As I walked out of the Hassler Hotel in Rome last week, a man in a business suit walked briskly by, surrounded by a security detail. It was Antonis Samaras, the new Greek Prime Minister, who was in town to meet with Italy's Premier Mario Monti.
Samaras is a man with his hands full. And his problems may be coming to your doorstep. Here's why... and what you might want to do to protect and enhance your hard-earned investment capital.
You probably saw the images last week of 50,000 protestors in Athens, some wearing helmets and gas masks and heaving firebombs at police. Demonstrations and violence also erupted in Spain.
The grievances in both countries were the same. Times are tough and Spaniards and Greeks don't like the new austerity measures being imposed on them as a condition of remaining in the Eurozone.
However, there are fiscal crises brewing not just in the European Monetary Union, but in Great Britain, Japan, Canada and the United States, as well.
All over the Western world, politicians have made promises they can't possibly keep - and have national debt crises to show for it. Yet most Americans still don't understand how serious the problem is. Yes, we've all heard about our metastasizing $16-trillion national debt. But few are aware that there's another $120 trillion in unfunded liabilities for Social Security, Medicare and Medicaid. To put this in perspective, the current liability for these programs alone comes to more than $1.05 million
per taxpayer.
Some believe we'll eventually come together as a nation and tackle this problem. But I wonder. Obama has promised not to raise taxes on anyone making less than $250,000. (And raising the top marginal rate to 39.6%, according to the Congressional Budget Office, would raise only $60 billion. Last year's deficit alone was roughly $1.5
trillion.) Joe Biden has given his personal guarantee (whatever that's worth) that Social Security will not be changed. And neither major party is talking seriously about reforming entitlements. (Even Paul Ryan's plan is too little, too late.)
The reason for politicians' reluctance is obvious. Look at Greece. Voters are in no mood to hear that they are likely to get
less government assistance. You can talk all you want about the unsustainability of these programs, which - in their current form - are certain to be undone by time and arithmetic. Likewise, you can talk all you want about personal responsibility, fiscal sanity, constitutional government or freedom and opportunity. Most voters will have none of it. They want their government checks. End of story.
For our entire lives, we have heard Western politicians tell us what they are going to do for us. It remains to be seen whether they can get elected (or re-elected) telling us what they are going to take away, either in the form of higher taxes or less entitlements. I am skeptical whether most Western voters are ready to have an adult conversation. (I refer you again to Greece and Spain.)
However, if governments can't rein in the spending, the fallout in the financial markets is going to be very ugly. It's not just the longtime gloom-and-doomers who recognize this. In an August 11 article in
The New York Times, Vanguard Founder John Bogle - as mainstream an analyst as mainstream gets - worried aloud about "the risk of a black-swan event - of something unlikely but apocalyptic."
Constructing An "End-of-the-World Portfolio" If you're worried about such an eventuality, what should you do? First off, don't make immediate, wholesale changes to your investments. My goal is not to scare the pants off you, but to make you consider the unthinkable. I also want to detail one way you could hedge against it with, for instance, an "End-of-the-World Portfolio," which I've written about here before.
Here's how it could be structured:
- Put 40% of your liquid portfolio in a laddered portfolio of AAA-insured tax-free bonds. (Be sure to buy state-specific bonds if you're in a high tax state.) Laddering means varying your portfolio between short-, medium- and longer-term bonds. This is your protection against deflation and the virtual certainty of higher taxes.
- Put 40% in a laddered portfolio of inflation-adjusted Treasuries, also AAA-rated. (For tax reasons, these are best owned in your retirement account.) This is your protection against inflation, as central banks might opt to spend us out of a crisis and argue that "temporary" hyperinflation is preferable to national bankruptcy.
- Put 20% in defensive, blue-chip, dividend-paying stocks. I'm referring to food companies, healthcare companies, utilities, defense contractors, gold mining companies and the like. This should provide some growth and income. Why include stocks at all? Because 200 years of history shows that an 80/20 split between stocks and bonds is actually less risky than a 100% bond portfolio. And, remember, you need to hedge for prosperity, as well.
Bear in mind, I'm not calling for the end of the world... yet. I'm only pointing out a possibility, however remote. What the odds are, no one knows.
But as investment legend Peter Lynch used to say, "If you're gonna panic, do it early."
Good Investing,
Alex
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