Big savers are in trouble in Cyprus. It has been reported many times over the last week that individuals holding more than $100,000 in Cypriot banks, traditionally a tax haven for Russian money, could be losing up to 60% of their capital as part of the country's bailout plan.
It's a tough pill to stomach, seeing something like that take place, and it's a stark reminder of the billions lost by retail investors and average households during the last financial bubble bursting.
Companies were bailed out by the government, people's life savings were being leveraged at sometimes 40 to 1 by irresponsible banking executives, and 401ks were emptied at the expense of big business and bankers.
Personally, if you still have control of your finances, you can prevent and prepare yourself for a similar type of situation so that losses are minimal, if any.
Here's four things you can do to prevent your own personal Cyprus.
1. Have Keynesian vs. Austrian School Macro Perspective (Gold vs. Federal Reserve Notes)
In order to know the markets and how they work, you need to understand the economic model being used in the U.S. and what the difference between the Keynesian and Austrian schools of financial thought is.
As succinctly and concisely laid out and stated generally on PeakProsperity:
Keynesian school - All recessions are bad and must be suppressed by government actions. This protects established businesses and jobs. The methods are elaborate and costly, but a benefit to the public overall.
Austrian school - When markets stray too far from reality they must be purged by adversity. This clears unneeded or failing enterprises so capital is not allocated wastefully, and new businesses can emerge. Periodic small recessions are the price of a healthy economy.
In the U.S., we are very much purveyors of the Keynesian school of economics and we have been since the establishment of the Federal Reserve. The Federal Reserve was founded to ease recessions, stop panic, and give people a short term warm and fuzzy feeling about the state of economics. The Federal Reserve is the big brother watching over everybody, keeping everybody safe and perpetually prosperous, no matter what the long term costs.
This is why we have things like quantitative easing from the Federal Reserve. While it's great for the markets, it creates bubbles that could burst just as quickly as the housing bubble did. To be a coherent investor and good with money, you have to understand the mindset that goes behind moves like this, how they stray from the absolute basics of supply and demand, and why that puts us at substantial risk; even while yielding the benefits of the markets "constantly skyrocketing."
Corrections are a normal part of finance. Like bubbles, they occur to readjust markets that are aligned incorrectly due to economic basics like supply and demand. Inflating our currency to avoid these small bubbles usually ends up creating massive super bubbles that could happen any time; make sure your portfolio is adjusted accordingly. Remember, there are ways to make money in a recession the same way there are ways to make money in a bull market; the key is timing.
How you can invest this rule: Make sure that you always have a "catastrophe" section of your portfolio set aside. You should keep 5% of your portfolio in mildly bearish to bearish positions; you can do this by writing out of the money calls, buying vanilla puts, going long on inverse ETFs such as BGZ, going short on sector ETFs like RTH and SPY, going long the VIX, or using any of several vehicles to short major markets in general (shorting index funds such as DXD and SDOW).
2. Diversify & Hedge
If you're going to be in the market, meaning you're going to own equities instead of holding a cash balance, you absolutely have to do these two things.
Hedging and diversifying are two simple tools that allow you to seriously mitigate the risk associated with your portfolio.
In "My Definitive 17 Cardinal Rules for Investing Success", I noted the importance of hedging:
In life, we hedge. We carry car insurance, homeowners insurance and life insurance. We want to be prepared for type of disaster that life may throw at us. It's important to take this concept and carry it over to your investing portfolio.
Methods of Hedging
There are countless numbers of ways to hedge, using ETFs, stock positions and options.
- Against a long position, one might acquire cheap premium put options to protect against the value of the equity that one is holding.
- Against a short position, one might buy vanilla calls or write puts.
- Ahead of a binary event, one might play an options strangle or straddle, even in conjunction with taking a position in the equity
- Sector-wise, diversification. Money spread across several sectors protects against an industry crippling event.
- Money-wise, more diversification. Utilize bonds, funds, stocks, options, futures and commodities to make sure your style doesn't get too aggressive or conservative. Maintain balance.
When hedging, it's important to understand your potential loss in each situation. There are no real situations where you're guaranteed to make money, unless you're already in the money on a position. Things like options spreads offer the feel of guaranteed wins sometimes, but the seductive nature of those positions often leads to people scratching their head when occasionally their entire position is wiped out. Do your research.
It's important to hedge the funds you have invested in stocks, as they are usually never insured. A loss is a loss, a gain is a gain.
How you can invest this rule: You can use any of the above strategies; puts against a long position, vanilla calls or writing puts against a short position, playing spreads ahead of binary events, and sector-wise and money-wise diversification. More commonly, using put options and GTC orders (sometimes) is a great way to "insure" your long position. Just don't forget, puts expire and cost a premium and GTC orders can get blown past and automatically converted to market orders on catastrophically bad news.
3. Use FDIC Insured Banks for Accounts Under $250,000
For a lot of cash, savings and checking accounts, there's an easier way to insure your funds up to $250,000: make sure you are depositing them in a bank that is FDIC insured. Surely you've seen the FDIC sticker in the window at your bank before, but what exactly does that mean?
From the FDIC's website:
The Federal Deposit Insurance Corporation (FDIC) preserves and promotes public confidence in the U.S. financial system by insuring deposits in banks and thrift institutions for at least $250,000; by identifying, monitoring and addressing risks to the deposit insurance funds; and by limiting the effect on the economy and the financial system when a bank or thrift institution fails.
An independent agency of the federal government, the FDIC was created in 1933 in response to the thousands of bank failures that occurred in the 1920s and early 1930s. Since the start of FDIC insurance on January 1, 1934, no depositor has lost a single cent of insured funds as a result of a failure.
The FDIC receives no Congressional appropriations - it is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities. The FDIC insures approximately $9 trillion of deposits in U.S. banks and thrifts - deposits in virtually every bank and thrift in the country.
The FDIC not only insures regular deposit accounts, but it also insures CD's and Money Market accounts -- two of my favorite conservative ways to store your money to begin with. Most retail investors have balances lower than $250k, and depositing in FDIC insured banks is one more warm security blanket to lay your money under.
How you can invest this rule: Make sure accounts under $250k are held in FDIC insured institutions.
4. Keep Your Personal Overhead Extremely Low, Save, and Keep Some Cash & Gold on Hand/In Protected Storage
You have to run your life like you would run a business.
Draw up your own personal cash flow statement and take a good hard look on the money you have coming in, and where it goes out. One of the first lessons of saving I ever learned was "pay yourself first". That means, set yourself up either on a 401k or automatic savings plan where money is deducted from your paycheck every single week without ever giving you the opportunity to see it, spend it, or take it out of an ATM that charges $7.50 fees drunk on a Tuesday at a casino in Vegas after drinking 16 Miller Lites (oh shut up, you've been there).
I started at saving 10% per pay, but have been able to walk that up to near 25% by reducing my fixed costs and keeping my variable costs on a monthly and yearly basis to a minimum. As your pay grows commensurate with how much you work (hopefully), this can make it easier to save larger amounts.
You have to draw up a personal budget and, as much as you may not want to, take a sobering look at where your money is going. Granted, you may not want to find out insane facts, like exactly how much you spend monthly on triple strawberry frappacinos, but you have to take a good hard look if you want to save correctly.
The second thing you need to do is trim your overhead to as slim as possible so that the amount you can save is considerable, while still leaving yourself money for everyday expenses. Examine all of your bills, cut out what you absolutely don't need, and all of a sudden you have found money.
When saving, make sure you physically have some cash or gold put away. This doesn't have to be a massive amount, just a tangible amount that adds another style of diversifying to add to your repertoire. While this may seem like a conspiracy theorist's version of how to save, large money managers usually have put aside some capital that they can physically get to in an emergency situation. It won't accrue interest, but you'll know exactly where it is and how to get to it.
Now, despite what Ben Bernanke thinks (or doesn't think) about the value of gold versus Federal Reserve notes, gold is still a sound & fixed source of holding currency/value. Ron Paul feeds the basics of supply in demand to Ben Bernanke on July 13, 2011. The conversation went like this:
Rep. Paul: Do you think Gold is Money?
Rep. Paul: It's not money? Even if it was a precious metal for 6000 years somebody reversed that, eliminated that economic law?
Bernanke: Well…it's an asset. Would you say treasury bills are money? I don't think they're money either.
Rep. Paul: Why do Central Banks hold it?
Bernanke: It's a form of reserves.
Rep. Paul: Why do central banks hold it? Why don't they hold diamonds?
Bernanke: Tradition, long term tradition…
Rep. Paul: Some People Still think it's money….
I contend holding gold is actually more valuable than holding cash in the long run because
1. Gold prices will continue to go up
2. Gold is a universal, non-renewable resource on which thousands of years of economics is based.
How you can invest this rule: You can go long gold by physically buying gold or investing in gold trusts like (NYSEARCA:GLD). You can maintain an emergency cash position by physically storing cash in a safe, vault, or safe deposit box.
These are four very macro-looking things to consider. However, in the grand scheme of things, they could be instrumental should our country (or your particular country) encounter a crisis of the same magnitude as Cyprus. At the least, I hope they provide some perspective for investors of all sorts and as always, wish you the best with your money management in the future.