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90% of Portfolio Performance Comes Down to Diversification

Editor’s note: This article was originally published on August 6, 2019 via Legacy Research Group.

Everybody knows the good times will end someday…

9 Stocks That Every 20-Year-Old Should Buy
9 Stocks That Every 20-Year-Old Should Buy

Source: Shutterstock

Stocks are up 321% since their post-crash low in March 2009.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

And it’s already been 121 months since the last recession – a record streak.

Eventually, financial gravity will return. And stocks, and the economy, will enter a downturn.

As we showed you yesterday, that downturn is probably closer than you think.

In fact, here at The Daily Cut, we see a bear market and recession within the next 12 months. And we wouldn’t be surprised if it happens before the year is out.

Now is the time to shield your nest egg…

That’s why, this week, we’re focusing on how to play defense in your portfolio. And we’ll start with the most important wealth-protection strategy of all today…

Studies show this strategy accounts for 90%-plus of how your portfolio rises and falls over time. (More on that in a moment.)

Yet it’s something a lot of financial publishers avoid discussing with their readers… They don’t see it as “sexy” enough to grab your attention.

But as you’ll see today, it could mean the difference between surviving the next downturn with your wealth intact… and even making money… or getting your wealth cut in half.

And there’s a bonus: This “boring” strategy is so easy to put into action, even a third-grader could do it.

Before we get to that, there’s something I (Chris) want to stress…

My crystal ball is as murky as everyone else’s.

I don’t claim that I can predict the future. All I can do is dive into market history for clues.

It’s possible the 10-year-old bull market keeps going a while longer. But that doesn’t mean you shouldn’t crash-proof your portfolio now.

I’ve been lucky enough to learn from guys like Bill Bonner… Mark Ford… Doug Casey… Teeka Tiwari… Jeff Clark… and Jeff Brown about how to build and hold on to wealth.

And I can tell you it has nothing to do with trying to predict the future.

Instead, it’s about knowing that investing ALWAYS involves shouldering risk. In fact, you can think of the whole game of investing as getting paid for carrying the burden of uncertainty.

Over time, what separates the successful investor from the flop is accepting that you don’t know everything… and prudently managing that risk.

That’s where the “boring” strategy I mentioned up top comes in…

Old-money investors call it “asset allocation.” Wall Street types call it “diversification.”

But the easiest way to think about it is putting your eggs in different baskets.

The more diversified you are, the less power any single event has to erase your wealth.

That’s why Mark Ford is so adamant about having a sensible asset allocation model. As Palm Beach Research Group cofounder, he built our Palm Beach Letter advisory around this approach.

And Teeka Tiwari, who now heads up The Palm Beach Letter, continues to hammer on how important that approach is today. Teeka…

The most important factor that determines your long-term wealth is asset allocation.

What percentage of your money should you invest in stocks? What percentage in bonds? How much real estate should you own? What percentage in options? How much in cryptos? What amount of cash?

How you answer these questions is what really moves the needle in terms of your wealth.

This isn’t just a theory… The numbers back it…

As I said up top, there are a number of studies based on real-world investor returns that back it up.

One study in 2000 looked at 10 years of monthly returns for 94 balanced mutual funds… and 10 years of quarterly returns for 58 pension funds.

It found that asset allocation explained about 90% of how those portfolios rose or fell over time.

Unfortunately, a lot of financial publishers shun discussing this key wealth-preservation strategy with their readers. This happens for two reasons, says Teeka…

First, every subscriber is different. It’s impossible to create a one-size-fits-all solution. It takes serious thought and effort to publish meaningful asset allocation advice for a large audience.

Second, asset allocation isn’t a sexy topic. It’s easier to keep you entertained with exciting stories and promises of riches rather than the “boring” stuff that actually helps you build and hold on to wealth.

Paid-up Palm Beach Letter subscribers can access Teeka’s 2019 asset allocation guide here.

So how does asset allocation work to protect your wealth in a bear market and a recession?

Take this simple example…

It’s a portfolio split among three asset classes: U.S. dollar cash, gold bullion, and a stock fund that tracks the performance of the S&P 500. We’ll call it Portfolio No. 1.

Portfolio No. 1 is split into 5% cash, 5% gold, and 90% stocks. Let’s assume for now that nothing happens to the cash and gold in this portfolio.

A 50% drop in the S&P 500 would mean a “drawdown” – or peak-to-trough fall – of 45% for your overall portfolio. (Keeping things simple, that’s 90% / 2 = 45%.)

Now, let’s say you’re a more cautious investor. Maybe you’re about to retire. You can’t stomach a 45% loss. So you go for a more cautious mix. Let’s call it Portfolio No. 2.

You split Portfolio No. 2 evenly among stocks, cash, and gold. Now, that same 50% plunge in stocks leaves you with only a 16.5% drawdown. (Again keeping things simple, 33% / 2 = 16.5.)

That’s still not great.

But it’s survivable in a way that a 45% loss is not…

Remember, compared to gains, losses have an outsized effect on your wealth.

To get back to breakeven from a 45% loss, you then need an 81% gain on that investment. (A 45% loss on $100,000 leaves you with $55,000. From $55,000 back to $100,000 is an 81% gain.)

That’s a big difference from the more cautious allocation. For Portfolio No. 2, you need a 20% gain to get back from the 16.5% loss.

But that’s not the only benefit of this strategy…

Cash is inert, like ballast in a ship. So when stocks crash, the cash in your portfolio doesn’t get more valuable.

Gold is different. It tends to zig when stocks zag. So a rising gold price offsets losses to your stocks.

For example, think back to the day Lehman Brothers declared bankruptcy – September 15, 2008.

Gold traded for $787 an ounce. It peaked at $1,900 an ounce three years later. That’s a 141% increase during one of the worst times for stocks in recent memory.

If gold soared just as much in the next crash, what would it mean for our portfolio split three ways among stocks, gold, and cash?

Instead of losing 16.5%, you would make 21%. Because your gold gains would more than offset your losses in stocks.

And we just saw gold rally as stocks hit the skids…

As we go to press, the S&P 500 is down 4.6% since the start of last week. Gold is up 6%.

And in the midst of all the turmoil in stocks, gold has leapt above $1,500 an ounce. That’s the first time it’s reached this level since 2013.

That’s 25% higher than when we first urged you to buy gold on August 27, 2018 in these pages.

Tomorrow, we’ll have more for you on that… including how colleague E.B. Tucker called gold at $1,500 back when most investors had left the metal for dead.

Meantime, don’t forget to check out our Ultimate Crisis Playbook.

It’s 24 chapters on how to protect your wealth… and profit… in a crisis. You’ll read from Doug Casey, Bill Bonner, Jeff Brown, Teeka Tiwari, Jeff Clark, and the rest of our analysts here at Legacy Research.

They’ll show you more about how owning gold and gold coins can protect your downside… how to profit from volatility using options… and how to shock-proof your portfolio.

As a Daily Cut reader, you can access it for free here.


Chris Lowe
Dublin, Ireland
August 7, 2019

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