Posts filed under 'Asset Allocation'
May 14th, 2008
Amy L. Barrett MBA, CFA, CFP®, CDFA™
Since active investing leads to inferior returns when compared with passive investing, the key steps to building a successful passive portfolio are below.
Choose stocks, bonds, and other assets based on Modern Portfolio Theory (MPT) - There is a trade-off between risk and return so select investments to gain the maximum expected return for a given level of risk.
Purchase broadly diversified baskets including a wide range of asset classes - A diversified basket includes
U.S. stocks (large and small), Foreign Equities (with Emerging Market stocks), Real Estate, Commodities, and perhaps high quality Fixed Income.
Hire investment managers that have low asset turnover - Turnover is buying and selling of assets. The turnover costs include a bid-ask spread (selling to the bid and buying the offer), market impact (big traders can cause the market to move), and higher trading cost (paying a commission on sales and purchases).
Keep your costs down - Mutual funds with high expenses reduce return. Buy only no-load, low cost funds (i.e., passive index funds).
Manage your taxes - Taxes reduce return so purchase tax-efficient investments for your taxable accounts. Tax-efficient investments control the amount of income distributed in order to reduce investors’ tax liability.
Systematically rebalance your portfolio - Rebalancing instills discipline by selling assets that have grown above the target. This reduces risk and adds return over time.
To answer “How Should You Choose Assets?” I recommend that the do-it-yourself investor visit The Vanguard Group website. Vanguard and other low cost index mutual fund companies offer a variety of broadly diversified index funds. For investors who are not the do-it-yourself kind, a good financial advisor can help you decided on a strategy and choose assets that can help you reach your long-term goals.
May 12th, 2008
Amy L. Barrett, MBA, CFA, CFP®, CDFA™
A previous blog dated March 5th provided a short risk tolerance questionnaire to help you, the investor, select a personal and appropriate level of stocks-to-bonds in your investment portfolio. With the right amount of investment risk (stock-to-bond ratio), you can withstand tough times — like current markets — without selling your investments. Armed with the knowledge of your risk tolerance, your next step in order to achieve a solid investment plan is to choose the stocks, bonds, and other assets to fill your portfolio. But, how do you choose your assets? If you are like most of our prospects, your investments are “all over the place” meaning that they are a hodge-podge of investments. Investors often collect assets without a thought of their overall strategy. Ideally, investors should purchase assets so that the portfolio may meet their life goals.
There are two investment philosophies, active and passive investing, that lead to different methods of building a portfolio. Active investors bet that they can pick the best stocks and funds plus they can “time the market” (buy when the market is low and sell when the market is high). Active investors believe their ability to select stocks and “time the market” will allow them to outperform all other investors. On the other hand, passive investing involves buying broadly diversified investment baskets - a broad variety of investments. Passive investors believe that their stock picking ability and market timing are not superior to the average investor’s ability. In fact, passive investors believe they have no more knowledge than average investors do. Though this view is not flattering, the fact is that passive investors routinely get better results than active investors do. A recent Savant analysis found that 70% of the large cap mutual funds (existing for ten years) had lower return than the S&P 500 Index return. After the investors pay taxes (which reduce return), perhaps 80% would fail to beat the index return. These funds fail because most fund managers are not superior at stock selection or market timing. Active investors may win for a while, but consistently winning over a long period of time is nearly impossible.
April 11th, 2008
Brent R. Brodeski, MBA, CPA, CFP®, CFA, AIFA®
I recently had the privilege of being interviewed and featured in an article that was syndicated throughout Canada. It was first run in the Ottawa Citizen and picked up by several other Canadian newspapers. The author, Keith Woolhouse, tracked me down to chat about the benefits of investing in U.S. stocks. He wisely observed that while U.S. stocks have struggled for a while (especially for local Canadian investors who have seen the U.S. dollar substantially weaken vs. their local Canadian dollar); they seem like a bargain for investors who can see past the recent market turbulence.
The article (see link at bottom) provides perspective regarding the importance of staying globally diversified even after a period in which international stocks have done better then domestic markets. While the author initially seems a bit dramatic, it is actually just a set up for the later part of the article that puts in perspective how much cheaper U.S. stocks are today than just a few years ago. He comes full circle and concludes “don’t count us (U.S. stocks) out, either now or ever.”
http://www.savantcapital.com/articles/ar080313.pdf
March 12th, 2008
Thomas J. Ptacin, MBA, CFP®
The term Asset Allocation is not new to the field of personal finance. Prudent investors seeking to diversify the risk in their portfolio divide investment dollars into a broad array of asset classes. While the concept is simple, the construction and implementation of a properly diversified portfolio is not. Below I will discuss some issues that need to be considered when allocating your investment assets.
In previous blogs last week, Amy Barrett shared some ideas for determining investor risk tolerance and a proper ratio of equities to fixed income. Generally speaking, those with a long time horizon until retirement can and should consider to be heavier in equities. As the investor ages and gets closer to retirement years, the need for preservation and stability emerges and increasing the allocation to fixed income typically makes sense. However, don’t overdo it. People are living longer and many retirements last in excess of 30 years. The risk of your portfolio eroding from inflation needs to be mitigated by maintaining some degree of exposure to equities in your portfolio.
Once you’ve chosen a mix of equities and fixed income that you are comfortable with, the next step is to determine the breakdown of the equity and fixed income components. When determining your asset allocation mix you should consider the following:
Invest in our Friends Overseas: By concentrating solely in the United States, you are ignoring over half of the global stock market capitalization. A mixture of domestic and international equities provides greater opportunities for diversification.
Don’t Forget about the Little Guys: Small Cap stocks actually have a higher expected return than Large Cap stocks. Furthermore, small companies have a low correlation to their big brothers. This means that oftentimes when Large Cap stocks are struggling, the small cap stocks are performing well. Healthy allocations to small cap stocks offer a great complement to the large caps in your portfolio, both in the US and Internationally.
Include the Tortoise along with the Hare: Growth stocks (the hare) can be exciting, but surprisingly value stocks (the tortoise) have historically come out ahead more often. Having a combination of growth and value stocks is important. Either is capable of winning the race in any given year. Unfortunately it is impossible to know the winner ahead of time.
Short isn’t so Bad: Try to limit the maturities on your bond portfolio to short and intermediate lengths. While long-term bonds typically offer slightly higher yields, they also come with more risk. Reducing portfolio risk on the bond side can allow you to spend more risk on the equities, which have a higher expected return.
January 30th, 2008
Brent R. Brodeski, MBA, CPA, CFP®, CFA, AIFA®
In light of the continuing market volatility we thought you might enjoy an advance look at the feature article included in our forthcoming quarterly newsletter. Clients have been recently asking if they should consider reducing their exposure to equities in response to the recent market turbulence. Click on the link below to gain some perspective regarding our thoughts on the matter. The article includes a series of questions you might ask yourself to asses the appropriateness of your current allocation. As always, let us know if you have any questions.
http://www.savantcapital.com/pdf/savantalk_allocation.pdf
January 7th, 2008
Theresa H. Harezlak, CFP®
Imagine, you have more than 50% of your retirement savings in the company you work for and the stock price continues to appreciate, making you thousands of dollars per year. Now imagine you worked for Enron or World Com. There are some people who own a lot of company stock that become millionaires, many more of you, however, just become disappointed with your portfolios.
The concern with owning too much company stock is two-fold—not only is your financial portfolio tied up in one industry and one company, but if you are also an active employee, your ability to earn a living is also tied up in that same company. This situation can be less than ideal when the company experiences layoffs, management changes, or any other downfall in their performance. You may be stuck out of a job and holding too much company stock that is declining daily. This scenario carries way too much risk.
Your mother always told you to not put all your eggs in one basket. The same holds true for owning company stock.
My advice: if you like the company you work for and you think good things are happening, keep 5% of your portfolio in your company’s stock. If you love the company and know that only good things are happening, keep up to 10% of your portfolio in that company’s stock.
Remember, there is no shame or disloyalty to a company if you choose to own none of its stock. Most advisors agree that no more than 10% of your portfolio should be in any one stock. While, there is always a chance that a single company will outperform a diversified portfolio, history shows this is rarely the case and that possibility simply comes with too much risk.
As with delicious food, a good wine, and so many other wonderful things in life, when it comes to owning company stock, moderation is the key to a good, healthy portfolio.
November 23rd, 2007
Brent R. Brodeski, MBA, CPA, CFP®, CFA, AIFA®
Investors are much like turkeys! The good news is we can learn from their experience before we too get our heads chopped off! To understand, let me first tell you about the day in the life of a turkey. When they first crack out of their shell, they are scared. They’ve been separated from their moms. They awake under incubator lights and are quickly greeted by big, scary looking humans. They are quickly herded off to pens with other confused and scared little turkeys. But after a while, as they fatten, the humans don’t seem so scary after all. In fact, like clockwork, each and every day the scary humans bring them food. They start to actually like humans. By the time October comes around each year, they look forward to spending time with humans. Why the heck were they so scarred? How naïve they were! Humans are nice people that let them play all day, bring them food and keep their pens clean. Of course, at the point they are most confident, they’re duped. We eat them for Thanksgiving dinner! It turned out that the risk (of losing their head) was greatest at the same exact moment they were most confident.
Too often investors act like turkeys. They pay close attention to recent events. When markets are on a roll (i.e. 1999), they get fat and happy and their confidence grows. They question why they own any bonds. They might even call their financial advisor or banker and suggest it’s time to buy technology funds or the NASDAQ QQQQ (since it is a low risk investment that only goes up). In fact, the banker might offer them a newly minted technology fund before they even get around to calling! Investing is easy! And, obviously, it’s different this time. It is a new paradigm. Unfortunately, you know the rest of the sad story. Like the turkey, at the point of greatest confidence, investors lost their heads. The NASDAQ fell almost 80%. S&P losses approached 50%.
At the bottom of the bear market (three years later), wary investors fell into the same turkey trap. It was March of 2003. Investors were beyond depressed… they were outright despondent (despondent investors just concede markets will never recover—markets are forevermore hopeless). Three years of declines, bad news and scary stuff (perpetuated by the media) caused turkey-like investors to finally sell. Enough is enough! By selling (even at a big loss) you could at least salvage a bit of your portfolio. By selling your stocks (minus the bankrupt dotcoms) you could start re-building your retirement fund. If interest rates go up (a lot), you might even retire by the time you’re 80! Sadly, we all know what happened next… markets rallied strong, right after turkey-like investors sold. Paying too close attention to scary markets during 2000-02 caused investors to confidently make exactly the wrong decision—selling at just the wrong time.
Of course, the 2000-02 bear market (and previous technology bubble) were extreme case studies of humans acting turkey-like. Still, these lessons are easily adapted to today’s environment. One month things seem to be doing well as the market coasts past 14,000. It feels good. Investors start to buy more. Life is good. Then, sub-prime worries re-surface—causing investors extreme angst.
With recent declines and volatility you might now find yourself questioning the wisdom of owning stocks. You might be tempted to bail out (or reduce your exposure to stocks) and sit in cash. I suggest you re-consider. Remember, prices are now cheaper than they were just two months ago. Don’t be a turkey! Don’t get duped by what’s happened recently. Instead, stick to a long-term plan (in the long-term stocks go up) and avoid the temptation to focus on recent scary stuff. And, just as important, don’t get too excited next time markets rally. Just remember… over time, markets go up. And, in-between, they fluctuate. Don’t let recent events, good or bad, affect your long-term strategy. Stick to a balanced plan while ignoring the latest buzz. In doing so, you just might avoid the butcher block!
(Footnote: I borrowed the turkey analogy from one of my favorite books: The Black Swan, by Nassim Nicholas Taleb.)
November 21st, 2007
Brent R. Brodeski, MBA, CPA, CFP®, CFA, AIFA®
Lately, foreign investing is the buzz. After being out of favor during most of the 1990s, it is back with a storm. Favorable valuations after the 2000-2002 bear market, globalization, a weak dollar and big growth in emerging markets has led to substantially higher foreign returns vs. those in the U.S. Like clockwork, whenever a particular investment category does well, investors notice. In fact, most net cash flows into stock funds in the last year have gone into foreign investments. Renewed interest in foreign investments makes sense. Not because they are hot lately but because they should be a key component of any investor’s long-term strategy. Still, we think it is critical for investors to first determine their proper overall foreign allocation before diving in.
Three theories exist to guide investors to make an optimal (reasonable) allocation to foreign stocks. These include:
- Identify optimal foreign allocation based on correlations and expected returns - Assuming one defines foreign stocks to include large, small, value, and emerging, and using long-term historical data, this approach typically leads investors to invest between 25-35% of their stocks overseas. What percent within this range really depends on what time frames one analyzes and what you expect to be the diversification benefit going forward.
- Determine foreign allocation based on consumption model – Americans spend approximately 80% domestically and about 20% on foreign goods. Accordingly, if one follows the logic that they should invest with whom they do business, to match their assets (investments) with future liabilities, a 20% allocation to foreign may be optimal.
- Invest in alignment with global market capitalization – This method suggests that investors invest where the money is. Said differently, approximately 47% of world market capitalization is in the
U.S. (down from 70% a few years ago) and 53% is in foreign developed and emerging markets. Of course, this does not recognize the fact that foreign assets also require investors to incur currency risk (while domestic investments do not).
Our recommendation: For many years Savant has maintained that 30% of equity exposure should be allocated to foreign. This is not a magic number but seems reasonable in light of the above three methods of determining international exposure. Having said this, one could easily make a case for 25-35% in foreign. Though it would be a bit out of my comfort zone, a range between 20-40% foreign might even be justified.
Bottom line, as global consumers, it is a no brainer to invest globally. Just be strategic about it instead of chasing after hot returns!
Amy L. Barrett MBA, CFA, CFP®, CDFA™ 
