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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Financial Safety During Financial Crisis and Stocks Bear Market

Personal_Finance / Financial Crash Oct 09, 2008 - 11:53 AM GMT

By: Christopher_Laird

Personal_Finance

Diamond Rated - Best Financial Markets Analysis ArticleSince so many of the financial community talk endlessly about where to invest, it always seems good to focus on the issue of financial safety. In my view, way to much emphasis is given to getting investing ideas, and little to how to keep what you have. Lots of people get caught in that.

It doesn't help that the financial media, like CNBC is always saying ‘how can you play this' or where would you invest in this situation. There certainly is nothing wrong with that, and surely CNBC wants to be relevant and useful to their massive world audience. But, aren't there times where the clearest strategy is what NOT to do?


But financial professionals make money by selling various investments, where they make a commission. There is just little incentive to encourage a person to put his money in a safe place and park it for a while. So, we never hear about that (or rarely).

Stay for the long term paradigm

One of the most dangerous investing paradigms we hear over and over and over is that a person should stay in the stock market because its average gains over 100 years or something is like 10 or 12% (they say). These stay forever people say if you get out of markets when they drop, you end up selling at bottoms, and if you were to stay with it, the market recovers …etcetera.

But of course, when the markets are facing a huge crash, this concept of hanging in there wears a bit thin. If you look at what happened to stocks in 1929 worldwide, or the US, the stock market dropped over 90% in a couple of years, and began the Great Depression in the US that lasted 10 painful years. Stocks did not start to really recover till the mid 1950's.

So, if people followed that logic of staying in for the long term, they were basically wiped out. I think that it's clear that the idea of always hanging in markets looking for the ‘long term' is a bogus and self serving idea for the brokerage industry.

The Yield paradigm

Then we can consider what I call the Yield paradigm. (A paradigm is a deeply held way of thinking about something, which often you don't even realize.) The Yield paradigm is that, if you have money it always has to be ‘working'. The person cannot sit still if it's not ‘always working'. This one keeps a lot of people out of gold longer than they should. It also keeps people in dangerous markets way too long for their own good.

The Yield paradigm is also a reason many people stay in the stock markets, as they believe that they should never let their money sit ‘idle'. This paradigm works well together with the ‘stay in the market long term' paradigm, and it again keeps people in markets when, perhaps, they should be out in cash or something (or gold coins in possession).

Now, Jesse Livermore, one of the greatest stock speculators of all time, stated in his books that there were clearly times to be totally out of the markets, in cash, and just go fishing. (He had a big motor yacht in the Gulf and he would literally go fishing for months when he was out of the markets).

Jesse Livermore NEVER stated that one should always be in the markets because they ‘give an average return of 12% long term'. He knew that was bogus.

But, the logic of that ‘be in markets for the long term' paradigm is very seductive. And, when people end up taking huge losses in stock crashes they inevitably return to that seductive idea, to comfort themselves. And, what really bothers me, is to see financial professionals and media repeating over and over that ‘stay in markets long term and don't get out' mantra, all the while people are losing a fortune.

So, let's dispense with that idea about always staying in markets because that is horse shit.

Cash, CDs, and gold coins

Our next point is to compare cash, CDs and gold coins. Once one frees his mind from the two paradigms we discussed above, then he has to find a place to sit ‘in cash' whilst he waits out the market crashes. Of course, one of the biggest problems right now is that banks and brokerage accounts are not all that safe. There is the issue of bank runs and so on.

Personally, I would think the safest way to keep your cash (not having institutional risk) is at home in a safe (which you don't tell people about!). Of course, lots of people get nervous doing that. And you won't get interest. But you can't have it both ways. In this case, one might choose a middle of the road approach, and half here and half there.

The most secure cash would be a gold coin. OF course, a gold coin does not earn ‘interest' and this key issue trips up many who would or maybe should go out and get a gold coin or two. Inevitably, when there is a currency crisis, they end up panicking and trying to get some gold or silver when its too late and not one will sell it.

I do not like safe deposit boxes because the government can lock you out of them. Bank ‘holidays' can also lock you out from your cash just when you need it most.
And of course, there is always the issue of the government confiscating gold again. But I would like to point out that no strategy can cover all risks, and anyway, a government can confiscate anything in an emergency.

Then, we get to what is becoming one of my favorite topics, the tax deferred retirements. I am coming to believe that these vehicles are particularly inappropriate for the longer term in the US and elsewhere. Putting aside the clearly self serving motives of the brokerage industry in creating these (with tons of lobbying), the inevitable collapse of the USD would likely wipe out most tax deferred retirements.

If the USD was not in such danger, perhaps the tax deferred retirements would be all right going forward. But, I do not personally believe these that safe for the next 5 or so years. The risk of a USD crisis is all too real.

Another thing about tax deferred retirements is that I am certain that, in a big US financial crisis, they will go after any remaining big pools of money, and guess what the biggest and most obvious target will be? Those juicy $trillions of ‘tax deferred' retirements! They likely will double taxes on taking any money out of them in a real US economic emergency. If that happens, as I suspect, so much for the tax deferral savings!

So, in effect, you are saving for the government and not so much for yourselves, like you were led to believe. Now, this is my assertion, not a certainty.

Bonds

I have a friend who bought quite a bit of California tax exempt revenue bonds. He worked for years saving a couple million at two teaching jobs. Now, with California in a huge financial mess (again) his bonds have lost 20% of their value, though they are not defaulted. Of course now, he is very reluctant to sell the bonds, as maybe he should, due to the 20% hit. He then will end up taking a lot of risk going forward, as California is ground zero of the real estate collapse. As the bonds fall further in value, it becomes harder for him to sell them.

California's budget will be a disaster for years going forward. In fact, they just made a request for a big loan from the US government so they can pay their bills in coming months.

I give this example because this guy's issue is the same for many people. The reason he is in the tax exempt bonds is to get yield. And, now he is facing some real risk of losing the money altogether. Once again, always insisting on getting yield (the yield paradigm) is a dangerous thing to do.

Return OF capital

Perhaps he would be far better to get a bunch of CDs within the insurance limit. He would not get as much yield, but has a much lower chance of losing his money. I know what I am saying is obvious, but there are a lot of people in this situation. Moving to lower yield to reduce risk is what must be done today, in my opinion. PIMCO's chief El Arian just stated the real issue right now is return OF capital, not return ON capital. He is right.

In fact, that exact problem, return of capital is the main source of the world credit crisis.
So, I think the main point of this article is that people need to find out how much those two dangerous paradigms are driving their thinking. Getting it wrong can be hugely costly. Sometimes it's just best to sit in cash.

Now, at this moment, the US stock market has not lost over 50%, like many foreign markets have recently. (China for example down over 60%). So, perhaps it's timely for you to take a good look at your thinking, and see just how deep those two paradigms are in you. Many times, we don't even realize how deep a paradigm has ingrained itself into our thinking. You need to find this out. You have to examine yourself…

We have a nice survival edition of our newsletter out this week. Stop by and have a look.

By Christopher Laird
PrudentSquirrel.com

Copyright © 2008 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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