Deleveraging – What Are the Consequences to Your Portfolio?

Deleveraging is a fancy financial word used to explain that people, business, or even the government is in the mode of paying off debt.  They are making more money than they are spending.  The extra cash flow is used for both savings and debt repayment.  In the long run, this is a healthy thing. In the short run, it doesn’t help our economy grow very quickly.  If you have read my book, 18 Common Sense Rules for Retirement, you already know that I am a zealot for living a debt free lifestyle.  With the dangers of excessive debt exposed, I suddenly find myself moving from being called a “nut case” to “merely being conservative”.

The recent financial crisis was created by all these groups spending more than they made.  Consumers were financing their excessive purchases by using credit cards and easy to obtain home loans.  The government also overspent, but has the luxury of owning the printing press without any limits.  The Government spends money trying to make the economy grow with the faint hopes that the growth will create future tax revenue to pay off debt.  Sometimes bold politicians even admit that they have no plans of paying off the debt; because it doesn’t matter as long as the total debt versus the government’s revenue sources is in line.  It’s no wonder that consumer’s behaviors have radically changed for the worse in the last generation with fine leadership such as this.

Unfortunately, less spending causes less business revenues and growth.  We are entering into a period of slower growth.  The slower growth mode could take a lot of time to work through, and I doubt if even the best of minds could accurately predict its duration.  My guess is that it could be a decade or more.

The following is a chart summarizing which countries will experience the highest amount of deleveraging.

The above chart points to the fact that Brazil, Russia, India, and China (BRICs) have less need to deal with past debt.  They are in a better position to grow than a lot of the remaining areas of the world.  I would anticipate their greater potential for growth will translate into greater stock market profits in the future.  Traditionally, the BRICs investment area has experienced greater volatility than the U.S. Markets, and I anticipate this will be true in the future as well. 

I have redesigned my traditional investment portfolios into what I term my Inflation Hedged Models.  These models increase the international exposure and reduce the United States exposure.  Within the international allocation, the BRICs allocation is increased as well.  The overall idea is to try and position the portfolios to take advantage of the long term trends that I see occurring.  I won’t outline the exact allocations in this document for everyone to read on the internet, but I would be happy to review them with you in person. 

Allocations should always be made within the context of a well defined financial plan that considers your goals and risk tolerance.  If you have a financial plan for your future that outlines a path toward achieving your goals, and if your investment portfolio is well diversified and supports the plan, then you can rest more comfortably through the market’s occasional uncertainty.