The 3 Investment Buckets

My Thoughts On How Investors Should Approach Building A Portfolio

Over the last couple weeks, I have had a couple discussions on investing with different people. One was a very long-term investor and the other discussion was with someone who was just getting started. The first was a discussion on different stocks, tax loss harvesting, and current events. We did have an interesting discussion on the connection between financial markets, culture, and current events, but unfortunately, I don’t have a great solution for harvesting tax losses on stocks that have been held for decades.

The other discussion was with someone who is just getting started and is trying to figure out where to start. This is part of why I do the weekly podcast and video posts, so readers interested in learning more can go to the (free) resources that I use for additional information. Today I will be writing about how I view my investments from a 30,000 foot view and how it impacts my portfolio.

I don’t think there is a one-size-fits-all approach to investing, especially for investors looking for something that is more complicated than the cookie cutter indexing approach. Everyone has a different risk tolerance depending on their age and personality. Some older investors I have talked to have no issues being 100% in stocks (which is a big no-no if you ask the typical financial advisor), but they tilt towards dividend stocks that generate income.

I prefer individual stocks today for several reasons, but mainly since it provides the opportunity to buy cheap assets (if you choose stocks wisely), something that isn’t possible with real estate today. My basic investment philosophy is buy something while it is cheap (and hated) and sell when it gets expensive. It’s a contrarian approach, but today I want to talk about the three main categories that my investments fall under.

Stuff That Pays You To Own It

For most investors, this should be the biggest bucket. It includes dividend stocks, rental real estate, and (God forbid) bonds. If you have $1,000,000 in dividend stocks that have an average yield of 5% and $1,000,000 in bonds yielding 5%, you have $100,000 in annual income. That means you have nice returns without having to make a sell decision.

This is especially important for investors that eventually plan to rely on portfolio income for their expenses. If you have no income producing assets, and you have to sell into a stock market crash (like 2008 or 2009 for example), you are potentially setting yourself up for trouble. If you own income producing assets, your net worth will take a hit in a downturn, but you will still have money coming in.

Real estate depends on the situation and leverage but you can generally get higher yields. Today real estate looks expensive to me, but that doesn’t mean I will prefer stocks to real estate forever. I’m sure there are special cases, but I think there is a disconnect between wages (especially for younger generations) and the cost of real estate.

For my portfolio, this includes Petrobras PBR 0.00%↑, Ecopetrol EC 0.00%↑, and Peabody Energy BTU 0.00%↑. Some might view these stocks as risky, but at the current valuations, I will take my chances. At some point I’m sure it will include real estate, but for now, the best opportunities in my opinion are in the energy sector in the stock market.

For you, it could be Apple AAPL 0.00%↑ or Microsoft MSFT 0.00%↑ (which look overvalued today in my opinion and yield less than 1%), but they both have a strong track record of growing dividends for a long time. It could be bonds or other debt instruments where you collect interest payments. This is not ideal in an inflationary environment, but 5% in a money market is much different than 0.01% in a savings account a couple years ago.

It could be a portfolio of real estate where you collect the rent payments. The size of this bucket will depend on the investor. I think the majority of an investment portfolio should pay you to own it, but that looks different to everybody. It could be 60%, it could be 80%, but I have talked with investors that refuse to own stocks that don’t pay dividends.

Speculations & Special Situations

While owning profitable stocks that pay dividends is a great long-term strategy, I don’t limit my investment options to just income producing assets. I think every portfolio should have some level of speculation in it. Not every stock pays dividends today, but that doesn’t mean it won’t pay dividends in the future. For me, this is Transocean RIG 0.00%↑, Tidewater TDW 0.00%↑. They don’t pay dividends currently, but their businesses are improving, and I think we will see much higher share prices and some combination of dividends and buybacks moving forward.

Frontera Energy also falls in the speculative bucket, and is probably more speculative than either Transocean or Tidewater. The upside makes it a worthwhile investment due to their small size and offshore exploration, but I think there is more risk there. This bucket should probably be smaller than the first one, but if you can find assets that have a reasonable chance of multiplying a small initial investment, I think it is worth putting a small portion of your portfolio in assets that are speculative.

Short Term Cash / Disaster Insurance

The last bucket will probably be the smallest for most investors, but I think every investor should have short term cash and physical gold and/or silver. If you will allow me to put on my tin foil hat here for a moment, I think there are reasons to hold a small portion of your assets in your physical possession. This includes physical cash (at least a couple hundred bucks for food and necessities in the worst case scenario), and some physical gold and silver. Most of our transactions are made using credit cards and other electronic means, but what happens in the worst case scenario that the electrical grid goes down?

I have seen people talking about Mad Max and other apocalypse scenarios, but I don’t think that it will happen any time soon. I could be wrong on timing, but I think it is worth having some amount of money outside of the banking system. If the worst case scenario does happen, I think people would benefit from having cash, gold, and silver to barter with. If you need to buy water, food, and other necessities, and your bank app doesn't work, and your credit card is just a piece of plastic, it is probably a good idea to have some cash and precious metals on hand.

I don’t want to push the fear narrative that you see sometimes from goldbug investors. You will see some Peter Schiff types talking about the idea that the whole system is going to collapse in the near future, but in the off chance that things do take a turn for the worse, it is probably a good idea to have some cash, gold, and silver in your possession to deal with it. I do think that gold and silver happen to be cheap assets today, so if you don’t have any gold or silver, I think that now is a decent time to be looking at buying physical gold or silver.

Conclusion

Every investor is different, and your risk tolerance and investment mindset is going to have an impact on what you want in your portfolio. I do think that most investors should lean heavily towards assets that pay you to own them. Some will lean towards real estate and physical assets that pay you to own them, but most real estate assets look expensive to me today. We have higher interest rates and we are still dealing with the back end of a real estate bubble built on near zero interest rates. Certain stocks look cheap, but most indices are expensive as well and are very concentrated in high valuation tech stocks.

While I think most investments should pay you to own them, I do think investors should be open to speculations if the risk/reward makes sense. I think energy is a good pond to fish in, especially with the offshore sector. If you look at the supply and demand picture for energy, I think it points to a very favorable setup for the offshore sector. The last bucket is up for debate, but I do think it makes sense to have physical cash, gold, and silver if we see some black swan event where the electronic payment rails go down. This is probably going to be the smallest bucket for most investors, but I will say this: I would rather have some cash, gold, and silver on hand and not need it, instead of the worst case scenario occurring where I would need some physical assets and not have it.

Each investment is different, but if you distill it down to basics, they can fall into one of these three categories. Most investments should generate income, but I do think it is worth having speculations where the risk/reward makes sense, and physical assets to deal with any potential black swan events. This is not a one-size-fits-all prescription for every investor, but I do think most investors should put resources into each of the three buckets. The ratio will depend on what you want as an individual, but I think this is where some diversification makes sense.

---

You should do your own research before making any investment decisions. Different investment strategies have different risk/return profiles which should be considered before making any decisions.