Investing in the face of a War and High Oil Prices

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Quiz!

What are ways to make money by staying out of the stock market for now?

  1. Move to cash until getting clarity about Iran in the near term.
  2. Move to US stocks that are perceived as a safe-haven for now.
  3. Move to cash for as long as it takes, until a resolution for the war is in sight.
  4. Move to bonds for safety.

Investing in the face of a War and High Oil Prices

Oil prices jumped over 50% in two months given the war in Iran, which borders the Strait of Hormuz – the biggest passage of oil for the world. Higher oil prices are inflationary, since they affect the price of gas for travel and shipping, heating oil, plastics including food packaging, fertilizers for food and more. The concern is that a rapid spike in inflation may lead to a global recession. One question is whether it is safer to invest for growth beyond inflation, or keep money not invested with the hope of buying lower. Here is what it would take for a successful bet on staying out of the market:

  1. The war continues with no signs of a potential improvement in passage of ships in the Strait, and you reinvest when uncertainty is higher, or
  1. The uncertainty continues for a very long time, with a spike in inflation hurting the economy. You invest when there is more clarity, but the economic damage is big, making the declines bigger than the gains thanks to the clarity.

Here are things that could lead to a missed opportunity:

  1. You keep money on the sidelines, and reinvest when there is clarity in the near term. When you see real clarity, big investment gains are likely to be behind us.
  1. There is some resolution before serious economic damage. So far, there are at least 30 countries committed to helping open the Strait. There are various paths to success, including one-sidedly stopping the attacks in Iran.
  1. Value stocks outside the US are priced around average, when considering inflationary forces that tend to increase the steady-state valuations (as measured by Price/Book or P/B). Avoiding holding them is very different from US Large Growth stocks that are priced extremely high – potentially higher than any other time since 1929.

At this point, it is impossible to be certain that one approach is better than the other. There may be more factors beyond those presented in the article. Please don’t use this information as personalized investment advice.

Quiz Answer:

What are ways to make money by staying out of the stock market for now?

  1. Move to cash until getting clarity about Iran in the near term.
  2. Move to US stocks that are perceived as a safe haven for now.
  3. Move to cash for as long as it takes, until a resolution for the war is in sight.
  4. Move to bonds for safety.

None of the answers is correct.

Explanation:

  1. Once we have real clarity about Iran, we would likely have big gains behind us. If this happens in the near-term it is likely to offset declines leading to it.
  2. While US stocks are often perceived as a safe haven at times of uncertainty, their extremely high valuations may more than offset the benefit. In addition, the reversal for non-US stocks is likely to be significantly steeper, given the combination of lower valuations and higher growth.
  3. This could work if there is a long path to a resolution of the war, and the economic damage is big enough to offset the spike in stocks due to more clarity. Given the risk of high oil prices, the world is more likely to find a resolution before letting the damage build up, so it may be a risky bet.
  4. Bonds do poorly when inflation goes up and interest rates may increase to fight the inflation. While economic damage typically leads to lower interest rates, when having to choose between fighting inflation vs. a recession, the choice is likely to be skewed towards fighting inflation, because high inflation can worsen a recession. In addition, in case of a resolution of the war before sustained economic damage, you could miss a surge in stocks.
Disclosures

Do you Know the Real Value of your Private Investment?

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Quiz!

If you have $10M in public investments and another $20M in private investments, and spend $600k per year. What is your withdrawal rate for risk planning?

  1. 6%
  2. 2%

Do you Know the Real Value of your Private Investment?

Bluerock Total Income+ Real Estate Fund was a private fund, until going public (symbol BPRE) on 12/16/2025. On that day, shares were traded at a loss of about 38% to the private share price. What happened? Private shares may not have ongoing trading information, so their stated price is not always reliable. In contrast, public investments typically exchange hands multiple times each day, creating the most reliable pricing data – what actual buyers are willing to pay.

This exposes an issue of private investments. Not only could they be locked for years, but their stated price may be flawed. This is not a reason to avoid all private investments at all times. It is a reason to do very careful risk planning around private investments. Examples of risk planning include:

  1. Making sure you have enough public investments that you can sell on a dime to buy food and pay your bills whether in retirement, between jobs or during a slowdown of your business.
  2. When calculating your withdrawal rate for risk planning, use annual spending divided by liquid investments (excluding private investments). This matches daily spending with investments that can be sold at any point, and at a reliable price.

Once you are able to and choose to sell your private investment, it can be used for spending with a known value and can be added to your risk plan. While this may seem harsh, I witnessed too many surprises with waiting for a liquidity event that failed on timing, value or both.

Quiz Answer:

If you have $10M in public investments and another $20M in private investments, and spend $600k per year. What is your withdrawal rate for risk planning?

  1. 6% [The Correct Answer]
  2. 2%

Explanation: You can’t reliably sell a private investment at its stated price to cover current expenses. For risk planning, it is safest to ignore it until sold. This means that your withdrawal rate is not $600k/($10M+$20M) = 2%, but $600k/$10M = 6%.

Disclosures

How to Benefit from AI (Artificial Intelligence) Without a Lost Decade

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Quiz!

Which of these investments can do well thanks to the AI revolution? (There may be multiple answers.)

  1. An Asian renewable energy company generating very cheap electricity.
  2. A company whose stock went up 1,000% in recent years.
  3. A trucking company using AI to improve many aspects of its operation.

How to Benefit from AI (Artificial Intelligence) Without a Lost Decade

AI is having a big impact, with an expectation for a transformation that would improve lives all around the world. The promise of AI led to outsized gains for technology companies. The excitement pushed prices higher much faster than actual earnings and book values (intrinsic values) of some of these companies. The effect surpassed the dot-com boom, with S&P 500 Price/Book (P/B) even higher than the peak of 2000, and is now the biggest seen since 1929, the onset of the Great Depression.

This creates a dilemma: Do you buy companies that are involved in a worldwide transformation, hoping to benefit from earning growth, or do you avoid them given that the price growth surpassed the actual earnings many times over? The most recent case when prices (relative to book values, or P/B) reached close to the extreme of today, was during a lost decade – a 10-year decline of 30% for the S&P 500, and a 14-year decline-to-recovery for the Nasdaq. The Nasdaq lost 78% over a grueling 2.5 years. This was the result of very successful companies continuing to be successful while adjusting prices to be more in line with reality.

While different bubbles pop at different levels, the current bubble has a solution that avoids the big risk while still aiming high. The reason it is possible is that there are plenty of stocks and entire stock markets (countries) that are not priced high. One solution is to invest in deep-value (much lower than typical P/B) companies around the world, emphasizing non-US stocks (international and emerging markets), and diversifying across sectors. The benefits:

  1. Efficiency broadly:  AI makes companies across all sectors and economies more efficient, increasing their values.  The benefit depends on the speed of adoption, and the ability to adopt.  With company and sector diversification, you can enjoy an overall benefit, without the risk of a company- or sector-specific bet.
  1. Spread:  As happens typically in tech cycles, the world will transition from a few early AI developers, to competition (e.g. DeepSeek).  This punishes companies with valuations that reflect expectation for eternal dominance, and rewards new entrants that start with low P/B.

Quiz Answer:

Which of these investments can do well thanks to the AI revolution? (There may be multiple answers.)

  1. An Asian renewable energy company generating very cheap electricity. [Correct Answer]
  2. A company whose stock went up 1,000% in recent years.
  3. A trucking company using AI to improve many aspects of its operation. [Correct Answer]

Explanations:

  1. AI consumes substantial energy. A company with competitive pricing along with the appeal of renewable energy can enjoy growing market share in a market with growing overall demand.
  2. Just because a company’s stock surged, we can’t know what its future will be. It could still be underpriced, or it could have become overpriced through people chasing past gains without studying the merits of the investment, including the company’s earnings and book value relative to its current price.
  3. Many companies may benefit from AI in multiple ways. Those who implement it smartly can get a big benefit, regardless of their sector, including trucking companies.
Disclosures

The Tax Bomb of Many Tax Strategies for Investments

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Quiz!

What are downsides of Separately Managed Accounts (SMAs) that are used to lower investment taxes? (There may be multiple current answers.)

  1. Extra risks.
  2. Extra costs.
  3. Higher taxes.
  4. Distraction from after-tax returns.
  5. Greater complexity.
  6. An eventual tax boomerang.
  7. Lower expected returns.

The Tax Bomb of Many Tax Strategies for Investments

There are many strategies that claim to avoid taxes on investments or greatly reduce them. Some have an obvious benefit without much of a downside. One example is Roth IRAs. Many more recent strategies come with a big catch: they don’t avoid taxes but only defer them, leading to a large future tax bill. This tax bill may come sooner than you expect as explained below.

What strategies have this catch? These are a collection of strategies that are typically housed in Separately Managed Accounts (SMAs). SMAs can be used to sell investments at losses to offset gains, creating an effect of lower (or no) investment taxes. A variant called direct indexing can start with an index and does the same to minimize taxes. Other variants go further with bets against investments using short positions or various derivatives. Some names are 130 / 30 (130% long + 30% short), and option overlay SMA (uses various derivatives to gain a short effect).

How is the tax bomb formed?

  1. Low basis, high gains: After a few years, the long positions end up with a very low basis and large unrealized gains and cannot be used to harvest losses.
  2. Lower returns: While you hold the strategy, there are many forces hurting the returns:
    1. There is an added annual cost to these strategies for the manager, plus financing cost for short leverage.
    2. The short positions and derivatives add risks. To manage the risk, portfolios often get tilted towards safer but lower-return allocations.
    3. Limited investments options, excluding the highest returning ones.
    4. The increased focus on taxes could create a distraction from maximizing after-tax returns.
    5. Over time, the portfolio holds increasingly overpriced stocks and gives up undervalued ones. This is the opposite of selling high and buying low.
  3. The tax bomb: After a few years (5 years according to product providers), the potential tax benefit diminishes so much, while the expected returns go so far down, that you would want to unwind these positions. Unless your goal is to never use the money on yourself (you hold till death or donate), you would have to pay the substantial built up tax.

Should you rule out all of these strategies in all cases? No. With the right set of circumstances these could make sense. Analyze the results over a full market cycle. This may require simulations given that many of these products existed for less than a cycle.

 

Conclusion: Be skeptical of tax strategies that promise to “eliminate” investment taxes. Often, they’re only postponing the pain, while lowering your returns in the process.

Quiz Answer:

What are downsides of Separately Managed Accounts (SMAs) that are used to lower investment taxes? (There may be multiple current answers.)

  1. Extra risks. [Correct Answer]
  2. Extra costs. [Correct Answer]
  3. Higher taxes.
  4. Distraction from after-tax returns. [Correct Answer]
  5. Greater complexity. [Correct Answer]
  6. An eventual tax boomerang. [Correct Answer]
  7. Lower expected returns. [Correct Answer]

Explanations:

  1. Without the extra focus on taxes, you can optimize for a combination of returns and diversification. The tax strategies can hurt both.
  2. These tax strategies typically involve extra costs.
  3. Taxes are expected to be lower, at least in the first few years.
  4. Given that higher returns often end up being taxed, the focus on taxes can distract from the ultimate goal, leading to lower after-tax returns.
  5. Tax strategies can add complexity in planning, implementation and tax reporting.
  6. The tax benefit can deplete within 5 years, with an allocation that targets much lower returns, leading to a big tax bill to unwind the unprofitable strategy.
  7. See #4.
Disclosures

The Failure of Investment Products with Downside Protection

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Quiz!

Which strategy offers the best downside protection?

  1. Defined Outcome Strategy
  2. Derivative Income
  3. Options Trading, Equity Hedged Strategy
  4. Stocks + T-Bills
  5. Buffered ETFs

The Failure of Investment Products with Downside Protection

If you are approaching retirement, you may be especially interested in limiting the downside of your investments. There are various strategies that fall into 3 Morningstar categories: Derivative Income, Defined Outcome, and Options Trading – Equity Hedged. Another common name you may have heard is buffered ETFs. What they have in common is a structure that limits the downside in exchange for giving up some upside.

Sounds great, right? The following article compares them to a simpler combination of Stocks and T-Bills (very short duration government bonds): https://www.aqr.com/Insights/Perspectives/Rebuffed-A-Closer-Look-at-Options-Based-Strategies. It turns out that the sophisticated strategies do worse than the simple stock / bond combo, not only in terms of returns, but even in terms of downside protection. There is a follow-up article with more details, especially for the skeptics: https://www.aqr.com/Insights/Perspectives/Buffer-Madness.

Why do these well-designed sophisticated strategies do worse than the simplest asset allocation? They are a form of insurance, with multiple costs. The costs reflect the big desire of people for protection, negating more than the entire benefit.

Is there an even better solution? Yes, a focus on diversified stocks. The cash / bond component introduces inflation risk – one of the toughest risks in retirement. The ultimate solution is reaching the point of low spending/investments (requires advance planning), eliminating the need for substantial cash or bonds. How? Say you withdraw 3% per year from your investments, and they declined by a dramatic 50% for a year, the cost is an extra 3% (6% total). Diversified stock portfolios enjoy growth that can make up for the penalty of withdrawals in down times. Such a strategy requires great discipline at all points in the cycle – otherwise, the entire plan can get derailed.

Quiz Answer:

Which strategy offers the best downside protection?

  1. Defined Outcome Strategy
  2. Derivative Income
  3. Options Trading, Equity Hedged Strategy
  4. Stocks + T-Bills [The Correct Answer]
  5. Buffered ETFs

Explanation: Stocks + T-Bills avoid the insurance-type costs of the other strategies. The article demonstrates the benefit based on a historic analysis.

Disclosures

One of the Most Destructive Forces in Investing, and How to Fight it

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Quiz

You hold a diversified investment that performed poorly for 10 years and want to make a change. What should you do? (Multiple answers may be correct.)

  1. Very gradually diversify into more proven investments.
  2. Very gradually diversify by including stable investments.
  3. Compare the valuation of the investment along with the investment you are considering for diversification, and avoid selling low to buy high.
  4. Compare the valuation of the investment relative to the long run, and also the returns relative to full cycles. If both are below typical, don’t make changes, and keep saving new money into it.
  5. Track the valuations and recent performance relative to the long run / full cycles. Be ready to diversify from a point of strength – at a high point, adding investments that are not at a very high point.
  6. Avoid making changes due to cyclical forces.

One of the Most Destructive Forces in Investing, and How to Fight it

Have you ever experienced any of the following:

  1. Had some money to invest and looked at the past 1-, 5- or 10-year performance, to help choose?
  1. Heard from someone that she/he made big money in an investment in recent years and felt the urge to put some money there?
  1. Lived through a long period (as long as 10 or more years) of poor performance relative to other investments and felt that it’s time to diversify?
  1. Learned about an investment that grew phenomenally for the past 10 years, felt that it is a solid investment, and felt secure to put money there?
  1. Saw your investment go through a big crash (50%+), with economic news giving a thorough explanation for a disastrous future, leading you to seek safety in solid investments (e.g. bonds or CDs)?

From my experience talking to people over the years, the scenarios above are very common. Why is that? In most avenues of life you can use experiences from recent years to project the future. Examples:

  1. If you get hungry, you learn to eat and then feel better. It was true today, one year ago, and any day.
  1. If you cross a street without observing the traffic, and nearly get hurt, you learn to always look for traffic before crossing the street. This will never be bad advice.

It turns out that investments involve cycles of various lengths. This means that learning about past years can be counterproductive. Examples:

  1. US Large Growth (high Price/Book or Price/Earnings) stocks outperformed US Value stocks from 1982 to 2000. You would expect 18 years to be plenty long to establish the trend. In the following 2 years, the entire benefit of Growth stocks over Value stocks was wiped, and Value outperformed Growth for the full 20 years! This brought the relative performance of the two groups in line with the long run. Imagine the devastation of a person who made a change in early 2000 – something that many did. Today’s P/B of the S&P 500 is right near the peak level of 3/2000, early in its latest 10-year decline!
  1. Real estate had unusual gains from 1995 to 2006. Some people became multimillionaires by buying many houses with huge loans. By 2006, you could have taken a 106% loan on a house, with no verification of income. In the following 5-6 years, home prices declined by varying degrees, depending on location, taking as long as 10+ years peak-to-peak. In California, typical declines were 30% from peak to bottom. Some loans in 2006 led to more than 100% loss on the original investment, unless you had the income and discipline to keep paying the mortgage for years until recovery. This brought some of those millionaires to bankruptcy.

It is surprising to realize how many investment mistakes are rooted in a single cause – underestimating and misunderstanding cycles. So, how can you avoid the traps above?

  1. Always look for logic – not just past returns. Companies bring value through efficiently providing products and services. Real estate offers a place to live or run a business. Bonds are a loan to a company or government, allowing it to spend money that it doesn’t have with the hope of adding value beyond the cost of borrowing (or print money in the case of a government).
  1. Be highly suspicious of investments that don’t generate value or are too new to have at least one clear full cycle. Cryptocurrencies, including Bitcoin, have both issues. Educated opinion: only after completing the next tech downturn, you may reach a full crypto cycle.
  1. Study the long history of investment types that you are considering. If you notice unusually good or bad returns for an investment, compare them to the full cycle. If there is an unusually large deviation, at least prepare for the potential of a reversal. Do not move money out of an investment that did poorly for 10 or even 15 years relative to its full-cycle average, and into an investment that did very well in the past 10 or 15 years relative to its full-cycle average.
  1. Most common investments have a way to value them. Stocks have Price/Book Value (P/B) and Price/Earnings (P/E), representing what people pay for the stock relative to the intrinsic value or earnings of the company. For diversified collections of stocks, you can compare the current values relative to the full-cycle average, and don’t expect an anomaly to last forever. There are valuation measures for different types of real estate, small businesses, and other investments. Use them instead of looking at the recent past.
  1. Never judge an investment by the length of an unusual period – always view valuation measures. The longer the anomaly, the more violent the reversals tend to be, and the bigger the damage in counting on persistence after the anomaly sustained for a long time. If an anomaly continues another year, or multiple years, there is a growing temptation to take it as proof that it is a new normal, and so does the damage, when the reversal does come. You can observe the returns of Japanese stocks for nearly 30 years after 1989, or gold for nearly 30 years after 1980.
  1. Imagine that a diversified investment you are considering went through 10 terrible or phenomenal years of returns. If the terrible years make you want to avoid the investment and the phenomenal years make you want to put money there, recognize that you may have fallen into the traps above. Go back to logic, valuation measures and full cycles.

Quiz Answer

You hold a diversified investment that performed poorly for 10 years and want to make a change. What should you do? (Multiple answers may be correct.)

  1. Very gradually diversify into more proven investments.
  2. Very gradually diversify by including stable investments.
  3. Compare the valuation of the investment along with the investment you are considering for diversification, and avoid selling low to buy high. [Correct Answer]
  4. Compare the valuation of the investment relative to the long run, and also the returns relative to full cycles. If both are below typical, don’t make changes, and keep saving new money into it. [Correct Answer]
  5. Track the valuations and recent performance relative to the long run / full cycles. Be ready to diversify from a point of strength – at a high point, adding investments that are not at a very high point. [Correct Answer]
  6. Avoid making changes due to cyclical forces. [Correct Answer]

Explanations:

  1. You already hold a diversified investment. Not all extra diversification is good. If you sell low to buy high, the added risk and harm to the expected returns can outweigh the benefits of extra diversification. See all explanations below to help decide. Also note that reversals after 10 unusual years are the norm, not the exception.
  2. Buying a stable investment can prevent the damage of buying high in #1, but it still keeps the potential damage of selling low, and introduces the additional damage of low growth (that is typical for stable investments).
  3. Future returns do not always repeat recent years – reversals are the norm. A much better predictor of future returns is valuations (P/E, P/B, various real estate ROI and affordability measures). Valuations may fail for a streak of years, testing the discipline of investors, but the longer they fail the bigger the reversal tends to be. It is difficult to win by buying high.
  4. See explanation right above + stick to the foundations: high long-term returns for the asset class in which you are investing.
  5. See explanations above + you can add diversification without the damage of selling low and buying high, by being as patient as needed. Being impatient with this can create lifelong damage.
  6. There is always a compelling story justifying low points. While it may explain the past, it may not explain the future. Be extra wary of mistaking cyclical forces for permanence – it may be the most common mistake that people do at extremes (lows and highs).
Disclosures

How Do Tech Bubbles Pop?

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Quiz!

How long did it take the Nasdaq to reach a new peak after the 3/10/2000 peak?

  1. It kept on going up – the Nasdaq doesn’t decline given the solid technologies produced by the companies in it
  2. 3 years
  3. 6 years
  4. 10 years
  5. 14 years
  6. It is unknown yet – it is still recovering.

How Do Tech Bubbles Pop?

On 1/27/2025, Nvidia and Broadcom stocks declined 17%. Why would the stocks of two of the leading AI companies in the world get hit so hard? This was in response to Chinese DeepSeek’s AI competing with ChatGPT, while its API access (access for programmers) is offered at less than 1/50th (2%) of the price of the ChatGPT API.

This is a common step in tech bubbles, going at least as far as the Roaring 1920’s (commercialization of the radio, TV and more) that were followed by the Great Depression. Here are typical phases of tech bubbles, from formation to popping:

  1. A new technology is introduced offering great value.
  2. As the technology gets demonstrated and improved, adoption increases, providing great profits to the companies offering it.
  3. The stock prices of companies offering the technology increase given their profitability.
  4. At some point, many investors buy the stocks given past returns and the future promise, while ignoring valuations, such as Price relative to Earnings and Book Value (P/E and P/B). That is when the gains form a bubble and can be seen with a spike in valuations.
  5. In the meantime, two effects happen:
    1. Economies of scale lower the cost to produce products with the technology.
    2. Competition, with a focus on efficiencies, offers the technology at much lower costs.
  6. As competition increases and costs go down, the entire industry lowers the prices. This includes the original companies offering the technology.
  7. With much lower prices, profitability of the producers of the new technology goes down, and the prior valuations become disconnected from reality, leading them to decline.
  8. That leads to a crash in those technology stocks, all while offering a very valuable service.
  9. While there is a logical progression, the timing isn’t easy to identify in advance.

Was 1/27/2025 the peak of the current tech bubble? It is tough to say, before reaching the depths of the decline. In 2022, we got a false peak with the tech-heavy Nasdaq declining a mere 33% (vs. the 78% decline in the dot-com crash that started in 2000). After 1 year, it bottomed and reached new highs less than 2 years later.

Once the real decline starts, how long can it take to recover? As typical, there are no guarantees in investing. Having said that, there has been a correlation between the excess valuations (relative to the typical) and the length of the decline.

  1. In the 2000’s the S&P 500 took over 10 years to recover, with a 30% decline a decade after its peak.
  2. In 1989 Japan reached significantly higher valuations that led to a decline to recovery of over 30 years, given much higher peak valuations.
  3. Fast-forward to 2025: The P/B (or Price/Book) of the S&P 500 on 1/27/2025 was slightly higher than the highest point in 2000, so another “lost decade” shouldn’t surprise us.

Quiz Answer:

How long did it take the Nasdaq to reach a new peak after the 3/10/2000 peak?

  1. It kept on going up – the Nasdaq doesn’t decline given the solid technologies made by the companies in it
  2. 3 years
  3. 6 years
  4. 10 years
  5. 14 years [The Correct Answer]
  6. It is unknown yet – it is still recovering.

Explanation: The Nasdaq declined by 78% over a span of 2 years and 7 months, followed by a long road to recovery, with a total of 14 years peak-to-peak.

Disclosures

Addressing Inflation: A Risk That Time Can’t Cure!

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Quiz!

What is the effect of 3% inflation over 24 years on your purchasing power?

  1. 0% – the purchasing power stays the same.
  2. 20% – it increases my purchasing power.
  3. -20%
  4. -50%
  5. -60%

Addressing Inflation: A Risk That Time Can’t Cure!

Most investments have occasional declines, sometimes lasting multiple years. As long as you are reasonably diversified, and don’t depend on a high withdrawal rate from your investments, you are likely to recover from declines and reach new highs over time.

There is one investment risk that doesn’t go away and grows with time – inflation. It is not just a risk – it’s a fact of life that doesn’t go away (with rare typically short-lived exceptions of deflation). To make matters worse, it compounds over time, rivaling the worst investment declines. A few examples:

  1. A moderate 3% inflation rate leads to a 50% irreversible decline in your purchasing power, compounded every 24 years.
  2. A person retiring in 8/1972 got 8.81% inflation over 10 years, equaling a 57% decline in purchasing power.
  3. A person retiring in 2/1966 got 6.38% inflation over 20 years, equaling a 71% decline in purchasing power.

This is especially important for retirees who depend on their savings to support their expenses for as long as they live.

What are examples of investments that are at risk with sustained inflation? Growth (high Price/Book) stocks, CDs (Certificates of Deposit), most bonds, cash.

What are examples of investments that may provide growth beyond sustained inflation? Value stocks, real estate.

While this article suggested tools to handle inflation, there are other risks to investing. They require a well-formed plan that considers your entire picture and specific goals.

Quiz Answer:

What is the effect of 3% inflation over 24 years on your purchasing power?

  1. 0% – the purchasing power stays the same.
  2. 20% – it increases my purchasing power.
  3. -20%
  4. -50% [The Correct Answer]
  5. -60%

Explanation: When compounding 3% annual increases 24 times, we get slightly over 100%. With products costing twice, it’s the equivalent of losing half of your purchasing power, or: -50%.

Disclosures

A Hidden Benefit of Roth IRAs

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Quiz!

When can you withdraw Roth IRA contributions without penalties?

  1. When your Required Minimum Distributions (RMD) start: age 72 or older
  2. Age 59½
  3. 5 years after the contribution
  4. 5 years after opening the Roth IRA
  5. Immediately
  6. Never

A Hidden Benefit of Roth IRAs

There are plenty of articles that talk about tax benefits of Roth IRAs. But, there is a benefit that can shine if used correctly:

  1. You can withdraw the contributions (as opposed to earnings) right away without penalties!
  2. You can also withdraw amounts that were converted to Roth IRA penalty-free, 5 years after each converted amount.

How can you use this benefit?

  1. As soon as you start earning income (whether you are 25 or 10 years old), put the maximum allowed into a Roth IRA, unless you are certain to spend it soon. If you don’t have enough low-volatility reserves outside the Roth IRA, keep building them inside the Roth IRA.
  2. If your income is too high, you can contribute to a Traditional IRA and immediately convert to Roth IRA, regardless of your income (nicknamed Backdoor Roth).
  3. If you have enough reserves (in taxable accounts + Roth IRAs), maximize your employer retirement contributions (e.g. 401k or 403b), putting the employee contributions into Roth (e.g. Roth 401k), if possible.
  4. The point above applies also if you are self-employed – you can maximize contributions to a Solo-401k, adding large employer contributions.
  5. Whenever you switch jobs, you can rollover your 401k or 403b to a [Roth] IRA, and convert the IRA to Roth IRA. For large balances, you can spread the conversion over multiple years, emphasizing years with low taxable income, to lower the effective income tax rate. Once in Roth IRA, it becomes available for withdrawal penalty free after 5 years.
  6. Count your Roth IRA contributions (not earnings) immediately & conversions (after 5 years) as part of your cash reserves, by calculating a sustainable withdrawal rate from them (typically 3%-4% for stock portfolios). For example, if you contributed a total of $100,000, you can count $3,000 or $4,000 of it as part of your cash reserves.
  7. There are a number of ways to access your Roth IRA earnings, without penalties. They are covered in many articles, but I will point out an important one: substantially equal periodic payments. It requires a commitment to withdrawals for 5 years, and at least until age 59½, so wait to use it after depleting all other sources (all money outside retirement accounts + all principal contributions to the Roth IRA). The nice thing is that it creates lifelong income, similar to the manufactured approach I described for the Roth IRA contribution right above.

Quiz Answer:

When can you withdraw Roth IRA contributions without penalties?

  1. When your Required Minimum Distributions (RMD) start: age 72 or older
  2. Age 59½
  3. 5 years after the contribution
  4. 5 years after opening the Roth IRA
  5. Immediately [The Correct Answer]
  6. Never

Explanation: You can withdraw Roth IRA contributions (not the earnings on them) without penalties right after making the contribution, with no delay, regardless of your age. See this month’s article for how to use this to your benefit.

Disclosures

A Strategy to Increase your Investment Growth without Sacrificing Security

by

Quiz!

What are the benefits of high investments in a diversified stock portfolio relative to withdrawals? (Multiple answers may be correct)

  1. They help get freedom from work.
  2. They add to your cash reserves, dollar for dollar.
  3. You can count a small portion of them as part of your cash reserves.
  4. They provide a potential snowball of accelerated increase in your wealth.

A Strategy to Increase your Investment Growth without Sacrificing Security

In a perfect world, you would allocate all of your money to high growth investments, to maximize the speed of building wealth. The issue is that growth comes with volatility, and you may need your money during a big decline for your investments. Examples for needs are a loss of job, a downturn for your business, buying a house, and the biggest of all – retirement. Common solutions involve a money market account, bonds and other low-volatility investments, that come with lower growth.

Is there a better solution? It turns out that there is another solution that lessens the compromises – a low withdrawal rate from a diversified stock portfolio. A diversified stock portfolio with a low withdrawal rate of 3%-4% may grow faster than cash or bonds when subject to the same withdrawal rate.

How do you get there?

  1. Build stable reserves to survive tough situations that are out of your control.
  2. Beyond that, invest in a diversified stock portfolio.
  3. Using a likely sustainable withdrawal from the stock portfolio (typically 3%-4%), reduce your reserves by that amount, moving it into the stock portfolio. You can check periodically (e.g. quarterly), and move the money whenever your investments grow relative to your spending (through any combination of new savings and investment growth).

This strategy creates a positive snowball: The more you have in stock investments, the more you can shift from the reserves to them. This accelerates the growth of your money, which allows to move more from your reserves to stocks.

Depending on how early you start, and how flexible you are with your spending, you may be able to reach 100% allocation to stocks before retirement, allowing you to sustain it for life. This can result in some combination of:

  1. Growing security (the fixed dollar withdrawal becomes a decreasing percent from a larger pot).
  2. Higher available spending (keeping the same withdrawal rate = a higher dollar amount, as the portfolio grows).

What is the catch? There are several catches:

  1. You have to stay perfectly disciplined with your strategy. It is tempting to sell low or put new savings elsewhere, when the news is grim. This can revert the entire long-term benefit.
  2. The plan is designed to allow selling a likely sustained portion (e.g. 3%-4% per year) for spending needs. This is fine as long as the needs have nothing to do with the investment performance. You may be tempted to sell low, to invest elsewhere. This is not a spending need, and if you are tempted to do that at low points, you are better off seeking a different plan in the first place.
  3. You may underestimate the needed reserves, or simply be surprised by something unplanned. As long as it comes at a normal point for the stock portfolio, there is no problem. But, it can hurt you during deep declines. Try to be realistic.

Quiz Answer:

What are the benefits of high investments in a diversified stock portfolio relative to withdrawals? (Multiple answers may be correct)

  1. They help get freedom from work. [Correct Answer]
  2. They add to your cash reserves, dollar for dollar.
  3. You can count a small portion of them as part of your cash reserves. [Correct Answer]
  4. They provide a potential snowball of accelerated increase in your wealth. [Correct Answer]

Explanation:

  1. They can cover your expenses while not working. If they are big enough, the investment growth/income can support long periods without work.
  2. Investments can be volatile, so you cannot assume that the full amount will be available for you at any point.
  3. You can count a likely sustainable withdrawal rate (typically 3%-4%) as part of your reserves, since that amount is likely to be there for you even during deep declines. Read this month’s article to learn more.
  4. Investments tend to grow by some percent on average. As the investments grow, a fixed percentage of larger pots becomes a large amount.
Disclosures