11-10-06

Ask Bud

Chris’s question: “Since we live in a global economy, shouldn’t we invest globally?”

I think part of the answer depends on your stomach for foreign investments and the kind of foreign investments. For example, it was easy for a partnership I'm in to decide to get a loan from England a few years ago with 2% interest. That was a loan that was hard to resist. On the other hand, the value in direct ownership is dependent on the respective values of US and foreign countries which are likely to be quite different when you sell than when you buy.

I rather like the idea of investing in US firms that do a lot of business abroad. I used to work for Boeing which is a great exporter and benefits from foreign growth. I don't know what Boeing's current policy is, but when I was there, we would not denominate sales in foreign currency values. This took the currency unknowns out of the equation. I expect that any US company with large foreign sales would either do the same or somehow hedge currencies.

I believe that most people don't think as deeply as your question implies. They just say a certain percentage of their funds should be in an overseas mutual fund and trust the mutual fund to make intelligent bets with their money.

I personally believe that the United States is so over extended in so many ways that there will be lots of economic problems ahead. I think taxes will have to go up and spending down. The slowing economy will make it tougher to get foreign countries to take our debts, so interest rates are likely to increase unless a US debt is still better than most of the lending opportunities elsewhere.

It's also possible that US inflation could be significantly higher in the long run, particularly if the prices of Chinese goods increase for whatever reason. Debtors are often the benefactors of inflation. For example, the national debt will seem proportionately less when valued in cheaper dollars. Those who have a large mortgage on their home will feel much more comfortable as the price of homes rise with inflation and bring increased equity.

As long as people continue to spend and not save, the US economy is likely to thrive. Higher taxes will dampen results for some people but permit increased spending for those on the receiving end of wealth redistribution. I strongly believe that it won't be too long before a large fraction of the baby boomers are going to realize that they can't possibly retire on what they've already saved. They will reduce their spending in order to save, and those who persist in retiring with inadequate savings will really curtail their consumption. This will be a blow that the US stock market will have to absorb. Hopefully, the pain will come slowly and not like 1929 or 1987, but public perception has as much influence as many other things on the rate at which these things happen.

I can't tell the future any better than anyone else. I don't believe in market timing. So, considering all of the above, I'm becoming more cautious. I think that the traditional 60% equity when working and 40% when retired is too high right now and that people ought to go back to the old rule where their percentage equity allocation is nearer 100 minus their age. This means a 55 year old would have 45% equity allocation and a 70 year old would have 30%. Part of that equity can be an international fund, but certainly not all of it. We’re not that global.

More important than all of the above is the need for people to save more. Historical national savings were 10% at a time when many people benefited from pensions as well as savings. Pensions are disappearing and the national savings rate is now in negative numbers. Saving 20% of their disposable income on the average may well be too little to recover that which has been lost, especially considering the demise of pensions.