The Weekend Edition is pulled from the daily Stansberry Digest.
What is risk?
It's a difficult question for many folks. But it's one that I like to revisit frequently...
I want to make sure our readers know how to think about – and answer – this question.
Hopefully, they can use it to take a deeper look at their own portfolios. Far too many investors take on more risk than they should... and that's a recipe for disaster when trouble floods into the markets.
Let's start with the basic framework...
Risk involves a range of possible outcomes. An asset with a wide range is considered "high risk." One with a narrow range is "low risk."
For example, most folks don't expect to make 100% in a year on a 10-year U.S. Treasury note yielding 1.8% (as they do today). Nor do they expect to lose any money.
On average, with this asset, you'll probably make a return of 1.8% per year for 10 years (before taxes and inflation). Then, you'll get your principal – the amount you loaned to the U.S. government through the Treasury note – returned to you at the end of that period.
The reasonable expectation is a narrow range of outcomes. It's a low-risk investment.
Now, consider an example at the other end of the risk spectrum – junior precious metals exploration and mining stocks. In the same 10-year period, you could lose everything... break even... make 100 times your money... or any one of myriad other outcomes.
Much wider range of outcomes... Much higher risk.
The benchmark S&P 500 Index is somewhere in the middle...
The index fell roughly 38% during its worst year (1931) and rose almost 54% during its best year (1954).
From best to worst, that's a wide range of outcomes. But most of the time, the range is more narrow... Roughly 80% of the time, the index drops less than 18% in bad years and gains less than 25% in good ones.
So while the price of a particular asset might change a lot... the range may not change much at all.
As you prepare to buy an asset, you must get two things right...
First, you need to figure out if you understand the full range of possible outcomes. And more important, you must realize where in that range the price sits at that point in time.
When an asset's valuation is high, the range of possible outcomes may still be wide. But at that point, more of the possible outcome is downside than when its valuation is low.
That brings me to an important rule to follow if you want to be a successful investor...
The only way to buy risky assets – those with wide ranges of possible outcomes, like the junior mining stocks I mentioned earlier – is to pay the dirt-cheapest prices. Nothing less will do.
That said, knowing that you'd be taking more risk in a given asset – or market – doesn't tell you where we are in the range of potential outcomes... in other words, what's likely to happen in the near term.
Remember, investing is an art that requires you to prepare for a range of future outcomes...
Since nobody knows the future, you never have enough information.
You're always making decisions with some level of uncertainty.
Insurance companies call this underwriting... They don't know which folks will have car accidents. But based on the data available, they know that red Porsches have more accidents than white Honda minivans in certain zip codes (probably in most).
That's one reason why it costs more for insurance on a red Porsche (or any red car, according to my agent) than a white minivan.
How can investors prepare for a range of outcomes?
Many prudent investors prepare by holding a sufficiently diversified portfolio at all times. (Diversification is "sufficient" when you're holding assets that don't tend to move up and down together.)
The old "Permanent Portfolio" is one of my favorite examples of diversification. The late great Harry Browne and Terry Coxon introduced the concept in their 1981 book, Inflation-Proofing Your Investments.
The basic idea behind the Permanent Portfolio is this...
First, Browne and Coxon said to split your portfolio evenly among four assets – stocks, long-term bonds, gold, and cash. Then, Browne and Coxon said you should rebalance your portfolio once each year by buying and selling these four assets to get back to the original four 25% allocations.
The rationale for this asset mix is simple and straightforward...
Stocks do well during good times. Long-term bonds do well during times of deflation. Gold does well during periods of inflation. And cash holds its value during recessions.
From 1974 to 2011, the Permanent Portfolio compounded at 9.4% per year.
Even better, folks following this strategy never suffered gut-wrenching declines... The portfolio's worst year occurred in 1981, when it fell 4%. Stocks outperformed the portfolio many years, but they also crashed a few times in that span. The Permanent Portfolio never did.
That's a small range of outcomes.
Now, I'm not recommending that you should blindly follow the Permanent Portfolio today (though I suspect you could do a lot worse over the long haul). It's just a simple example of "sufficient" diversification.
But I'm starting to wonder how the Permanent Portfolio will do over the next few years...
The U.S. stock market currently trades at 2.4 times sales, according to Bloomberg data. That's higher than at any time in history... even in the heady days of the dot-com era.
And of course, regular readers know how I feel about bonds today...
The world currently has more than $10 trillion in negative-yielding debt. And the U.S. 30-year Treasury bond yields just 2.2% – abysmally tiny compensation for a 30-year loan.
Gold is never cheap or expensive on an absolute basis... As long as stocks and bonds remain expensive, I believe gold is cheap. And even though cash yields diddly squat today, we can trust it to just sit there and not do anything. That's the whole point of holding it.
For the bond and equity portions of your portfolio, I bet you'll do a lot better following Stansberry Portfolio Solutions products – The Capital Portfolio, The Income Portfolio, The Defensive Portfolio, and The Total Portfolio.
Headed by Austin Root, these fully allocated portfolios provide a more up-to-date – and lately, more profitable – example of diversification...
These portfolios contain the highest-conviction ideas from our universe of Stansberry Research publications. Austin and the investment committee – Steve, Porter Stansberry, and Dr. David "Doc" Eifrig – work together to develop one-and-done model portfolios that will provide a clear, diversified path to outperformance.
In the latest issue, published earlier this month, Austin told subscribers that all four portfolios met or exceeded their goals last year.
For example, The Total Portfolio was up 32.6% in 2019. The Capital Portfolio was up 42%. Meanwhile, the S&P 500 went up around 31% in the same span. Likewise, both Total and The Income Portfolio significantly outperformed their closest comparative benchmark, the Vanguard Balanced Index Fund.
Earlier this week, Porter, Steve, and Doc held a live event to share their respective predictions for 2020...
In particular, they noted that stocks are going up for now – thanks to the "easy money" policies of the Federal Reserve and global central banks – and there's no sense in denying it. As Porter and Steve both like to say, "Make hay while the sun shines."
However, as they also noted, it's just as crucial to be prepared... because those same policies will eventually send stocks crashing down.
It's an uncertain market... No doubt about it. And you must prepare for a wide range of outcomes as an investor today.
So if you missed Tuesday's informative discussion, I encourage you to watch the replay before it goes offline. You'll learn how the investment committee suggests preparing your portfolio today... And you'll hear what the Portfolio Solutions strategy is all about.
Plus, you'll learn their favorite stock ideas for 2020... their latest updates on the Melt Up, gold, and bitcoin... and much more.
In the meantime, remember, cash is the part of the old Permanent Portfolio that is designed to get you through a recession... or an epic financial crash that tramples the markets like a herd of 2,000-pound bison running at 40 miles per hour.
You'll always be able to find some values and opportunities. And as my colleagues have noted, the bull market marches on – at least for now.
But I do think now is a great time to hang on to a little cash... just to be prepared for what could be lurking around the corner.
Don't say I didn't warn you.
Editor's note: It's rare for our top three gurus to go live and discuss exactly what they're seeing in the markets today. Thousands of folks tuned in to hear Steve, Porter, and Doc share their favorite stock ideas for 2020... and to find out how Stansberry Portfolio Solutions helps take the guesswork out of investing.
The investment committee has also reopened access to Portfolio Solutions through our best offer yet – including a unique performance guarantee. To learn more, watch a replay right here.