Although the economy is showing encouraging signs of recovery, it has left disaster in its wake. From the professionals to the everyday investor, everybody lost money during the recent recession and many are still far from restoring their net worth.
Looking back at the past few years, most are now looking forward and asking themselves what they should do with their investments in the future. For those who have saved a substantial amount, they don't want their net worth wiped out by the next financial crisis that could occur within the next few decades. (Without this risk-reduction technique, your chance of loss will be unnecessarily high. See The Importance Of Diversification.)
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Diversification is one of the most important rules of a safe portfolio. Stock investors often use diversification to mean investing in different stock sectors. A diversified stock portfolio may have a healthcare, oil, technology and industrial stock. Diversification can also mean investing in stocks, bonds, cash, CDs and real estate.
Not all aspects of your portfolio are diversifiable, though. Market or systemic reactions like the stock market tumble of recent years affected all asset classes.
Is cash a good way to preserve net worth? Even with interest rates at a historic low and inflation nearly non-existent, staying in cash is still netting a small gain but that's not why investors like cash.
Cash and cash equivalents (checking, savings, short-term CDs and treasury bills to name a few) are in the portfolios of nearly every professional investor. In fact, it is estimated that 5% to 10% of an investor's portfolio is left in cash. They keep cash on hand in order to have funds available to finance a seemingly "can't-lose" investment opportunity but you may want it for a different reason.
The value of the dollar may fluctuate but keeping cash in your account instead of investing it is not only safe from investment market crashes, but the FDIC insures your cash up to $250,000. Cash isn't going to earn much as an investment but it is safe, and safety should be a part of any portfolio.
Not just gold but silver, copper and other precious metals have become an investment of choice for those wanting to preserve wealth. Gold and silver have seen a huge run up in recent years. In fact, if you had invested in gold five years ago and held on to it until the present day, you have seen a 23% annualized return. This is largely because of the perceived safety of the metals while also giving the investor a large scale gain.
Paper money, regardless of which country it comes from, is representative of something. The paper it's printed on holds no true value, which is why paper currency has a long of history of going extinct but gold does not. Gold has held value for thousands of years and as monetary concerns heat up around the world, gold may only be at the beginning of its run up in value. Beware, though: if gold is experiencing a false "bubble" like the tech bubble of the '90s, it could see a dramatic depression in value. Gold has been used by investors for years to preserve net worth.
Seeing the amount of debt that the United States currently has, it may be tempting to invest in foreign bonds, but be careful. Foreign bonds come with not only the risk of default but also currency risk, and with the U.S. dollar being affected by a variety of different factors including QE2 and interest rates, foreign bonds may not be the best way to diversify your portfolio in order to protect your assets.
In addition, with countries like Greece and Ireland having serious financial problems as of late, The United States and all of its debt still seem more attractive than many foreign bonds. (Historically, international investing has worked out well for investors, but this may no longer be the case. Check out Does International Investing Really Offer Diversification?)
The Stock Market
The stock market may be the world's scapegoat when something goes wrong in the economy, but it still has a consistent history of success. For an investor who invests in a stock with a track record of safety and a reasonable dividend, the stock market can produce gains of 6% in dividends alone. By setting automatic stop- loss sell orders to trigger when a stock falls below a certain amount, the investor can hold on to their net worth and feel safe in the stock market.
Bargain hunters are seeing the depressed real estate market and thinking of buying up foreclosed homes for rock bottom prices, but should you do this as a way to further diversify? Over the past 10 years, home prices have seen an average annualized return of only 2.2%, lower than the average rate of inflation - and remember that most homeowners are paying an average of 5% in interest to own the home. Then there's care and maintenance.
With the housing market flirting with another recession of its own, it's hard to see real estate as a good way to preserve wealth over time. In a few years, that may change, but for now, buying an asset that very few want is probably not a good idea.
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The Bottom Line
The best way to preserve wealth is the same tried and true methods. Invest in stocks and bonds while keeping some money in cash accounts. This allows for diversification of your portfolio which has saving many for devastation. (This investing strategy retains its charm as a protection against random events in the market. See Diversification: Protecting Portfolios From Mass Destruction.)
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