I am thinking of calling my next book The Smartest Doomsday Prediction You'll Ever Read.
After all, if you want to write a best-selling book, predicting disaster for the U.S. economy seems like a sure bet.
It worked for Howard Ruff. His book, How to Prosper During the Coming Bad Years, racked up huge sales in 1979. Ravi Batra's, The Great Depression of 1990 topped the best seller list in 1987. These are just a few of many examples.
Some of the questions I answer in this week's column reflect similar gloomy sentiments.
Please ask questions for consideration in next week's column by adding a comment to this blog. I appreciate all of your questions and will continue to do my best to answer as many of them as I can.
Question From DavidJames
Dan,
I understand your approach to diversification. Why do you only put 30 percent of your example portfolio's equity investments in overseas investments?
Wikipedia indicates that 75 percent of the world's assets are outside the U.S.
Shouldn't the portfolio's distribution of assets mirror the world's, for ideal diversification?
Right idea but wrong benchmark.
Instead of assets, you want to look at "global equity capitalization." This is a far more accurate measurement of economic size.
Market capitalization is computed by taking the share price and multiplying it by the number of shares outstanding in a public company.
The total global market capitalization is approximately $51 trillion. Domestic (U.S.) stocks currently account for 44 percent of the total global equity capitalization.
You could make an argument that your allocation of domestic versus foreign stocks should mirror these numbers. If so, you would increase your foreign exposure to 56 percent. However, I would not recommend it.
Some studies have shown that you can achieve maximum diversification benefits from exposure to foreign markets by allocating between 20 percent and 40 percent of your assets to those markets. As you increase your foreign exposure, these benefits diminish.
The same studies show that allocations above 30 percent - 40 percent do not reduce volatility by any significant amount and may even increase volatility during certain time periods.
Finally, most advisors recognize what could be called a "regional bias" towards the domestic economy. For this reason, they generally recommend overweighting domestic holdings. For example, when I wrote the Canadian Edition of The Smartest Investment Book You'll Ever Read, I recommended that Canadian investors invest 10 percent of their assets in Canadian stocks, even though Canada accounts for only about 2 percent of the world's economy.
If you recognize these issues, and believe you can cope with them, it might indeed make sense for you to increase your exposure to foreign markets to reflect their increasing dominance in the world's economy.
Question From MamaRage:
My question is: I often see advice that in the couple of years before retirement, one should move one's investments away from equity funds into bonds. But, I am a very healthy 60 with both parents still living (83 and 82 years) and Dad's still working just for the fun of it! Shouldn't I be more concerned about inflation over the next 30 years? Thank you
You are absolutely correct. Not all those nearing retirement should be heavily invested in bonds. Each situation is different. And you are very wise to be concerned about the ravages of inflation, which could seriously affect the quality of your life by reducing the purchasing power of your retirement nest egg.
Take the asset allocation questionnaire here or the Risk Capacity Survey. It will tell you what an appropriate asset allocation should be for you. Then proceed accordingly.
Question From Fewkes
I am retired and have an account with a broker that I like. My retirement IRA is in a fund that has been performing well for the 1 1/2 years that I have been in it and the broker says it has been averaging a conservative 6 to 8 percent a year. How do I tell if it is diversified?
A diversified portfolio has exposure to the domestic stock market, the foreign stock market and the bond market.
Specifically, the Russell 5000 is a benchmark that gives you broad exposure to the domestic stock market. The MSCI EAFE Index measures the performance of the international equity markets. The Lehman Aggregate Bond index measures the performance of high quality bonds in the U.S. bond market.
The best way to achieve this diversification is through low cost index funds, either individually or using a balanced fund or a life-cycle fund.
Unfortunately, few brokers recommend index funds. If your broker is an exception, hold on to him. If he isn't, consider investing directly with Vanguard, Fidelity, Charles Schwab or T. Rowe Price, but be sure to request their index funds that use these benchmarks, and not their actively managed funds.
Question From twgbonehead
Dan,
I have a question. What is the rationale behind "rebalancing" your portfolio? I have always felt that you should balance your contributions, and then let them ride (slowly transferring funds from stocks to bonds as you get closer to retirement).
The market doesn't tend to go in one-year cycles; it tends to move over multi-year cycles, and therefore annual rebalancing tends to move funds from overperforming areas to underperforming areas. (For example, look at the slide from '01 onward - I cringed every time the talking heads said "Don't forget to rebalance" as the market continued it's long-term slide.
At the very least, could you run a comparable analysis of this "set-it-and-forget-it" strategy vs. one that includes rebalancing?
I can understand your confusion since rebalancing can be counter-intuitive. After all, who wants to sell an asset class that is going up and buy more of one that is going down?
However, rebalancing is a critical part of portfolio management. When you determined your asset allocation, you took into account your tolerance for risk, your time horizon and your investment objectives.
Because stock and bond returns vary over time, unless you rebalance, you may find that you are taking too little or too much risk. Both scenarios can cause big problems.
Most experts advise rebalancing at least once a year. You don't want to rebalance unless your percentage of stocks or bonds deviates by more than 5 percent. Remember, rebalancing may involve both transaction costs and tax consequences, so you should only do it when it is necessary.
You can avoid rebalancing by investing in life-cycle funds (sometimes called "target funds") or in balanced funds. The fund managers of these funds do the rebalancing for you. However, if you decide to go this route, be sure that the underlying funds are index funds and not actively managed funds. Vanguard is a good resource for these funds.
Question From Mr. Fitz
Invest in an index fund? That's old news. What's so special about Vanguard?
Everyone is always looking for something that correlates directly with returns. Here it is: low costs.
Vanguard has historically been the lowest cost provider of index funds. However, competition is heating up. You should consider Fidelity, Charles Schwab, and T. Rowe Price as well.
Your final decision is really very simple. If two index funds have the same benchmark (like the Wilshire 5000), pick the one with the lowest expense ratio.
As for "old news", you are right. Unfortunately, given the hype of the securities industry and the financial media, this "old news" is lost on most individual investors (but not on institutional investors!).
Any objective review of the long term historical data that compares the returns of a properly diversified portfolio of index funds to a comparable portfolio of actively managed mutual funds or a portfolio of stocks and bonds, would demonstrate superior returns from the index fund portfolio. Yet, millions of investors ignore this data. Why? Because brokers steer them towards high commission, expensive and underperforming actively managed funds.
If index funds were high commission items, 90 percent of the investing public would own them.
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.
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1) Do I liquidate all current investements that do not fit your broad diversification plan? If I'm holding an individual stock that is up significantly, do you recommend selling it off regardless of gain, to move the funds into the recommended mix?
2) Do you tailor your recommended mix based on tax-advantaged (i.e., IRA or 401K accounts) vs. conventially taxed investement accounts? For instance, hold the stock segment in tax-advantaged accounts, and hold the bond segment in conventional accounts?
3) What about company 401K accounts with limited choices? Is the best advice there to "do the best you can, given the choices"?
Thanks in advance for taking any one or all three of these under consideration.
The current Wilshire fractal pattern of interest starts from the low on 14 March 2007 with a pattern of 13/30/20 days. 11 May 2007 concluded the 30 day second fractal. The Wilshire's'final x/2.5x/2x (to 2.5x) saturation fractal series'' begins with the 20 day third fractal of the preceding growth series. Starting on 11 May this series, as of 13 October, has progressed in a 20/49/41 day fractal pattern with 16 August at the 49 day 2.5x low and 11 October at the 40 day 2x high. On 11 October 2007 the Wilshire gapped in a minutely fashion at the day's opening above its previous day's closing high and to a new record high. At its close it was near the low of the trading day and below the preceding day's close. This exhaustion gap activity for the Great Wilshire occurred on 40th or 2x day of the defined 20/49/40 day saturation fractal series. From the lows on day 40 on 11 October, a perfect 6/14/12 x/2.5x/2x 15-minute unit fractal can be easily observed taking the Wilshire to its close on 12 October 2007. Even with the pricing aberration and fractal caricaturization associated with the largely unanticipated 0.5 per cent Fed Funds rate cut, if the Wilshire's price-volume-time multiple and area under the curve for July 2007 ultimately exceeds that of its recent October price-volume-time integration, the 11/27/22 monthly Wilshire high will maintain its position as the price-volume-time composite valuation high for the asymptotic area of Wilshire's saturation curve - proxy for the global macroeconomic system. Will the 20/49 40 day fractal series proceed further .... to 20/49/49-50? Not likely.
I'd like to see a more sliding tax rate for investments. Tax the day traders a whopping 40%..(okay..maybe 30%)..as they are NOT investing..NOT helping the infrastucture of anything. I'd tax investments held 1-3 years at a much lower 20%..3-5 years 10%..and if someone hangs onto an investment over 5 years..hell..I'd not tax it at all!.. reward investment..and tax gambling... what do you think?
oh..and while I'd like to get rid of "hedge funds" altogether..I'd sure as hell get rid of their tax breaks...and Hilary just voted to keep them...republicans should adore her..
Also, besides those mentioned, what other trends should we try to be aware of that can affect world markets and investor choices?
if I am right, U.S. government (Bush's) policies since 2000 have resulted in a huge decline in the value of the dollar, whether measured against the Euro, the loonie, or Gold. If what I just said is correct, would that not be a consideration in investing more that 30% of one's capital overseas? If the dollar continues to slide, even a savings account in Euros, paying only a few percent interest, would perform much better than an investment in the U.S. climbing by 8%, no?
The other week Arianna Huffington blogged about the importance of Naomi Klein's new book, 'The Shock Doctrine: The Rise of Disaster Capitalism'. As you likely know, this book describes how the current political and climactic situation around the globe has given rise to a new sort of hyper-aggressive profiteering on the part of a number of companies. While there are a handful of companies that stick out like a sore thumb, there are many more that are involved to some degree or another with this same issue. Aside from Arianna's post, John Cussack and others have blogged about the same topic. It seems the 'military industrial complex' is a major issue these days.
Since many Huffington Post readers are very concerned about this issue, and since you are offering financial advice for these same readers, would you be willing to offer some advice for those of us who would like to learn more about 'social' or 'green' investing? For many of us finding that right fund for our portfolio is not only about performance, fees and expense ratios, it's equally as much about those harder to measure qualities that help us sleep at night.
You have a big chance to bridge a major disconnect between the Business section of this site with the front page.
Please let us know your thoughts on this, thanks.
Overtime, if you have 40% invested in bonds, you will make more than being fully invested at all times, partly because they don't usually go down when the market does, sometimes the face value goes up. Also, they produce a steady amount of money, while your stocks are going down or sitting still.
A simple example is, if you have $100,000 and have $40,000 in bonds and the market falls to half. If you have 60,000 in the market, you will lose $30,000, but you have your bonds, so your balance will be $70,000. If you have the entire $100,000 in the market and it falls to half, then you have $50,000 left. You can take part or all of the bond money to buy more funds, once the market stops falling, to recoup your losses.
Having said that, I haven't had much luck with the face value of bonds. A month ago, I bought $10,000 worth of intermediate bonds and the face value has went down $59. I earned $41 interest, so I have lost $18, which isn't much in the grand scheme of things, but looks bad compared to funds this month.
Does anyone have an example what the difference would be, if the same funds were used, with one totally in the market and one 40% in bonds when the market goes down?
I suppose, if you have made twice as much being full invested, then you can afford to lose half of it.
Being fully invested would work better, if the investment is in ETFs, since it is easier to get out of ETFs. 401k managers get hostile about trading too often.
You have to take circumstances at the time into account, too. The market is at an all time high and we still have war drums beating, so I will keep my bonds.
Thanks for your advice, Dan.
Dan, please let your readers know about FXA and FXC (no..don't chase them)..but..investors has so many new ETF's today...I used to be a skeptic..but am now a believer...
and..as a further hedge against a down market..there are "inverse" funds..that respond exactly opposite the "index" they represent..i.e.,..go "down" when the Dow goes up..and go UP when the dow goes down..again.not as a full position..just to "hedge" your stock portfolio...without having to invest in put options..which have gotten far to expensive for the average investor AND expire...
Forgetting all the political diatribes, where would you put your money if you believed the U.S. will attack Iran in the next 4-8 months.
I am trying to figure out the shot-term and long-term effects.
I am imagining a scenario where the U.S. initiates some air attack of indeterminate magnitude, and Iran counters by sinking tankers in the Strait of Hormuz with anti-ship missiles, resulting in 20% of the world's oil supply being shut off for some period of time.
Clearly, there are a lot of "if's" in that scenario, but I am trying to envision what would happen, besides oil futures going insane.
Your column is a welcome addition...and thank you Huff and team.
The QUESTION: I do not understand, nor do I accept, the "fact" that inflation is inevitable, yet I am extremely wrong. Just exactly why the HELL is THAT and what could/should be done to stop it? (These questions were prompted by MomaRage's questionings.)
I REALLY would like an answer to this question.
Anybody game?
I don't understand the recommendation to include bonds in a long-term index fund portfolio (say 10 to 20 years before cashing anything in) and for someone who can tolerate occasional dramatic (say 30%) drops in one's net assets. The expectation is that even a 30% drop will recover over the life of the portfolio.
Bonds prevent the possibility of a total loss (if the whole market crashes to zero) but they also prevent the high returns during the good years.
In the meantime the stock market has been going gang busters over the last five years.
My question is if all these negative factors were eliminated (not just discounted or ignored) would the streets of this country truly be paved with gold?
BUSH HAS SQUANDERED AT LEAST 1/50th OF THE WORLDS (OR 1/25th OF ALL USA) ASSETS. HOW AND WHY CAN SUCH A CRIMINAL PERSIST?
As for rear-view mirrors, some are useful. Like rainfall, there are business cycles and market cycles. Looking backward as well as forward can tell you where you are now.
...and then you can take some of Dan's advice.
As always, I recommend Joseph Granville's books on the markets. Still valid about cycles.
Worldtraveler, there are several problems with the approach you espouse, but the primary one is this: "trading" is a fool's game. This article isn't about trading - it's about long-term investing. There's a big difference.
Mr. Solin has it right.
2- I am not talking about day trading I am talking about long term management.
3- I love Dans major premise, there is no better advice than DIVERSIFY.
4- What I am saying is simply that it is a trade-off. I recognize the increased risk distribution but it would be foolish not to also recognize what I am saying. In the simplest example justlook at 2 different portfolios of only 2 stocks. Google and Microsoft. Assume 3 years ago you purchased equal dollar amounts of both. In 1 portfolio you never touched. In the other, everytime 1 stock made up 60% of your portfolio you sold it to rebalance by buying the other. Which portfolio performed better??? With the second method you will generally grow rich but you are removing the possibility of ever having the home run. Now before someone says rear view mirror do the test with any high and low performing asset combination and you will see the same exact thing. Again and Again and Again. If they both went down same holds true.. Why take from the one that went down less to buy more of the bigger losers??