Reserve is in trouble.  The economy is meandering.  Unemployment levels have reached full employment, but labor force participation levels are low.  The Fed accentuates the negative and projects gloom about employment.  Wages stagnate, and, net of inflation, are lower than a generation ago.  The dollar is strong, which encourages imports while discouraging inflation. The Consumer Price Index is dropping, leading some to conclude that we have deflation.  This conclusion is a classic example of how statistics mislead.  Prices are higher if you take out energy costs.  If the price of everything except energy is going up, and energy is dropping a lot, do we really have deflation?  Or a misleading statistic?

But we digress. The Fed has greatly reduced its quantitative easing measures, since they didn't seem to be doing much good any more.  It's holding short term interest rates lower than a snake's belly.  But it can't do more.  The Fed is now low on ammo and can't expend what it has left; it has to hold something in reserve in case the economy belly flops.

There's no possibility of fiscal stimulus.  The federal government tied its budget into knots with the sequestration law, which requires automatic spending cuts each year through 2021.  Congress and the White House can get around the cuts by passing specific legislation providing for something other than sequestration.  But, given how the daily love fest between Congress and the White House consists of brickbats, but not bouquets, the chance for fiscal stimulus is lower than short term interest rates.

That leaves you, dear consumer.  The U.S. economy is about 70% consumption, and if consumers don't consume, the economy reaches for one of those little airline bags.  So spend, spend, spend.

Right?  Come on, right?

Or maybe not.  Consumers learned the hard way after the 2008 financial crisis that lavish spending and debt accumulation are shortcuts to financial ruin, and that saving improves the quality of your sleep.  Just because the Fed made it cheap to borrow doesn't mean borrowing is a good idea--soda is inexpensive but drinking a lot of it is a very bad idea.  If the Fed can't move short term interest rates above a complete goose egg, you have to suspect that maybe the Fed knows that the economy is a complete goose egg.  In which case, the last thing you want to do is spend freely.

We live with a contradiction:  our individual financial health requires acting in a way that is unhelpful to near term economic growth.  But those who are prudent can get through hard economic times, and it makes sense to put self and family first.  This leaves policy makers with controversial choices--negative interest rates, easing immigration restrictions to bring in educated, ambitious foreigners, and even more hotly debated measures (can you say Ex-Im Bank?).  How likely are these?

The truth is government policy is largely played out.  The economy will have to rise or fall based mostly on its own.  The next surge of growth, whenever that is, will probably come in a rush of technological innovation that may be hard to foresee.  Until then, the economy will likely meander.  If you're building up your savings and preparing for a tough slog, you'll probably be okay.  Ask not what you can spend for your country.  Ask what you can save for yourself and your family.

Planning For Your Obsolescence

The ongoing debate over trade policy highlights a major career risk:  the possibility that you could become obsolescent because of cheaper labor elsewhere and/or automation.  For example, in the auto industry, many car parts and some cars are made in other countries and shipped to America because labor and other costs are cheaper elsewhere.  In America's auto assembly plants, robots have replaced large numbers of people because robots are more reliable and cheaper.  This trend will continue as many other tasks become mechanized and/or cost-effective in lower wage nations.  Computer programming, radiology, legal research and legal document review have joined data entry and call center jobs as routinized work that can be done by smart people living in many countries.  What can you do about your potential obsolescence?

Keep up your skills.  Maintain and upgrade your professional skills.  People capable of cutting edge work will often have an advantage over foreign competition and robots.

Be flexible.  Keep an open mind about working in new and different jobs.  Many people have succeeded in fields they didn't plan on entering.  But they were open minded about learning new things and taking on new challenges.  The economy will keep changing, and success can follow if you change with it.  If you're unemployed, be open to taking temporary and part-time work in order to prevent your personal finances from eroding faster than necessary.

Computers and computer science.  Much of the reason for personal obsolescence is computerization.  Computers and related technologies (most importantly, the Internet) make it possible for workers overseas and robots to compete against American workers.  Don't get angry about this because computerization will continue--and most likely at an accelerating pace.  If you can't beat them, join them.  Acquire and maintain computer skills.  Go into a computer-related field.  Become a programmer, technician, data management engineer or something else computer-related that fits your skills.  Computers won't become obsolete, and people who can work with them have a better chance of staying employable.

Build your benefits.  Work as long as possible to build Social Security credits.  If you have the potential to earn a pension, stay in that job long enough to qualify.  Having a stream of payments that doesn't depend on your employability is a major victory over obsolescence.

Save.  Here's an ugly truth:  just as the wages and salaries of the middle class have fallen due to globalization and other reasons, the returns on capital have improved.  People who hold capital are becoming comparatively better off, while people who work are on average becoming comparatively worse off.  Save. Acquire capital and improve your chances for a comfortable life.  Then save some more.  Whatever your views on social issues like the distribution of income and wealth, you are individually better off with a pool of savings to protect you from the riptides of a free enterprise economy.

Idolatry in the Financial Markets

A lot of investors, it would appear, are throwing money at increasingly esoteric investments in order to prevent inflation from eroding their capital.  Junk bonds, asset-backed securities and real estate investment trusts have become fashionable.  With the Fed waging a 24/7 scorched earth campaign against positive interest rates, risk is being embraced.  One can only hope that the end result isn't like embracing a cobra--"risk on" investing strategies aren't risk-free.

A false premise widely circulated by financial sales people and cable TV pundits is that you have to preserve your savings from the ravages of inflation.  And, certainly, over long periods of time, inflation can significantly diminish your capital.  But you can't overlook the costs and risks of trying to protect yourself from inflation.  If those risks smack down your net worth, you haven't accomplished anything except lose money and then suffer inflation's death of a thousand cuts.  There's nothing wrong with losing a little ground now and then to inflation, while saving and investing with a view to long term financial equanimity.  If you lose ground to inflation for one, two or even a few years, don't panic.  Try to position your portfolio so that you can make up the "losses" later on.  Also spend less and save more.  This will increase your net worth without requiring you to dial up the risk.

The same is true of keeping pace with market averages.  The Dow Jones Industrial Average, the S&P 500, or whatever benchmark you might follow may be convenient ways to assess the performance of money managers who want to take your savings.  But market indices don't need to be your financial goals.  If your portfolio is conservatively deployed and doesn't keep pace with the S&P 500, you haven't "lost" unless you decide you're a loser.  As long as you are saving enough for retirement, your kids' college costs, and whatever other goals you might have, it doesn't matter a rat's left ear whether or not your investment returns match one market index or another.  If your portfolio is more cautiously invested than the stocks found in an index, you won't suffer the volatility of the index.  Maybe the Dow just reached a record level (although this really isn't a record once you factor in inflation).  But looking back at what happened in 2000 and 2007 after the Dow previously reached record levels will tell you that keeping up with market indices can be a losing proposition. 

Keeping pace with inflation and with market averages are, for individual investors, false idols that they need not worship.  Building your net worth isn't a contest.  It's a process.  There are lots of ways to make your retirement years golden.  Do whatever helps you sleep at night.

Keep Your Investments Simple, Because the Alternatives Could Be Worse

As reported by the New York Times (and linked through CNBC.com:  http://www.cnbc.com/id/100449551), retail investors are once again being burned by complex alternative investments.  This is an old story in the annals of investment busts.  The more complex an investment, the less likely a retail investor will understand it, and the greater the advantage an unscrupulous broker will have in foisting it on the unsuspecting.  What's troubling is that many of the victims weren't seeking a fast, speculative buck.  They were often conservative investors who were pushed by the Federal Reserve's scorched earth policy against interest rates to hunt in dark, dank thickets for elusive, ethereal positive yields.  Desperate for investment income, they fell victim to sales people saying what they wanted to hear, but maybe not what they needed to understand.

An underappreciated element of saving and investing is the need to manage risk.  Manage doesn't mean avoiding all risk, and it certainly doesn't mean seeing greater risk as the path to greater rewards.  It means understanding that risk and reward are linked, and that not getting too greedy about rewards is the way to long term success.  Some risk is reasonable, as long as you don't expose yourself to so much volatility that you grab the little paper bag in the seatback in front of you and put all your money in a mattress.  The tortoise beats the hare when it comes to investing.  Searching for quick returns is like donning wings of paraffin and flying toward the Sun.  Don't invest in anything that you don't understand--and that means having a full appreciation for every way your hmmmm can be deep fried.  Simple, steady and average are a decidedly better bet for making you comfortable in retirement than the latest in glam financial fashions.  For more, see http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.

Consider a House To Hedge Against Inflation

The housing market, having walloped the bejesus out of tens of millions of Americans, may seem an unlikely hedge against inflation.  But history shows that home prices tend to move up briskly during inflationary times.  During the 1940s, inflation burst out, driven first by World War II rationing and then by pent up consumer demand after the war.  Consumer prices moved up about 72%.  Census Bureau data indicates that housing prices moved from a national average of $2,938 in 1940 to $7,354 in 1950 (unadjusted for inflation).  That's an increase of 150%.

During the stagflation of the 1970s, consumer prices rose 112%.  Housing prices rose from a national average of $17,000 in 1970 to $47,200 in 1980, an increase of 178% (unadjusted for inflation).  You can find Census Bureau data on housing at https://www.census.gov/hhes/www/housing/census/historic/values.html.

The data show that housing prices rose faster than inflation during two of the most inflationary decades in the past 75 years.  Of course, the sales prices of houses don't tell the entire story.  You can't directly compare prices of housing against prices of stocks or inflation-adjusted bonds like U.S. Treasury TIPS, because housing requires periodic lawn mowings, plumbing repairs, new roofs, maintenance of HVAC systems, and replacement of dishwashers.  It's also taxed locally every year, and sometimes hit up for special assessments if the water or sewer systems need to be gussied up.  But you'd directly or indirectly bear those expenses anyway if you rented.  So owning a house and capturing the upticks in value might work out well for you during inflationary flareups. 

Why would housing be such a good inflation hedge?  Professional economists might be tempted to wheel out a wagon load of regression analyses to demonstrate their erudition.  But the simple and obvious explanation is that a hard asset with substantial utility will have significant value no matter what the paper currency is doing.  A house provides shelter, warmth, indoor plumbing, and a private place to pig out on high fat, high sugar, low nutritional value junk foods while long-term parked in front of a 124-inch TV, parboiling your brain without the neighbors seeing what a couch burrito you really are.  Market forces will adjust the paper value of that hard asset upward when the fiat currency is going haywire.

At the moment, inflation seems to be spotted about as often as the ivory-billed woodpecker.  But that doesn't mean it's extinct.  History shows that inflation can be quiescent for long periods of time, and then burst forth like an oil well blowout.  Inflationary pressures right now are doing a fan dance, often out of sight but still faintly visible in profile.  Ultimately, unless the Fed and other central banks can repeal market forces, their massive money prints and asset purchases of recent years will eventually inflate paper currencies.

 Housing, like politics, is first and foremost local.  Some markets would make mediocre investments no matter what (like areas with high unemployment).  Some types of housing, like condos, may not be ideal for inflation hedging.  Their values tend to be less stable than that of the 4-bedroom, 2 1/2 bath Colonial with the white picket fence and English sheep dog.  A house isn't a substitute for sensible investment diversification.  Stocks, TIPS and perhaps other assets might also play a role as reasonable inflation hedges in a well-diversified portfolio. 

It's hard to have confidence in housing after the free fall in prices of recent years.  But investment success can often come from buying disfavored assets.  Buying bubbly assets like bonds (especially junk bonds) isn't likely to be the epitome of financial perspicacity.  Home sweet home, be it ever so humble, may work out better if inflation rears its ugly head.

Why Insurance Products Can Make Lousy Investments

If you're considering an insurance product that includes an investment feature, consider the following two examples of why you might want to say no.

Mass Mutual.  On Nov. 15, 2012, the SEC sued Massachusetts Mutual Life Insurance Company in an administrative proceeding (an agency process somewhat like a court case, although conducted within the SEC instead of in a court).  Mass Mutual settled without admitting or denying the SEC's charges.  The essential accusation the agency leveled against Mass Mutual was that it didn't adequately explain to customers how withdrawals from variable annuities under certain circumstances could drain their accounts of value.  (See the SEC's press release at http://www.sec.gov/news/press/2012/2012-230.htm.)

Variable annuities involve the customer making periodic payments for a number of years and directing how the money is invested in a tax sheltered annuity. Eventually, the invested amounts can be used to purchase an income stream from the insurance company. The investments may do well or poorly.  To ameliorate the potential for poor investment returns, Mass Mutual offered an optional rider that, for an additional premium, gave customers a GMIB, or Guaranteed Minimum Income Benefit.  The GMIB guaranteed a minimum value that customers could use eventually to purchase an income stream, regardless of how poorly their investments did.

The GMIB could increase by 5% or 6%, depending on the rider.  Mass Mutual capped the level of the GMIB (through a somewhat complex formula).  Once the cap was reached, the GMIB wouldn't increase.  Mass Mutual also allowed customers to make withdrawals from their annuities before they converted the investment value into an income stream.  If they made a withdrawal before the GMIB reached its cap, the withdrawal would reduce the GMIB value (and the value of the invested assets as well), but wouldn't prevent the GMIB from continuing to increase.  However, after the GMIB reached its cap, withdrawals would decrease the GMIB and it wouldn't increase the next year.  Thus, making withdrawals after the GMIB reached its cap could permanently shrink the GMIB--under some potential circumstances, to zero.  According to the SEC, Mass Mutual didn't clearly explain how the GMIB, which might be thought by customers to be a guaranteed minimum value, wasn't guaranteed if the customer made withdrawals after it reached its cap.

Got it?  Pretty simple, right?  To be sure, after it was nabbed by the SEC, Mass Mutual did the right thing and eliminated the cap on the GMIB.  But if you furrowed your brow over the details of this annuity (and we've just summarized them--read the SEC's press release and order cited above for a gorier rendition), you should think twice--and then three times--and then four times--and then five, six, seven and many more times before investing in a variable annuity.

Universal Life.  The other example is in today's Wall Street Journal (Nov. 17-18, 2012, P. B9), which reports that low interest rates may require universal life insurance policy holders to pay higher premiums or face the cancellation of their policies.  Universal life is a form of permanent life insurance that allows customers to have life insurance coverage for long periods of time (i.e., longer than the perhaps 20 years allowed in term life coverage), often with flexibility in the amounts of the premiums paid.  Universal life also has an investment feature, and customers can use money from the investment account to help cover the cost of their life insurance.  As customers age, the cost of life insurance coverage naturally increases.  But today's low interest rate environment has been detrimental to investment returns, including those of universal life policies.  Many universal life customers are facing the need to pay increased premiums, or see a reduction of their life insurance coverage or even the cancellation of their policies.  Large numbers of universal life policies were sold years ago, before the Federal Reserve declared war on positive interest rates.  So the current low rate environment and its consequences for universal life policies probably come as a surprise to many customers. 

Insurance products like variable annuities and permanent life insurance can sometimes put customers into the middle of the complexities of the financial markets.  You're subject to many of the same risks as professional investors and traders.  But you probably don't have the same level of knowledge, experience, and information as they do.  Sophisticated insurance products can be labyrinthine mazes of risk shifting, and it's possible to run into the Minotaur.  Traditional insurance, which consists of the pooling of risks, can offer sensible protections.  But stick to policies that are easy to understand, because then you'll know what you're getting into.  Term life and fixed annuities can be useful for many people. Super dooper, turbo-charged complex insurance products that also invest your savings, pick up your dry cleaning and get the oil changed in your car are to be viewed cautiously, and then skeptically.

The Great Anxiety

The Great Recession has morphed into the Great Anxiety.  Economic growth is tepid, enough so that it inspires little confidence.  Unemployment, still high, is falling, but so slowly that consumers' animal spirits remain tame.  Individual investors, confronted by three year highs in the stock market, celebrate by fleeing.  The members of Congress devote their energies to calling each other finks, rat finks, double rat finks, and triple rat finks, while the nation veers toward a fiscal vortex.  Both candidates for the Presidency, although individually quite intelligent and accomplished, swap lies about how the other is lying and inspire little more than resigned sighs from their supporters.  The Federal Reserve is operating the only show in town, and its program consists of printing money, printing money while riding a bicycle sitting backwards, printing money while juggling eight balls and printing money while doing double somersaults on a trapeze.  But the Fed can't do much to resolve the problems in Europe, which is now sliding into recession even as the sovereign debt crisis gets kicked farther down the road.

If the Federal Reserve Board is correct in believing that public confidence is crucial to economic growth, then we are a long way from healthy, sustainable growth.  By all current indications, whichever candidate for President wins won't inspire much confidence.  Congress appears likely to remain divided between a Republican House and a Democratic Senate.  Gridlock isn't that big a problem when the economy is strong.  But it is deadly when the economy is moribund.  For better or for worse, a somnolent economy needs a decisive government, and we probably won't have one. Can kicking isn't a sound federal economic policy.  Both Japan, and more recently, the European Union, have vigorously kicked the can numerous times.  The problem, though, is that business people and consumers all know that the can is still there, and can bite them in the butt big time.  So they don't make big commitments; they don't go exuberant.  Can kicking virtually guarantees stagnation.  Yet can kicking has been the order of the day in Washington.

In a time when lukewarm coffee is all that you can hope for, invest cautiously.  It's not a bad idea to hold some risk assets.  But limit your exposure, and avoid the riskiest.  Hold a good dollop of stable assets, and don't stretch for yield.  One important way to give your net worth a boost is to save more.  Remember that the thriftiest squirrels have the best chance of surviving winter--and the coming winter could be cold indeed.

How the Federal Reserve Discourages Consumer Demand

The Fed has, for the past four years, waged a relentless war on interest rates, suppressing them to zero at the short end of the yield curve and to record lows at the long end. This was all done in the hope of encouraging lending and fostering consumer demand. With about 70% of the U.S. economy coming from consumption, there is good reason to try to encourage consumers. But the Fed's basic approach has been to tilt the playing field sharply toward borrowers and punish savers for having the temerity to be frugal, all with questionable impact on consumer demand.

The boost given to borrowers appears to be limited. Interest rates on credit cards have, if anything, been rising. This is in part due to changes in the law that have limited some of the fees with which banks previously whacked their customers. But the sharp drop in short term rates since 2008 has not been mirrored in the credit card market. With recent credit card rate increases, borrowers have the incentive to reduce balances, not boost spending.

In the mortgage markets, rates are reaching all time lows. But only a limited segment of mortgage borrowers are able to qualify for refinancing (and a lot that can refi have already done so). The people who need help the most (i.e., those underwater on their mortgages) find refinancing a tough slog, if possible at all.

In the business world, rates may or may not be dropping, depending on the creditworthiness of the borrower. Business people tend to be cautious right now, with all the headwinds from slowing economies in America and Asia, recession in Europe, the unsolvable Euro crisis, and near complete political dysfunction in Washington. Drops in interest rates aren't likely to greatly affect their view toward business borrowing, investment or hiring. That's evident from the fact that businesses are choosing to hold billions of dollars in cash for essentially no return rather than invest or hire. If you're not deploying your own cash to invest or hire, why would you borrow even at a low interest rate to invest or hire?

But the impact of low interest rates on savers is significant. Let's hypothetically take a relatively frugal American who is approaching or in retirement, and in 2006 had $750,000 in a diversified portfolio. During the financial crisis of 2007-08, this portfolio, we'll assume, was pummeled down to $500,000. Many investors victimized in this fashion have fled equities and put their reduced savings into fixed income investments. For the sake of simplicity, let's assume the Fed's war on interest rates kept the yield curve 1% below where it might have been with a somewhat more balanced approach by the Fed. (Thus, at the low end, the Fed would today be targeting a fed funds rate of 1 to 1.25% instead of today's 0 to 0.25%.) The interest lost by our hypothetical saver would be $5,000 a year. Compounded over 4 years, the saver would have lost about $20,302 before taxes. While this amount after taxes wouldn't buy a yacht, and only a modest car, consumption would probably be noticeably boosted if millions of Americans had enough additional money to buy a modest car.

Given that the Fed has promised to keep interest rates ultra low until late 2014, the lost income will reach approximately $30,760 per hypothetical saver in a couple of years. And this amount could increase if the Fed extends that promise into 2015 (a serious possibility).

It's important to keep in mind that these income losses are permanent. There is no way savers can recoup these losses. The Fed won't boost interest rates extra high later on in order to bail out the frugal. So savers' consumption will be permanently reduced.

The Fed claims to be greatly concerned with consumer expectations and their general state of mind, believing that public confidence is crucial to restoring demand and prosperity. The message sent by the Fed's long and continuing war on interest rates is that things are bad and will be bad for a long time. Any rational consumer, particularly those that are frugal to begin with, will hunker down, dig the fox hole even deeper, cover it with a sturdy layer of thick logs, camouflage it with an abundance of branches and brush, and never even dare to peek out.

The situation in Japan is illuminating. The Japanese central bank has, since its own financial crisis in 1989-90, banished positive interest rates from the land (encouraging the so-called carry trade, where Japanese citizens deploy their savings or borrowed yen into investments in foreign currencies that offer positive returns; thus Japan's capital is productively used in other nations). Japanese consumers have gone from being luxury hounds to penny pinchers and bargain hunters. Japan has been stagnant for more than two decades, and its most recent economic statistics show that the stagnation has become a seemingly permanent and undesired house guest. America appears to be headed down the same path. Although the headlines generated by politicians and candidates for political office promise solutions, hard evidence to be optimistic remains scarce. Even the tech sector, America's economic sweetheart, has offered a lot of disappointment lately, with Facebook's stock losing almost half its IPO valuation and other familiar tech companies serving up results akin to the financial equivalent of Spam quiche. Will America become Japan? This is no longer the question. The question now is how will America stop being like Japan.

The Key to Long Term Investing: Liquidity

Paradoxically, liquidity is a very important component to success at long term investing. Stocks have a good long term record, if you measure in decades. Real estate is less profitable overall, but is the long term investment of choice for many Americans since they are homeowners. Having to sell unexpectedly early, though, can ruin the value of either stocks or real estate as investments. If markets are shaky when you have to sell, you can be a big loser.

To increase your chances of long term success, you need liquidity--cash to keep you going without having to sell your long term investments. This includes having a bulked up emergency fund to cover unexpected cash needs (like unemployment or a medical crisis). It also means having a stable source of cash for a long period of time. Most people work for that stable source of cash. Those with pensions have a steady cash flow in retirement. Highly rated bonds and stocks with a strong record of paying dividends can also serve this need. Immediate fixed or inflation adjusted annuities from highly rated insurance companies can provide long term liquidity. Don't forget Social Security. It's like a pension. Even if it doesn't cover all your needs, its predictable inflation-adjusted monthly payments are the financial foundation for most retired Americans.

If your day-to-day liquidity needs are met, you can hold your long term investments until the moment you, and not circumstances, choose as the time of sale. Avoid borrowing to meet these liquidity needs. Debt tends to destabilize your finances. (See http://blogger.uncleleosden.com/2010/07/why-you-should-avoid-debt.html.) Instead, securing a steady income and living within your normal cash flows can give you a good chance to win over the long haul.

Are Stocks Still a Good Investment?

The latest jobs report, on Friday, which revealed no net job growth, confirms what a lot of people suspected: that the economy is stalled out. The prospects for the future are guarded, at best. Businesses don't want to hire. Consumers don't want to spend. Political pressure from the right prevents further large scale governmental intervention. Except possibly by the Fed, and its options don't look appealing. The most it can hope for is that further money printing might puff up the financial markets and create a "wealth effect" to spur spending by the rich. But Tiffany, Hermes and Louis Vuitton don't employ that many people in America's heartland, so more money for the rich won't do much to revive the overall economy.

Are stocks still a good investment? Whatever the Fed does, it will have only a short run effect. QE2, announced a year ago, is already dissipating. If the Fed does QE3, it will likely have little or no impact beyond the months the Fed is running the money printing presses. After that, we'll probably stagnate again.

Japan's experience suggests pessimism. In the late 1980s, Japan had a real estate and stock market bubble that, if you can believe it, was more extreme than America's recent bubbles. Real estate prices went so high that people were taking out 100 year mortgages to pay for their homes. When it comes to encumbering future generations, that takes the cake.

The Nikkei 225 average peaked at 38,916 on December 29, 1989, and then popped a la Dow Jones Industrial Average circa 1929-1933. It eventually dropped below 8,000 (not a typo; we're talking a belly flop of more than 80%), and now putters around the 8800 level. Adjusted for inflation, that means the Nikkei 225 is still almost 80% below its all time peak. A minus 80% return for over 21 years is, no matter how you look at it, pretty stinky.

An example closer to home of the deleterious effects of an asset bubble is the Nasdaq stock market. The Nasdaq index peaked at 5,048.62 March 10, 2000. Since then it has dropped as much as 70% or so. It has never recovered more than half its peak value, after adjustment for inflation. Today, it trades around 35% of its 2000 peak, on an inflation-adjusted basis. A minus 65% return for 11 years is also pretty stinky.

The performance of other U.S. indexes isn't as bad as the Nasdaq. After adjustment for inflation, the S&P 500 trades around 54% of its all time peak on March 24, 2000 of 1527.46. The Dow Jones Industrial Average trades around 70% of its all time peak on April 11, 2000 of 11,287.08, after adjustment for inflation. Nevertheless, all of the major indexes are significant losers over the past 11 years.

Japan's government did a lot of the things the U.S. government has been doing since the 2008 financial crisis--deficit spending, money printing, zero interest rates, keeping downward pressure on its currency. None of it revived the economic locomotive that was the Japanese economy during the 1970s and 80s (although these measures may have prevented things from getting worse). The Japanese government protected jobs by keeping zombie corporations and zombie banks on life support. After ten or more years, the Japanese government began to eliminate zombie businesses. By the time it was done, however, the Japanese consumer was thoroughly beaten down, and China and other Asian nations had muscled into the export markets that Japan had previously dominated. While Japan remains a wealthy nation with a large export sector, it has limited potential for growth. Its stock market may not ever, in a time relevant to anyone reading this blog, recover its luster.

What of U.S. stocks? Economic growth is one factor crucial to future stock values--growth in America and growth overseas where U.S. corporations have markets. At this juncture, that's anyone's guess. Add to the mix downward pressure from Baby Boomers (in Europe and Aisa, as well as America) selling stocks to finance their retirements, and stocks appear to be a speculative bet. It is true that, after the 1929-33 crash, stocks recovered to about 50% of their pre-crash value after 21 years. But the enormous stimulus of wartime spending for the Second World War, plus the fact that America had most of the world's functioning industrial base immediately after the war, account to a large degree for that partial recovery.

Or course, not being in stocks means missing market upswings. If you buy today, you aren't paying the peak prices of 2000, but today's somewhat beaten down prices. Your basis is lower and future returns may be positive. It makes sense to have part of your portfolio in stocks. But don't think in terms of maximizing upside potential--that necessarily means maximizing exposure to downside risk. The past 21 years teach that risk of loss isn't a fictional bogeyman from fairy tales. You will lose money from time to time if you invest in stocks. But you may make some or all of it back, and perhaps enjoy net gains.

Put a good chunk of your portfolio in bonds and/or CDs. These investments add stability, and a bit of income. Reinvest the income (along with any dividends you get from your stocks) to get the benefit of compounding (for more on compounding, see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html).

A portfolio invested 60% in stocks and 40% in bonds has historically performed pretty well in capturing most stock market gains while providing greater stability in value than stocks alone. As you get older, avoiding loss becomes more important than securing gains. So shifting as you age to a stocks/bonds and CDs ratio of 50-50, 40-60 and later 30-70 is prudent. None of this means you will necessarily make money. You may lose it. But you might lose more if you invest only in fixed income and money market instruments. Asset values, artificially inflated over the past 15 years by inordinate amounts of easy credit from central banks, have been deflating and may continue deflating for a long time. The only way to predictably increase your net worth is to save more. If you're nervous about the future, increase the amounts you're saving.