Derek Sivers

Fail-Safe Investing - by Harry Browne

Fail-Safe Investing - by Harry Browne

Go to the Amazon page for details and reviews.

Its main point is the “Permanent Portfolio” - a beautiful simple idea to have 25% of your savings each in investments that do well during boom (stocks), bust (bonds), inflation (gold), deflation (cash). Then just rebalance when they get too far out of 25% each. No predicting the future. No worrying about the news. Just 25% each and rebalance.

my notes

The 17 Simple Rules of Financial Safety

RULE #1 BUILD YOUR WEALTH UPON YOUR CAREER

Most part-time investors who try to beat the markets lose part or all of the savings they've worked so hard to accumulate.

Can you make big profits by relying on an expert who does have the proper qualifications? How do you identify a true expert? That task is no easier than picking the right investments. If you don't understand investing as well as the pros, you won't know how to evaluate those who seek to advise you. And you can't rely on an advisor's track record, even when it's presented honestly. Track records tell you only how advisors did in the past - not how they will do next year.

You're violating Rule #1 if you think your investments can be the sole source of your retirement wealth - or if you steal time from your work to manage your investments - or if you think about abandoning your job to become a full-time investor.


RULE #2 DON'T ASSUME YOU CAN REPLACE YOUR WEALTH

You earned your wealth because your talent and effort harmonized with the circumstances in which you found yourself. But the world won't stand still for you or repeat itself when you need it to.

So assume that what you have now is irreplaceable, that you could never earn it again - even if you suspect you could.

Say “No!” to any proposition that asks you to risk losing it.


RULE #3 RECOGNIZE THE DIFFERENCE BETWEEN INVESTING AND SPECULATING

When you invest, you accept whatever return the markets are paying investors in general. When you speculate, you attempt to beat that return.

You're speculating when:

* You select individual stocks, mutual funds, or stock market sectors you believe will do better than the market as a whole.

* You move your capital in and out of markets according to how well you think they'll perform in the near future.

* You base your investments on current prospects for the nation's economy.

* You use fundamental analysis, technical analysis, cyclical analysis, or any other form of analysis or system to tell you when to buy and sell.


RULE #4 BEWARE OF FORTUNE-TELLERS

As with the rest of your life, safety doesn't come from trying to peer into the future to eliminate uncertainty. Safety comes from devising realistic ways to deal with uncertainty.

We live in an uncertain world - and that no one can eliminate the uncertainty for you.

Look for ways to assure that the uncertain future won't hurt you - no matter what it turns out to be.


RULE #5 DON'T EXPECT ANYONE TO MAKE YOU RICH

The Helper (accountant, etc) is worth listening to. He or she can acquaint you with investment alternatives you weren't aware of, and that might be a good fit for you. He can teach you the mechanics and procedures for getting things done in the investment world. He can raise the questions you need to answer in order to devise a portfolio that suits your needs. He can help you reduce the tax bill on your investment profits.

You don't act on the advice of someone you never heard of. And you hear of him only after - and because - he has made several profitable recommendations in a row.

The investment expert with the perfect record up to now will lose his touch as soon as you start acting on his advice.


RULE #6 DON'T EXPECT A TRADING SYSTEM TO MAKE YOU RICH

Trading systems generally arise from one of two sources.

The first source is a commonsense observation about human behavior - which someone then tries to transform into a quantifiable, mechanical system.

For example, Contrary Opinion is a theory that says, among other things, that an investment is likely to be near its peak when everyone seems to know how good its prospects are.

The idea makes some sense. If everyone already knows something is a good investment, most people who are likely to buy it probably already have done so - leaving very few investors to buy it and push its price still higher. In such a case, you should be skeptical about its prospects as a speculation. But that doesn't mean we know precisely when or at what price the investment will peak. You know only that there doesn't seem to be room for the price to go much higher.

But people who devise trading systems aren't satisfied with anything so indefinite. They devise indicators to measure the precise degree of bullishness and bearishness surrounding a specific investment - and then construct formulas that provide specific signals for buying and selling. This is similar to taking an obvious truth - such as that attendance at sporting events is generally smaller on rainy days than on sunny days - and constructing a formula that supposedly translates the number of inches of rainfall into an exact forecast of the attendance.

Trading systems are based on the unstated assumption that the world doesn't change. But the world is in constant change - as desires change, demand changes, and supplies change.


RULE #7 INVEST ONLY ON A CASH BASIS

When someone goes completely broke, it's almost always because he was operating with borrowed money.


RULE #8 MAKE YOUR OWN DECISIONS

Many individuals have lost their fortunes because they gave someone (usually a financial advisor or attorney) the authority to make their decisions and handle their money.

Even when there is no wrongdoing, no advisor can be expected to treat your wealth with the same respect you give to it. You don't need a money manager. Investing is complicated and difficult only if you're trying to speculate and beat the market.

Above all, never give anyone signature authority over money that's precious to you.


RULE #9 DO ONLY WHAT YOU UNDERSTAND


RULE #10 SPREAD THE RISK

No one investment is good for all times.

You can't rely on any institution to protect your wealth for you. Old-line banks have failed, pension funds have come under a cloud of suspicion, and scandals - both real and imagined - are common on Wall Street. The company you depend on to keep your wealth may no longer be there when you're ready to withdraw your life savings.

Diversify across investments and institutions - and keep things simple enough to manage yourself - you can relax, knowing that no one event can do you in.


RULE #11 BUILD A BULLETPROOF PORTFOLIO FOR PROTECTION

The portfolio should assure that your wealth will survive any event - including events that would be devastating to any one investment.

Three absolute requirements for such a portfolio are:

1. Safety:

It should protect you against every possible economic future. You should profit during times of normal prosperity, but you also should be safe (and perhaps even profit) during bad times - inflation, recession, or even depression.

2. Stability:

Whatever economic climate arrives, the portfolio's performance should be so steady that you won't wonder whether the portfolio needs to be changed. Even in the worst possible circumstances, the portfolio's value should drop no more than slightly - so that you won't panic and abandon it. This stability also permits you to turn your attention away from your investments, confident that your portfolio will protect you in any circumstance.

3. Simplicity:

The portfolio should be so easy to maintain, and require so little of your time, that you'll never be tempted to look for something that seems simpler, but is less safe.

You leave it alone - to hold the same investments, in the same proportions, permanently. You don't change the proportions as you, your friends, or investment gurus change their minds about the future.

Your portfolio needs to respond well only to those broad movements. And they fit into four general categories:

1. Prosperity:

A period during which living standards are rising, the economy is growing, business is thriving, interest rates usually are falling, and unemployment is declining.

2. Inflation:

A period when consumer prices generally are rising. They might be rising moderately (an inflation rate of 6% or so), rapidly (10% to 20% or so, as in the late 1970s), or at a runaway rate (25% or more).

3. Tight money or recession:

A period during which the growth of the supply of money in circulation slows down. This leaves people with less cash than they expected to have, and usually leads to a recession - a period of poor economic conditions.

4. Deflation:

The opposite of inflation. Consumer prices decline and the purchasing power value of money grows. In the past, deflation has sometimes triggered a depression - a prolonged period of very bad economic conditions, as in the 1930s.

Investment prices can be affected by what happens outside the financial system - wars, changes in government policies, new tax rules, civil turmoil, and other matters. But these events have a lasting effect on investments only if they push the economy from one to another of the four environments I've just described. The four economic categories are all-inclusive. At any time, one of them will predominate. So if you're protected in these four situations, you're protected in all situations.

Thus four investments provide coverage for all four economic environments:

STOCKS take advantage of prosperity. They tend to do poorly during periods of inflation, deflation, and tight money, but over time those periods don't undo the gains that stocks achieve during periods of prosperity.

BONDS also take advantage of prosperity. In addition, they profit when interest rates collapse during a deflation. You should expect bonds to do poorly during times of inflation and tight money.

GOLD not only does well during times of intense inflation, it does very well. In the 1970s, gold rose twenty times over as the inflation rate soared to its peak of 15% in 1980. Gold generally does poorly during times of prosperity, tight money, and deflation.

CASH is most profitable during a period of tight money. Not only is it a liquid asset that can give you purchasing power when your income and investments might be ailing, but the rise in interest rates increases the return on your dollars. Cash also becomes more valuable during a deflation as prices fall. Cash is essentially neutral during a time of prosperity, and it is a loser during times of inflation.

Any attempt to be clever in assigning portions to the investments probably will do more harm than good. I prefer the simplicity of allocating 25% to each of the four investments.

The only maintenance required is to check the portfolio's makeup once a year.

If any of the four investments has become worth less than 15%, or more than 35%, of the portfolio's overall value, you need to restore the original percentages.

When you make your once-a-year check of the portfolio's value, if all four investments are within the 15-35% range, no rebalancing is necessary. During the year, if you happen to notice that there's been a big change in investment prices, you may want to check the values of the investments. Again, if any investment has strayed outside the 15-35% range, go ahead and rebalance the entire portfolio.

The test of a Permanent Portfolio is whether it provides peace of mind. A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity. No actual or threatened event should trouble you, because you'll know that your portfolio is protected against it.

If someone warns about the “alarming parallels” between the current decade and the 1920s, you shouldn't wonder whether you need to sell all your stocks. You'll know that your Permanent Portfolio will take care of you - even if next year turns out to be 1929 revisited. The deflation that could devastate stocks would push interest rates downward and bring big profits for your bonds.

When someone claims the inflation rate is headed back to 15%, you shouldn't wonder whether to dump all your bonds. You'll know that the gain in your Permanent Portfolio's gold would far outweigh any losses on the bonds.

When someone announces that a new debt crisis is on the way, or that a bull market is about to begin in stocks, bonds, or gold, you won't feel pressured to decide whether he's right. You'll know that the Permanent Portfolio will respond favorably to any eventuality.

I can't list every potential event. So if you become concerned by any possibility, reread this chapter and you should be reassured that there's an investment in your Permanent Portfolio that will cover you if the worst should occur. Whatever the potential crisis or opportunity, your Permanent Portfolio should already be taking care of you.

The portfolio can't guarantee a profit every year; no portfolio can. It won't outperform the hotshot advisor in his best year. And it won't outperform the best investment of the year. But it can give you the confidence that no crisis will destroy you, the assurance that your savings are secure and growing in all circumstances, and the knowledge that you're no longer vulnerable to the mistakes in judgment that you or the best advisor could so easily make.


RULE #12 SPECULATE ONLY WITH MONEY YOU CAN AFFORD TO LOSE


RULE #13 KEEP SOME ASSETS OUTSIDE YOUR OWN COUNTRY

For complete safety, don't allow everything you own to be within the reach of your government. If you keep some assets in a different country, you'll be less vulnerable, and you'll feel less vulnerable. You won't have to worry so much about what your government might do next.

Keeping some investments abroad provides safe and easy protection against surprises that might happen anywhere - confiscation of gold holdings by the government, exchange controls, civil disorder, even war.

No one knows how the people elected in the coming years might choose to solve the economic problems the country will face. It might strike them that the quick and easy solution is to take your property - as has happened so often already. Your assets will be safe even if war, civil disorder, a weakening of law enforcement, or a physical catastrophe should disrupt record-keeping in your own country.

Your entire estate will no longer be vulnerable to economic, political, or legal setbacks in your own country.

Geographic diversification is a necessary part of making sure the Permanent Portfolio can handle whatever hazard materializes.


RULE #14 TAKE ADVANTAGE OF TAX-REDUCTION PLANS

Tax deferral: the basic method for reducing the tax burden on your investment program. With tax deferral, the money you don't pay in taxes today can work to produce more earnings every year until you finally have to pay the tax.


RULE #15 ASK THE RIGHT QUESTIONS

In what economic circumstances is the investment's price likely to go down?
Are other investments in your portfolio likely to take up the slack by gaining in those same circumstances?
Under what circumstances could I lose a substantial share - 20% or more - of my investment?
Under what circumstances could my entire investment be lost?
Would I have any residual liability - that is, can I lose even more than the cash I invested?

Interest rates generally reflect an investment's risk. A higher interest rate means there's a greater possibility the capital can be lost - through default or inflation.

Under what circumstances, if any, is the investment likely to appreciate?
Under what circumstances, if any, is the investment likely to depreciate?
In good circumstances for the investment, will the overall return - yield plus capital appreciation - help your portfolio overcome losses in other investments?

If the investment is a mutual fund, you want the fund with the lowest yield - other things being equal. Any dividend paid by a mutual fund simply reduces the price of your shares

"Is this company a potential takeover candidate?”

The crowd isn't always wrong, but you can't make much betting with it - because you will buy at a price that's already high. By going against the crowd, you buy when an investment is out of favor and cheap; if it does succeed, there's a long way for it to go up. So the most important factor in speculating is whether you expect something that most people don't expect. For example, the time to consider buying inflation hedges speculatively is when most people believe inflation is under control. The time to consider buying a particular company is when everyone knows what a dog it is - not when everyone talks about its great promise. Unpopularity doesn't guarantee profits, but you'll never make a killing with a popular investment.

“Do the technical factors favor the investment now?"

You must have an investment plan. Without a plan, you will be tossed and turned by all the conflicting ideas you read and hear- - and you'll never ask the right questions. With a plan, you'll have a basis for evaluating whatever you hear. You'll know to ask the questions that help you determine whether an investment furthers your plan.


RULE #16 ENJOY YOURSELF WITH A BUDGET FOR PLEASURE

Budget a sum of money that you can spend each year without concern for the consequences. If you stay within that amount, you can feel free to blow the money on cars, trips, anything you want - without worry, because you'll know you aren't blowing your future.


RULE #17 WHENEVER YOU'RE IN DOUBT, ERR ON THE SIDE OF SAFETY

If you wind up losing something, let it be only an opportunity that was lost - not precious capital. People rarely go broke playing it safe. But many go broke taking great risks or making investments they know too little about.

If you're hesitating, it's because you don't yet know enough about the investment or the problem to make a confident decision. That means you shouldn't take the plunge until you know more and you're sure you understand all the ramifications.

The premise for speculation is that you're more astute than most other investors - that you understand the market better, that you have information not available to other investors, that you can make better decisions, or that your interpretation of available information is especially perceptive. The elements of speculation are timing, forecasting, trading systems, and selection. Any time you use any of these tactics you're speculating.

Investment forecasts can be exciting. But in other areas of our lives, we think of fortune-tellers as entertainers.

Forecasts are not entirely useless. Someone's predictions can help you recognize that your own expectations for the future aren't the only possible outcome. This can help keep you humble and prudent.

If you come to feel a given event is quite possible but most people disagree with you, the market probably will provide a big payoff if you bet on that event and prove to be right. So if you like to watch the investment markets closely and you see a potential future that most people are ignoring, you may want to make a small speculation with money you can afford to lose.

A sure way to lose what you've accumulated is to risk the funds that are precious to you on the idea that some event is inevitable.

In 1970, the chief gold trader at the largest Swiss bank told a friend of mine that the gold price would never go above $40. When asked how he could be so sure, the trader replied, “Because we control the market."

“Insiders” are no more help than fortunetellers or high-priced pros.

You can protect yourself against the possibility of institutional crisis by using more than one institution. You can protect yourself against the failings of individuals by relying only on yourself. And you can protect yourself against investment roller coasters by diversifying across investment markets.

Split the 25% stock-market portion among three mutual funds.

For the bond portion, you don't want to have to monitor credit risk, so buy only U.S. Treasury bonds. So long as the U.S. government has the ability to tax people or print money to pay its bills, there is virtually no credit risk.

Put the 25% in the Treasury bond issue that currently has the longest time until it matures. That will be close to 30 years. Ten years later, the bond will have only 20 years to maturity; at that time replace it with a new 30-year bond.

Buy bullion coins - coins whose only value is the gold bullion they contain. They sell for about 3-5% more per ounce than gold bullion. That means a one-ounce coin will sell for about $310-$315 if the price of gold is $300 an ounce.

The cash portion should be kept in a money market fund investing only in short-term U.S. Treasury securities, so that you don't have to evaluate credit risk. These securities are safer than bank accounts and other debt instruments. If your cash budget is large enough, divide your holdings between two or three funds - for further protection against the unthinkable.

The value of real estate in your portfolio is indivisible, and everything else must accommodate it. Just like a 15-foot piano in the living room, you have to arrange the rest of the furniture around it.

Your house is a consumption item - the place where you live and enjoy your life.

Don't play games with your Permanent Portfolio. Don't wait for any investment to become cheaper before you buy it. And don't go overboard investing in something that happens to be doing well now. Just put 25% in each of the four categories.

No matter how strong your expectations about the near future, you could easily be mistaken. And the point of the Permanent Portfolio is to ignore your own expectations and let the portfolio take care of you no matter what may come.

Fund it with equal portions of all four investments and don't worry over which is going to do best. It is a package of investments that provides the safety you need. Tear apart the package and you tear apart the safety.

A foreign account in any country outside your own is a tremendous improvement over having everything in your home country. But some countries are more hospitable than others. And some have legal traditions that protect your privacy. I've always been partial to Switzerland and Austria, because each has a centuries-old tradition of respecting privacy and fending off inquiries from other governments.

If you buy and hold gold through the foreign bank, the gold most likely will be stored within the bank itself.

The secret - that things rarely work out as expected - is shared unwittingly by investors, brokers, advisors, newsletter writers, and financial journalists, few of whom can bring themselves to acknowledge it. Each wants to appear to be in command of the situation, on top of the markets, aware of what's happening and what's going to happen - and to appear as though everything that has already happened was anticipated. A professional needs to keep up this guise because he must look sharper than his competitors. Even investors often pose as members of the all-knowing - perhaps because no one wants to appear to be the only loser, and everyone else seems to be so smart.

When you give up the search for certainty, an enormous burden is lifted from your shoulders.

The less you know - and the more honestly you recognize the limits of your knowledge - the more likely your investment program will turn out okay. Humility is accepting that you don't know everything, or even everything about any particular topic, and it is an investor's most vital asset. Arrogance eventually ruins any investor.