How to build a portfolio that can handle any crisis

From Brian Hunt and Ben Morris, DailyWealth Trader: 

Did last week’s market volatility stress you out?

Did it make you worry about your retirement portfolio?

If you answered “yes” to either question, it means you’re human… And you probably have too much money in stocks.

Or, maybe you simply have too much money in the wrong stocks.

Either way, today we’ll show you how to fix this problem…

One of the most important reasons to build wealth is to reduce your worry… to reduce your stress levels. If you’re glued to your computer every day, sweating each 1% or 2% move in the markets, something is wrong with your approach. It’s time to adjust your “catastrophe-prevention plan.”

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, we suggest using intelligent position sizes and stop losses. For your overall portfolio, we suggest conducting regular position audits.

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 number one goal with asset allocation is to avoid making huge bets in just one asset class.

For example, many Enron employees suffered huge hits when the company went bankrupt in 2001. They kept all or most of their retirement account in Enron stock. They made huge asset allocation errors. They “bet the farm” on one horse (which turned out to be a loser).

People who borrowed lots of money to speculate in real estate back in 2006 were wiped out when housing prices collapsed. They bet it all on one idea and lost everything. The same goes for people who bet everything on tech stocks in 2000.

Again, when it comes to asset allocation, you want to spread your wealth around a handful of good ideas. That way, you’re not vulnerable to losing everything if one idea doesn’t work out. You want to own some cash… some shares of valuable businesses… some real estate… And so on. You want a wealth fortress that sits on a sturdy, diversified foundation.

When you practice sound asset allocation, you often have some holdings that “zig” when other holdings “zag.” This makes it so a small market pullback will barely register on your radar… And in the case of an all-out financial storm (like many are predicting right now), you’ll prevent catastrophe.

There’s no “one size fits all” asset allocation plan. Different people have different financial goals… different obligations… and different risk tolerances.

However, we can follow a general plan of staying diversified… and staying safe. We can spread our wealth across various asset classes. Here is a “middle of the road” plan that 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 and it gives you some diversification outside of stocks.

Today, we like municipal bond funds like the Nuveen Municipal Opportunity Fund (NIO). Munis still have a relatively high yield (NIO yields 6% today)… The income is free from federal taxes… They have historically low default rates, which makes them safe… And if you buy a “closed-end fund,” you can often buy them at discounts to their underlying values.

Since we recommended buying NIO in DailyWealth Trader in October 2013, we’ve collected 9% in tax-free income… And we’re up 17% on share-price gains.

We also hold a leveraged U.S. Treasury fund (UBT) in the DailyWealth Trader portfolio. It provides diversification… but not much income. This trade was meant to profit as interest rates fell… And it has worked out great. (We’re up more than 40% since April.)

Precious metals (5%-10%)

Gold, silver, platinum, and palladium could soar during a financial crisis. We suggest owning some physical metals in coin or bar form. And sometimes, it makes sense to own shares of precious metal miners and royalty companies. You can read about gold as disaster insurance right here.

Cash (10%-20%)

Cash is “dry powder”… It allows you to buy bargains if they appear. This is the cash in your bank account and your brokerage account. And you might even hold some in foreign currencies.

This is an extremely important part of your catastrophe-prevention plan. So important, our colleague Dr. David Eifrig dedicated the most recent issue of his Income Intelligence advisory to how you should hold cash. (It’s called “The Cash Issue,” and it’s exceptional.) If you aren’t a subscriber, this issue alone is worth the cost of a year’s subscription. You can learn how to get access here.

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.

You might consider stocks that own or are involved in real estate part of this allocation, too.

Stocks (20%-30%)

Over the long term, stocks have averaged returns around 9% 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). You can buy domestic stocks and foreign stocks. You can buy individual names or simply own an index fund that holds lots of different companies.

Trading for income” (our term for selling options on great, cheap companies) also fits into this category. Since launching DailyWealth Trader in May 2012, our closed trades using this strategy have averaged 13.5% annualized returns.

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).

Again, keep in mind there’s no such thing as a one-size-fits-all asset allocation… 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.

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.

Again, the key is to not bet it all on one type of investment. Don’t make the insane mistake of betting your retirement all on one company… or all on the stock market.

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.

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