How to Protect Yourself From a Market Crash

July 17, 2019

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Have You Ever Thought About How to Protect Yourself from a Market Crash?

Investing in assets, whether real property, equities, derivatives, commercial debt, or more recently cryptocurrencies have been especially profitable for some people and times. While not everyone is a winner even in good times, the general trend is upwards. One thing most of us don't think about - until it's too late - is how to protect ourselves when things go bad.

The truth is that no one can predict when markets will go up and down. Try to do so in the short-run and you might be right occasionally, but when you average over the short-runs over the long-haul, nobody really knows what's coming and when. Too often, we procrastinate thinking about bad things.

Don't Procrastinate Risk Management

Piers Steele at the University of Calgary's Haskayne School of Management spends a lot of time studying procrastination. He has the following to say. "Strong and consistent predictors of procrastination were task aversiveness, task delay, self-efficacy, and impulsiveness, as well as conscientiousness and its facets of self-control, distractibility, organization, and achievement motivation."

If seasoned executives can experience these things, how do the rest of us fare?

Steele's conclusions support "temporal motivation theory, an integrative hybrid of expectancy theory and hyperbolic discounting." This might not always be a bad thing. Take for instance how in finance we always assume that something is worth less tomorrow than it is today.

Well, that's how things should work... Weird negative interest rate environments such as in Europe, where government debt sells occasionally at negative yields, are therefore especially shocking.

 

...and don't get wiped out.

You are probably happy taking your existing wealth and building it up over time. In fact, you are probably interested in growing it faster than inflation eats at the value of your dollar. And so you invest. Often, you even invest more than you probably should, since you know markets are cyclical.

More often than not, we end up in bad situation because these two factors combine. You put in cash you would otherwise have on reserve, and then markets sour, and now you need to pay rent and have to sell assets at significant discounts. Meanwhile, intelligent investors are taking advantage of a superb buying opportunity.

If you're smart and can afford not to move your money, sensible investments will typically trump the best savings accounts. But you already know that. So what's there to do? Well, if you look at the smartest investors, for example, Ray Dalio, you find them taking contrarian positions. Often these positions appear to be contrarian because no one else is taking them. On the other hand, if you read through the logic, you find gold. That's why Dalio has in fact been investing heavily in gold.

 

Learn How to Protect Yourself from a Market Crash with Insurance

While some of us might be comfortable taking a gambler's approach to the markets, not everyone can sleep at night that way. To have some measure of peace of mind, you need to do as the professionals do and try to manage and mitigate your risks. And don't think only Wall St. knows about risk management. Farmers and precious metals dealers alike use strategic tools such as hedging with futures contracts to manage their exposure to market volatility. This allows us to focus on long-term wealth creation and reduce the risk you will be wiped out because of a bad market. That's why it's a de facto insurance.

So like us, you are probably not comfortable ending up with less money than what you started with. Good. Now all you need is a way to protect your money while it works. Now, don't think that all insurance is just a cost.  The Motely Fool's Matthew Frankel summarizes the difference between whole and term insurance as just that. "[I]f you want insurance that doesn't expire, and the idea of building up cash equity is more appealing...whole life could be the best option."

Insure Prior to an Economic Downturn.

Before times get tough, invest in various hedges that will protect you from declining asset values. Much like the cost of life insurance, the closer you get to needing it, the more expensive these hedges get. That's why a quiet, stable, market can be the best time to buy such a policy. Depending on bad you could see things getting, and how long you think it will take to get that way, you could go with various solutions.

One tool people use are contracts to have someone (or the option for someone) to buy your investments at a future time and fixed price. can plummet. These contracts are called derivatives because they derive their value from the value of the assets they cover. Many commentators and investors, however, blame their misuse as contributing to the magnitude of the 2008 financial crisis

Depending on where and when you're reading this, you might be wondering how exactly you can predict the next crash and/or recovery? The downside of contracting is that you are effectively handicapping the economy. No matter how good you are, chaos will ultimately win out. Moreover, any contract that covers you indefinitely will be prohibitively expensive. That's why institutions and retail investors alike turn to a more long-term strategy.

Whether driven by concerns over nations going bust, or the declining value of money without a gold standard,  shrewd investors often turn to what we call "true money." I allocate around 5% of my income that way because there is nothing stopping another downturn, and I'm not going to bet my savings on predicting exactly when it's going to happen.

How Do You Protect Yourself From a Market Crash with Precious Metals?

Just own them. The answer is really as simple as that. How much you should own is a complicated question. I'm not in the business of giving investment advice because frankly, I don't share in your profits but get blamed for losses. What I will say, however, is that precious metals are a terrific long-term insurance policy to protect your wealth. Throughout history, king and pauper alike have treasured gold as the only real form of money. Despite that fact we no longer use the gold standard and our government presses are printing money day and night, the USA is still the world's largest gold owner. Some people question whether all the gold is really there, but ask yourself why it even matters?

To paraphrase J.P. Morgan, real money is gold, and everything else is credit. Countries understand this eternal fact and know that even the illusion of gold reserves puts faith into a currency. While most assets are busy losing value when times are tough, precious metals do the opposite. The fact that people flock to gold during a depression is proof that most people procrastinate buying insurance. Gold and silver, which get the bulk of investment, are in-fact easy and relatively cheap to purchase during boom times. Often, booming times are a great time to follow Dalio's advice that "[G]old should be a part of everybody's portfolio to some degree because it diversifies the portfolio...some portion should be in gold." Why? He answered that you need to remember "when you have a fiat monetary system" you need to have a back up for crashes.

Gold and Silver Work Kind of Like Cash

Over the long-term, they're not going to generate wealth. Rather, they protect you when times get really tough. The reason this happens is because demand for gold and silver isn’t affected anywhere near the same way as stocks, property, and even cash. If you want to buy a 1 oz gold bullion bar during a crash, you are paying more because you are paying the true worth of gold. When everything else hits the fan, gold can bail you out of just about any situation. Money, on the other hand, becomes less and less valuable over time.

Because of this, many investors rush to convert their cash, stocks, and property into precious metals during a crash. This rush causes the value of precious metals to rise, due to the laws of supply and demand.

Don't forget that precious metals were once used as a currency, and many trading houses still treat it as something not quite a commodity. Then, when fiat coins and notes were introduced, these were backed by the amount of gold held in a nation’s reserves. The gold standard served to limit inflation, protect faith in a national currency, while reducing the cost of making currency out of gold. Now abandoned, you need to protect yourself from both the slow cut of inflation and the deeper hit of economic and yet worse socio-economic crises.

Inflationary measures such as quantitative easing are now possible, but if something goes wrong (sooner or later it always does) people can all-together lose faith in paper money. When used irresponsibly by governments, fiat currencies can deepen market crashes and cause severe lack of faith in recoveries.

In Summary…

During economic crashes, there is typically more speculation about the gold standard being introduced, which is another reason for investors rushing to buy gold. Unfortunately, a market crash is a bout the worst time for a government to introduce a meaningful gold standard because it would require much more gold. Yet, during boom times, governments don't want to do so because it will limit their ability to see through extravagant promises to special interest groups.  At the end of the day we only know that we know nothing. Only in recognize how unpredictable events can be are we able to add some measure of control. After all, no matter how much you make, without protection, it could all dispensary in a day.

Nothing is 100% reliable in the world of investing, but precious metals as an answer to how to protect yourself from a market crash is close. Throughout history, this has been the case. So long as scarcity exists, it will likely continue to be. There's just not enough gold and silver to go around. We've been advised to keep anywhere from 5% to 25% of our assets as precious metals investments to hedge against a market crash. We've previously talked about how much gold or silver to buy, but the real matter is that you should buy at least some. Remember that market conditions play a huge role in the fluctuation of precious metals, and a good economy is a good time to buy gold and silver.

Looking Forward.

There may be other ways how to protect yourself from a market crash. One touted measure has been to invest in cryptocurrencies. The argument is that people will move in this direction as currencies devalue. While certain cryptocurrencies have more value than others, that is not to say that any particular one has very much long-term potential. At an annual meeting for the Daily Journal, Berkshire Hathaway's VP Charlie Munger stated that he would have nothing to do with Bitcoin. He further lamented of the get-rich quick illusion that "[i]t’s just disgusting. Bitcoin is noxious poison."

The truth is that I don't know. Just like precious metals, Bitcoin gains from inflationary measures like quantitative easing. On the other hand, so many new coins have emerged that the fundamental similarity to gold is disappearing. Security concerns aside, Bitcoin's intangibility is also antithetical to gold's history as real money in every part of the world. Pundits will tell you otherwise; Bitcoin was created in 2008 as a response to the major global market crash. It remained relatively unknown during this crisis, but it makes sense that a cryptocurrency boom was inevitable. Since then, the bubble began to deflate and may even be headed for worse times as countries move to regulate it and diminish its black-market appeal.

For now, I'm sticking to things I can hold in my hand



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