Before you worry about investments, take care of the basics!

 

I've been reading Jared Dillian's latest weekly investment and finance newsletter.  (It's free to subscribe:  if you aren't reading it yet, and are interested in financial and investment matters, I suggest you do.  He has interesting things to say.)  This edition is titled "The Importance of Diversification" (for investors, of course).  Here are a few excerpts.

I am not a fearmonger. But these days, telling people that they should diversify sounds like fearmongering. You know what? Stocks might not go up forever. Maybe stocks will go down. Maybe something else will go up.

Index funds are sold on the premise that if you buy an S&P 500 index fund, you are diversified because you have 500 stocks. Do you really think you are diversified if you have 500 stocks? 

. . .

... leverage in the financial markets increases volatility and exposes us all to wild swings and crashes. You can’t put the genie back in the bottle, but if I could go back in time and somehow stop stock index futures from being listed, I would. 

You might remember that the Crash of 1987 was blamed on program trading an index arbitrage. Index arbitrage is net delta neutral—that was not the cause. Program trading is just trading baskets of stock all at once. It was the futures that did it, in the hall with the candlestick.

. . .

Most of the time, this all works, and things are stable. But how fragile everything is, and people put their life savings in this stuff? I worked in equity derivatives for a decade. 80% of USDA chicken inspectors no longer eat chicken.

. . .

You should try to make your investments as slow and boring as possible so you never have to look at the balance in your brokerage account. Maybe once a year. But when seven crazy tech stocks make up 35% of the index, you kind of have to look at it every day. It is no longer slow boring.

There's more at the link.

What Mr. Dillian is saying is, of course, very applicable to investing in general, and to those with the financial resources to invest in such things.  However, for most of us, it's a non-issue, because we don't have enough money left (after paying our routine expenses) to invest at that level.

Nevertheless, many of us get all sorts of offers for lower-level investments, from precious metals (gold and silver coins, etc.) to insurance policies to retirement annuities.  Most of them contain hidden traps and pitfalls that make using them hazardous to our wealth, to put it mildly!  To note just one example, several companies advertise gold IRA's (Individual Retirement Accounts), buying gold from them and storing it in their vault.  One was recently in the news after it was found that the fees it charged, and its markup on the gold purchases, were exorbitant, greatly reducing the return on any investment through them.  One financial forum notes:

Setting up a gold IRA sounds simple enough, but companies that offer this service often charge multiple layers of fees. Here’s a breakdown of some of the most common charges you might encounter:

1. Account Setup Fees: Establishing a gold IRA requires a specific type of account with a custodian. This initial setup fee can range from $50 to several hundred dollars, depending on the company.

2. Annual Maintenance Fees: Unlike traditional IRAs, which may have minimal annual fees, gold IRAs typically come with an annual maintenance fee to cover account management and reporting.

3. Storage Fees: Gold IRAs require physical storage in an IRS-approved depository, which means a recurring storage fee. These fees vary, but they often range from $100 to $300 per year, depending on the amount of gold held and the depository chosen.

4. Transaction Fees: Companies may also charge transaction fees when buying or selling precious metals for your IRA, which can be a percentage of the transaction or a flat fee. Since gold is a long-term investment, these fees may not be immediately felt but can add up over time.

5. Markup on Precious Metals: Companies often add a markup to the price of gold or silver sold to customers. This markup can vary and might be disguised in the form of a “spread,” making it difficult to assess the true cost of your investment.

These fees combined can significantly cut into any returns that you might make on gold.

I'm not an investment advisor, but I've been studying the field for many years, thanks to my business education (I hold a Masters degree in management) and experience (I was a director of two smaller companies before being ordained as a pastor).  The subject interests me, even though I don't have enough money to actively invest in anything much.

As a pastor, I often had to speak with parishioners who found themselves in financial trouble, sometimes through bad decisions (investment and otherwise), other times because they simply didn't have enough money to cover their routine needs.  It taught me a lot about how badly our schools, colleges and universities prepare students to face the realities of life.  Parents no longer seem to take the time to teach their kids about these things, either.  I don't understand that at all.  From an early age, my parents gave each of us kids a (very small) weekly allowance.  If we wanted to buy something that was important to us, we had to find ways to earn the money to pay for it.  Some of that came from faithfully doing our household chores - and if we didn't do them, we didn't get our chore money!  More came from vacation employment (I started out cleaning the cages in a local pet shop in my early teens, which taught me a lot about cleanliness as well as about earning and spending!)  In most cases, we had to find at least half the money for anything important to us.  If we did, often our parents would contribute the rest:  but we had to show willing, and be responsible.  That taught us a lot, right there.

What I've said to people for years (decades!) is that they do the following, in order, as best they can.

1. Eliminate short-term debt (credit cards, charge accounts, etc.).  If you use a credit card, pay off its balance every month, rather than use revolving credit (which usually carries an exorbitant interest rate, too).

2. Put aside an emergency reserve, so that you can pay for any sudden, unexpected needs that arise (e.g. fixing a broken-down car, a medical expense, a sudden trip to see a family member, being laid off without warning, etc.).  I usually suggest trying to save up a minimum of three months' worth of expenditure;  many authorities recommend six months' worth.  One has to do this slowly, over time, of course;  but perseverance pays.

3. Establish a reserve of critical needs (food, water, household necessities, etc.) sufficient to last for a reasonably foreseeable period, in the event of an emergency.  FEMA, the CDC and others recommend at least a 72-hour reserve, with some extending that to two weeks.  I'd recommend a minimum of 30 days, and longer if you can afford it.  If the power went out tomorrow and stayed out, remember that almost everything on which we rely - electricity generation, fuel pumps, factories, offices, etc. - would shut down with it.  Could you survive where you are, with what you have on hand, for two to three weeks if that happened, until the power was restored?  That's a question far too few people ask themselves, and even fewer take steps to prepare for it.

4. When you've done ALL OF THE ABOVE, then, and only then, is it safe to think about longer-term investments and financial provision.  If a bill has to be paid, you generally can't use a gold or silver coin to do so:  and if an emergency arrives, you can't eat an IRA certificate!  (What's more, if the power's out, nobody's likely to be able to advance you a loan against your IRA or another investment, either.)

Concepts such as diversification, leverage, arbitrage, etc. are all very well in their sphere, but they don't have much to do with getting the basic foundations of our life into order.  There's an old English proverb that says "Look after the pennies, and the pounds will look after themselves".  That applies very practically to getting our financial lives in order:  if we look after the basics, the more advanced elements will have a solid foundation on which to build (and we'll be able to afford them!).

Peter