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Why You Shouldn't be Afraid of the Financial Markets

   Why You Shouldn't be Afraid of the Financial Markets

      In a world of doomsday scenarios, perhaps one of the most prolific is that of a stock market crash.  One doesn't have to look very hard on survival sites to find information on the dangers of the financial markets and the possible effects of a meltdown.  Is the fear warranted?  Is it possible that our biggest threat is not that of nuclear war, civil unrest, or a large scale disaster; but a financial implosion that will result in the struggle for mankind's survival?  In short, no.  While financial crises can, and do, occur, it is unlikely one will result in the end of the world as we know it (TEOTAWKI).  What does this mean for prepping?  

A Brief History of the Markets

     In order to understand the limited danger of the financial markets, it is important to have a grasp on the history of markets in general.  The markets as we know them likely got their start in the 1300's when Venetians began trading securities from other governments[1].  In the 1500's, Belgium had a stock exchange; however, it only dealt with promissory notes and bonds, not stocks.  In the 1600's, with the formation of the Stock ExchangeEast India Companies, a stock was created which payed dividends on the proceeds from the voyages.  Eventually, this led to a meteoric rise in the investment of businesses, many of which had no legitimate forms of income.  When these businesses were unable to pay their dividends, a market crash ensued, causing the government to outlaw the issuing of shares until 1825.  The first stock exchange in the United States, the Philadelphia Stock Exchange(PHLX), was formed in 1790[2].  The New York Stock Exchange(NYSE) was formed shortly after, in 1792[1].  The NYSE quickly grew into the powerful stock exchange that it is today.

Stocks, Bonds, etc.

      What does this all mean for stocks, bonds, and other commonly traded instruments? For one, it shows their resiliency.  Throughout the years, markets have had their share of crashes.  They have gone through bull and bear markets.  While they have resulted in Stocksfinancial ruin for companies and individuals alike, no real doomsday scenario has come to light.  Stocks have, and will continue to be, great investments to grow wealth.  Investments in stocks have considerably outpaced inflation since 1926[3].  Since that time, the largest decrease in the markets has been 86% (in 1929).  The largest increase has been over 417%.

What about Derivatives?

     According to James Wesley, Rawles, an editor at SurvivalBlog.com, derivatives are the biggest risk to our financial market.  To many outside the investing world, derivatives are likely either completely foreign or seen as high risk gambles used only by billion dollar hedge funds.  To understand derivatives, we must first define them.  According to Investopedia, a derivative is a security with a price that is dependent on (derived from) one or more underlying assets.  There are many different types of derivatives:  futures, forwards, swaps, options, and credit derivatives.  The most common are futures, options, and swaps.  Individual investors are able to be involved in futures and options, whereas swaps are typically relegated to institutions.

     So are these instruments dangerous for investors, and might they cause a major collapse in the financial markets?  As with nearly anything, lack of knowledge can result in disastrous consequences.  People expect training to be required for jobs, driving, etc.  Understanding investment products, such as derivatives, is no different.  It is important Derivative Contractsto understand the risk and leverage that such products provide.  Fortunately, unlike when JWR wrote his article in 2006, we now have a historical perspective of a crash involving derivatives.  According to the Financial Crisis Inquiry Commssion, credit default swaps and over-the-counter derivatives contributed to the crisis of 2008[4].   Despite the large drop in equities and ultimate bailout, we did not experience TEOTAWKI.  The market eventually recovered and has ultimately reached new highs.  Derivatives continue to be a valuable investment vehicle when used properly.

Gold.  The Safe Investment?

     It's the one thing many survivalists will recommend you put your money toward.  Gold and silver, the world's money.  However, gold has limited uses for an investment portfolio[5].  Gold itself seems to have little or no correlation with inflation.  A 100% investment in gold would have under-performed inflation for quite some time. While it may Goldprovide some protection against hyperinflation, gold does not provide protection against typical currency movements.  Even in periods of hyperinflation, gold only performs slightly better than burying cash in the ground.  The price of gold does not necessarily rise in low or negative return stock environments. Gold, just like any other commodity, can derive its price base on value and demand that the market determines.  Considering a TEOTAWKI scenario, one must consider the value of gold against cash, securities, or something far more tangible, such as food and bullets.  

What Should I do with my Money?

      It is important to make sure you are prepared for a variety of scenarios.  One very real and likely scenario is that you are able to retire and continue living as you are today, with no major disasters or emergencies causing a significant shift in your way of life.  You will want to make sure you have money saved up and invested for this possibility.  However, you should also prepare for disasters that are likely to affect you.  For Moneyinstance, if you live on the coastline, you will want to prepare for hurricanes and floods.  Set aside money for building up a food supply and preparing survival kits.  Your money should be spread between survival supplies (which should cover everything from a blackout to a major natural disaster), tangible assets(property, commodities, etc), and securities(stocks, bonds, etc.)

Shouldn't I Still Prepare for a Crash?

     There are many things you can put your money toward to prepare for a variety of survival scenarios.  Specifically preparing for TEOTAWKI as a result of a financial meltdown is not necessarily one to focus on.  Instead of removing your money from the markets and burying it in the ground, or only using it to buy tangible property such as gold and land, make sure you maintain a diverse set of asset classes.  Learn the markets yourself and be active.  Learn the different products and be proficient with futures, options, stocks, and bonds.  Do not trust your money to a money manager, as the only person who can truly take care of your money, is you.  You should continue your survival preparation while also being engaged with the markets.  Will there be another market crash in the future?  Absolutely.  However, just as learning and preparing for survival will help you in the possibility of disaster, learning and understanding the markets can prepare you for the inevitable market crash.

 Disclaimer:  

     I am not a Registered Investment Advisor, Broker/Dealer, Financial Analyst, Financial Bank, Securities Broker or Financial Planner. The Information on the Site is provided for information purposes only. The Information is not intended to be and does not constitute financial advice or any other advice, is general in nature and not specific to you. Before using this information to make an investment decision, you should undertake your own due diligence. None of the information on this site is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, Company, or fund. I am not responsible for any investment decision made by you. You are responsible for your own investment research and investment decisions.

 

Sources

[1]http://www.investopedia.com/articles/07/stock-exchange-history.asp

[2]http://www.investopedia.com/terms/p/phlx.asp

[3]http://fc.standardandpoors.com/cms/Custom_Site/57488/gallery/S&P_Chart_FINAL.pdf

[4]https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf

[5]http://www.cfapubs.org/doi/pdf/10.2469/faj.v69.n4.1



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