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TAKING HEED AT TAX TIME

Another April is upon us, which to a good many folks means not only “tax time” but the bothersome annual ritual of “portfolio review.” One of the primary tasks performed in a proper portfolio review is to “rebalance” a portfolio to its stated or intended asset allocation. According to Investopedia.com – asset allocation is defined as:

“The process of dividing a portfolio among major asset categories such as bonds, stocks or cash. The purpose of asset allocation is to reduce risk by diversifying the portfolio”.

I would like everyone to stop and think about how the assets in their own investment portfolios are “divided” amongst the categories listed above – namely, bonds, stocks and cash. If you are reading this, you might [and I hope you are] asking yourself WHY conventional and accepted asset allocation models do not even make mention of gold or precious metals as a distinct or important asset category.

The ideal asset allocation differs based on the risk tolerance of the investor. For example, a young executive might have an asset allocation of 80% equity, 20% fixed income, while a retiree would be more likely to have 80% in fixed income and 20% equities.

How about bonds? Bonds – as an asset class – are something I have written about in the past. Relating to the understating of inflation, I frequently voice my concerns about how this impacts fixed-income-laden portfolios of pension funds at such behemoths as GM, FORD and the airlines; and how this has greatly contributed to these companies' dismal financial performances.

Why Reinvent The Wheel When Someone Lets Air Out of Your Tires?

Current methodologies of determining prudent and proper asset mixes employed by these funds were developed fifty or more years ago – in an era when data was gathered and reported accurately and honestly. These asset allocation models were designed and sold to the pension funds as a means to provide for adequate and sustainable benefits for their employees and retirees on an ongoing basis. Farmers were well aware of the demographics of their labor force. They knew folks would age and they also knew what average age folks would choose to retire. These things are all, by their very nature - predictable. However, these asset allocation models would never have had assumptions built into them that presupposed or assumed that the data they were inputting would be “patently false.”

The Mother of All Dilemmas

Data has been obfuscated in an attempt to conceal or disguise inflationary policies being pursued by Central Banks and Government. As a result, my biggest concern going forward is the threat of HYPERINFLATION. Research reveals that the seeds for this outcome have already been sown by reckless money printing on the part of the Federal Reserve. The onset of hyperinflation is more a question of “when,” not “if.” With the Fed’s recent move to cease reporting the broadest measure of the money THEY CREATE - M3 money supply data – the “when” could, in fact, turn out to be “very soon.”

Conventional and widely held asset allocation models in use today DO NOT accept nor make any provision for the reality that inflation data is misreported. Additionally, they do not make any provision for the possibility of hyperinflation. If they did – at a bare minimum – precious metals would be included as a distinct asset class, but they are not.

Now, I would like to elaborate a little bit more about bonds held in individual investor’s portfolios. While I am not fond of the asset class [for reasons stated above] at all – I do recognize the importance of the function they are intended to serve in a properly constructed investment portfolio, namely, income and security.

A Plausible Alternative

Here is an alternative you might consider:

Switch your fixed coupon treasury bonds in your investment portfolio for government issued ‘real return bonds’ or TIPS:

A special type of Treasury note or bond that offers protection from inflation. Like other Treasuries, an inflation-indexed security pays interest every six months and pays the principal when the security matures. The difference is that the coupon payments and underlying principal are automatically increased to compensate for inflation as measured by the consumer price index (CPI). Also referred to as "Treasury inflation-indexed securities."

While a TIPS security cannot protect an investor from the deliberate “underreporting” of inflation, they can and likely would amount to “financial salvation” on the fixed income portion of your portfolio should we actually experience hyperinflation. But remember, the additional security – like an insurance policy - comes at a cost,

If U.S. Treasuries are the world's safest investments, then you might say that TIPS are the safest of the safe. This is because your real rate of return, which represents the growth of your purchasing power, is guaranteed. The downside is that, because of this safety, TIPS offer a low[er] return.

Since widely held, most recommended and accepted asset allocation models generally dictate that the-older-one-gets, the more fixed income one should have in their portfolio – folks nearing or who are actually retired ‘likely’ stand to lose [or gain] the most in this regard.

Today’s Market

Overseas equity markets began the week on a positive note with Japan’s Nikkei Index gaining 273 points to close at 17,333. Meanwhile, North American markets ended the day mixed with the DOW up 35.62 to 11,144.94, the NASDAQ off by 3.10 to 2,336.70 and the S & P up 3.00 to 1,297.80. NYMEX crude oil futures lost .38 to close the day at 66.38 per barrel.

In foreign exchange markets, the U.S. Dollar Index gave up .09 to close the day at 89.30.

Interest rates rose 2 – 4 basis points across the curve with the benchmark 2-year at 4.85%, the 5-year at 4.83% and the 10-year bond finishing the day at 4.87%.

Precious metals did better on the day with COMEX gold futures up 7.80 to 590.20 and COMEX silver futures ahead by .25 to 11.79 per ounce. The XAU Index gained 1.12 to 142.74 while the HUI closed at 338.13 – up 1.81 on the day.

Wishing you all a pleasant evening as well as a happy and prosperous tomorrow!

Rob Kirby

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