crawlingroad

Actually the US defaulted twice in the past 100 years IMO:

In 1933 they broke the gold standard and confiscated citizen's gold. After the gold was converted to paper money they took the official price from around $20 an ounce to $35 an ounce thereby reducing the purchasing power of the paper (you needed $35 to buy what once cost you $20 just a few months earlier). Since Treasury notes then were essentially gold certificates promising to pay the bearer in the dollar value of gold, the US defaulted because they wouldn't honor the conversion. US Citizens were not allowed to own gold outside of jewelry again until 1974.

In 1971 Nixon closed the gold window for international holders of dollars. Foreign countries with dollars would no longer be allowed to convert their dollars for gold at the agreed to rate of $35 per ounce. So this too is a default as the terms of the agreement were not followed and we left foreign holders with dollars that were declining in value rapidly due to our inflation.

I'm not expecting the US to default any time soon, but there are ways for it to happen that technically aren't a "default" but achieve the same outcome. High inflation is the most likely way they'd do this if it came down to it.

All correlations are based on past performance. In general, I think correlation data between asset classes is misleading and investors should never rely on it.

The only thing investors should be concerned with is how the assets they own correlate to the economy and not each other. Stocks for prosperity. Gold for inflation. Bonds for deflation (and prosperity). Cash to ride out recessions.

Stocks and bonds are not negatively correlated all the time. During the 1970s stocks and bonds both did horribly in real terms because inflation was so bad. The correlation of them to each other didn't matter, only how they correlated to the economy did.

Prior to 2008 investment gurus said that stocks and long term bonds were actually positively correlated and that both would suffer at the same time. I guess that's maybe true in mild recession or inflation, but not true in a deflation. They reached their conclusions because we hadn't seen deflation since the 1930s and they were just looking at the past few decades. Their data and economic analysis was incomplete and they were unpleasantly surprised by the outcome when stocks lost over 30% in value and long term Treasury bonds went up 30% in value. Prior to 2008, many investment gurus poo-poo'd treasuries and encouraged investors to take on credit risk in lower quality bonds for more return. That was also a bad bet. Junk bond funds for instance dove almost as much as stocks. Corporate bonds also did not fare as well as Treasuries. All the correlation data they had proved to be incorrect because they were looking at the wrong things.

Gold is a volatile commodity because there is so little of it in relation to dollars in circulation. If there is no serious inflation expected in the dollar (say 5% or less per year), then gold will not perform well. But if it gets over 5% a year (or it is anticipated to do so) investors will start thinking that gold is looking pretty good compared to holding dollars and will buy it running up the price.

But we should also remember that asset allocation strategy should avoid looking at any one asset in isolation. Only how all the assets perform in the entire package matters.

I can make a case that any asset is horrible to own. Stocks the last 10 years have been real stinkers but I still own them because the next 10 years they could be great. In the 1990s nobody wanted gold but by the time the tech bubble popped gold was poised to go on a tear the next 10 years to today. In the late 1970s nobody wanted bonds because inflation had killed them the prior decade. But once inflation came under control bond prices went through the roof and continued to turn in excellent performance the next 30 years!

So I strongly encourage investors to step away from the mindset of correlations and guessing what assets will do best and just spread your money around. It is counterintuitive, but by owning four major assets of stocks, bonds, cash and gold you are actually far safer risk-wise than concentrating your investments.

This question of which asset class will do best and whether to own Asset X or Asset Y comes up a lot. I wrote a post about it that includes a snippet from Browne explaining his experience in this as well that readers may enjoy:

http://crawlingroad.com/blog/2010/01/12/what-asset-will-do-b...

The US Govt. can always print money to pay off creditors. Yes, this would be highly inflationary. But, it means the bonds can always be paid. More likely, they will simply raise taxes to cover the debt load.

But compared to other bonds, the US Treasuries are probably the safest. Even the Euro bonds are less safe. IMO. They are having big problems that will only get worse.

However if this all goes to hell, then you have an allocation to gold to cover the inflation fallout from the mess.

But in 2008 everyone thought inflation was coming when gas was $4 a gallon and climbing. But by the end of the year we had a deflation situation and Treasury bonds went up 30%. Nobody saw that one coming which is why portfolios should hold a wide variety of assets at all times and not try to use market timing.

BTW. In case I wasn't clear the site I run focuses on on passive investing strategies relating to the Permanent Portfolio asset allocation. You can read more about it here:

http://crawlingroad.com/blog/2010/02/06/permanent-portfolio-...

I run the site listed below on the Permanent Portfolio approach and saw all the hits coming in from this page. First let me say that if you want 4-5% a year you need to earn probably 8-9% a year. That's because you'll lose 4% or so just to inflation and taxes.

Next, with that much money you will have many people that may want to take it from you. So go out and get an umbrella insurance policy that covers your net worth to protect against ambulance chasers.

Also, you're going to have relatives and long lost friends coming and asking your for money for all sorts of things. I suggest you harden your heart and learn to tell them "NO" right now before you get burned. If you want to give them money, then make it a gift and not a "loan." Those types of loans are never repaid and if you are expecting them to be re-paid and they aren't it will ruin your relationship.

Now for actual investing advice.

First, you don't want to do anything stupid and lose that money. So be VERY conservative in your investment decisions. You do not need to risk 10-15% a year returns because you already are in the top 1% of net worth in the country at this point.

Second, most financial advisors do not have your best interests at heart. They will sell you expensive products that generate fees for them and probably underperform the market. So your best choice if you want exposure to stocks is to just buy a low cost index fund and not get into the stock market trading game.

Third, you will want bonds to work as fixed income and I'd only buy Treasury bonds as they have no credit or call risk. You don't save enough in taxes usually to make the risks of munis worth the price of admission. IMO. During the credit crisis in 2008 Munis went DOWN in value, but Treasury Bonds were up almost 30%. That tax savings people thought they had went out the window when the market panicked.

Fourth, you should have some hard assets for inflation shock insurance in your portfolio. Gold works best. IMO. It doesn't produce interest or dividends, but it can go up like a rocket when stocks and bonds are suffering.

Finally, you should keep a slug of cash sitting around to help you ride out market storms and support yourself so you don't have to sell assets out of desperation when they are down in price.

So I do think the Permanent Portfolio allocation would be a good choice. It gives you growth with an average CAGR of 9-10% the past 40 years. It gives you protection with the worst loss being in 1981 when it lost about -4-6%. It gives you stability because it won't have crazy swings in value. Lastly, it gives you control over your finances so you don't need to use a money manager and pay exorbitant fees.

For now, you may want to park that money in a very safe Treasury Money Market fund while you make your decision. They pay almost no interest, but it's better than jumping into something and losing your shirt. Don't let the financial advisors you're going to meet pressure you into expensive and dumb investment products. And, BTW, that's mostly what they're going to offer you.

If this sounds like too much to handle, then just go to www.vanguard.com and contact their money managers. They charge a small fee each year but will not do anything dumb with your money and their index funds are well run and cheap.