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All Golden Eggs in One Basket

Dear Editor,

I am a college student and amateur trader. I have a friend of a friend who I have the unfortunate acquaintance with every now an then, and when so I get to hear his loud obnoxiousness. He is a strong believer in the “fraud” of Keynesian Economics and thinks I am “foolish” to invest in stocks. He has recently inherited a fair sum of money and has invested it solely in Silver and Gold. I believe that as long as companies continue to make money and use their leverage responsibly, stocks can be a solid investment.  I do not wish to debate my beliefs with this person because as I have been told, “You shouldn’t debate with a rock, because a rock won’t budge”.

I was however wondering what a professional like you would say to someone who believes solely in Coins and Ammunition?

Thanks for you time,

Dylan K.

Dear Dylan,

Historically, everything runs in cycles. It seems like each decade has one big winner. During the 1970’s Gold made fantastic profits, during the 1980’s it was foreign stocks, during the 1990’s it was tech- stocks, but what usually happens is what-ever the big winner was one decade it is rarely the same over the next decade. As a matter of fact the following decade it is usually the big loser. So after the big run up for stocks in the 90’s it has gone virtually nowhere over the last 10 years it’s been volatile but no net gain.

A good article on the cyclical nature of stocks http://www.nytimes.com/2009/07/19/your-money/stocks-and-bonds/19fund.html

On the other hand, during the same period, Gold has gone from $300/oz to $1200. And these things always end in a big blow off top like Real-Estate recently. So Gold is only in the middle of its rise. It has good potential yet the key is to get out during the blow-off top without waiting too long and losing it all again.

Does that mean you should put all your money in it? Not hardly, you shouldn’t put all your money in anything. If you are right you could make a fortune if you are wrong you can lose your shirt.

Van Tharp has done extensive study on risk management and shows how without good risk management everyone loses in the long run. So I highly recommend his book Trade Your Way to Financial Freedom . Especially the part on position sizing.

The biggest risk with “inherited money” is that you have no experience managing it. So you take risks like putting it all in one asset class. Even if you believe Keynesian Economics is a fraud and the Government will rob us blind there are other alternatives to Gold for at least part of your money. And even if you are right you can still lose money. The market has a way of doing that. So you should never stand to lose more than about 5% of your investment in any one thing. That doesn’t mean you can’t put more than 5% in one thing you just have to set your “stops” to limit losses to 5% of your net worth. By the way some experts are saying that now that real estate has crashed picking up distressed property (especially if you can do it for “all cash” ) could be a low risk investment. And the worst that could happen is that you have a house to live in mortgage and rent free.

Timothy McMahon, Editor

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