Saturday, September 5, 2015

Volatility Again

Here we are again, enduring a period of crazy volatility. I see many questions posed...what to do? Best advice for times like this is to do nothing. If looking at your portfolio balances is driving you crazy then resist the temptation to look. Every serious investor should have a well thought out plan. When I say well thought out, I mean one that enables you to weather storms such as we have seen recently and worse ones too. One thing I do is reflect on how long I have until I must sell a stock. That answer puts things in perspective and helps me relax. If you're retired and holding 10 years worth of fixed income, why worry about the ups and downs of a few days, weeks, months or more? If you're working towards retirement, and that goal is years away, the conclusion should be the same. Stay the course, stick to your plan.

Wednesday, October 15, 2014

Stay The Course

Recent stock market volatility has a lot of people questioning their stock market strategy. Even though we are, as of this date, not even in official "correction" territory, the worrywarts are out in force. How quickly we lose our perspective. We're coming off a great year in 2013 and some not so bad years before that. Markets correct, it's a fact of life. Here are some pointers that hopefully will be helpful.

1. The single decision that will account for at least 90% of all your future investment gains is what percentage to dedicate to stocks and what percentage to bonds or cash (fixed income instruments). When one decides to invest money in stocks, it would be wise to expect that the stock value, at some point will decline by 50%. That way, if you're 100% stocks your portfolio will lose half it's value in a 50% bear market. If you're 50% stocks, expect a 25% decline in value, 25% stocks - 12.5% etc. The lesson here is that your allocation between stocks and bonds is a risk control measure.

2. Rebalancing a given asset allocation will automatically have you selling overvalued assets and buying undervalued assets (buying low, selling high). It's automatic! You don't have to agonize over what the stock market is going to do. Pick the proper risk level and you'll sleep better. This takes us back to point number 1. Don't overestimate your risk tolerance. Seeing money melt away is no fun. Once again, the importance of that first decision on Asset Allocation cannot be overemphasized.

3. Pay attention to expenses. Know what you are paying to invest. Here's a link to a calculator that will help you estimate expenses. That little 1.5% expense ratio may not seem like much but over time it will suck up a huge amount of your investment returns. Over a twenty year investment period a 1.5% expense ratio will eat up about 26% of your investment return. Conversely an expense ration of .10 %, which is easily attainable with some index mutual funds will reduce your investment return by only 1.98 % for the same period. To quote the great Jack Bogle "Expenses Matter!".

There is no substitute for a well thought out investment plan. One that you've carefully considered and understand. The truly successful investors are the ones who can stay the course and stick to their plan through up markets and down. Success in any other way is most likely the result of luck. I for one am not interested in attaining investment success at the whim of a coin flip.

Thursday, September 5, 2013

What Asset Allocation Should I Have?

I've heard the question "What asset allocation should I have?" over and over. Actually I think it's part of a larger issue for some people. Some people approach the idea of investing as if there is a formula for doing the right thing at the right time. The reality is that each individual situation is different. Jack Bogle, founder of Vanguard, has offered the guideline of "age in bonds". I don't think he meant it as an inviolable rule, but a good starting point in determining what portion of your assets belong in equities (stocks, mutual funds, etc.) or fixed income (cash, bonds, CD's etc.) There are many factors that will have a bearing on your need to take risk by investing in equity vehicles. Among them are age of the investor, sources of income, and the need, ability and willingness to take risk. The risk I am referring to in this case is equity market volatility risk. The fluctuation of your portfolio value caused by the ups and downs of the equity markets.

Your single most important decision as investor, is your overall asset allocation to equity and fixed income. It will account for the vast majority of your future returns. Look at it this way. It is not all that uncommon for the equity markets to lose 50% of their value in a downturn. There have been times when losses exceeded 50%. When trying to determine your equity exposure, EXPECT a 50% loss and apply it to your equity position. If you are 50/50 between equities and fixed income, then a 50% drop in the equity markets would equate to a 25% drop in your portfolio value. We humans, feel the pain of loss approximately twice as badly as we feel the pleasure of gain. Planning for that loss is important, so that when the time comes, we can stay the course and maintain our asset allocation. To do otherwise is to invite disaster.

In answering the original question, "What Asset Allocation Should I Have?", in addition to educating yourself, expect what your losses will be and learn your emotional reaction when you see your portfolio value melting away. Knowing yourself and understanding the basics of investing are the  two greatest tools you have.

Thursday, June 9, 2011

Manage Risk And The Return Will Follow

The vast majority of people I've known always focus on one primary idea when they discuss investing - Return. How much can I make and how fast can I make it? Not surprising since greed is a large motivator in the markets. The other major motivator being fear. What most people don't account for is the risk they are taking for the compensation they are seeking. How many times have we heard stories of people who just couldn't stand the pain and sold out at the bottom? It's a classic and happens over and over, as the markets trace their inevitable ups and downs. The very facet of human nature that will always lead you astray in the markets is the very thing that is hardest to step away from - Emotion. The emotion of fear, has us doing dumb things to protect ourselves at precisely the wrong time and the emotion of greed has us throwing money at investment vehicles that have already peaked and are on their way down. That's why it is so important to understand ourselves and to understand risk.

Rule number one regarding risk. You will not be compensated, in a consistent way, for taking a risk that you could have avoided. If you buy a stock, you take on individual stock risk. Since you can diversify individual stock risk away, you will not be compensated for that risk over the long term. You might get lucky and make an outsized profit, but that's just luck. Luck comes in handy when gambling, but has no place in an investment strategy. At least not one with any hope of success. Risk is necessary for an investor to reap their rewards. The higher the risk, the greater the return or the loss. Many people forget the last part of the previous statement. However, risk that is not necessary, offers nothing or very little in return.

Here are some ideas to help manage risk in a portfolio:

1. Construct an investment portfolio with different asset classes. It could be as simple as equities and fixed income. The two non-correlating assets will offset movements in each other and make your portfolio more stable. There are many asset classes out there that can be used to diversify a portfolio. You can make it as simple or complicated as you desire. Remember to give a lot of thought to your asset allocation strategy, so that you will be able to stick with it over time. Be aware of how much risk your overall portfolio will exhibit. If you want to include a volatile asset class in your portfolio, keep its overall percentage of equity low so you can enjoy the diversification benefits while mitigating volatility risk. Never make outsized bets on risky asset classes. It's just that, a bet, and has no place in a real investment strategy.

2. Consider using low cost index mutual funds or exchange traded funds to build your portfolio. By using mutual funds that track indices, you eliminate individual equity risk. You also eliminate the risk of losing half your investment return to expenses, by keeping costs low.

3. Develop a system to rebalance your portfolio asset classes in a disciplined manner. This is not always easy to do, when things are going to hell in a handbasket and your model is telling you to buy more of your losers, but it's necessary to manage the risk in your portfolio. Always remember that you rebalance to adjust the risk profile of your portfolio. If you are successful the profits will follow, and you will find yourself in the top ten percent of all investors, including the so called pro's. You can rebalance based on time - every quarter, six months, or year. You can also rebalance based on asset class value. I rebalance anytime an asset class strays 20 % from its target or anytime my overall equity/fixed allocation moves 5 % from its target. If you can apply a disciplined system to maintaining portfolio balance, you will always be buying low and selling high. That's more than virtually all active managers, market timers and stock pickers can claim.

Finally, sit back and watch it work. Resist the temptation to tinker with asset class percentages based on whim, or past performance. If you're successful in applying the discipline of rebalancing, you'll be rewarded with the insight that your model has you making great moves at the right time. As time passes, you will gain more and more confidence in your well thought out strategy.

Thursday, March 3, 2011

The Current Gold Bubble

I watch with amusement how the gold ads disappear when the price of gold eases a little. Looks like they are back in full force now, given the current world political situation and therefore the rise in the price of the yellow metal.

I did a little research and came up with some interesting figures. Over the past 200 years or so, gold has pretty much been a hedge against inflation. Of course, when you buy  is critically important, since you could easily get an unwanted haircut buying such a volatile asset at the wrong time. Quite a bit of risk, for an asset that does not provide an income stream, or any kind of promise of future value.

So, given that gold retains its value in an inflationary environment, where are we now?

Well, for the period 1975 -2010, inflation has been approximately 322 %. For the same period, gold has appreciated 700%. So our inflation hedge, is running more than double what we have actually experienced in inflation of the dollar. Over time, where is the future price of gold headed? I put my money on over 200 years of data, and say down. The only catch is that there is no way to know when, and no way to know how high it will go before it starts its decline to its historical mean.

So if you're a speculator, heed the ads and jump on board. If you're a serious investor, interested in taking only calculated risks for a reasonable return, avoid gold like the plague.

Sunday, January 2, 2011

Asset Allocation

The S&P 500 returned approximately 13 percent in 2010. Nothing to complain about since it is above its long term mean of 9-10 percent. The beginning of a new year is a good time to adjust your asset allocation to reflect the risk exposure you desire. Managing risk exposure via asset allocation rather than expected return is the way to long term success. If you manage your risk properly the returns will follow.

Tuesday, August 10, 2010

The Tyranny of Expenses

Many of us have heard of Albert Einsteins famous opinion that expressed his admiration for compound interest. Unfortunately too few of us realize that it works in reverse too. The link below, even though it addresses 403b accounts, is applicable to any mutual fund investment. The bottom line is that expenses do matter, far more than the investment industry wants us to know. As the article below points out, the investment industry has it pretty cushy. They invest 0% of their money, take 0% of the risk, and over a typical investors lifetime take 80% of the profits.

What's an investor to do? Pay attention to investment expenses! They are one of the most important aspects of investing. Index mutual funds and ETF's tend to be low in expenses. Concentrate your money there.

The 403b Boondoggle: John Bogle Breaks It Down!