How Would a Global Depression Affect Your Investments?

I have no idea where the economy is headed. I do not want to trivialize the problems which caused the current crises. It could get better or worse--much worse.

I am struck by the sensationalism of the financial media and suspicious of its motives. Stirring the pot with breathless speculation about a "financial meltdown" and the coming "depression" boosts ratings and sells magazines and newspapers.

Here are some objective facts to consider:

We are not in a recession, much less a depression.

A "recession" is defined as a period of two quarters of negative growth in the Gross Domestic Product (GDP).

According to the Bureau of Economic Analysis, real GDP increased 0.9% in the first quarter of this year. In the second quarter, it increased at an annual rate of 2.8%.

A "depression" is defined as an economic downturn where real GDP declines by more than 10%.

In the Great Depression, real GDP declined by 33%.

During the period 1973-1975, real GDP declined by 4.9%. That was the worst decline in the past sixty years.

Readers of this column know that I advise investors to determine their asset allocation and invest in a globally diversified portfolio of low cost index funds.

What exactly does "globally diversified" mean, and how has this kind of portfolio held up in the current economic climate?

Let's take a look at a hypothetical, diversified portfolio. It is invested solely in index funds, Exchange Traded Funds or passively managed funds, with 60% exposed to the stock markets and the balance in bonds. This asset allocation is typical of the ones used by most pensions and trusts, managing trillions of dollars in assets.

This portfolio would have over 17, 000 total holdings The bond portion of the portfolio would be invested in short and intermediate term bond index funds.

The total market value of the stocks in this portfolio would be in excess of $36 trillion. Total sales would be more than $34 trillion. Net profits would be around $2 trillion. The companies in this portfolio would sell their products and services in more than 192 countries.

This portfolio would still lose money in this market, but it would lose significantly less than the S&P 500.

Recent recessions have lasted 1-2 years.

The Great Depression lasted 10 years.

In order for a depression to dramatically affect the value of a globally diversified portfolio, it would have to be global, not one limited to the United States alone.

The Great Depression was triggered by the failure of the Federal Reserve to increase the money supply, which fell dramatically.

In response to the current crises, central banks around the world are engaged in a coordinated effort to pump money into their various economies. Whether it will be sufficient to stave off another Great Depression is unknown.

What is known is that investors whose asset allocation is appropriate for them and who invest in a globally diversified portfolio of low cost index funds will be in the best position to limit their losses. History also tells us that investors who held on during hard economic times were rewarded with the long term annualized returns consistent with the underlying risk of their portfolios. For this portfolio, those returns would range from 8%-10%.

Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books 2008).

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.

Comments

[LRM216]

What investments???????? If you had asked this a year ago, I might have been able to answer.

[JBS]

It may not be a recession where you're sitting, but it damn sure looks like one from down here on the bottom!

[cylindar]

Dis you say "we are not in a recession"? Hahahahahahaha

[lapoutlander]

"A "recession" is defined as a period of two quarters of negative growth in the ... (GDP)."

This is not the definition. From the wiki
"a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."...

American newspapers often quote the rule of thumb that a recession occurs when real gross domestic product (GDP) growth is negative for two or more consecutive quarters. This measure fails to register several official (NBER defined) US recessions."

Tthe US is beginning a recessionary period. Real income less transfers falling, unemployment rising, with other declines continuing into next year. The question is how deep is the contraction and how long. Credit will be tight for 1-2 years.

Barring the unlikely depression what is more worrying is what growth will come afterwards. Japan's case after their real estate bubble is worth noting. Lack of fiduciary clarity delayed confidence and with other factors resulted in stagnation. Being an older demographic they were in a bad position needing to begin cashing out their stocks for retirements. That is what worries me about cheerleading the market today. Past performance when the population was younger is no guaranty of the near future when babyboomers start retiring. The long term balance of buyers vs sellers may do a long slow shift toward sellers pushing PE ratios into their historically low range.

[PermacultureMainer]

We're screwed if we don"t start seeing our world for what it is....if you parse things fine enough you can see nothing in the end...Mr. Solin, sir, you need to step back and take a good look around...I bailed out of the market on December 7th of 2007 and moved out of CD's and into CASH 6 weeks ago....I have put up a small commercial greenhouse on my suburban lot and my wife and I got involved with farm and energy committees here in our town last year...we are helping our friends and neighbors learn how to grow and preserve food, conserve water and all forms of energy, and we gather frequently with folks to break bread and share helpful and hopeful ideas and thoughts.....the point is there are other forms of "capital" that we can "invest" with...invest time and ideas in your community, invest your energy in making the most of what you have.....

[PermacultureMainer]

UPDATE: Dan I think the bottom is around 6000...but it won't matter because folks will end up cashing out at whatever level to pay their mortgages. buy groceries, heating fuel, food....the future will be tomorrow not 5 or 10 or 20 years from now. If we stopped bailing out and started creating jobs with the same money we'd come out much better and much sooner.......

[dukeitout]

Dear financial news media: We recognize that bad news means higher ratings. Really bad news means huge ratings. Keep up your doomsday pitch. Stock prices keep going down. We value investors appreciate your efforts.

[uncleentropy]

Government deficit spending, including the Christmas in Spring stimulus checks, counts as part of GDP. Take this smiley face accounting out and you will have several quarters of negative GDP. The "virtual" recession is becoming real now....we can't borrow and spend to artificially inflate GDP anymore.

[research]

Oh, That is So true!

The GOP "economic expansions" are always borrowed!

OPM

[WorkingClass]

"We are not in a recession, much less a depression".

With all due respect sir. How do you explain this?

http://www.shadowstats.com/

[SeekWisdom]

actually the url you want I believe is

http://www.shadowstats.com/alternate_data

Those charts show a truer picture by removing the governments "number fudging" and real GDP has actually been showing negative growth since 2004.

It seems Dan hasn't noticed that the Government routinely makes "adjustments" in the way statistics are calculated whenever the "old way" starts getting ugly.

[HeevenSteven]

For years I've been telling several friends who are always glued to CNBC that all those financial pundits are full of crap. Did any of those geniuses see any of this coming? They're all full of crap.

Dan you're the only one who ever gets anything right.

[Chavez08]

The "Great Depression" was a phenomenon exclusively of the very rich. For decades prior, many hard-working Americans were in poverty and were homeless and dying of common ailmnents and the bankers were screaming for liquidation and the re-birth of "Debtors Prisons" while the most cunning criminls enjoyed the "Gilded Age".

It was only when the market collapsed that historians felt it worthy to note such a "catastrophy" and it took a true leader (FDR) to rebuild after the richest, greediest fell pray to typical human nature and ruined their system in an apathetic storm (much like the events today) and make a NEW economy that would work for the majority of Americans.

Another "Depression" would not hurt most Americans but would promise to change public dialogue and force the establishment to un-disappear the tens of already millions of poor, homeless, disenfranchised (the many victims of predatory capitalism) from under the radar that are not part of this rich-mans economy that is subject to events "recessions" and "depressions" as measured by mainstream economists per cryptic formulas.

That being said, bring on the "Depression"!!

[RoloTomassi]

Well, we agree on a lot of points. but this:

"Another "Depression" would not hurt most Americans..."

Is just simply wrong. I do believe the bottom is rising up quickly to meet us, and it is foolish to underestimate just how serious this fiasco might be. Despite all of our Depression era protections, if the whole global economy tanks there will be massive business failures/job loss, non-existent credit, acute famine around the globe, an ever growing number of homeless people, and a depth of financial misery not even imagined by the majority of Americans under the age of 60.

You delude yourself if you believe otherwise. Of course, there's no certainty to be found right now, so who knows what the outcome will be. But I found the following to be quite disturbing...here's a excerpt:

"The recession of 1929-1939 was initiated by financial collapse. However, a Great Depression was created by those who fought to save the financial industry and, in the process, destroyed the economy. The same is happening today. Hank Paulson and Ben Bernanke are engineering a second Great Depression."

http://pix.cs.olemiss.edu/depress

[Chavez08]

The underclasses/invisible of this country are screwed regardless of the Wallstreet economic indicators and the disenfranchisement is a cancer that works its way up the pyramid in a thorough fashion.

Based on your response, I am assuming you currently have a job, a house and have a retirement account. Jobs with real income are being systematically eliminated from the U.S. market and there already literally tens of millions who are poor, homeless, underemployed, victimized by creditors and the overall Reagan class-war that has driven many to drugs, suicide, crime and they are unnaffected by Wallstreet. They don't know what it's like to have a 401k or to check their favorite stocks because their savings and investments (if any) had already been drained because of uninsured health conditions, predatory home interest rates/foreclosure or cheated out of contractual compensation by imperialistic corporate employers looking to exploit the labor market and a robber-baron friendly government.

Sooner or later, this will be the rest of us. Neoliberalism isn't an inclusive club. There will be winners and losers and you would be foolish to think you'll be in the circle after all the dust settles, regardless of economic formulas.

We are all in this together sooner or later. I'm merely proposing we get the bad stuff out of the way so we can roll in revolution/evolution from Friedman capitalism.

[Rule Of Law]

As you both know, any Depression affords the Oligarchy the opportunity (created by them) to enrich themselves further at bargain basement rates! Check the families that were wealthy before '29 and how they fared after, and the increase in wealth and power is apparent.

It is always the poorest of us and the working class--upon whose backs the fortunes of the Uber-Wealthy is built--who suffer the greatest. It isn't justice, and they aren't getting their payback for being either greedy or shiftless. They are--We are--pawns in a global social engineering phenomenon known as International (One World?) Banking, and the Central Banks are the Royalty of the World.

Solin may be technically correct re the definition of a recession, but the numbers he uses are bogus, supplied by the same people with the greatest vested interest in this melt down, and still showing the stretch marks of the inflated gdp based on the churning of mortgage money through the system that Bush relied upon in order to Claim growth, while blowing the greatest money transference bubble known to man.

If most of these bloggers had to carry a lunch box, you would get a more realistic view of what it is like in the trenches of working America.

[Unrepentantliberal]

Thanks Dan. I started reading you earlier this year and changed my investing style from a highly risky 100% stocks approach that can only be charitably described as gambling, to your globally diversified mix of index funds consistent with my capacity for risk. Yes, I have lost money so far this year it's true. But, I've lost allot less than I would have under my previous approach and I feel much more confident and at ease about my portfolio over the long term.

You and Suze Orman are my heroes.

[ReasonIsMyReligion]

Whew.
Sanity, not Hannity.
Thanks, Dan.

[Halsey]

Dan,

Keep fighting the good fight..yes..people should NOT go to 100 cash..selling all investments at a loss...
Factories WILL keep producing goods...People will still eat...and buy essentials..(soap, toothpaste, etc)..

It is simply beyond frightening for us baby boomers (yes..this is of our own making..I KNOW that!)...
Retire at 65 like my father?..HA! If I live to be his current age (85)...I will STILL be working..or pushing a grocery cart around...babbling about the good old days..

[worldtraveller]

Ha don't get out and that way you haven't taken the loss. I always loved that one. Look at the brokerage statement, you have already taken that loss.

[sonoffestus]

LOL..........."babbling about the good old days." Sounds a bit like John McCain. Don't worry he knows how to 'Fix" everything, but it's a secret he won't share with anyone. Did I tell ya I was a POW?

Yes, I'm hanging in. I had planned on working till I stopped breathing anyway. It just looks like they'll be more competition for those "greeter" jobs at Wal Mart. Maybe if I sign up now , I'll get seniority. What do you mean no unions, no seniority?

[theeconomicfractalist]

The World's Greatest Macroeconomic Depression

One of the utilities that the new science of quantum saturation macroeconomics shares with all other sciences is predictability. As of this posting the final fractal decay sequence for the Great Wilshire is 9/23/3 of 23 days with day 22 and 23 shared between the second and third fractals. For the Wilshire 8-9 days of nonlinear growth are now predicted - unrelated to today's coordinated world banks' rate cuts, The Wilshire will fall in a nonlinear during the final 14 days of the third decay fractal to a valuation level that will leave little doubt about the coming depression. A sustained drop in GDP representing the real economy will further compound the massive debt and entitlement problems that America collectively owns. For the world this US 150 year second fractal macroeconomic depression wlll supercede the severity of its twin subfractal depression occurring 70-75 years ago.

[joebaggadonuts]

If I have any money left, I think I will buy in when the DOW reaches 6500.

[tompoe]

Dan needs to take a look at any 401(k) out there, and then we can discuss depression.

[WIpatriot]

An average loss of 20% over the last 15 months qualifies as what??

[Rule Of Law]

The national debt just became to big for the big board at the NYSE!!!

When do these talking heads become willing to admit that if this was a car lease, we are to upside down in it, that the jaws of life can't save us!