One problem with reading financial blogs is that you seem to get a lot of the same advice, over and over again. Most of this advice is time tested and well meaning. It comes from smart people and is based on sound principles. But, it may not work for you. What if all of this financial advice is wrong? What if the conditions are changing and the old rules no longer apply?
Can you afford to bet your financial future on advice that is outdated?
Investors are Overconfident
I have been investing for a long time and I have seen and made plenty of mistakes. The biggest mistake is thinking what worked well in the past will work in the future. It’s called the Normalcy Bias and it has fooled a lot of experienced investors.
For years, financial planners have used projections of 2-3% inflation and a 7-8% investment return. There was a time when those numbers were realistic. In the future, they may not be. I believe inflation is closer to 7% right now and it may rise. Index funds have returned very little in the past 10 years and that may continue in the future. We may face another decade like the 70s where the stock market is flat and inflation is high.
Investors aren’t expecting a decade of high inflation or low returns.
Economists are Deceptive
Another problem is that we are constantly being reassured that everything is OK with the economy, when it’s obvious that it isn’t. Our elected officials care more about their political parties and reelection then the strength of our nation. The banks care more about fleecing their customers and gambling with derivatives than protecting the global economy. Not only are they distracted from their mission, they are grossly negligent in their duties. Ordinary citizens like you and I will have to pay the price for their failure.
The reality is that inflation is close to 7%, when calculated using the 1990 CPI standard. The unemployment rate is around 23%, when using the 1994 standard, which included short and long-term discouraged workers. The U3 rate reported by the BLS only includes the 9% of people receiving benefits. This makes it difficult to judge the economy and plan for the future. The only thing you can count on is the bias will continue, because the government can’t afford to publish the accurate rates of inflation and unemployment.
Never trust anything the government or their economists tell you.
The Deficit is Unsustainable
Everyone knows the federal deficit is out of control. In fact, it has almost doubled in the five years I have been writing this blog. While the Budget Super Committee is arguing back and forth about how to cut $1.2 Trillion in the next 10 years, the deficit is growing at $1.3 Trillion per year. So far, we haven’t suffered any dire consequences from this reckless spending. But, that day is certainly coming soon and likely sooner than most people expect.
Federal Budget in Summary
- Annual Revenue = $2.3 Trillion
- Annual Expenses = $3.6 Trillion
- Annual Deficit = $1.3 Trillion
- Outstanding Debt = $15 Trillion
- Unfunded Liabilities = $116 Trillion
I don’t have a PHD in Economics, but I’m pretty good in math. And simple math tells me there is no possible way for the government to repay the deficit. Even if they cut Federal spending in half tomorrow, it would take over 30 years to pay off the deficit. That’s at the artificially low interest rates we have today. If the interest rates were to suddenly shoot up near the real rate of inflation, the annual interest on U.S. debt would surpass $1 Trillion and eat up close to half of the Federal revenue. If you add in the unfunded liabilities from public pensions, Medicare and Social Security, the budget numbers are hopeless.
There is no possible way for the U.S. Federal government to pay off its debts.
The Dollar is Declining
So far, the Feds have gotten away with overspending using two dirty little tricks. First, they force exporting nations, like China, to balance the current account by accepting our debt. Second, they simply print more money. Both of these scams have consequences. The Chinese and other nations are growing weary of our debt. They have been quietly meeting with other countries to find a way to trade around the dollar. We have recently lost our AAA credit rating and further downgrades could cause investors to dump our Treasury bonds. We have been printing money like crazy and the inflationary effects are already starting to appear. The U.S. dollar has fallen nearly 30% since 2002.
Inflation could easily reach double-digits, like it did in 1947 and 1980.
The Government is Desperate
Where will all of this lead us? Will the Treasury Department try to inflate their way out of debt? Will they devalue the dollar or raise taxes dramatically? Will they try to nationalize industries or confiscate private assets? I know this sounds unrealistic, but there are many historical precedents. Most American’s probably don’t know the U.S. confiscated all the gold coins and bullion in 1933 and it was illegal to own gold, except as jewelry, until 1974. People may not realize the British Pound was devalued by 30% before it lost status as the world’s reserve currency. Most people have no idea how much exposure the U.S. financial system has to shaky European debt.
Unless we change course, it’s not unthinkable the U.S. could:
- Lose Status as the World’s Reserve Currency
- Trigger Hyper Inflation
- Devalue our Currency
- Default on Bonds and Debt Obligations
In a crisis, citizen’s rights will be trampled and private assets coveted.
Surviving the Apocalypse
OK, that’s enough doom and gloom for one post. There are a number of ways to protect your wealth and reduce your exposure to inflation and currency devaluation. The most important thing is to diversify from a portfolio of purely financial investments, such as stocks, bonds, CDs and mutual funds. It is also important to diversify from a portfolio that is exclusively denominated in U.S. dollars. Real assets tend to hold their value in times of high inflation and it will be important to own a much higher percentage if the dollar hits the fan.
Investments that could buffer inflation and currency problems:
- Real Estate
- Foreign Assets
- Precious Metals
It’s impossible to own the dollars without being exposed to the debt.
The Bottom Line
The bottom line is that it’s no longer practical to stick money in an index fund and expect to prosper. Anyone who isn’t diversifying both their income and their investments may be risking a difficult future.
“Politicians say they’re beefing up our economy. Most don’t know beef from pork.”
This post was featured on the Carnival of Personal Finance over at My Personal Finance Journey. If you aren’t familiar with the Carnival of Personal Finance, you need to check it out. It’s where all the cool bloggers hang out.