By JACK HOUGH
U.S. shares tumbled nearly 2% yesterday as the latest Greek protests turned violent. At issue in Athens are tax hikes and budget cuts that workers say have inflicted much pain and done little to shrink the country's crippling debt and revive its moribund economy.
If that sounds far removed for U.S. investors, consider this: A Greek default, which credit agencies view as likely with or without austerity measures, would leave American banks with $7 billion in direct claims and $34 billion more in indirect exposure (like the sort of complex default insurance that brought down AIG), according to the Bank for International Settlements. And that's only the beginning. Such an event would surely make default more likely for Greece's struggling peers, such as Portugal. Meanwhile, a decline in the euro -- it lost 2% to the dollar yesterday -- is a threat to American exporters because it makes their goods comparatively expensive.
Don't panic. Do, however, take a few simple steps to make sure your investment portfolio is as safe as it should be.
First, make sure stocks, international and domestic, aren't your only holding. As I wrote recently, suspiciously high corporate profits and pathetic dividend payouts each bode poorly for future profit growth, which in turn suggests stocks could slip. Investors shouldn't dump stocks entirely: Supreme certainty of the future is best left to cable television pundits. Benjamin Graham, the architect of modern value investing, suggested having no less than 25% and no more than 75% in stocks at any time. That seems prudent. I'd stick with the lower half of that range for now.
Second, do what you can to favor dividend-paying companies, here and abroad. If prices fall, reinvested dividends allow investors to continuously buy low and compound their income instead of just idly hoping for bulls to return. Most investors 65 and younger have a skewed expectation for stock returns, because during the 1980s and 1990s, compounded yearly returns were about 18%. That was due more to rising valuations (and shrinking yields) than true economic growth. Over the past two centuries, yearly returns have averaged 8% and dividends have accounted for more than half of that.
Third, extreme country bets aren't the way to dodge crashes or juice returns. It's too risky. Emerging markets have provided stellar returns over the past decade, but over the past year, developed markets have done better. China is raising interest rates and restricting asset prices in an effort to cool speculation. Brazil's economy is expected to expand 4% this year--healthy growth, but well slower than last year's 7.5% expansion. It's better to spread money among regions according to their economic size--with roughly equal shares for the U.S. and Europe, less for Asia and Latin America.
This kind of international diversification may not help much during a crash, but it does something even more important: it helps investors avoid prolonged slumps. A paper published last year by Clifford Asness and fellow money managers at AQR Capital used stock data for 22 countries between 1950 and 2008 to demonstrate the limitations and benefits of diversification. Global investors did little better than local ones during crashes; the average country lost 28% during its worst month, versus a 24% loss for a global portfolio during its worst month. But over longer period diversification proved its merit. Single-country investors lost an average of 57% during their worst five years. The global portfolio lost 38%--not a pleasant outcome, but far better than a 57% loss. (All figures were adjusted for inflation.)
U.S. investors who are lacking international diversification can add some easily by using exchange-traded funds. Vanguard's FTSE All-World ex-U.S. (VEU)
If there's one country U.S. investors should overweight relative to others, it's the one under their feet. For all the doom-saying about America's fiscal problems, they're remarkably fixable. For example, the U.S. is the world's No. 1 spender in health care and defense as a percentage of its economy. If it brought spending in just those two categories down to match the level of the No. 2s (France and the U.K., respectively) its deficit would disappear overnight. More on that another day.
Lastly, don't fret about holding too much cash this summer (including short-term Treasury bonds, bank certificates of deposit and money market funds). The dollar might be the biggest investment bargain going. According to a measure called purchasing power parity, which looks at what a basket of ordinary goods costs in different regions, the dollar looks at least one-third undervalued versus the euro. A sharp recent slowdown in inflation suggests oil and other commodities might lose ground to the dollar, too. And having ready cash to deploy won't hurt: I suspect stock and bond bargains will only get better as the year goes on.