Why Diversification is a One-Way Ticket to Poverty

I got another client for my investment advisory services today; an old friend of mine meet me for breakfast. We always had good conversations, and this was no exception. I thought my readers here would benefit from a condensed version of what we discussed. As we were meeting to discuss investment strategies, the specific focus of our conversation was how to position yourself to survive a crash in the dollar- a topic which I know something about.

My friend brought up the topic of the Weimar Republic. He is quite a history buff and I know that he recently completed reading a book on the rise of the Nazis. Today he was wondering how stocks did during that period. The answer was that the broad stock market took quite a hit during that period, but, as a wealth preserving measure, the stock market certainly did far better than say bonds or cash did (although the calculation are a little complicated because of the currency switching). But if we were to place ourselves in that situation, would we place ourselves into the equivalent of a broad based stock mutual fund.

The answer was an obvious no. Not only would we need to survive hyperinflation and the collapse of the Weimar Republic, but also the ensuring World War that saw the devastation of the country. Who would want to own the German stock market over that time? But, if you owned shared in a company that did survive, such as BMW, you would have an investment that would have preserved at least a portion of the wealth you had put into it. If your investment horizon was even longer, BMW would, I’m sure, show quite a return on your investment- even if you had invested on the eve of the hyper-inflationary affair.

Of course, we are acting here with the gift of hindsight. We have knowledge now that BMW is a good car company in 2009, so if we are picking German companies to have owned in 1920, BMW seems a good one. That brings us to the topic that is on everyone’s mind today: where should I put my money in order to best preserve and perhaps grow it in the future. Many people will tell you that the answer to that question is unknowable without the future knowledge that we possessed in our hypothetical Weimar example. They’re wrong. The future really isn’t as hard to predict if you know where to look.

It should have been fairly obvious to anyone who lived in the Weimar Republic that their currency was in trouble. They had lost a war and been saddled with a war debt that they could not possibly pay. Sure, they may have maintained the debt for a time, but how could anyone have thought that such a debt would eventually get paid off? As it turned out, it didn’t survive the first serious post-war economic downturn.

We are not in such a different situation today. It should be obvious to most anyone that the United States is never going to pay off its debt. It would be far too onerous. Instead, there will come a time when the debt will be rendered worthless either because of default of hyperinflation of the currency. We know that day will come eventually, so it’s not as if our own future is so hard to foretell. Given that knowledge of future events, how should we preserve our wealth?

Gold is the obvious choice. Not only does it become more desirable in times of crisis, it can help you bribe officials when you flee the country… if it comes to that. Try doing that with a mutual fund. But if we wanted to step away from the goldbug position for a bit and recommend broker sold securities so we can be respectable at dinner parties, which ones present themselves as tempting targets?

I talked about two different investment options that I found attractive: foreign Real Estate Investment Trusts (aka REITs) and, my personal favorite, Barrick Gold. Each presents an attractive option; foreign REITs are yielding in the neighborhood of 15% in foreign currencies and Barrick gives you exposure to gold while being a dividend paying stock. Ultimately, it seems he seems to be favoring Barrick. That took me by surprise a bit given that he works closely with real estate projects. I though the foreign REITs would have been a natural choice, but it seems he’s taking the political upheaval possibilities pretty seriously. 

We also reviewed his tax situation. I told him about a maneuver he could use to make his kids private school tuition tax deductible. It’s perfectly legal and it should save him a fair amount of money. I took real pride in knowing the difference I can make in people’s lives. When the whole world’s going down the tubes, the smallest victories have meanings. I vaguely remember the closing lines of the movie City of Joy with Patrick Swayze. The movie was brutal in its depiction of life in India, and, at the end, Om Puri says something like “The odds are stacked against being human.”

Swayze’s character replied, “That’s why it feels so good to beat the odds.”

2 thoughts on “Why Diversification is a One-Way Ticket to Poverty”

  1. The issue I have with your recommendation of BMW (during the hyperinflationary period of the Weimar Republic) is that it is made with a narrow focus: how do I passively earn the most money from my existing hoard? I guess BMW’s a fine choice for that. If you have a problem with their use of forced labor during World War II and their involvement with the Nazi regime (probably a huge factor in why they surived in the first place), then it’s not such a clear choice anymore.

    Don’t let the game of playing the stock market cloud your ethics. Mastery is fun and you have a zeal for figuring out how to win the game, but don’t lose sight of everything that isn’t connected to raw profit. I predict the companies that are going to do the best during the coming crisis are likely to be corrupt somehow — receiving government favors, dodging taxes using offshore havens, or abusing their workers. Would you really like to subsidize such behavior with your money?

  2. Well hoarding gold doesn’t involve oppression, unless you are worried about the environmental impacts of mining operations. In terms of surviving a fascism by investing in the stock market, you are correct in saying that the companies that are most likely to survive are going to be the ones that work with the dictators and, therefore, unethical.

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