When you read in the news that a person whom you know as rich and wealthy is in financial trouble or has declared bankruptcy, it is easy to feel a sense of futility about managing your own money. You start to think that if such a rich person, who has access to the best financial advice, can come to this state, what chance do I have?
If you read deeper into his or her story you will find that he has come to this state because he violated some basic rule of life. The Golden Rules of Financial Safety of Harry Browne are the basic rules for financial success. They are simple and obvious and if you abide by them, there is less chance than one in a million that you could lose all that you have….
Let us learn what they are…
Rule 1: Your career provides your wealth
Build your wealth upon your career.You most likely will make far more money from your business or profession than from your investments. Only very rarely does someone make a large fortune from investments.
Your investments can make your future more secure and your retirement more prosperous. But they can’t take you from rags to riches. So don’t take risks with complicated schemes in the hope of multiplying your capital quickly. Your investment plan should be aimed, first and foremost, at preserving what you have—preserving it from investment loss, government intervention, or mismanagement.
Most part-time investors who try to beat the markets lose part or all the savings they’ve worked so hard to accumulate.
Can you make big profits by relying on an expert who does have the proper qualifications? How do you find a true expert? That task is no easier than picking the right investments. If you don’t understand investing as well as the pros, you won’t know how to check those who seek to advise you. And you can’t rely on an advisor’s track record, even when it’s presented honestly. Track records tell you only how advisors did in the past – not how they will do next year.
You’re violating Rule #1 if you think your investments can be the sole source of your retirement wealth – or if you steal time from your work to manage your investments – or if you think about abandoning your job to become a full-time investor.
Your Wealth May Be Non-Replaceable
Rule 2: Don’t assume you can replace your wealth.
The fact that you earned what you have doesn’t mean that you could earn it again if you lost it. Markets and opportunities change, technology changes, laws change. Conditions today may be considerably different from what they were when you built the estate you have now. And as time passes, increasing regulation makes it harder and harder to amass a fortune.
So treat what you have as though you could never earn it again. Don’t take chances with your wealth on the assumption that you could always get it back.
You earned your wealth because your talent and effort harmonized with the circumstances in which you found yourself. But the world won’t stand still for you or repeat itself when you need it to.
So assume that what you have now is irreplaceable, that you could never earn it again – even if you suspect you could.
Say “No!” to any proposition that asks you to risk losing it.
Investing vs. Speculating
Rule 3: Recognize the difference between investing and speculating.
When you invest, you accept the return the markets are paying investors in general. When you speculate, you attempt to beat that return — to do better than other investors are doing — through astute timing, forecasting, or stock selection, and with the implied belief that you’re smarter than most other investors.
You’re speculating when:
- You select individual stocks, mutual funds, or stock market sectors you believe will do better than the market as a whole.
- You move your capital in and out of markets according to how well you think they’ll perform in the near future.
- You base your investments on current prospects for the nation’s economy.
- You use fundamental analysis, technical analysis, cyclical analysis, or any other form of analysis or system to tell you when to buy and sell.
There’s nothing wrong with speculating — provided you do it with money you can afford to lose. But the money that’s precious to you shouldn’t be risked on a bet that you can outperform other investors.
Forecasting the Future
Rule 4: No one can predict the future.
Beware of fortune tellers.
Events in the investment markets result from the decisions of millions of different people. Investor advisors have no more ability to predict the future actions of human beings than psychics and fortune-tellers do. And so events never unfold as we were so sure they would.
Yes, there have been forecasts that came true. But the only reason we notice them is because it’s so exceptional for even one to come true. We forget about all the failed predictions because they’re so commonplace.
No one can reliably tell you what stocks will do next year, whether we’ll have more inflation, or how the economy will perform.
As with the rest of your life, safety doesn’t come from trying to peer into the future to eliminate uncertainty. Safety comes from devising realistic ways to deal with uncertainty.
We live in an uncertain world – and that no one can eliminate the uncertainty for you.
Look for ways to assure that the uncertain future won’t hurt you – no matter what it turns out to be.
Rule 5: No one can move you in and out of investments consistently with precise and profitable timing.
Don’t expect anyone to make you rich. You’ll hear about many Wall Street wizards, but the investment advisor with the perfect record up to now most likely will lose his touch the moment you start acting on his advice.
Investment advisors can be very valuable. A good advisor can help you understand how to do the things you know you need to do. He can help call your attention to risks you may have overlooked. And he can make you aware of new alternatives.
The Helper (accountant, etc) is worth listening to. He or she can acquaint you with investment alternatives you weren’t aware of, and that might be a good fit for you. He can teach you the mechanics and procedures for getting things done in the investment world. He can raise the questions you need to answer in order to devise a portfolio that suits your needs. He can help you reduce the tax bill on your investment profits.
You don’t act on the advice of someone you never heard of. And you hear of him only after – and because – he has made several profitable recommendations in a row.
The investment expert with the perfect record up to now will lose his touch as soon as you start acting on his advice.
But no one can guarantee to have you always in the right place at the right time. And worse, attempts to do so can sometimes be fatal to your portfolio.
Rule 6: No trading system will work as well in the future as it did in the past.
You’ll come across many trading systems or indicators that seem always to have signaled correctly where your money should have been, but somehow the systems never come through when your money is on the line.
Trading systems generally arise from one of two sources.
The first source is a commonsense observation about human behavior – which someone then tries to transform into a quantifiable, mechanical system.
For example, Contrary Opinion is a theory that says, among other things, that an investment is likely to be near its peak when everyone seems to know how good its prospects are.
The idea makes some sense. If everyone already knows something is a good investment, most people who are likely to buy it probably already have done so – leaving very few investors to buy it and push its price still higher.
In such a case, you should be skeptical about its prospects as a speculation.
But that doesn’t mean we know precisely when or at what price the investment will peak. You know only that there doesn’t seem to be room for the price to go much higher.
But people who devise trading systems aren’t satisfied with anything so indefinite. They devise indicators to measure the precise degree of bullishness and bearishness surrounding a specific investment – and then construct formulas that provide specific signals for buying and selling.
This is similar to taking an obvious truth – such as that attendance at sporting events is generally smaller on rainy days than on sunny days – and constructing a formula that supposedly translates the number of inches of rainfall into an exact forecast of the attendance.
The second source is probably finding something that has worked in the past and assuming it will work in the future. Trading systems are based on the unstated assumption that the world doesn’t change. But the world is in constant change – as desires change, demand changes, and supplies change.
Operate on a Cash Basis
Rule 7: Don’t use leverage.
When someone goes completely broke, it’s almost always because he used borrowed money. In many cases, the individual was already quite rich, but he wanted to pyramid his fortune with borrowed money.
Using margin accounts or mortgages (for other than your home) puts you at risk to lose more than your original investment. If you handle all your investments on a cash basis, it’s virtually impossible to lose everything—no matter what might happen in the world—especially if you follow the other rules given here.
Make Your Own Decisions
Rule 8: Don’t let anyone make your decisions.
Many people lost their fortunes because they gave someone (a financial advisor or attorney) the authority to make their decisions and handle their money. The advisor may have taken too many chances, been dishonest, or simply incompetent. But, most of all, no advisor can be expected to treat your money with the same respect you do.
You don’t need a money manager. Investing is complicated and difficult to understand only if you’re trying to beat the market. You can preserve what you have with only a minimum understanding of investing. You can set up a worry-proof portfolio for yourself in one day — and then you need only one day a year to monitor it. Allowing the smartest person in the world to make your decisions for you isn’t nearly as safe as setting up a safe portfolio for yourself.
Above all, never give anyone signature authority over money that’s precious to you. If you should put money into an account for someone else to manage, it must be money you can afford to lose.
Understand What You Do
Rule 9: Don’t ever do anything you don’t understand.
Don’t undertake any investment, speculation, or investment program that you don’t understand. If you do, you may later discover risks you weren’t aware of. Or your losses might turn out to be greater than the amount you invested.
It’s better to leave your money in Treasury bills than to take chances with investments you don’t fully comprehend. It doesn’t matter that your brother-in-law, your best friend, or your favorite investment advisor understands some money-making scheme. It isn’t his money at risk. If you don’t understand it, don’t do it.
Rule 10: Don’t depend on any one investment, institution, or person for your safety.
Every investment has its time in the sun — and its moment of shame. Precious metals ruled the roost in the 1970s while stocks and bonds were in disgrace. But then gold and silver became the losers of the 1980s and 1990s, while stocks and bonds multiplied their value. No one investment is good for all times. Even Treasury bills can lose real value during times of inflation.
And you can’t rely on any single institution to protect your wealth for you. Old-line banks have failed and pension funds have folded. The company you think will keep your wealth safe might not be there when you’re ready to withdraw your life savings.
We live in an uncertain world, and surprises are the norm. You shouldn’t risk the chance that a single surprise will wipe out a large part of your holdings.
Diversify across investments and institutions – and keep things simple enough to manage yourself – you can relax, knowing that no one event can do you in.
Rule 11: Create a bulletproof portfolio for protection.
For the money you need to take care of you for the rest of your life, set up a simple, balanced, diversified portfolio. I call this a “Permanent Portfolio” because once you set it up, you never need to rearrange the investment mix— even if your outlook for the future changes.
The portfolio should assure that your wealth will survive any event — including an event that would be devastating to any individual element within the portfolio. In other words, this portfolio should protect you no matter what the future brings.
It isn’t difficult or complicated to have such a portfolio this safe. You can achieve a great deal of diversification with a surprisingly simple portfolio.
The portfolio should assure that your wealth will survive any event – including events that would be devastating to any one investment.Three absolute requirements for such a portfolio are:
1. Safety:It should protect you against every possible economic future. You should profit during times of normal prosperity, but you also should be safe (and perhaps even profit) during bad times – inflation, recession, or even depression.
2. Stability:Whatever economic climate arrives, the portfolio’s performance should be so steady that you won’t wonder whether the portfolio needs to be changed. Even in the worst possible circumstances, the portfolio’s value should drop no more than slightly – so that you won’t panic and abandon it. This stability also permits you to turn your attention away from your investments, confident that your portfolio will protect you in any circumstance.
3. Simplicity:The portfolio should be so easy to maintain, and require so little of your time, that you’ll never be tempted to look for something that seems simpler, but is less safe.
You leave it alone – to hold the same investments, in the same proportions, permanently. You don’t change the proportions as you, your friends, or investment gurus change their minds about the future.
Your portfolio needs to respond well only to those broad movements. And they fit into four general categories:
1. Prosperity:A period during which living standards are rising, the economy is growing, business is thriving, interest rates usually are falling, and unemployment is declining.
2. Inflation:A period when consumer prices generally are rising. They might be rising moderately (an inflation rate of 6% or so), rapidly (10% to 20% or so, as in the late 1970s), or at a runaway rate (25% or more).
3. Tight money or recession:A period during which the growth of the supply of money in circulation slows down. This leaves people with less cash than they expected to have, and usually leads to a recession – a period of poor economic conditions.
4. Deflation:The opposite of inflation. Consumer prices decline and the purchasing power value of money grows. In the past, deflation has sometimes triggered a depression – a prolonged period of very bad economic conditions, as in the 1930s.
Investment prices can be affected by what happens outside the financial system – wars, changes in government policies, new tax rules, civil turmoil, and other matters. But these events have a lasting effect on investments only if they push the economy from one to another of the four environments I’ve just described. The four economic categories are all-inclusive. At any time, one of them will predominate. So if you’re protected in these four situations, you’re protected in all situations.
Thus four investments provide coverage for all four economic environments:
STOCKS take advantage of prosperity. They tend to do poorly during periods of inflation, deflation, and tight money, but over time those periods don’t undo the gains that stocks achieve during periods of prosperity.
BONDS also take advantage of prosperity. In addition, they profit when interest rates collapse during a deflation. You should expect bonds to do poorly during times of inflation and tight money.
GOLD not only does well during times of intense inflation, it does very well. In the 1970s, gold rose twenty times over as the inflation rate soared to its peak of 15% in 1980. Gold generally does poorly during times of prosperity, tight money, and deflation.
CASH is most profitable during a period of tight money. Not only is it a liquid asset that can give you purchasing power when your income and investments might be ailing, but the rise in interest rates increases the return on your dollars. Cash also becomes more valuable during a deflation as prices fall. Cash is essentially neutral during a time of prosperity, and it is a loser during times of inflation.
Any attempt to be clever in assigning portions to the investments probably will do more harm than good. I prefer the simplicity of allocating 25% to each of the four investments.
The only maintenance required is to check the portfolio’s makeup once a year.
If any of the four investments has become worth less than 15%, or more than 35%, of the portfolio’s overall value, you need to restore the original percentages.
When you make your once-a-year check of the portfolio’s value, if all four investments are within the 15-35% range, no rebalancing is necessary. During the year, if you happen to notice that there’s been a big change in investment prices, you may want to check the values of the investments. Again, if any investment has strayed outside the 15-35% range, go ahead and rebalance the entire portfolio.
The test of a Permanent Portfolio is whether it provides peace of mind. A Permanent Portfolio should let you watch the evening news or read investment publications in total serenity. No actual or threatened event should trouble you, because you’ll know that your portfolio is protected against it.
If someone warns about the “alarming parallels” between the current decade and the 1920s, you shouldn’t wonder whether you need to sell all your stocks. You’ll know that your Permanent Portfolio will take care of you – even if next year turns out to be 1929 revisited. The deflation that could devastate stocks would push interest rates downward and bring big profits for your bonds.
When someone claims the inflation rate is headed back to 15%, you shouldn’t wonder whether to dump all your bonds. You’ll know that the gain in your Permanent Portfolio’s gold would far outweigh any losses on the bonds.
When someone announces that a new debt crisis is on the way, or that a bull market is about to begin in stocks, bonds, or gold, you won’t feel pressured to decide whether he’s right. You’ll know that the Permanent Portfolio will respond favorably to any eventuality.
I can’t list every potential event. So if you become concerned by any possibility, reread this chapter and you should be reassured that there’s an investment in your Permanent Portfolio that will cover you if the worst should occur. Whatever the potential crisis or opportunity, your Permanent Portfolio should already be taking care of you.
The portfolio can’t guarantee a profit every year; no portfolio can. It won’t outperform the hotshot advisor in his best year. And it won’t outperform the best investment of the year. But it can give you the confidence that no crisis will destroy you, the assurance that your savings are secure and growing in all circumstances, and the knowledge that you’re no longer vulnerable to the mistakes in judgment that you or the best advisor could so easily make.
Rule 12: Speculate only with money you can afford to lose.
If you want to try to beat the market, set up a second — separate — portfolio with which you can speculate to your heart’s content. But make sure this portfolio contains no more of your wealth than you can afford to lose.
I call this second pool of money a “Variable Portfolio” because its investments will vary as your outlook for the future changes. It might be all or part in stocks or gold or something else — whatever looks good at any time — or just in cash. You can take chances with the Variable Portfolio because you know that, whatever happens, no loss can be devastating. You can lose only the money you’ve already decided isn’t precious to you.
Rule 13: Keep some assets outside the country in which you live.
Don’t allow everything you own to be where your government can touch it. By having something outside the reach of your government, you’ll be less vulnerable — and you’ll feel less vulnerable. You’ll no longer have to worry so much about what the government will do next.
For example, maintaining a foreign bank account is quite simple; it’s little different from having a mail or Internet account with an American bank or broker.
Keeping some investments abroad provides safe and easy protection against surprises that might happen anywhere – confiscation of gold holdings by the government, exchange controls, civil disorder, even war.
No one knows how the people elected in the coming years might choose to solve the economic problems the country will face. It might strike them that the quick and easy solution is to take your property – as has happened so often already. Your assets will be safe even if war, civil disorder, a weakening of law enforcement, or a physical catastrophe should disrupt record-keeping in your own country.
Your entire estate will no longer be vulnerable to economic, political, or legal setbacks in your own country.
Geographic diversification is a necessary part of making sure the Permanent Portfolio can handle whatever hazard materializes.
Rule 14: Beware of tax-avoidance schemes.
Tax rates are still low enough in the U.S. that you might gain very little from the risk and effort of constructing elaborate tax shelters. And a great deal of money has been lost by people who hoped to beat the tax system. The losses came from investments that provided special tax advantages but didn’t make economic sense, and from tax shelters that were disallowed by the IRS — incurring penalties and interest on top of the liabilities.
There are a number of simple ways available to minimize taxes — through such things as IRAs and 401(k) plans. Take advantage of these tax reduction plans. These plans are effective but non-controversial. They won’t come back to haunt you.Tax deferral is the basic method for reducing the tax burden on your investment program. With tax deferral, the money you don’t pay in taxes today can work to produce more earnings every year until you finally have to pay the tax.
Rule 15: Ask the right questions
In what economic circumstances is the investment’s price likely to go down?
Are other investments in your portfolio likely to take up the slack by gaining in those same circumstances?
Under what circumstances could I lose a substantial share – 20% or more – of my investment?
Under what circumstances could my entire investment be lost?
Would I have any residual liability – that is, can I lose even more than the cash I invested?
Interest rates generally reflect an investment’s risk. A higher interest rate means there’s a greater possibility the capital can be lost – through default or inflation.
Under what circumstances, if any, is the investment likely to appreciate?
Under what circumstances, if any, is the investment likely to depreciate?
In good circumstances for the investment, will the overall return – yield plus capital appreciation – help your portfolio overcome losses in other investments?
If the investment is a mutual fund, you want the fund with the lowest yield – other things being equal. Any dividend paid by a mutual fund simply reduces the price of your shares
“Is this company a potential takeover candidate?”
The crowd isn’t always wrong, but you can’t make much betting with it – because you will buy at a price that’s already high. By going against the crowd, you buy when an investment is out of favor and cheap; if it does succeed, there’s a long way for it to go up. So the most important factor in speculating is whether you expect something that most people don’t expect. For example, the time to consider buying inflation hedges speculatively is when most people believe inflation is under control. The time to consider buying a particular company is when everyone knows what a dog it is – not when everyone talks about its great promise. Unpopularity doesn’t guarantee profits, but you’ll never make a killing with a popular investment.
“Do the technical factors favor the investment now?”
You must have an investment plan. Without a plan, you will be tossed and turned by all the conflicting ideas you read and hear- – and you’ll never ask the right questions. With a plan, you’ll have a basis for evaluating whatever you hear. You’ll know to ask the questions that help you determine whether an investment furthers your plan.
Rule 16: Enjoy yourself with a budget for pleasure.
Your wealth is of no value if you can’t enjoy it. But it’s easy to spend too much while the money’s flowing in. To enjoy your wealth, establish a budget of money that you can spend yearly without concern. If you stay within that amount, you can feel free to blow the money on cars, trips, anything you want — knowing that you aren’t blowing your future.
When in Doubt . . .
Rule 17: Whenever you’re in doubt about a course of action, it is always better to err on the side of safety.
If you pass up an opportunity to increase your fortune, another one will be along soon enough. But if you lose your life savings just once, you might never get a chance to replace it.
If you wind up losing something, let it be only an opportunity that was lost – not precious capital. People rarely go broke playing it safe. But many go broke taking great risks or making investments they know too little about.
If you’re hesitating, it’s because you don’t yet know enough about the investment or the problem to make a confident decision. That means you shouldn’t take the plunge until you know more and you’re sure you understand all the ramifications.
The premise for speculation is that you’re more astute than most other investors – that you understand the market better, that you have information not available to other investors, that you can make better decisions, or that your interpretation of available information is especially perceptive. The elements of speculation are timing, forecasting, trading systems, and selection. Any time you use any of these tactics you’re speculating.
Investment forecasts can be exciting. But in other areas of our lives, we think of fortune-tellers as entertainers.
Forecasts are not entirely useless. Someone’s predictions can help you recognize that your own expectations for the future aren’t the only possible outcome. This can help keep you humble and prudent.
If you come to feel a given event is quite possible but most people disagree with you, the market probably will provide a big payoff if you bet on that event and prove to be right. So if you like to watch the investment markets closely and you see a potential future that most people are ignoring, you may want to make a small speculation with money you can afford to lose.
A sure way to lose what you’ve accumulated is to risk the funds that are precious to you on the idea that some event is inevitable.
In 1970, the chief gold trader at the largest Swiss bank told a friend of mine that the gold price would never go above $40. When asked how he could be so sure, the trader replied, “Because we control the market.”
“Insiders” are no more help than fortune tellers or high-priced pros.
You can protect yourself against the possibility of institutional crisis by using more than one institution. You can protect yourself against the failings of individuals by relying only on yourself. And you can protect yourself against investment roller coasters by diversifying across investment markets.
Split the 25% stock-market portion among three mutual funds.
For the bond portion, you don’t want to have to monitor credit risk, so buy only U.S. Treasury bonds. So long as the U.S. government has the ability to tax people or print money to pay its bills, there is virtually no credit risk.
Put the 25% in the Treasury bond issue that currently has the longest time until it matures. That will be close to 30 years. Ten years later, the bond will have only 20 years to maturity; at that time replace it with a new 30-year bond.
Buy bullion coins – coins whose only value is the gold bullion they contain. They sell for about 3-5% more per ounce than gold bullion. That means a one-ounce coin will sell for about $310-$315 if the price of gold is $300 an ounce.
The cash portion should be kept in a money market fund investing only in short-term U.S. Treasury securities, so that you don’t have to evaluate credit risk. These securities are safer than bank accounts and other debt instruments. If your cash budget is large enough, divide your holdings between two or three funds – for further protection against the unthinkable.
The value of real estate in your portfolio is indivisible, and everything else must accommodate it. Just like a 15-foot piano in the living room, you have to arrange the rest of the furniture around it.
Your house is a consumption item – the place where you live and enjoy your life.
Don’t play games with your Permanent Portfolio. Don’t wait for any investment to become cheaper before you buy it. And don’t go overboard investing in something that happens to be doing well now. Just put 25% in each of the four categories.
No matter how strong your expectations about the near future, you could easily be mistaken. And the point of the Permanent Portfolio is to ignore your own expectations and let the portfolio take care of you no matter what may come.
Fund it with equal portions of all four investments and don’t worry over which is going to do best. It is a package of investments that provides the safety you need. Tear apart the package and you tear apart the safety.
A foreign account in any country outside your own is a tremendous improvement over having everything in your home country. But some countries are more hospitable than others. And some have legal traditions that protect your privacy. I’ve always been partial to Switzerland and Austria, because each has a centuries-old tradition of respecting privacy and fending off inquiries from other governments.
If you buy and hold gold through the foreign bank, the gold most likely will be stored within the bank itself.
The secret – that things rarely work out as expected – is shared unwittingly by investors, brokers, advisors, newsletter writers, and financial journalists, few of whom can bring themselves to acknowledge it. Each wants to appear to be in command of the situation, on top of the markets, aware of what’s happening and what’s going to happen – and to appear as though everything that has already happened was anticipated. A professional needs to keep up this guise because he must look sharper than his competitors. Even investors often pose as members of the all-knowing – perhaps because no one wants to appear to be the only loser, and everyone else seems to be so smart.
When you give up the search for certainty, an enormous burden is lifted from your shoulders.
The less you know – and the more honestly you recognize the limits of your knowledge – the more likely your investment program will turn out okay. Humility is accepting that you don’t know everything, or even everything about any particular topic, and it is an investor’s most vital asset. Arrogance eventually ruins any investor.
The Rules of Life
The rules of safe investing are little different from the rules of life: recognize that you live in an uncertain world, don’t expect the impossible, and don’t trust strangers. If you apply to your investments the same realistic attitude that produced your present wealth, you needn’t fear that you’ll ever go broke.