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Evasive Action

John Lim  |  November 23, 2020

DEAR FAMILY, you know I don’t typically give unsolicited investment advice. But today, I’m breaking that rule, because I don’t want you to get hurt financially.

I can’t promise that, by following my advice, you’ll be better off in the short run. But I firmly believe that you’ll be better off in the long run, by which I mean in the next five to 10 years. Please take this letter for what it is, simply a warning and food for thought. Ultimately, you must make your own decision.

1. If you’re fortunate enough to have large gains in growth stocks such as Amazon, Apple, Facebook, Microsoft, Netflix, Tesla and Zoom, I urge you to take some profits. At a minimum, I recommend selling an amount equal to your cost basis—what you paid for these stocks. If you have great conviction in these companies, hold whatever remains after selling your cost basis. That way, you cannot lose. If these stocks drop dramatically—I’m not necessarily predicting that—you’ll still have a profit because you’ve sold your cost basis. These stocks are selling at extremely lofty valuations. History is clear: Trees do not grow to the sky, and nor do growth stocks.

2. If you’re overweight U.S. stocks and underweight international stocks, rebalance into international. The U.S. market has trounced international stocks since 2009, with the S&P 500 up 261%, versus 37% for developed international markets and 86% for emerging markets (excluding dividends).

How much should you have in international stocks? I advocate allocating at least 30% of a stock portfolio to international. But if you’re like most people, you’ve given up on international stocks and are overweight U.S. shares. This is exactly the wrong time to take such a position. Valuations matter. There’s simply no question that the U.S. is among the world’s most highly priced markets.

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What’s the cheapest? Emerging market stocks. While I don’t recommend that you follow my footsteps, I have almost no U.S. stocks. Almost my entire stock allocation is international. This is extreme and I don’t recommend you do this, but I mention it so you know how much conviction I have.

3. Again, if you’re like most people, there’s a good chance you’ve given up on value stocks. For what seems like an eternity, growth stocks have triumphed and value stocks have underperformed. The valuation disparity between the two has never been so great, perhaps with the exception of the market peak in 2000. If you’re overweight growth, do yourself a favor and rebalance into value. You might take some of the proceeds from your sales of growth stocks and put them into value stocks and, better yet, international value. One of my favorites is Dodge & Cox International Stock Fund (ticker: DODFX).

4. My final piece of advice: Have a small amount of gold exposure. This could be accomplished by buying an exchange-traded fund (ETF) such as SPDR Gold Shares (GLD) or iShares Gold Trust (IAU). When I say “small,” I’m talking about 5% or less of your total portfolio. I personally have about 5% in SPDR Gold and 2% in VanEck Vectors Gold Miners (GDX). The latter is an ETF invested in a diversified basket of goldmining companies.

This is perhaps my most controversial suggestion, so let me explain. Over the past decade, and especially this year, there’s been extreme money printing by the Federal Reserve in the form of QE, or quantitative easing. Take a look at this chart, which represents how much money the Fed has printed. Next, check out this graph of U.S. money supply, particularly the far right end of the curve. On top of this, the Fed recently made a substantial change in policy. It’s now targeting average inflation of at least 2%, which means we may see higher inflation in the future to compensate for the recent far lower inflation rate.

The bottom line: Inflation is a greater risk today than ever before in my investing career. While there’s no guarantee that inflation will spiral out of control, think of gold as insurance for your portfolio. Normally, Treasury Inflation Protected Securities, often known simply as TIPS, would also serve as an inflation hedge. But their yields are currently negative, which is not terribly attractive, though they would certainly provide some protection if inflation spiked higher.

My first three points are based on two fundamental tenets of investing. First, valuations matter. Second, regression to the mean is real. Both principles argue for moving from growth to value and from U.S. stocks to international markets. I don’t have a crystal ball, but everything that I know about investing tells me the above advice is sound. Think about it.

Sincerely yours,

John

John Lim is a physician and author of How to Raise Your Child’s Financial IQ, which is available as both a free PDF and a Kindle edition. His previous articles include My BadSix Lessons and Risk Returns. Follow John on Twitter @JohnTLim.

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