Between the hub-bub with Peter Schiff, articles like this one from the WSJ and the wave of Ponzi schemes being uncovered I am reminded of how complicated people make investing and personal finance.Keeping it simple (or if you prefer simplistic) avoids a lot of problems and a lot of tears.
I apply this in a couple of ways. First personal finance issues. How old were you when someone extolled the virtues of saving money? Did you want something as a kid and your parent told you to save for it? How did you feel when you finally had enough saved? How old were you when someone said something to you about not going into debt?
It is a good bet that you have known you should save money since before you were ten years old and you probably learned a little about debt shortly thereafter. Do those truthisms about saving and debt still stand up? If you are saving money and not incurring too much debt then you are probably living within your means and can absorb a shock like losing a job unexpectedly.
In terms of investing I am not sure if most people know what being diversified means or not. It seems like in conversation a lot of people say the right thing but often that ends up not being executed prudently. Safe to say it starts with the appropriate mix of stocks bonds and cash. The right mix is different for different people based on all sorts of variables. Then within the stock and bond portions cover all the bases and avoid big bets.
How much is a big bet? That also depends on the person but if it is a fund (narrower than the S&P 500 or total stock market) and it went down 75% what would be the damage, everything else being constant, would that be too much? Then keep in mind that if a fund did go down that much nothing else would be constant. If you have 5% in a stock that goes to zero is that hit too big? On a slightly deeper level if you have 20% or 30% of your equity portfolio riding on one outcome at that outcome sours you are going to take a nasty hit.
Keeping in with the theme of simplicity for this post, if across all your holdings you have more than 20% in any one sector of the market you are vulnerable to a outsized decline should the market start heading south.
The picture is from Hellnar, Iceland.
10 comments:
What, no super bowl prediction ?
good point. the Steelers are clearly the better team on paper but the Cards appear to be good enough and have more of a we shocked the world team of destiny thing about them.
Cards by 4?
Hi Roger - loving your work.
You say "it starts with the appropriate mix of stocks bonds and cash"; is there somewhere online I can find a rough approximation of the appropriate mix for me? Let's assume I have cash resources to not work for a year, I'm looking at building a long-term (20-30 years) portfolio and tax issues aren't important to me.
I am not aware of a specific resource but I would doubt the utility of that resource if i knew about it.
In terms of numbers and how things work the simple answer is 100% equities. Unfortunately that does not take into account things like tolerance for volatility.
I'm not a fan of 100% equities for that reason but the starting point for understanding is that stocks can grow but bonds cannot.
You can take the risk capacity survey at Index Funds advisors to play around with stock/bond ratios if you want. THey don't have a way to work cash into it.
Paul Merriman's site has been helpful to me in answering the how much in stocks question. See his article: http://www.fundadvice.com/articles/buy-hold/fine-tuning-your-asset-allocation.html
Paul agrees with Roger, 100% equities delivers the best long-term returns, but many of us are not comfortable with the risk (of drawdowns) in an all-equity portfolio.
Portfolio diversification should include UNCORRELATED ASSETS from +1 to -1 (S&P). You get 100% negative correlation by going against the Mkt indexes by buying inverse ETFs & or BEAR MFunds!
If one had done this with say, 20% of your portfolio along with 20% cash and the remaining in (selected)long position, your loss would have been limited to single digit instead of 40% or more!
Having seen all sectors go down in the recent flush seems to bring into question your assertion that the answer is non-correlated assets. The markets behavior of the last several years points out that perhaps as a function of globalization, or?, we are living in a more and more correlated world. And with that greater correlation, the very basis of portfolio theory comes into question. If everything moves together, buying "different" things has less utility.
Two other points: your statement that "stocks can grow but bonds cannot" is clearly not reflective of the past year, and perhaps Anonymous 11:08 has it right, inverse investments are the only non-correlated assets left.
I've kept track of about twenty different hypothetical portfolios over the past ten years to see how they do over time... the portfolios range from simple S&P500 to balanced index portfolios to global stock and global balanced portfolios to serious slice and dice portfolios with a fair share of alternative strategies that sort of mirror how I perceive Roger to allocate his client portfolios... and then there are a few actively managed stock funds
As of January 1, 2009, the winners by a long shot were the actively managed stock funds CGM Focus with close to an 850% return and Fairholme at around 240% total return over this ten year period... both hold around 20 stocks, with CGM trading furiously while Fairholme trades very little... each takes a very different route but winds up truly rewarding the risk undertaken in investing in equities...
Of course we dont know if this trend will persist going forward but I thought it was curious that the best performance by a long shot, even after the massive equity crash, remained with the focused stock funds run by the best managers available to the retail investor... it would seem that it really is easier than it might look providing one can identify the managers, give them enough of the portfolio to make a difference, stick with them over time and continue to contribute...
Imagine the investor that invested 500.00 or so in these funds every couple of weeks over that ten year period, regardless of the awful or gleeful headlines... for them it would likely be game over even taking into account their paper losses of the past year
Ajw
Fairholme has only been around 9 years, and their home page says the return for the life of the fund is 153%, not 240%.
I haven't checked CGM Focus yet.
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