What To Do For A Market Crash

I received this comment/ question recently:

“Any chance you could write a post about what a person could do if they see a collapse coming.  For instance, what would I do with my 401k if the market started tanking or if I felt like it was about to crash?  What has been the smart thing to do in past recessions?  Those are questions I’m sure a lot of people right now are worried about.”
That last statement is probably quite accurate, so I am addressing this question as a post, because I do think it is on a lot of people’s minds.
First, it is important to remember that we cannot predict the future.  The market is made up of millions of buyers and sellers and it is impossible to predict the actions of these people.  It is also quite difficult to predict the actions that will be taken by the government and the Federal Reserve.
While a lot of people may be worrying about such a scenario, it doesn’t mean it will happen.  The day after this comment was written, the Dow surged past 13,000.  We must not forget that the Fed tripled the monetary base after the fall of 2008.  Some of this may be leaking out now and it could easily cause a boom in asset prices such as stocks.  Again, it is impossible to predict with certainty.
For that reason, I continue to advocate the permanent portfolio as described by Harry Browne in his book Fail-Safe Investing.  It is designed to protect your investments in any economic environment.  While it probably has its poorest performance during recessions, we have to remember that recessions are usually short-lived.  They will turn into depressions or rebounds.  In addition, price inflation tends to be low during recessions, so you are not losing much to inflation.  In an inflationary recession like we saw in the 1970’s, then gold will probably do well.
But what if you are a good speculator and you really strongly believe that the market is about to tank?  What can you do with the speculative portion of your investment portfolio?
If you are really brave and you think you can time the market crash, then you should be playing the futures/ options market.  If you buy put options on the stock market, then you are betting on it to go down.  But it would have to hit a certain strike price before the option expires, otherwise it will be worthless.  (You could technically make money if the market goes down and it doesn’t reach your strike price, if you sell it early enough before expiration.)
Again, the problem with options is timing.  If your prediction of a market crash is a little early, then it will probably cost you the full premium that you paid for the option.  However, if you are correct, then the leverage can be very powerful and you can make a lot of money in a short period of time.
If you believe a market crash is coming but aren’t certain about the timing, then you have a number of choices.  You obviously want to be out of stocks completely.  Bonds will most likely do well if interest rates go down.  I understand that this is a scary investment to some people right now because rates are already so low.
Another choice is to buy ETFs that short the market.  You can even leverage your money and buy double or triple inverse funds.  SDS is twice the inverse of the S&P 500.  DXD is twice the inverse of the Dow.  You can even buy something like SPXU that is three times the inverse of the S&P 500.  These funds will all go up in a down market.
One warning I have about these funds is that they have management/ expense fees and they also don’t always correlate perfectly with the index in question.  For that reason, I would try to avoid holding these for a long period of time.
Another option in anticipation of a market crash is to buy the VIX.  There are different ETFs you can buy, including leveraged ones.  This is a measure of the volatility index.  It tends to spike up during a market crash.  You can make big gains in a short period of time with this if you guess correctly.  Just be aware that the reverse is true and that you can lose quickly too.
One of the specific things mentioned in this comment was about what to do in a 401k plan.  This is hard to say because these plans vary so much.  Aside from the above suggestions, there are mutual funds you can invest in that benefit from a down market.  However, if your options are really limited in your 401k plan, then the best thing to do might just be to move it to a money market fund, if you anticipate a coming recession.
The most important thing in investing is capital preservation.  You don’t want any really big losses that will make it hard to recover.  That is why I recommend the permanent portfolio.  But if you are really anticipating a stock market crash, then the most important thing is to sell your stocks before everyone else starts selling.  Any profit you can make in such an environment is really just icing on the cake.

Who Invented the Internet?

The Wall Street Journal ran an article earlier this week about who invented the internet.  The author says it is an urban legend that the government launched it.  The article describes a brief history of some of the individuals and companies (like Xerox) that helped bring about what we have today.

I have always thought it was a ridiculous claim by statists to point out the internet as an example of something in which the government created or helped innovate.  The internet itself would be nothing if not for all of the contributing individuals and companies in the free marketplace.  How could anyone seriously ever compare the government to Google, Apple, Amazon, Ebay, or Yahoo when it comes to innovation?

The other thing that has always annoyed me about this claim that the government invented the internet is that it completely ignores what Bastiat taught.  A good economist should not just look at the things we can see, but consider all of the unseen things that never came about.  Government at all levels in the U.S. takes almost half of our income.  With that much money, it is actually surprising that the government can’t innovate more and invent more, especially with help from private companies.

If I had a trillion dollars per year at my disposal, I would think that I could hire enough people that I could at least cure a few diseases each year and invent some great new gadgets.  You could do a lot with even just 1% of that.  With 10 billion dollars per year, you could probably come up with some great things.

If the government hadn’t been taking all of this wealth out of society and misallocating it for the last several decades, it is hard to imagine what luxuries we would enjoy now.  Twenty, or even ten, years ago, nobody could have imagined an iPad because there was no such thing at that time.

The other interesting thing to note about this article is a fact that is missed on most people.  It was hard for the author of the article to pinpoint who exactly invented the internet.  It is hard to get it down to one company and even harder to get it down to one name.  That is because most things are not really invented by one person.

Most of the great things we have in our lives today were not invented by one person or even one company.  People are constantly building off of the works of others.  Chip speed and storage are getting better exponentially.  Yet, how many people could explain why?  How many techies do you know who could actually give you a coherent explanation as to why this is occurring?  A few might be able to tell you something, but they will probably just be blowing smoke.

There is nobody who knows how to make a car from scratch.  There is nobody who knows how to make a computer from scratch.  As Leonard Read told us in I Pencil, nobody even knows how to make a pencil.

This is the way civilization works.  We are constantly building off of the ideas and works of others.  This is how society can progress at such a rapid rate.  Most people specialize in one small thing.  They cannot tell you how all of the other parts work in the process.  They don’t need to.  It somehow all comes together.

In truth, nobody invented the internet.  It was millions of people who contributed.  Some people were more important than others, but it still would have happened if any one person had not existed.  It is rare that you have someone like Steve Jobs who makes such big contributions.  But even if Jobs had never existed, we would still have many great gadgets today.  It is hard to say if we would have iPads, but I’m guessing we would have other things similar.

Just imagine if the government ever got out of the way and all of the bright minds in this world were allowed to flourish.  Technology could grow even faster than it is today.  We can only imagine what might exist in another ten years.

Mitt Romney and the 10th Amendment

There are two human beings in the history of America to have signed legislation mandating that individuals buy health insurance.  It just so happens that those two individuals are the two major candidates in the presidential election this year.

Mitt Romney and many of his conservative defenders like to point out that Romneycare was just done in Massachusetts.  They point out that it is a state issue and that while Romney passed such a plan for the state while governor, he would not support such a thing for the entire country.  In other words, there are many Republicans who are actually claiming that Romney is a states’ rights kind of guy.

Of course Romney only signed legislation affecting Massachusetts.  He was a governor.  There was no way he could pass something for the whole country.  And of course Romney is against Obamacare.  The hatred of Obamacare is the one thing that most unites Republicans and Mitt Romney is running on the Republican ticket.  Do you think he would have gotten the nomination if he said he supported Obamacare?

So the one major difference between Obamacare and Romneycare is that Romneycare only applies to one state and not the whole country.  But does this make Romney in favor of states’ rights?  Is he a big supporter of the 10th Amendment.

The 10th Amendment reads, “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

If Romney really supported the 10th Amendment, then he would not support 90% or more of what the federal government actually does.  In fact, he would be calling for the elimination of entire departments like Education, Housing, and Agriculture.  Unfortunately, Romney is not calling for the elimination of any departments or really any specific cuts at all.  He didn’t even do this while campaigning in the Republican primary, so you know he is certainly not going to cut anything if he is actually elected.

Romney can’t even get it right with another medical related issue.  He implies he is against Obamacare because he is in favor of states’ rights, but he doesn’t even respect the right of states to determine their own laws regarding medical marijuana.  He says he would fight against medical marijuana tooth and nail.  Watch the video below (thanks to Lew Rockwell):

Romney has no interest in smaller government.  He talks about it a little bit to pander to his base.  Anyone who is going to vote for Romney thinking they might get smaller government is simply naive.

The only way anything will be cut under a Romney presidency is if the Federal Reserve makes the decision to stop buying any more government debt and let interest rates rise.  That may force the government to cut back, or at least slow down.  Government spending will not be cut because of any philosophical principles that Mitt Romney holds.

The Case Against School Vouchers, Part II

Yesterday, I made a case against school vouchers using a moral argument.  Today, I will continue to make a case against school vouchers, but this time will use pragmatic arguments.  There could be a lot of unintended consequences (as with so many government programs) and these possibilities need to be explored.

Let’s say that in a particular school district or in a particular county, the average spending per student is $12,000.  Conservatives (and unfortunately, some libertarians) see the failing schools and unaccountable teachers and propose to institute school vouchers.  This means that every parent of a school-aged child would receive a voucher worth $12,000, to be used for the school of their choice.  Let’s explore some of the problems that could arise.

First, let’s say that you already send your child to a private (slang for non-government) school.  As a parent, you realize this is a rip-off because you already pay property taxes and other taxes that fund government education, which you choose not to use but are still forced to pay for.  Now that every parent/ child has a voucher, you will save money.  However, you weren’t part of that $12,000 per student before.  So if every child is given a voucher, the education costs will go up quite significantly, depending on the percentage of kids who go to private school.  There will now be more children to spend $12,000 per year on because the number will now include those not attending government schools.

It would be completely unjust to not offer a voucher to those already in private schools.  These parents would be really mad if that happened.  But either way, there would come a point where every child would receive a voucher.  In other words, government spending just went up and taxes will have to go up too.

Second, there are several reasons why parents might choose to send their children to a private school, even though they are double-paying (once through taxes and once to the private school).  They probably think the education is superior.  However, if vouchers are instituted, then that means any child could attend their school.  Now, I’m not against poor kids going to a good private school if the parent/ child really cares about getting a good education.  However, it is not hard to imagine that your school would all of a sudden be interrupted by troublemakers.  The parents who didn’t care before, probably still don’t care.  The same goes for the child.  Perhaps the school could kick out big troublemakers, but we can’t even be sure of that (see reason three next).

Third, if virtually all schools are receiving their revenue from vouchers, then politicians will start to exercise control over these schools.  It is not hard to imagine a politician saying that since these schools are receiving government funding, then they should have to meet certain criteria.  Perhaps they can only teach a certain curriculum.  Perhaps they can no longer teach anything about religion.  Perhaps they cannot kick kids out of their school for misbehavior (see reason above).  Perhaps they will have to give certain tests to make sure the children are learning the “right things”.  When the government has control, there are endless possibilities.  The really bad thing is that virtually all schools will be under government control in a voucher system, whereas at least now private schools do not have as many government rules and regulations to follow as government schools in most places.

Fourth, if every parent now has $12,000 per year to spend on each child for education, why wouldn’t education prices go way up?  It would be hard to imagine a school charging anything less than this amount.  Isn’t this the reverse of what libertarians want?  It isn’t complicated that when government subsidizes something, prices usually go up.  We can see this with medical costs and higher education.

These are just a few of the major reasons that libertarians should be against school vouchers.  Not only are they not ideal for libertarians, they are not even a step in the right direction.  They may actually be a step in the wrong direction, leading to government control over all schools and completely out-of-control government spending on education.

In conclusion, libertarians (and even conservatives) who advocate school vouchers should be careful what they wish for.  It could be a dream come true for the advocates of big government.

The Case Against School Vouchers, Part I

The issue of school vouchers is a highly divisive one.  It is even controversial within the libertarian community.  The libertarian argument in favor of school vouchers is similar to that of conservatives.  They see the government-funded school system as wasteful and in the hands of the teachers unions.  They see the lack of accountability and want some kind of a change.  They figure they can just hand a big check to parents each year to determine the school of their choice and that it couldn’t be any worse than what we have now.

There is a strong case to be made against school vouchers from a libertarian standpoint.  This is the position that I take.  It is completely different from those on the left who oppose school vouchers because they want the status quo.  I do not like the status quo at all.  I don’t believe in government education.  As I have written before, government education is a form of welfare.

As with most issues, there are two arguments to be made against school vouchers from a libertarian standpoint.  There is the moral argument and there is the pragmatic argument.  Today, I will focus on the moral argument against vouchers.

Libertarians generally believe that force or the threat of force should not be used for political or social change.  While I kind of stole that from the Libertarian Party pledge, it applies to all libertarians, whether or not they are a member of the actual party.

School vouchers does not change the fact that people are being threatened with force to obtain their money.  In fact, school vouchers don’t even reduce the amount being confiscated in most cases.  Most advocates of vouchers are not proposing a dramatic decrease in education funding.  They are just changing the direction of the funding.  Instead of the money going directly into the school systems, the money will first go to the parents, who will then decide on where the child and money go.

School vouchers are still welfare.  It is still a redistribution of wealth.  There is no way around it.  There are many people who never have kids, yet they are forced to pay for other people’s kids.  For those who have kids, the numbers vary.  Some have just one child, while others may have 4 or more.  Yet, when people pay their property taxes, it is based on the rate of the tax and the value of the property.  It has nothing to do with how many kids you have.  If anything, the money coming from Washington DC for education comes disproportionately from those with fewer kids or no kids, because they do not get the extra tax credits and deductions.

School vouchers would not reduce government in any significant way.  They would not eliminate or even reduce the amount being confiscated, so it is hard to make a libertarian argument in favor of them.

As we will see in Part II, there are also pragmatic reasons to be against vouchers for libertarians.  They may not necessarily improve education and they could make things worse.  Stay tuned.

Typical Investment Advice

I received a comment recently from an anonymous person.

This person sounds like a fairly typical example of a somewhat average American.  Perhaps you could say this person is somewhat of a typical example of an average American who reads my blog, since the person has some gold investments.

It is hard to comment precisely, not knowing details about family, location, income, total savings amount, and risk tolerance.  But I can make some comments that might be helpful.  Since others may find them helpful, I decided to write a separate post, instead of just a response in the comments.

First, I think this person is on the right track.  He (I will assume this is a “he”) has a good portion invested in gold and silver (hopefully more gold than silver).  He has some of his savings in cash or cash equivalents, which is actually a good position to be in right now.

It is good that he is only contributing to his 401k plan up to the company match.  You should never go beyond this.  I have written about the risks involved with 401k type plans before.  If your contributions are hurting your other savings to a large degree, then you might even consider not contributing to the 401k.  Yes, I know every financial advisor out there is screaming.  But 401k money is the most illiquid savings you can have, especially when your employer won’t let you withdraw your own money.  It is more important to have an emergency fund that you can actually access, than a 401k.

He did not say what his investments are in his 401k plan.  Hopefully it is well diversified.  Some plans allow you to opt in to a special brokerage link account where you can buy any mutual fund that you want.  You would probably have to fill out a special application for this.  If your company allows this, then you should do it and you can then put the majority of your 401k money into PRPFX.

I would not start a regular IRA.  If you are going to start an IRA, then go with a Roth.  At least you can withdraw your principal money (not any gains) before hitting retirement age without getting hit with a penalty.

For the brokerage account, this person can set up something similar to the permanent portfolio using ETFs.  I have written about this strategy before.  He is already doing one portion with a gold ETF, probably GLD.

I’m not sure the total net worth of this individual.  He says that he has some of his savings in cash though.  If he is in a decent location, he might want to consider investment real estate.  If he could just buy one three-bedroom house and put 20% down, it might be a good payoff in the long run.  Mortgage rates are historically low and housing prices are low, depending on where you live.  This should generate positive cash flow for the average month.  If it doesn’t, then it shouldn’t be done.

Of course, there is also the option of paying down your mortgage if you own a home and have a mortgage.  This is a guaranteed rate of return equivalent to the interest rate on your mortgage.  It is a good compliment to gold holdings that hedge against inflation.  Paying down your mortgage is more of a hedge against deflation.

Overall, I encourage everyone to set up the majority of their investments (outside of real estate) into something similar to the permanent portfolio.  You will probably sleep better at night.

Will Gold Stocks Keep Going Down?

While the price of gold in terms of U.S. dollars has been fairly steady over the last several months, that hasn’t been the case for gold stocks.  Most gold mining companies have been hammered, particularly in the last year.

Fidelity’s gold mutual fund (FSAGX) is down over 30% over the last year.
GDX, a gold mining ETF, is down about 30% over the last year.
GDXJ, a junior gold mining ETF, is down a whopping 49%.

This is why gold stocks should not be part of your permanent portfolio.  They should be left for your speculative investments.  It is obvious why by looking at the recent performance.

So where do gold stocks go from here?  It is a tough question to answer and I think it will all depend on the direction the economy takes.  If we fall back into a recession (not that it seems like we ever got out of one), then gold stocks are likely to continue their poor performance.  If a recession is averted, at least for a little while, then we could see gold stocks resume an uptrend like we saw years ago.

Much of this will depend on the Federal Reserve.  The adjusted monetary base has been flat since QE2 ended just over a year ago.  The Fed is on hold, waiting to see what happens.  It is possible that it is waiting for another crisis like we saw in 2008 where it bailed out the big banks and financial institutions.  It is possible that the Fed will give in to pressure to boost the economy if the stock market turns down significantly or even if unemployment stays high.

If the Fed starts creating new money out of thin air again on a regular basis, then I would expect gold to start another run up.  I would also expect that gold stocks would then reverse the downtrend and go up. If that happens, then now might be the deal of the decade with how much of a beating the gold stocks have taken.

If the Fed stays tight and the economy falls into recession, then gold stocks will likely continue their fall, especially with a fall in the broader stock market.

Owning investments that reflect the price of gold are still much safer than owning gold mining companies.  If you try to speculate on some gold stocks, or funds that invest in gold stocks, just be sure that it is money you can afford to lose.

Canadians Now Richer Than Americans

The top headline on Drudge Report today is, “Canadians Now Richer Than Americans”.  It links to an article by U.S. News that says the average Canadian household is worth about $40,000 more than the average American household.  The article claims that this is the first time in recent history.

The article states, “The net worth of the average Canadian household in 2011 was $363,202, compared to around $320,000 for Americans.  It goes on to point out that the Canadian dollar has caught up to the U.S. dollar and the two currencies are at about par.

The U.S. and Canada have been somewhat similar for a long time now, although there is certainly a perception that the U.S. is still somewhat better in terms of economic growth.  There was probably a certain element of truth to this in the past, as Canada does have a little more of a welfare state.

There are several reasons contributing to the average net worth being higher for Canadians.  Some of them are good and some are bad.

As the article points out, “real estate held by Canadians is worth more than $140,000 more on average and they have almost four times as much equity in their real estate investments.”  The last part is good.  More equity means that Canadians have saved more, at least in a sense.  It means that more Canadians will reach the point of paying off their mortgage and freeing up their incomes for other things.

The fact that Canadian real estate is worth more than real estate in the U.S. is not necessarily a good thing for Canadians.  The Canadians may be richer on paper in this respect, but it doesn’t necessarily translate into wealth.  We should all know that from the peak in the housing bubble, approximately 6 years ago.

It is likely that parts of Canada are having a real estate bubble of their own now.  Have you seen the prices of houses in Toronto?  It looks like parts of California and Florida did 6 or 7 years ago.  If the real estate pops in Canada as it did in much of the U.S., then it will show that some of this wealth was illusory and there probably isn’t much of a difference between the two countries in terms of wealth.

As far as government policies go, there are also differences that are good and bad between the two countries.  As mentioned, Canada is a bigger welfare state.  Canada has higher taxes.  There is a national sales tax there.  These are all negatives.

On the other hand, Canada is not as entrenched in the warfare state.  While Canada has symbolically supported the U.S. in its wars abroad, the expenditures do not come close to matching the U.S., even on a per capita basis.

Another difference is that the central bank of Canada has been a little better than the Fed in the recent past.  Of course, if Canada experiences a real estate bust, maybe the central bank there will be stupid enough to follow in Bernanke’s footsteps and create new money out of thin air like crazy.

Overall, despite some differences, Canada and the U.S. are very similar.  I don’t really see Canadians as being wealthier than Americans.  It’s not to say this couldn’t happen in the future, but that will depend on government and monetary policies.

PRPFX and Silver

I have written about the recent performance of PRPFX.  Yesterday I wrote about the stock holdings in PRPFX.  Today, I will discuss the silver portion.

One of the main reasons to invest in the permanent portfolio as described by Harry Browne is that it provides diversification in almost any economic environment.  It tends to do the poorest during a recession, but these are usually short-lived and there is also a tendency for stable or even declining prices during those times.

The primary protection for the permanent portfolio in an inflationary environment is the 25% devoted to gold and gold related investments (but preferably not gold stocks).  There is some additional protection with stocks, but even stocks did not hold up too well in the 1970’s when there was high price inflation in the U.S.

The mutual fund PRPFX does things a little different.  It holds approximately 20% in gold and 5% in silver.  While the overall percentage in metals is the same as the regular permanent portfolio, the mutual fund deviates with silver.  The regular permanent portfolio does not have silver at all.

This is a fairly small percentage (five percent), so a major drop in silver isn’t going to completely crush the mutual fund.  However, it can make a little bit of a difference, and it can be good or bad.

Silver is far more volatile than gold.  In a boom of precious metals, silver is likely to outperform gold.  In a bust period of precious metals, silver is likely to fall much further than gold.

Another difference is that silver is used more as an industrial metal.  While silver has some history of being used as money and gold has some uses outside of being money, gold is heavily favored over silver when being used as a form of money.  In a recession, silver is more likely to go down due to its uses as an industrial metal.

Another interesting aspect is that central banks and governments hold gold.  They don’t usually hold silver.  In the past, this could have actually been a reason to prefer investing in silver over gold because central banks had more of a tendency to sell gold, thus driving down its price.  Today, I would say the opposite.  Central banks all over the world are actually increasing their gold reserves, probably because of the shaky financial system and the growing mistrust of fiat currencies.  This has seemed to put a floor on the price of gold.

As far as PRPFX, what does this mean?  It means that it will tend to be more volatile.  One of the great attractions about the permanent portfolio setup is that it tends not to move in wild swings.  You don’t feel like you are on a roller coaster the way pure stock market investors have felt over the last 4 years.  By adding a little silver to its fund, PRPFX can potentially be a little bit more volatile than the regular setup.  In a high inflationary environment, it will probably pay off.  In a recession or depression, it will probably mean bigger losses, or at least less gains, assuming that precious metals take a big hit.

In conclusion, while it would seem that having 5% in silver would add diversification, it actually makes the fund more volatile.  This may not be a bad thing for younger and more aggressive investors, but you should at least know that there is a slight amount of increased risk due to this allocation.

PRPFX and Stock Holdings

For those who follow me, you know I am a big advocate of setting up your own permanent portfolio as described by Harry Browne in the book Fail-Safe Investing.  Since investments are dependent on human action, nobody can predict with absolute accuracy what stocks and other investments are going to do in the future.  It is even harder in trying to time such investments.  Therefore, I suggest that you put at least half (for risk takers) or closer to all (for conservative investors) of your investments into a setup like the permanent portfolio.  This would not count investment real estate.

I recently wrote a piece about the mutual fund PRPFX and its performance.  I said that it did not do a near perfect job of emulating the actual permanent portfolio, particularly because of the holdings in Swiss francs.

There is another aspect of PRPFX that differs from the permanent portfolio as described by Harry Browne.  The fund invests in individual stocks instead of the broad stock market.  For example, PRPFX holds BHP Billiton, FedEx, and Wynn Resorts, among others.  To be fair, none of these holdings make up over 1% of the fund.  However, it should be noted that according to the regular permanent portfolio setup, only 25% should be in stocks.  Therefore, if a stock had only a 0.5% weighting in PRPFX, it would actually be about 2% of the stock portion.

If any one company were to go bankrupt overnight, then it would not hurt PRPFX by any more than 1%.  This is really the purpose of mutual funds.  It diversifies risk, particularly with individual companies.

The main reason I point this out is because I want people aware that PRPFX is not the same as the permanent portfolio as described by Harry Browne.  The fund is actually speculating in stocks, even if it is in small amounts.  If it were true to the permanent portfolio, then the stock portion of the fund would just invest in the overall S&P 500 or even a broader stock market fund.  It would not be trying to pick individual winners.

I’m sure the managers at the PRPFX fund have done their research and found these individual holdings to be solid companies.  You may benefit with a higher return if you are invested in PRPFX.  However, I just want to reiterate that it is a form of speculation, even if much less so than the average mutual fund.

I still believe PRPFX is a simple and easy way to put at least some of your money into a setup that is at least close to the actual permanent portfolio.  It is just important to know what you are buying when you do so.

Combining Free Market Economics with Investing