monoblog

Here is an email I wrote to a friend regarding short term investments:

Knowing the time horizon and your risk aversion is key. Because you aren't sure about whether you're buying a house yet though, I'll list a couple options based on the time frames given.

If you decide soon that you want to get a house in a few months, I would say either a 3- or 6-month CD would work well as you are guaranteed around 3.5-4% annually. It's not a fantastic return but it is nearly risk free. Check out BankRate.com for possible places to buy one. Any other investment that could return higher could also return significantly lower in the short term, or even result in losing money. Also, if you go the CD route, make absolutely sure you are dealing with a reputable bank, as there is the chance that we will see one or more bank runs this year.

If you want to postpone getting a house (more on the topic below), you may want to consider setting up a brokerage account and investing all of your available money into the Permanent Portfolio fund, which has the ticker PRPFX. This mutual fund invests evenly into four different types of assets: gold, U.S. Treasury bonds, Swiss franc denominated bonds and natural resource stocks. It is an eclectic mix that works surprisingly well in nearly all economic conditions – of the 25 years the fund has been around, it has only dropped in price for 3 years. Also if you graph the fund over time (using Yahoo Finance or a similar website) you will notice that it gains in price in a very consistent manner. For the past 10 years the annualized return has been 9.3% and over the past 5 years the annualized return was 13.1%. For any time period over 1 year I think this is the way to go. The gold and natural resource components of this fund should do very well in the coming year for the following reasons:

• The Federal Reserve is lowering interest rates drastically. This is making money easier to borrow, which increases the money supply and devalues the currency. See this graph for a graph of the U.S. dollar compared to a basket of other world currencies. In addition to the lower Fed rates, the fiscal stimulus package that Congress and the White House passed through will serve to further devalue the currency and result in inflation. In this situation, precious metals such as gold and natural resources tend to do well because they are good inflation hedges. However, both of those types of investments can have corrections of 10-20% in short time frames so I would only recommend them for longer-term investing. In terms of the Permanent Portfolio fund, the 1/4 weighting of each asset type would shield against these sorts of drops in the longer term (>=1 year).
• As long as the Fed lowers rates, the dollar will drop and the price of gold will increase... So the gold portion of the Permanent Portfolio I mentioned earlier will stand to do well as long as that trend continues. If you want to learn more about that portfolio and why it works so well, look at the book "Fail Safe Investing in 30 Minutes" by Harry Browne. It's available on Amazon.com for a couple dollars. Also I highly recommend reading "Barron's Guide to Making Investment Decisions" – it is $0.01 on Amazon... It is a little old but it still has a *lot* of good info. It is the book that got me started.
• Also important to note is that inflation is not being reported accurately by the government. There are numerous adjustments to the consumer price index such that it is being reported lower than it actually is. For example, ground beef is used instead of steak. Also, housing and energy are not included in the CPI because they are considered "too volatile". Because inflation is not being reported correctly, any investment tied to the CPI (bonds such as Treasury Inflation Protected Securities or TIPS for short) are bound to perform poorly despite their advertised merits. See ShadowStats.com for more info on the CPI and rate of inflation is based on the government's prior way of calculating it. If your investment isn't exceeding the true rate of inflation, you're losing money. Even a CD with 4% yield will not overcome the result of true inflation, but in reality no short term investment does.

The reason why I am against buying a home right now is that home prices are most likely going to drop significantly over at least the next 1-2 years. Merrill Lynch is predicting a 15% drop in 2008 and a 10% drop in 2009, which would make for a terrible investment, especially considering the leverage involved. The number of properties entering foreclosure, as well as the excess supply of new housing, tells me there is still significant downward pressure on home prices.

Here is an Excel file I made that comprehensively compares renting vs. buying. It also compares which option is cheaper and optionally invests the difference so you can get a better apples-to-apples comparison. If you enter in an annual drop in home prices, it shows that it would be a poor investment because of the leverage of a mortgage.

Another really good idea you may want to consider is opening an account at EverBank.com. In addition to being able to open a gold storage account, they have foreign currency CDs and other interesting investment opportunities. Their commodity CD holds CDs in four different currencies that are closely tied to the price of commodities... It is currently returning 5.4% annually. Another good one is the South African rand single-country CD – it returns 8.5% annually. About the only risk you'd need to worry about is currency fluctuations, but I don't think that the U.S. dollar isn't going to appreciate any time soon. I wouldn't put all your eggs in these baskets but certainly consider a 20-30%. Here is a link to their foreign currency CD webpage.

Let me know what you think, or if I can elaborate on anything further. As always, please seek a professional investment advisor or decide for yourself which route to take. The statements above are for information purposes only and are not advice.