Take Some Time This Week to Consider Your Catastrophe-Prevention Plan

As you read this, investors around the world are panicking…

For starters, China’s economic growth is slowing. With a population approaching 1.4 billion, China consumes a huge portion of the world’s resources, goods, and services… So a slowing Chinese economy means a slowing global economy.

China’s stock market dropped 7% on the first trading day of the year… It closed out the week down 9.9%.

[ad#Google Adsense 336×280-IA]Stock markets around the world have followed its lead.

The Japanese and European benchmark stock indexes are each down at least 7% so far in 2016, after just five trading days.

The U.S. benchmark S&P 500 Index isn’t far behind.

On top of that, the price of crude oil is lower than it has been in more than six years.

It’s now trading almost exactly at its February 2009 financial-crisis low. Low energy prices are good for lots of businesses.

But they’re terrible for oil producers… and for the folks who have funded oil operations.

Bankruptcies and defaults in the energy industry will send waves of volatility across the financial markets.

I’m not saying that this is the start of a crash… But I am saying you need to be prepared for one. Today, I’ll show you how to set up your own “catastrophe-prevention plan.”

Longtime readers know a catastrophe-prevention plan is an all-inclusive wealth plan that dramatically reduces the risks to your financial well-being. You should consider this plan every time you make an investment decision.

For preventing catastrophe with individual investments, I suggest using intelligent position sizes and stop losses. But at the core of any catastrophe-prevention plan is “asset allocation.” This will have 1,000 times greater impact on your wealth than any single trade.

Asset allocation is the component of your wealth plan that deals with the amount of money you have in various assets. How much of your wealth is in cash? Stocks? Gold? Real estate? This is all under the umbrella of asset allocation.

The No. 1 goal with asset allocation is to avoid making huge bets in just one asset class…

When the tech bubble burst in 2000, the S&P 500 Information Technology Sector Index – which housed many of the popular tech names – dropped 83%. Folks who had a lot of money in tech stocks were crushed.

From 2006 to 2010, home prices around the country fell 33% from their peak. In some cities, prices fell as much as 62%. Folks who got too caught up in the real estate frenzy lost their shirts.

The simplest way to avoid this kind of financial disaster is with asset allocation. When you practice sound asset allocation, you often have some holdings that “zig” when other holdings “zag.” That way, you’re not vulnerable to losing too much if one idea doesn’t work out. And, in the case of an all-out financial storm, you’ll prevent catastrophe.

So what does sound asset allocation look like?

There’s no “one-size-fits-all” asset-allocation plan. Different people have different financial goals… different obligations… and different risk tolerances. But the following plan can work for a lot of people…

Bonds (20%-30%)

When you buy a bond, you are loaning money to a government, an individual, or a business. Owning bonds allows you to collect steady streams of income.

In the DailyWealth Trader portfolio, we hold municipal bonds through the Nuveen Premium Income Municipal Fund 2 (NPM). Munis still have a relatively high yield (NPM yields 5.9% today). They have historically low default rates, which make them safe. The income is free from federal taxes. And if you buy a “closed-end fund” like NPM, you can often buy munis at discounts to their underlying values.

In the past, we’ve also profited from the leveraged U.S. Treasury fund (UBT). U.S. Treasurys don’t pay much in income… But they’re seen as one of the lowest-risk investments in the world. So investors buy them for a safe place to park some cash.

Both municipal-bond funds (including NPM) and U.S. Treasurys were up over the past week, while stocks were dropping.

Precious metals (5%-10%)

Gold and silver (and to a lesser extent, platinum and palladium) could soar during a crisis. Like U.S. Treasurys, gold and silver are seen as safe-haven assets. They’re especially valuable in a currency crisis… or when folks are worried about one.

I suggest owning some physical metals in coin or bar form. Sometimes it makes sense to speculate on precious metals miners and royalty companies, too.

Gold and silver were also both up last week, while the broad market sank. If the markets deteriorate from here, you’ll likely be glad you’re holding precious metals.

Cash (10%-20%)

This is an extremely important part of your catastrophe-prevention plan.

Many people don’t like to keep large portions of their wealth in cash because they feel like they always have to be “doing something.” They hate sitting still. They see a large cash balance in their account and start looking for a stock to buy… a commodity to buy… anything to buy. It burns a hole in their pockets.

But holding cash can go a long way toward reducing market-related stress. For that reason alone, cash is one of the best assets to hold in uncertain markets. Also, it’s “dry powder” that allows you to buy bargains if they appear. (And in a crisis, bargains always appear.)

You can hold cash in your bank account and your brokerage account. You might even hold some in foreign currencies.

It’s also not a bad idea to keep at least a couple months’ worth of expenses in cash hidden at home.

Real estate (20%-30%)

This could be your own home… a producing farm… or a rental property. If you’re looking for extreme diversification, consider buying real estate in a foreign country.

Real estate has inherent value. You (or someone else) can live in it. You can eat what you grow on it. No matter what happens in the world, people will always value food and shelter.

Stocks (20%-30%)

Over the past 70 years, stocks have returned around 7% a year, on average. And if you had reinvested your dividends, that number jumps to more than 10% a year. So it’s a good idea to hold stocks with some portion of your money. But be sure to diversify…

You can own some small growth stocks and some large, stable, dividend-payers… and stocks in all different market sectors (like consumer staples, financials, health care, and energy). And you can own index funds that hold lots of different companies.

In DailyWealth Trader, we also diversify by using different trading strategies. “Trading for income” – our term for selling options on great, cheap companies – is one way to reduce risk and earn income. (If you’re not familiar with the idea of selling puts and covered calls, you can learn more about how these strategies work here and here.)

We’ve also recommended selling stocks short as a great way to balance out your stock buying.

Collectibles (0%-10%)

Outside of the five major asset classes mentioned, you may want to include collectibles in the mix, too. If you know a lot about antique cars, rare coins, or custom knives, these “hold-in-your-hand” assets can increase in value and provide more diversification to your portfolio (read our educational interview with the master of collectibles, Van Simmons, right here).

Keep in mind, the right asset allocation for you is the one that lets you sleep well at night… especially when the stock market has a bad day, week, or year.

If you’re extremely risk averse, consider having more of your assets in cash and real estate. If you’re able to accept more volatility, consider holding more of your assets in stocks.

The key is to not bet it all on one type of investment. Take some time this week to consider your catastrophe-prevention plan. If you’re not confident in your asset allocation, start working toward your “sleep-well-at-night” balance today.

Regards,

Ben Morris

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Source: Growth Stock Wire