Sustaining Wealth in an Uncertain Environment

by Axel Merk and Charles Rotblut, CFA

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Axel Merk is author of the new book “Sustainable Wealth” (John Wiley & Sons, 2010). I spoke with Axel prior to May’s market correction about how some of the principles discussed in his book apply in the current market and economic environment.

—Charles Rotblut, CFA

Charles Rotblut (CR): Many people have seen their portfolios rebound since the bear market, but still do not have the wealth they had a few years ago. What are some steps that someone in this situation should consider if they are trying to figure out what to do with their portfolio now for the next 10, 20, or 30 years?

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About the author

Axel Merk is the founder and president of Merk Investments.
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Charles Rotblut is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at
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Axel Merk (AM): The big challenge facing investors right now is where to place their savings. We have witnessed a major rally across most asset classes from their lows. While the major stock indexes may continue to go up, there is considerable risk that stock prices may experience a significant correction. In parallel, there is a substantial risk that interest rates might go up. There’s a substantial risk that inflation might go up. There’s also a substantial risk that all the government intervention that has occurred over the past two years is causing distortions, including a disincentive to invest because of erratic policies. All this may impact investments, and investors are spooked.

From my point of view, in this sort of an environment caution should prevail. This may sound counterintuitive—especially if people are desperately trying to make up the money that they previously lost—but being very conservative can be the best strategy.

A strategy that involves being very conservative does not necessarily mean that investors should simply park their money in cash. In fact, in the present environment of increased central bank intervention, even cash may need a diversified approach. Consider what central banks are doing, which is diversifying their reserve holdings. Central banks aren’t simply holding one currency; they are diversifying globally in baskets of currencies in an attempt to mitigate the risks associated with any one currency. But at the same time it’s not risk-free either. In my view, there is no such thing any more as a risk-free investment. For the individual investor, the lack of a risk-free investment poses some very great challenges and there is no easy answer.

The best thing an individual investor can do is try to be alert, try to be diversified and to allocate assets in a way that provides true diversification. In the fall of 2008, most people came to the harsh realization that allocating their portfolios among growth stocks and value stocks, large cap and small cap, and real estate, did not provide sufficient diversification. As a result, investors need to look for alternative ways to diversify. That, of course, can be very difficult. There are more and more mutual funds out there now that offer additional ways to diversify your investments into low-correlated asset classes. Ultimately, when it comes to diversification, an investor should really look at the return stream that any investment is generating—and not just think ‘Oh, it’s a slightly different asset class and, therefore, it has to be providing diversification.’

Monitor very closely how different asset classes perform in parallel: One of the best market bubble indicators is when a wide range of different asset classes increasingly move in tandem. That has been happening all the more on the back of policymakers’ decisions to throw trillions of dollars at any and all of our financial problems. Many asset classes have become inflated, moving up in lockstep. While everybody feels good as everything goes up, the risk that the bubble may burst also increases. That is the exact time when people may want to consider taking chips off the table, diversifying further or becoming more conservative.

One has to be willing to make these choices realizing that they may not make the decision at the most optimal time. But an investor has to make it in the context of their risk profile and what they can afford to lose and obviously always in the context of whether there are better values elsewhere, better opportunities to deploy your assets.

Sustainable Wealth Principles

Axel advocates that to build sustainable wealth, investors should challenge conventional wisdom, which would have you focus too much on your income and assets (which you cannot control). Rather, investors should take time to focus on the things they can control: their expenses and liabilities.
Key maxims of sustainable wealth management are:

  • Income and asset values can be influenced, but will fluctuate beyond an individual’s control;
  • An individual, meanwhile, has full control over his expenses and liabilities.

Axel lays these factors out in what he calls the “Sustainable Wealth Grid.”

CR: In your book, you discuss challenging conventional wisdom when making portfolio decisions. Would you explain what investors should be thinking about in terms of challenging conventional wisdom?

AM: Despite the uncertainty, it is critical for an investor to remember that they are at the controls. This means it is the investor’s responsibility to challenge conventional wisdom and determine what they want to achieve with their portfolio. When you use an investment advisor, for example, work with that person. Financial advisors may be tempted to just use an allocation model, where investors simply give them two or three parameters that are “plugged in.” But does it really work? Don’t just say ‘Oh, I have a high-tech company and a large-cap company and this or that and, therefore, I’m diversified.’ Look deeper. Look at where the returns are being generated and whether these returns really are non-correlated.

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Emotions play a large role too. The best example is housing. Many people think that home prices are too expensive when they try to look for a house. However, once the house is purchased, investors find a thousand reasons why the neighboring homes are underpriced and should really be much higher.

Investors should always try to distance and personally detach themselves from the investment and try to make a rational decision based on parameters that they looked at when they initially made the decision. That’s one way to look at these things.

Another way to look at conventional wisdom is to really develop a picture of how the world is evolving and use that as a filter in your investment process. That doesn’t mean that an investor with a strong worldview should put all their eggs in one basket. Sure, if such an investor puts their money where their mouth is and gets it right they can make substantial returns. But should they get it wrong, they can also lose a lot of money. What I like to do is assign probabilities to my various economic views and invest accordingly. In addition, don’t be distracted by the mood of the day. Rather, make adjustments based on your life situation, based primarily on the risk that you can afford to take.

This also means that during a bull market, the underperforming assets might be fulfilling a purpose. When assessing any investment, first look at why that investment was made in the first place, and sell the security only if the reason why you bought it doesn’t apply anymore.

CR: Carrying this a step further, if someone has a view on the direction of the economy and the markets, how do they balance their expectations with keeping risk levels at acceptable levels?

AM: In order to make those decisions, an investor has to take into consideration, first and foremost, the risks they can take. They should look at their current situation, future cash flows, other assets they have, any future costs they will face and so forth. An investor cannot simply be guided by the fact that things have plummeted or gone up. The moves of the market are really secondary. An investor needs to find good values, assess the types of risks they can take and then make their investment decisions accordingly. Over the medium or long term, if the investments rise, that’s great. But if they don’t, the investor has only taken the risks they could afford to take.

Now that doesn’t change the fact that many people haven’t saved enough. But an investor cannot fix that problem by pouring more money into risky assets. The worst thing an investor can do is say ‘Oh, I haven’t saved enough. Therefore, I have to chase the latest trend and I have to go into this risky investment.’

That’s one of the important messages of my book. In the book I refer to Richard Russell [Dow Theory Letters newsletter advisor], who says the difference between the poor investor and the rich investor is that the poor investor will always try to chase the next trend, and will ultimately be bound to invest at the top of any trend and lose a lot of money. Conversely, the wealthy investor has many more streams of income and has plenty of opportunities, so they can afford to miss a rally. A wealthy investor can look for the right value, wait it out and if they see something they like, make the investment. With such a strategy, even the poor investor could become rich: If he just looks for value, looks for the opportunity and only puts down the money when he can afford it, over time, through compounding, that investor can build quite a substantial nest egg.

CR: If someone is dependent on income from their investment portfolio—maybe they’re taking required minimum distributions—what’s your strategy? Should they consider staying in short-term Treasuries and wait for interest rates to get better?

AM: The Federal Reserve has been the enemy of anybody who has savings. Anyone with savings is not getting rewarded with the current policies. The Federal Reserve wants to keep interest rates low to boost economic growth at any cost. And by having interest rates near zero, investments are not going to provide much income.

Rather than accepting these near-zero interest rates, investors are looking for riskier strategies. This is good if the bonds deliver, but it is not so great if the bonds default. It is a very tempting thing to go into higher-yielding securities, on the fixed-income side in particular. But when you go down in credit quality, you can face very serious risks.

This is why it often does not make sense to try to get just a couple of extra percentage points of yield for taking on tremendous risks. If the issuer defaults, the investor may end up getting close to nothing. Is a 3%, 4%, 5% or 6% premium really enough to compensate for that additional risk? Should an investor buy junk bonds? For many people who are close to retirement age, this simply may not be appropriate.

Conversely, of course, an investor can go out on the yield curve. He can buy longer-dated bonds. However, there is the risk that inflation gets priced into the market. Or if the market requires higher real rates of return because of the government spending, then he may also lose out. That means an investor is just going to get a very lousy return right now and yield-seeking investors may need to stick it out.

CR: You talk about personal spending in “Sustainable Wealth,” something that is not typically discussed in investment books. Could you explain how personal finances fit into portfolio planning?

AM: Sure. The other side of the equation everyone has to work on is the cost of living. Nothing gets around it, and it can be a tough choice. For most of us, there’s no government bailout waiting around the corner and so if you can’t meet your obligations through the asset side or income side of things, then you do have to fine-tune the living expense side.

This is not just an important point; it is ultimately the most important point. Companies don’t go bust because of missing revenues; they go bust because their expenses are too high. People don’t declare bankruptcy because they don’t have income; they go bankrupt because their expenses are too high. Once somebody has an iPhone, cable television or latte at Starbuck’s, they want to keep it. It takes both small and large steps. The easiest step, the one thing an investor can control, is expenses. The investment is something a person can make better and worse decisions about, but on the expense side people don’t do enough.

CR: Let me ask you about taxes. We are looking at a situation right now where, as you know, the Bush tax cuts are expiring and it’s uncertain what new tax policies will emerge from Congress. Even though you suggest not investing based on tax policy, taxes still weigh on investors’ minds. What are your suggestions?

AM: As far as taxes, if there’s one thing worse than high taxes, it is uncertainty about taxes. We all hate our taxes but the one thing that’s really bad for investing, and also for business investment and personal investing, is uncertainty over regulations.

This year people can convert their investments to a Roth IRA account from an IRA account. The key thing about that is in a Roth IRA account an investor is not required to make any withdrawals, unlike standard retirement accounts. What that means is that if an investor does not need to rely on that income stream, he can allow that money to continue to grow tax free. If people don’t need to make a withdrawal, then a Roth IRA is a good way to go. Even if you’re not the youngest person anymore, you may want to discuss with your tax advisor whether that’s a reasonable strategy for you.

Given the massive budget deficit, the government increasingly relies on taxable income to meet its obligations, which is why they are raising tax rates. The cost of borrowing for corporations and the government also may go higher. Investors will demand a higher return to compensate for those taxes. While on the one hand higher taxes will reduce the income an investor is getting, on the flip side, investors will demand higher returns. And of course, if one takes it a bit further, this means the headwinds for corporate America are going to get stronger because the cost of borrowing is going to go up with higher taxes. People always think of higher taxes only from their own perspective. But there’s really one perspective for the government, one for individuals, and one for businesses—and these are dynamics that will have a profound impact. Again, clarity is often more relevant in the long run than high taxes alone.

Investing in Boom and Bust Markets

In his book, “Sustainable Wealth,” Axel offers the following suggestions for investing in boom and bust markets.

Boom Markets:

  • Diversify your income stream; focus on cash flow.
  • Take on more risk, but only if you feel comfortable; ensure other bases are covered.
  • Do not expect to find the top; take profits when warranted, don’t hang on too long.
  • Take some money off the table; recent winners should not make up too large a portion of your portfolio.
  • Invest what you can afford to lose; be realistic about this amount.

Bust Markets

  • Diversify your income stream; focus on cash flow.
  • Consider a steady asset allocation; maintaining that allocation will automatically defend you against busts.
  • Take less risk; if market risk increases but your risk profile hasn’t, pare down risk.
  • Do not expect to find the bottom; markets can overreact, be patient.
  • Put money on the table slowly; consider cost averaging.
  • Invest what you can afford to lose; this value may change in a bear market.

CR: Those are good points. Anything I didn’t ask you that you think should be mentioned?

AM: People always talk about investing, but often overlook the cost side, and the other important aspect: sustainable life balance. Put investing into the context of where you are in life and what you want to do with your life and with your investments. A person should not be a slave to their investments. Rather, investing should be a tool that helps you achieve your goals. If you are stressed about your investments, odds are that you need to change something. Maybe lower the risk profile, maybe look for a different advisor, or maybe look for an advisor if you don’t presently use one. At the end of the day, you need to be able to sleep well at night with your investments. If you can’t, you should reassess your investment positions.

Axel Merk is the founder and president of Merk Investments.
Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at


Robert Heacox from WA posted over 4 years ago:

In the fall of 2008, most people came to the harsh realization that allocating their portfolios among growth stocks and value stocks, large cap and small cap, and real estate, did not provide sufficient diversification.

Excuse me, but if you had such a portfolio and you left it alone, then by some time in 2011 it would have fully recovered. If, instead, you sold the portfolio as it went "south", then you have experienced sex without love. You will have needed to pick the point where "the market is really recovering" and bought back in. Warren Buffet may not live at your house, but he does release "clues" to everyone who can read. There are no real "timing geniuses". Own things that you believe in and believe in them when others do not.

NewJoizey from NJ posted over 4 years ago:

"...the headwinds for corporate America are going to get stronger because the cost of borrowing is going to go up with higher taxes."

What is the basis for that statement? Haven't I been reading about how the fed is supposed to be guaranteeing QE through 2015? Doesn't that mean borrowing rates are going to remain low or go down?

As for the statement regarding portfolio allocation among growth/value/largecap/smallcap/real estate not providing enough diversification, well then what did? Hold it - don't answer, because whatever the optimal mix was from 2008-2011 I'm sure will perform abysmally 2012-2015. Remember, "...the poor investor will always try to chase the next trend, and will ultimately be bound to invest at the top of any trend and lose a lot of money"

There is so much conflicting information in financial media. The whole thing is paradoxical and it is dang frustrating. You have all these qualified people offering their own opinion, but at the end of the day nobody really knows anything.

There is a lot of worthwhile information in this article. I don't mean to sound crotchety. But our financial futures are at stake here.

Clifford Wyble from PA posted over 4 years ago:

NwJoizey - Correct - 100% - Our financial futures are at stake. Not knowing our direction in the world is not an road the U.S. need's to go down. The greatest generation has much wisdom. Politico's should ask for a spoon full.

Vaidy Bala from AB posted over 2 years ago:

I agree with Robert Heacox. I experienced -40% in 2008 with a kind of 80% Canadian stocks blend , the loss was about K$150. I sat through passively for things to recover without really pouring into media or reports. It did gain back. So Buy and Hold seems to work in crisis or buy more if got cash. when all is lowly.

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