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What to Expect from the S&P 500

February 13th, 2018 at 11:39 am


Many people are counting on an 8% compound interest to get them to retirement. Dave Ramsey’s book “Total Money Makeover” even claims a 12% return! Where on earth did these numbers come from? Are they at all a reasonable expectation?

What is the Long-Term Return on the S&P 500?
To start, I plotted the S&P daily opening values since 1871 (when they started tracking) and added a trendline. I choose to use a trendline to back out all of my expected returns so that all of the data within the range count towards the return. Because the odds of buying at the beginning and selling right at the end are astronomical, I think this trendline method gives a better idea of what people actually experience.



Looking at the equation of that trendline, I could conclude that the S&P 500’s annual return is 4.49%. That is a lot less than 8%.
As you can see though, we need to look a lot closer at the data to see if it actually matches in the trendline. With this zoomed out view, it is impossible to tell if the first 100 years are skewing the trendline down away from the 8% people expect. Because we are seeking the exponential return, a logarithmic graph should show us the data more clearly.



There! Now you can actually see the data. As suspected, the old data is very different from the new data. We are going to have to consider this data in pieces based on historical changes.

I’m going to walk you through several historical periods to get you adjusted to what is historically normal. If you want to just skip to the current period, be my guest and scroll down to 1995.

1871-1914: Industrializing World before the World Wars



During this exciting 38 year period where we experienced serious industrial expansion, urbanization, and erected the brand new Statue of Liberty, the annual S&P 500 return was only about 1.9% growth. Yup, definitely skewing the data down.

1914-1945: World Wars and The Great Depression



During this 31 year period the overall return was only about 1.32%: -1.1% during WW1, 2.14% between the two wars, and 4.83% during WW2. I find the cycle between the wars particularly important to look at as we are currently going through massive build ups followed by devastating crashes. The difference here is that we were still on a global gold standard so the recovery didn’t involve a boost from printed money (inflation).

1945-1971: Tense Global Cooperation



This 26 year period the US experienced several civil rights movements and the major world powers fought the cold war and indirect wars though Korea and Vietnam. This is our first period to yield high S&P 500 returns at 8.9%! Yay!

1971-1995: Goodbye Gold Standard



In my opinion, this is the most important dividing line in our financial history, the flight to fiat currency. In 1971 we got the "Nixon Shock" and the US Dollar decoupled from gold. Since 1971, the very essence of what money is has changed. All major currencies have abandoned any physical backing and floating exchange rates emerged. I don’t know that we can really count any data prior to 1971 towards identifying trends. (see fiat currency).
During this again profitable period of 24 years, the S&P 500 grew by 8.5%, but it lost some ground in the monetary policy switch and shifted to the right before resuming the growth.

1995-Present: Federal Reserve Induced Oscillation



In the piloting world, there is something called PIO, pilot induced oscillation. This is caused by a pilot pulling up, but the airplane delaying its response. The pilot’s instinct is to pull up harder, but when the plane finally starts responding, it is too hard of a pull, sending the plane towards a stall. To correct the error, he or she will quickly nose over and try to dive. Again, the delayed response of the plane intensifies the action as it convinces the pilot to keep pushing down. If the pilot doesn’t fight the instinct to recover, the rollercoster motions will increase in intensity until it suddenly stops and the plane lay in pieces on the ground.

I fear we are experiencing the same phenomenon in the financial world:

Since entering this increasing rollercoaster of crashes and bailouts and bubbles, we’ve dropped back down to, a 4.4% annual return on the S&P 500. That’s just under the all-time historic average of 4.5%, but this time we aren’t gold backed.

That 4.4% might actually be a little high. The graphed data includes 2.5 full cycles: three ups, but only two downs. The next bear market will push the trendline down.

Now I understand that I'm looking at much less data now making the numbers somewhat cherry picked. It is over 20 years though. 20 years is definitely significant in a 40 year career path. I don't really care if I can count on a 100 year return of 8%. I don't plan on working 100 years!

I can't use more data because things probably won't work out the way they did over 20 years ago. Can we really pull numbers to predict the future from before Bill Clinton and Greenspan (former Chairman of the Federal Reserve) started playing with money? I'm worried we can only really expect the 4-5% overall return until money game shifts again. When it does shift, who is to say it will be back to the 8% we got for only 50 years out of 147 or the 8% we got for only 24 of the 47 non-gold backed years?



Unfortunately, one of my hypothesis is that it will actually be a lot worse. If you recall the PIO example, it doesn’t just oscillate forever, expect a catastrophic collapse:

Dotcom boom and bust
With the excitement of the internet, new companies popped up all over and investors poured money into anything ending in “.com”. No one cared how much a company earned, only how many views they received. The Dotcom bubble had formed and the S&P 500 spent 5 years shooting up at a rate of 24.8% annualized.

Eventually, it became clear that many of these companies had failed business models and were going bust and there was a major sell off. The S&P 500 plummeted for two and a half years at a rate of -18.0%. The Federal Reserve slashed interest rates and encouraged investing.

Housing Crash
With the slashed interest rates and incentives, it became very easy to buy a home. With the extra buying of houses, the sticker prices of the houses increased. At first, the increased price simply offset the decreased interest rate, but then people started noticing trends and got greedy. With the house prices shooting up, people started buying houses and using them as banks. Some would buy as big of a house as they could with special interest only loans. The assumption was that they would sell it in a few years for much more than they were in debt for and turn a huge profit. Others took out home equity lines of credit on the appreciation they received on the home they already owned. With this buying frenzy, prices continued to shoot up, and paper wealth abounded. The S&P 500 again shot up for 5 years, this time at an annualized rate of 11.0%. People had thought they found the secret to unlimited wealth. That is, until some people started realizing they couldn’t actually afford the payments that the bank was so willing to sign them on.

Banks began to receive house keys as people walked away from their mortgages. As the buying frenzy reversed, house prices plummeted, destroying the crazy dream of living off home appreciation and putting many families “under water” owing more than their home was worth. The S&P 500 dropped at an annualized rate of a whopping -38.5% for one and a half years. Again the Federal Reserve slashed interest rates, but this time to unprecedented levels. In the dotcom aftermath the interest rates were slashed from around 5% to 1-2%, but this time they went all the way down to 0.1% for years. In addition, the Federal Reserve bought up securities, increasing the money supply.

Dollar Crash?
Again the Federal Reserve is fueling a crash by creating a “bailout bubble”. Each one getting larger than the one before. The interest rates stayed at experimentally low levels low for a full decade. For some reason, people are again thinking this can go on forever and the S&P 500 has grown at a rate of 12.1% for almost 9 years. Investors have become complacent knowing that the Fed refuses to let the market slide and will bail them out in the case of disaster. That’s what it did all through Obama’s administration, but who knows where the new Federal Reserve Chairman and Trump have their priorities: normalizing or market stability?

I worry the next crash will actually break confidence in the US Dollar. I don’t see any way the Federal Reserve can avert the oncoming crisis. I see two options:

1. They could continue to raise rates and shrink their balance sheet (sell the securities acquired after 2008). This would send the stock market into a crash and increase the price of servicing the debt to levels we can’t pay, causing countries to drop the dollar. The dollars would all find their way back home and become worthless.

2.They could reverse rhetoric and start easing to save their struggling economy, but sacrifice the dollar in inflation, also triggering countries to not want the dollar or dollar securities.

Luckily, I am not the one choosing the options. My hope is that there is a third option that those in power will come up with once they notice the cliff they are running towards.

It is hard to know what this will do to the S&P 500. The hundreds of years of data is somewhat useless since we have never had a market like the one we have today. My personal guess is it will crash, then grow but mostly due to inflation.



It all comes out in the inflation wash
If you read my explanation of what inflation really is, you understand that we are really hovering around a 5% inflation! In other words, unless the stock market starts beating its 4% growth, your gains are just adjusting your money to inflation (or pent up inflation). If you have a mixed portfolio with bonds, you're losing to inflation. By all means, that is much better than losing the full 5% to inflation, but it does make retiring a challenge.
I re-ran my retirement numbers with the following grim assumptions:
1. Any money I gain in the stock market will be negated by inflation
2. Any pay increases you gain will be negated by a higher cost of living and taxes

In effect, it is as if we just kept replaying today over and over until retirement.

The good news is with these assumptions, we expect to be millionaires in today's money before I'm 50! The bad news is my husband will have to work till he's 69 before we can retire. Luckily, I should eventually be able to help him out, so I doubt it will really be that long. The numbers are still sobering though. Even maxing out our 401K ($18,000/year) isn't necessarily going to cut it.

If you want to run your own numbers with these depressingly conservative assumptions to see what could be ahead, here's a simple and free spreadsheet.

Bottom line:
If anyone is telling you long term rates (especially Dave Ramsey's crazy 12% expectation), ask how they derived those numbers. The data can be cropped, skewed, and made to tell anything you want. When it comes to something as important as retirement planning, you've got to do your own thinking and figure out what makes sense to you (and don't forget inflation!).
Good luck!
-Milly




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.

Bitcoin vs. Gold

February 7th, 2018 at 01:43 pm



The 2017 Bitcoin Frenzy has led to quite a debate on which is better, Gold or Bitcoin? Some are even calling Bitcoin Digital Gold. I see two ways of addressing this question: Which makes the better money and which makes the better investment. Let's start with the first question:

Which is the Better Money? Bitcoin or Gold?

Scarce
For a currency to work, the quantity must both be fairly low and fairly stable.  If the currency is too abundant, then huge quantities would have to be used for everyday purchases.  If the quantity fluctuates too much, it becomes difficult and speculative to price goods or form contracts.

What makes Bitcoins usable is its elegant, indestructible self-regulation.  Bitcoins cannot be created at the whim of a computer developer.  Actually, no one even knows who created it.  It isn't regulated by a single party, but by the entire system itself (decentralized) and the computer code is open source for all to inspect.  You can't hack your way to Bitcoin creation because the way to create Bitcoins is essentially using your computer to figure out numbers that fits an increasingly difficult sequence.  That number is part of the coin.  If you and your computer can figure out a usable number, then you have legitimately mined the coin.  You can't modify the structure, because it is continuously validating itself and checking for problems.  Because the release of bitcoins is asymptotic, there will never be more than 21 million coins released.  The supply is scheduled (by an adaptive level of mining difficulty) and limited.

Although Bitcoin itself is scarce, there is an infinite number of other cryptocurrencies that can be created and popularized.  Over a thousand types have been created already!  Litecoin, Bitdeal, Beatcoin, BipCoin, Bit20,  BitBTC, Bitcloud, Bitcoin 21, Bitcoin Cash, Bitcoin Planet, Bitcoin Plus, Bitcoin Unlimited, BitcoinDark, BitcoinFast, BitcoinTX, Bitcore, Bitcurrency, Bitdeal, bitEUR, Bitgem, bitGold, Bitland, Bitmark, BitSend, BitShares, bitSilver, BitTokens, bitUSD, BTCGold, BritCoin, Bytecent, and Bytecoin are all trading on the market.  Some are bringing in millions or even billions of dollars.  For this comparison, we will only consider Bitcoin itself and make the VERY poor assumption that if Bitcoin were to be used as a currency, it would be the only cryptocurrency to do so.

One of my friends humorously stated that gold is so rare that you can buy it at any pawnshop in any city.  It is true that there's a lot of gold out there, roughly 165,000 metric tons of it (what that looks like).  It is still scarce though because the available gold supply grows more slowly than the demand for it.  Unlike Bitcoin, there is no substitute for gold.  No other material in existence has the same useful material properties (nearly impossible to corrode, extremely malleable and ductile, efficient at transmitting heat and electricity, and very pretty).

If there is a sudden breakthrough in lowering mining costs, especially if it allows us to mine deeper or in the ocean cheaply, then we could see a supply jump.  That would lower gold's credibility as currency, but I think the yellow metal will always be aggressively sought after.

Winner: a protected Bitcoin

Fungible
I know, it's a funny word.  Fungible means non-unique.  If someone pays me a dollar, I am not worried that they gave me a 2016 dollar instead of a 2014 or a serial number ending in a lucky 7.  For something to work as currency, each piece must have a standardized value and not require a collector's evaluation.



Bitcoins are identical.  Sure the strings of numbers vary to identify the coin, but the users don't know what those strings are.  They are hidden within the code.  All the user sees is a quantity on the screen.  It could be any Bitcoin, or more likely, fractions of many Bitcoins.  By lacking a physical form, I don't think you can get any more fungible without also being easily counterfeited.

Gold is a little more collectible.  People are more willing to pay top dollar for rare or flawless coins, nuggets, and intricate jewelry.  When that happens though, it isn't being used as money.  Those coins and trinkets are effectively outside of the money supply and are a product of themselves.  When gold is melted down, refined, and made into uniform pieces, fungibility is not a problem.  Right now though, gold tends to be special and people care what form it is in.

Winner: Bitcoin

Divisible
It us useful to have a currency with enough precision to represent the finest subtleties of worth.  This allows for transactions of tiny amounts, or slight differences in value.  Imagine if there were no subdivision to the US dollar.  Buying produce by the pound would be a game of "The Price is Right" as you try and get the most tomatoes without tipping it to the next dollar.  Sales taxes would be difficult for stores to directly pass on to the buyer.  Stock market values would be more stair stepped.  It is also important that the sum of the divisions equal the whole.  Four $0.25 pieces cannot be worth more or less than $1.

Bitcoins can be subdivided in to a hundredth of a millionth of a Bitcoin, also known as a satoshi (0.00000001 BTC).  In other words, Bitcoins would have to reach a value of $1,000,000 USD per coin before it is less precise than pennies (1 satoshi = $0.01 USD).  My understanding is that it is also possible to open up more decimal places if needed.



Gold is also highly divisible.  It has been pounded to 0.000002 inches thick for coating astronaut visors.  That is so thin that it is actually translucent!  A single ounce of it can be stretched 50 miles (5 microns thick).  It can be divided into such small particles that you would get more gold scooping up a random cup of dirt.  At some point the divisions of gold will get too small to handle properly or see clearly and counterfeiting would abound.  Imagine trying to buy something small like a candy bar.  It would be hard to weigh out tiny flecks of gold.  It could become standard to use volumes of a standard gold solution or use "gold bills" with tiny flecks laminated inside.  At that point counterfeiting becomes much easier though.  Copper or other metals could be used for smaller quantities, but then your small coin to large coin rates would fluctuate with the relative metal prices.

Winner: Bitcoin

Durable
There have been societies that operated off food as currency.  It is a great system because what is more inherently valuable than food?  I guess water and air, but usually those are both available without cost in these situations.  One problem is almost all foods are poor long-term stores of value.  To invest your life energies into a currency, you need some assurance that it won't be destroyed or made worthless.

Bitcoins are difficult to destroy, but easy to lose.  Since the beginning of Bitcoin, there have been just over 10 coins destroyed on creation.  It turns out, it is possible to earn a block of coins, but not claim them all.  If you claim fewer than the reward, the remaining coins disappear forever.

It is much more common to lose them.  You could send coins (not very likely to happen by accident) to a bogus receiving address, never to be used again.  Thousands may have already been lost to this method. Another method is to put an OP_RETURN script on them (I don't know what that means either), which paralyzes them from future use.

Probably the biggest problem is if one loses access to an account via computer crash (with no backup or paper record), forgetfulness, or dies without passing it on.  There is no third-party you can call to open the account for you.  Likely the largest holder of Bitcoin is its creator with about a million coins.  There is also speculation that this mysterious person has died with those coins never to be circulated.



Gold, on the other hand, is here to stay.  It cannot be destroyed.  I guess you could chemically dissolve it and disperse it to the point where it is no longer economically practical to mine again, but that's about it.  It is also possible to lose gold, but unlike Bitcoins where there are more combinations than the entire energy of the sun could go through with a perfectly efficient computer, I imagine gold usually eventually gets found.  In any case, you'd never accidentally lose it to shelf-life or damage.

Winner: Gold

Transferable
You must be able to easily exchange the currency to properly use it in commerce.



Bitcoin has a great advantage in that it can be digitally transferred.  I can pay someone from across the globe with Bitcoin.  In person it is just as easy.  All you need is your smartphone with a specialized app.  

Of course Bitcoins are not widely accepted yet.  Sure you can use Bitcoin for Overstock.com, Newegg, Subway, Microsoft, Dish Network, and Virgin Galactic as well as anything from charities, to local shops, but I don't think anyone pays their rent in Bitcoin.  I believe most of the companies that do accept Bitcoin trade for their preferred currency as soon as possible.  They don't actually want the Bitcoin, they just want to tap into the paper assets the Bitcoin owners have.  If the Bitcoin volatility settles off, we could see a change here.  

Another problem Bitcoin is facing is it is expensive to transfer and very slow. Users are repeatedly suprised by extreme and varying transaction fees and sometimes loose access to their coins for days as they are stuck in transactions.

The other restriction to Bitcoin exchange is the requirement of hardware and internet.  If the power goes out or service is disrupted, you are stuck.

Gold, unfortunately, loses ground here.  The advantage to gold is that you could use it in a pinch even without electricity.  It has been used as money for thousands of years, so even if they are not set up to take gold, they might make a deal.  

I don't think physical gold could ever return to the normal currency status though.  Imagine if you had to mail out gold pieces before ordering anything online!  That would be even more expensive and slower than Bitcoin. Even in person it could be a pain.  As mentioned earlier small denominations could prove problematic.  In order to make tiny fractions usable, they will have to be packaged.  That could get bulky or counterfeitable.



There is a solution though!  GoldMoney Mastercard lets you preload your card with a certain amount of gold you buy out of their vault.  You can then use your card just as any other prepaid card.  You simply are selling back your gold at whatever the current market price is and GoldMoney sends the dollars to the seller.  The physical gold is also available for your request at any time if you'd prefer to cash out in gold.  Of course, you are still limited to companies that take Mastercard and you'll have internet and hardware restrictions.

In theory this system is brilliant.  Just be careful because this is a major tax grey zone and the company is unproven.  Similar companies such as e-gold and MtGox have failed and the users lost. I think this company will do fine, but do your homework first.

Winner: Bitcoin

Overall, is Bitcoin or Gold best as a Currency?
Both mediums of exchange do very well on most categories and MUCH better than the US Dollar when it comes to scarcity.  I think the transfer of gold is just too crippled in the digital era and Bitcoin was designed as an attempt at a perfect currency. Bitcoin takes the overall best currency win.

Note: This is still taking into consideration the HUGE assumption that Bitcoin has a monopoly on cryptocurrency and other variations are barred from the market or fail for other reasons.



Unfortunately, just because Bitcoin is a more useful currency than gold doesn't necessarily make it a good idea to buy.

Which is the Better Investment? Bitcoin or Gold?

Inherent Value
Bitcoins don't exist!  They are just a blip on the screen and are as real as Pokeballs.  Just because they don't exist, doesn't mean they aren't valuable.  A Picasso painting is only useful for looking at, yet they can be worth millions.  The same can go for other unique and rare virtual items.  Americans spend billions of dollars every year purchasing pixels.  Some even flip-sell in virtual markets.  When all is said and done though, there is nothing of value in the Bitcoin except its clever novelty.



Gold actually is fairly similar in this aspect.  Most gold isn't productive either.  52% is used in jewelry, 34% is reserved as money (government holdings, individual retirement, etc), and only 12% is used industrially.  The remaining 2% is unaccounted for.  In the extreme case where all "pretty" or "hope to resell" gold was dumped on the market as people need money, the industrial demand should still command a fair price in the growing technological world.  This isn't a very great way to look at it, but I'm not going to devote more time to the study:  12% of $1,330 (Feb 2018 price) is $160 per ounce, so you could probably expect that much as a bare minimum.

Winner: Gold

Market Cap
First off, Bitcoin's price passing gold's price (and even trading in 5 figures) means nothing.  If twice as many Bitcoins were released in each block, then the price per Bitcoin would be roughly half the current amount.  If we wanted to look at gold in pennyweight, Bitcoin would have passed its price in 2013.

What does matter is market cap, or how much money are people willing to collectively dump into that investment vehicle.  Most experts agree that in all of history roughly 165,000 metric tons of gold has been mined.  That is 5.4 billion troy ounces.  With the current market price of gold of about $1,330 USD (Feb 2018), that is a market cap of about $7 trillion US dollars.  As of 5 Feb 2018, there are a total of 16,845,938 Bitcoins mined.  With a Bitcoin price of $8,271 USD, the market cap is about $139 billion USD (over 50 times smaller than gold).



That is actually quite impressive considering cryptocurrency has only been around for a few years.  It is amazing that something so new could capture that much market.  There are three problems with this picture though.

1. The Bitcoin market cap changes pretty dramatically day to day.  Since Jan 2017, the weekly Bitcoin price spread has averaged at 22%, whereas the weekly gold price spread has averaged at 2.3% in the same time period. Bitcoin's record weekly change since 2017 could be as high as 80%, but gold only had one instance over 10% in many years (when President Trump was elected) and quickly resumed it's normal pace. Bitcoin is extremely volitile.

2. Bitcoin isn't the only cryptocurrency out there.  Ethereum, the second largest cryptocurrency as of writing, was only released in July 2015.  At initiation, its market cap was about 3% of the size of Bitcoin's.  A year later it was 10% the size of Bitcoin, 11 months later (June 2017) it peaked at 83% the size of Bitcoin.  If there were no other cryptocurrenies, Bitcoin would have lost almost half of its market to Ethereum.  Of course there are over a thousand other cyrptocurrencies that are also trying to eat Bitcoin's market.  Although Bitcoin has gained some of that market share back (Ethereum's market cap is about 60% the size of Bitcoin's), it is easy to imagine another currency disrupting it's position in the future.

3. Bubbles always grow... until they don't.

(here's my Cryptocurrency Excel Spreadsheet, dated 5Feb2018 ,if you want to play with the data yourself)




I love the idea of cryptocurrency, but I just don't know that Bitcoin is going to be the winner.  Something I learned from Peter Lynch's Beating the Street is a company gaining market share in a depressed industry is generally a great buy.  Bitcoin was losing share in a booming industry.  In other words, we might be paying top prices during the hype for something that won't last.

Another Lynch rule Bitcoin breaks is that if your shoe shiner is telling you to buy a particular stock, it is time to get out of that market.  We are to the point that people who have never bought precious metals, foreign currency, or even an individual stock in their life have heard about the millions some have made in Bitcoin and are advising on the matter. Even as Jannet Yellen gave a testimony to congress in July of 2017, a man held up a "Buy Bitcoin" sign in the background.

Here's a place where you can listen to up to date podcasts about the financial markets, he almost always does a few minutes at the end on Bitcoin: Peter Schiff Show

Winner: not Bitcoin

Politics
Bitcoin's position is precarious when it comes to government.  Bitcoin is legal in most countries, but rules and restrictions vary by country and are still evolving.  In the swish of a pen, Bitcoin could become illegal, deemed a "security" and have massive regulation, or be heavily taxed.  The anonymous nature of the coin would make it difficult to enforce, but companies would not be able to offer Bitcoin as a payment option, restoring it to its original limited peer to peer nature.

Gold could also come under condemnation.  Particularly since WWI, governments have been manipulating gold away from the people.  The good news is that, as a physical commodity that has been around for longer than human law, things change less frequently and there is a long list of precedent cases to draw from.

Winner: Gold

Definition of a Bubble



If people are buying an item solely for the purpose of reselling due to a climbing market, you can bet you're in a bubble.  If you buy whatever is going up in stocks instead of researching the actual company or at least the dividend history, you need to rethink your strategies.  I think most people who buy Bitcoin buy it because they see huge gain numbers that previous holders have seen and get dollar signs in their eyes.  They don't actually want the Bitcoin, they want profits.

In contrast, I think many people who hold gold don't do it because they think gold's value will skyrocket, but because they think the dollar will tank.  They aren't looking to flip-sell.  They are looking to protect.

Winner: Gold



Overall, is Bitcoin or Gold the better Investment?
Although the argument for Bitcoin as a currency is extremely compelling, I don't recommend it as an investment choice.  If you are dead set on Bitcoin, don't just buy it because it is gong up, but because you believe it is the future of money. Or even better, invest in a company that facilitates the transactions and benefits from Bitcoin volatility, whether up or down.



Gold does provide a decent hedge against the dollar and is a sound investment.  Of course, in a future post, I will show you something even more powerful.  Subscribe to my newsletter in the left sidebar so you don't miss it!

Good luck!
-Milly




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast.  Anything I recommend should be personally analyzed and discussed with your financial adviser.

Should I buy Gold or Silver?

February 5th, 2018 at 09:52 am

This is part 2 of Milly's "Precious Metals for Beginners" series. For part 1 see: Why you NEED Precious Metals in your Portfolio.


One of the first things to consider is what type of metal to buy.  I'm only going to consider silver and gold in this analysis for 3 reasons.

1. Other precious metals such as platinum and palladium are foreign to the average person.  Yes, they are valuable.  Yes large dealers know what their worth and you could probably sell them when ready.  You'd have a much harder time selling them to your neighbor though.  They look a lot like silver and most people have no clue what their worth is.

2. Copper and other industrial metals have little value when compared to other things you could put in storage.  At today's prices, a pound of copper is less than $3.  The upside to copper is it is fun.  For less than $2 extra on your gold coin order, you can get an extra replica (made out of copper, larger, and with a different reverse) just to play with.  Or you can get other designs just for fun.

3. I've only studied gold and silver, so anything I say about other metals is unfounded.

Denomination
In some ways asking if you should buy gold or silver is akin to asking if is it better to put your cash savings in $1 bills or $100 bills.  Both operate by the nearly the same means, but have different liquidity and portability.

Silver is a great choice because it is more divisible.  Although gold can be pounded to 0.000002 inches thick and easily broken down to less than a cent's worth in value, the smallest bars major dealers circulate is 1/2 gram and rarely under 1 gram (that's tiny and very thin!).  At today's $1,330ish spot price, 1 gram is worth about $43 USD.  Silver, however, is at about $16.70/toz (at the time of writing) and also can sell in 1 gram bars that's $0.54 a bar!  Smaller denominations make it much easier to actually use for things like groceries.

The problem is, if you try and put some of your life savings into precious metals, that could amount to quite a bit of silver.  You can carry enough gold just on your person to start a new life.  It is also easier to hide since gold is much smaller than it's silver equivalent.  If gold were $1,330/toz and silver were $16.70/toz, the gold would be about 80
times lighter and about 147 times smaller than the same value of silver!

I guess, it comes down to how you imagine needing the metals. Will they be used for day to day life? or bulk wealth preservation? Probably a mixture of both.

Markets
Another consideration is the two have separate markets and their relative prices vary.  Right now, Gold is about 80 times the price of silver.  Since 1995 (just before the dotcom boom), that ratio has averaged around 62.  In other words an ounce of gold will buy more silver today than it has for most of the last couple of decades.  Silver is "on sale" in terms of gold.  Of course, there is always the possibility that this is the new norm.

Another thing to note is that silver might be more volatile than gold.  If you normalize the two metals in 1995 like I did in the graph below, you see that silver jumps to a higher percent gain than gold does in both the dot com and housing crises, then comes back together at the resolution.  If you are trying to play the market, buying low and selling high, silver might be the more useful vehicle.



One final market consideration is found in monetary policy.  Fiat currency is starting to fail on a global scale.  No country is willing to admit this because they are desperately trying to keep confidence in their paper money, but the complex systems of national debt, supposed assets, and inflation have reached unsustainable levels.

In the background, India, Russia, and China are buying up immense amounts of gold.  A while ago I heard some whispers about a backing of the dollar by gold and other assets. A few months ago I heard one about indirectly backing the Chinese yuan with gold.  Both of these seem like very far fetches, but what choice do we really have?  With Donald Trump's nominating 5 of the 7 Federal Reserve Governors recently and in the near future and Trump's history of "stirring the pot", who knows?  Maybe he could actually pull something off.

Regardless, I think it is clear that countries know that gold is their best chance for a favorable end game, but it is a very delicate game. There is a lot more money than gold (at the current prices) and no one wants to loose the confidence of their currency.

If any country does make the jump, it will likely put a huge upward move on the gold price and not have the same amount of force on silver.

Of course, that also means a higher confiscation risk, especially with the historical precedent. I don't think silver will be cost effective for the government to confiscate, at least not at the individual level.

Summary:
Silver is better for day to day bartering.
Gold is more efficient in terms of size/weight.
Silver may be a better deal right now.
Silver may be better for playing the market.
Gold may be better for long term moves.

How you should invest is based on your personal needs and philosophies.

Good luck and enjoy your shiny wealth!
-Milly

This is part 2 of Milly's "Precious Metals for Beginners" series. For part 1 see: Why you NEED Precious Metals in your Portfolio.



Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.

Why you NEED Precious Metals in your Investment Portfolio (especially in 2018)

January 19th, 2018 at 11:40 am



Gold and Silver should be a part of anyone’s savings and investing. My personal goal is to have it represent 10% of my retirement portfolio and up to a quarter of my emergency savings.

I didn’t start out believing in gold. It gets a lot of hype in sensational language, which always makes me skeptical.

My biggest obstacle to adding precious metals to my portfolio was is it is hard for me to imagine going back to using gold and silver as currency. It is just too out of place in today’s modern society and impractical in the digital world. If there were a dollar crisis, my tools would probably be worth more than useless metals and I can use them now.

I knew their are some inherent physical properties to the metals that make them valuable in industrial and medical applications, but I still don’t think it would cost nearly as much if those were the only competitors for the metals. Only 10-12% of the gold out there is used industrially. It is mostly people just liking precious metals and speculating in the metals that keeps the prices so high. I didn’t want to invest in other people’s fancies.

Let me Change your Mind
Now I see gold and silver in a new light. A lot of the people who don’t like precious metals point to the S&P 500 and show that gold isn’t going anywhere, but the stock market is. Well, it may be true that US stocks have matched or out performed gold, but not by nearly as much as we are led to believe.

Gold as an Investment
From 1971 (when the US abandoned the international gold standard) through 2016, gold has actually tied the return of the MSCI US (large and mid cap US market) at a return of 10.6% annualized. That wasn’t all in the huge gold jump that happened at the beginning either. The last 10 years has returned an average of 7.7%, lagging the US stock market by only 0.5% (source with pretty pictures).

I did my own math and graphing with an exponential trenline (to avoid cherry picking dates) and came up with both the S&P 500 and the Perth Mint gold prices returning 7.3% annually.

That is not a lot of missed gains compared to the risk of a major market correction any day. You might pay the 0.5% in fees to your brokerage anyways. If you agree with Lewitinn in Yahoo Finance that 93% of the stock growth since November 2008 is resultant of Federal Reserve moves, then that is a lot of risk. You could see 93% of those gains come crashing down any day, especially if the Federal Reserve isn't able to do the tightening and normalization they planned (rate hikes and unloading the balance sheet).

Precious Metals as Protection
Even with all of those investment benefits, I still see precious metals as the way to preserve wealth, not to invest. I suspect much of the gold rise is actually dollar weakening. No matter what any politicians or leaders do to the US dollar (and you know what they are going to do), precious metals will hold value. Jim Rickards once asked someone how their family preserved their wealth for 800 years. The response was a third in land, a third in art, and a third in gold. These are the things that last.



Another benefit to precious metals is they are individually and physically owned. I believe Jim Rickards’ “Ice-9” prediction (Road to Ruin). There will come a day when the government will be forced to freeze all digital money except for a small amount for gas and groceries, much the same way as they have done in Greece. Even if the money never is seen again, or inflation happens to an extent that it isn’t worth anything when we get it back, precious metals will preserve.

Why 10%?
One question you might be asking: If you believe that much in gold and silver, why only 10%? One answer is I’ve seen a compelling prediction of a $10.000/oz price of gold. That's in today's dollars, so if there is major inflation, the number will be higher. This isn't some fudged Wall Street chart pattern prediction either. This is a mathematical analysis done by a world expert on currency wars and is based on the required non-deflationary price of gold. If we reach $10,000, your 10% would become about 100% and even if you loose everything else, you’re insured.

Why not more than 10%? Right now we are in a very difficult time for investing. According to John Keynes, we are in a depression which is highly deflationary. Companies are laying off workers (who in turn find part-time jobs, "creating" jobs on federal reports), individuals are deep in debt, and savings are at a record low. In times like this, short term opportunities are the way to go.

At the same time, countries around the globe are cheapening their currencies with monetary easing. The US government simply cannot afford the real value of their dollar denominated debt to increase. Eventually, they will have to change course and switch back to monetary easing "money printing". Inflation will win at some point.

In his book, The Big Drop, and in this article, Jim Rickards explains the thoughts and methods behind a "barbell" strategy that is loaded up on the ends as a protection against inflation AND deflation, with cash in the middle ready to pivot positions as needed. So if you put 35% of your investments in hedge funds, private ventures, angel funds, and the like for your deflation hedge, and leave 30% cash (and treasury bills) in the middle, you only have 35% to diversify into a inflation hedge. As stated earlier, those should include precious metals, undeveloped land, and fine art (try 10%, 20%, 5%). If you want to tweak those numbers you are always welcome to.

I know that was a lot of external thoughts and analysis in a beginner's precious metals post. The bottom line is you don't want to put it all into gold.

In any case, Jim Rickards recommends 10% and most precious metal companies recommend 10%. If people who do more research than me and are an even bigger believers in precious metals than me recommend 10% in gold, I should say the same.



What about confiscation?
When looking into gold as an investment, fingers are often pointed to Executive Order 6102 signed by President Roosevelt in 1933, which required gold to be traded in to the Federal Reserve for the official gold price of $20.67 per troy oz. The criminalization of “hording gold” in the US lasted all the way until 1974, after we left the gold standard. Other gold controls have occurred in Australia and much more recently in India. I’m not going to let fear of confiscation prevent me from buying for 5 reasons:

1. There was a good reason for gold confiscation at the time. It is one thing for the government to confiscate items that cause destruction such as illegal weapons and drugs, but the confiscation of gold comes down to one thing: they needed it, so they took it. As terrible as it is to have the “land of the free” to secure themselves a discount on your savings, it was this confiscation that allowed us to keep on the gold standard for about 40 more years. Without this questionable move, we would have had a run on the gold reserves and it is impossible to say what that would have done to the American future we live in today. Was it the right thing to do? I doubt it, but I may be reaping the rewards today. (or maybe it just means it is going to be that more painful when the ungrounded financial system fails)

2. Gold owners were compensated. It is against the constitution for gold to be sized without just compensation. Sure, the government might do something sneaky like dump a bunch of gold supplies into the market to suppress the price just before they close the market so that they can buy at discounted prices. Even if they don't, you’ll still miss out on some massive gold hikes in the event of a gold crisis. Either way, you’ll probably still be better off buying gold today and selling it to the government in a few years than just holding onto dollars. The shakier things get, the more gold will go up.

3. Not all gold was confiscated. There were exceptions for industrial uses and some personal exceptions as well. Rare coins were exempt and individuals were even permitted the equivalent of 5 troy ounces of coins.

4. Owning gold is the patriotic thing to do. If there is going to be a future gold confiscation, wouldn’t it be much better for the United States to get a bunch of gold from it’s citizens than to have that gold sitting in India, China, and Russia? I don’t want to give away real money for fiat currency, especially when it is in a crisis, but at least it is going to someone who wants the United States to be strong. We want as much of the world’s supply of gold in our own borders. Owning gold is the patriotic thing to do.

5. The risk of confiscation is smaller today. In 1933, the dollar was backed by gold (what it is backed by today). They had to stop a run on the gold reserves when the gold peg was strained.
Today, we live in the world of floating exchange rates.
If the US really gets into a bind, instead of confiscating gold, they can just print whatever money they want to cover their debts. Yes, creditors will be upset about taking a "haircut" when paid in a debased currency, but they took an inflation risk when they bought the government securities.


Good luck!

-Milly

This is part 1 of Milly's "Precious Metals for Beginners" series
For Part 2, click here: Should I buy Silver or Gold?





Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.