Stock Investing: Taking Your Money Off The Table Until Things Calm Down?

Like most articles you’ve seen about about the recent market gyrations, I think people with long-term investments should act like it and not do anything special. But really, the past several days was nothing compared to real fear and uncertainty. In early 2009, a phrase I heard often was “I’m just going to take some money off the table until things calm down. Why risk it?”

Well, here’s a chart from FiveThirtyEight.com comparing the results of a “cautious, play-it-safe” investor and the “do-nothing” investor:

538_markets

Imagine two people who each invested $1,000 in the S&P 500 at the beginning of 1980. The first one buys once and never sells. The second one is slightly more cautious: He sells any time the market loses 5 percent in a week, and buys back in once it rebounds 3 percent from wherever it bottoms out. At the end of last week, the first investor’s holdings would be worth $18,635. The second investor would have just $10,613.

Remember, the only two possibilities for the stock market are all-time high or a drawdown. The highs you don’t really feel. The drawdowns are quite painful. Here’s a nice chart from Doug Short illustrating the drawdowns since 2009. Lots of painful drawdowns, but during that time the market is up over 200%.

538_dshort2

This is also why financial advisors tell you to create an investment policy statement. That’s where you write down ahead of time “If the markets drop 10% in a week or two, I will do [action or lack of action] because [reason].” Then when the drop actually happens, you break out that piece of paper to remind yourself what the calm, rational version of yourself would have done.

Robinhood App Review: Free Stock Trades With No Catch?

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Updated review in August 2015 to include new Android app, new order types, and more.

Fintech start-up Robinhood wants to “democratize the financial markets” by creating a mobile-first brokerage that offers unlimited free trades with no minimum balance requirement. That is a pretty bold move, and I was skeptical when they started getting noticed in late 2013.

I started out as a beta user in mid-2014 with their beautiful but manually-installed iPhone app. They officially opened to the public in March 2015. As of August 2015, they have both an Apple iOS (and Apple Watch) and Android app and have processed over 2 million free trades. Here’s my updated review based on my experiences with them.

Application process. You must provide your personal information including Social Security number, net worth, income, investing experience, etc. This is the same as any other brokerage firm, but this may also be the first such account for many users. Everything was done online; there were no paper documents that required mailing or faxing.

Core features.

  • Yes, the app really gives me $0 commission trades with no minimum balance requirement. That means you could open account, put in five bucks, and buy a single share of Zynga (ZNGA) if you wanted to (maybe two on a bad day…).
  • Robinhood now supports market orders, limit orders, stop limit orders, and stop orders. Certain orders may be entered as good for the day or good till canceled (GTC).
  • You can open an individual cash or margin account.
  • Customer service is best through their e-mail support@robinhood.com, but they have added a phone number now during market hours (9:30am – 4:00pm EST) at (650) 940-2700.

Along with all the other legit brokerage firms, Robinhood Financial is a member of the SIPC which protects the securities in your account up to $500,000. Data is encrypted with SSL. Apex is their clearing firm.

Funds transfers. You can manually link any bank account with your routing number and account number, but you can also directly use your username and password at these banks: Chase, Bank of America, Citibank, Wells Fargo, U.S. Bank, Charles Schwab, PNC, Silicon Vally Bank, and USAA. ACH transfers are free and take approximately 3 business days (same as other brokerages).

Robinhood recently added an automatic deposits feature where you can schedule ACH transfers on a weekly, biweekly, monthly, or quarterly basis.

What’s missing? Getting free trades is great, but I think it’s also important to know what you won’t get, at least right now:

  • You must access your account via a mobile Apple iOS or Android device (iPhone, iPad, iPod Touch, Android phone, Android tablet). Web interface is “coming in 2015″.
  • Broker-assisted phone trades are $10 each, according to their fee schedule.
  • Electronic statements are the default. I don’t even see an option to enable paper statements in the app, but according to their fee schedule paper statements cost $5 a pop.
  • As of August 2015, Robinhood does not support ACAT transfers, so you can’t move over your existing assets from an outside brokerage. (Or move out your assets via ACAT either, I’m guessing.)

How do they make money? For now, Robinhood will make money the same way other brokers do: collect interest on your idle cash, charge you interest for margin loans, and sell order flow. The most innovative prospect is to the plan to sell API access to other financial apps.

The fact that Robinhood sells order flow may leave you with a slightly worse execution price as compared to other brokers with more complex order routing. If you are making large value trades, then this small percentage difference may add up to something significant that matters more than commission price. With my tiny order volume, I am fine with them selling my order flow if they are giving me commission-free trades.

User interface. Over the last 10 years, I’ve opened an account at the majority of the “discount” brokerage firms. I’ve had $0 trades before, along with $2 trades, $2.50 trades, $4.95 trades and so on. What makes Robinhood special is their modern, app-centric approach. I agree with this quote from Wired:

But the app’s simplicity is meant to be about more than style. Ease of access and understanding is meant to make Robinhood compulsively engaging for a new generation of investors that don’t find the stock market very accessible from the mobile screens at the center of their lives.

Even though I don’t trade frequently, I still check the app all the time. More often than my primary Vanguard account. Why? Because it’s so easy. One tap on the Robinhood app logo, and either a quick 4-digit PIN or thumbprint with a newer iPhone. It’s a pet peeve of mine to have to type in a 16-character password on a tiny keyboard just to check a balance. I think other finance apps can learn a lot from Robinhood in this respect. I think only Mint and Robinhood support Touch ID on my phone.

Screenshots.

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Recap. Robinhood delivers on their free stock trades with no minimum balance promise. The app-only user interface is clean and intuitive. Customer service is a bit lean, but my requests were responded to within a day or so. They continue to make incremental improvements every month. I’m still skeptical about whether they can make the economics work over the long run, but they do appear to be streamlining wherever they can.

More: Fee Schedule, Official FAQ, Techcrunch, Buzzfeed

Playing “Fill-In-The-Blank” Mad Libs with Financial Buzzwords

madlibscoverAfter you spend enough time consuming financial media week after week, you start seeing patterns in the noise. I understand why of course, as creating content to feed the beast can get quite exhausting. But hopefully, by pointing out these out, you as an individual investor can realize that there may or may not be any substance behind the marketing buzzwords and short-term forecasts. Entertaining? Yes. Useful and actionable? Much less likely.

A good analogy would be with the classic word game Mad Libs, where “one player prompts others for a list of words to substitute for blanks in a story, before reading the – often comical or nonsensical – story aloud.”

Here’s how the usual “Profile of successful mutual fund manager” article usually goes. I am paraphrasing myself in 2006.

[Name of recently successful mutual fund manager] may not look the part, but at the helm of [formidable sounding firm], his [mutual fund name] has outperformed its benchmark by [big number]% annually over the past 5 years. The key is to [something skill-based like “on-the-ground” human research or complex computer algorithms] and also [something classic like “long-term perspective” or “focus on the fundamentals”]. As a result, the manager says that people should [something vague and simple for the Average Joe investor].

There are also the marketing materials coming directly from the firms themselves. Here’s an actual quote taken from a 2008 fund brochure. I’ve bolded the buzzwords for your convenience:

The OIM Core Plus Fixed Income strategy is rooted in the idea that individual security selection produces the best opportunity for risk-adjusted excess returns over time. Through an extensive, bottom-up research process, our portfolio management team focuses on optimal bond selection of investment grade corporate bonds, mortgage-backed securities, US Government Treasuries and taxable municipal bonds. The team employs a tightly controlled duration discipline and closely manages all portfolio risk factors. The portfolio management team’s objective is to produce predictable, consistent excess returns net of fees over the Barclay’s Capital Aggregate Bond Index.

The Oppenheimer Core Plus fund was supposed to be very conservative and was marketed to those with children within 5 years of college. What happened next? It proceeded to lose 38% of its value in 2008, while the fund’s benchmark actually rose 5.24%.

Barry Ritholz probably digests more financial media than 99.9% of folks out there, and in a recent WaPo article he pretty much nails the average CNBC guest who gets the question “Where’s the Dow going to be in a year?”:

“Our view is that the economy in the U.S. continues to _______, and we foresee _______ problems overseas ______. China is _______, and that has ramifications for the Pacific Rim’s ______. Greece is ______ in Europe. The commodity complex is causing _____ for emerging markets. But many sectors of the U.S. economy remain _______, and some sectors overseas are still _______. The valuation issue continues to be _____, and that means _____ for investors. That has ramifications for corporate profits that will be ______. We think the economy is going to do ______, and you know that means inflation will be _____, which will force interest rates to ______. Under these conditions, the sectors most likely to benefit from this are ______, ______ and ______. The companies best positioned to take advantage of this are ____, ____ and ____. Based on all that, we especially recommend an overweight allocation to ____, ____ and ____. Thus, we believe the Dow will be at ______ next year.”

There are good mutual fund managers, good financial reporters, and good hedge fund managers out there trying to do the right thing. But the problem is that when you see such meaningless words and phrases, you just can’t tell if they are good or bad. Next time you watch CNBC, Fox Business, or Bloomberg TV, see if you can match up the blanks and buzzwords. Thanks to reader CJ for the Ritholz article tip.

Acorns App Review: Auto-Invest Your Spare Change, Now Free For Students

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Updated review. New Android and web versions. Added details about “students invest for free” feature (anyone 24 and under). When I wrote about WiseBanyan, I remarked that now people could start investing a portfolio of ETFs with as little as 100 bucks. Well, what about investing just 57 cents at time?

Acorns is a new smartphone app that lets you invest your “spare change” into a diversified ETF portfolio of stocks and bonds. For example, if you bought something for $10.43, the Acorns app will “round up” your purchase to $11 and invest $0.57 into a brokerage account. The idea is that these small investments will make it simple and easy for folks to start saving and investing. Thanks to reader Steven for the tip.

How does it work? You’ll need to provide them:

  • Your personal information (name, address, SSN) because this is still a real SIPC-insured brokerage account underneath.
  • Your debit or credit card login information (so they can track your transactions and calculate round ups)
  • Your bank account and routing number (so they can pull money into your investment account)

The app scans your transactions, calculates the round-ups, pulls that money from your checking account, and automatically invests it for you. You can also make one-time deposits or schedule recurring deposits on a daily, weekly, or monthly basis. The app also tries to identify “found money” like rebates and rewards which it encourages you to also invest with a quick tap. Here’s a YouTube video demo:

Fees. You do not get charged any trading commissions for your investments, which can be a big factor in traditional brokerage accounts.

As of January 1st, 2015, Acorns has changed their fees to be either $1 a month (balances under $5,000) or 0.25% of assets per year (balances above $5,000). So on a $10,000 balance that would be $25 a year. No fee on $0 balances.

As of July 8, 2015, the management fees above will be waived for all students – defined as anyone under the age of 24 or you register under a .edu e-mail address and list your employment as “student”.

Withdrawals are free, but you may incur capital gains at income tax filing time. I don’t know if they will support asset transfers via ACAT.

Portfolio details. You can choose one of five target portfolios, ranging in risk level from conservative to aggressive. Mostly the popular Modern Portfolio Theory stuff that most other automated advisors offer… not surprising as their “Nobel Prize-winning economist advisor” is Harry Markowitz, who is a paid consultant.

acorns_portfolioma

All portfolios are constructed using the following six index ETFs:

  • Vanguard S&P 500 ETF (VOO)
  • Vanguard Small-Cap ETF (VB)
  • Vanguard FTSE Emerging Markets ETF (VWO)
  • Vanguard REIT ETF (VNQ)
  • PIMCO Investment Grade Corporate Bond ETF (CORP)
  • iShares 1-3 Year Treasury Bond ETF (SHY)

Fractional shares are used. Dividends are reinvested. Rebalancing happens automatically. Their asset allocation has much in common with most other automated portfolios, although it is probably one of the more different ones that I’ve seen in that you have no exposure to any stocks from Developed European and Asian countries like the UK, Japan, or Australia.

I’m a little concerned about all the tax lots created when buying stocks in such small amounts. Dealing with taxes when you sell might be a headache if they don’t import directly to TurboTax or similar tax software.

Availability. You can now use Acorns in either iOS/iPhone/iPad, Android, or online web-based application. The apps are also compatible with Apple Watch and Android Gear, for those so inclined.

My thoughts. My first reaction was… that it was a great idea that I wished I thought of first. I used to participate in Bank of America’s Keep The Change program, which is similar in that it also rounds up your BofA debit card transactions to the nearest dollar but instead moves the money into a BofA savings account paying essentially zero interest. Acorns takes it further by letting you use any bank and any debit or credit card, and also lets you invest it for potentially higher returns.

In addition, I agree that Acorns will lower the psychological barrier to investing because you don’t even have to commit to $25 a week or $500 a month. You know if you can afford a gizmo or meal at $15.66, you can afford it at $16, so why not invest that spare change? The hurdle can’t get much lower than that.

At the same time, we have to be realistic. With this model how much you save depends entirely on how many purchases you make, with a theoretical average of 50 cents saved per transaction. Even buying five things a day times 50 cents is $2.50 a day or $75 a month. It’s good as a kickstart, but not nearly enough to fund a retirement.

If you want to look at it purely mathematically, a monthly fee of $1 taken out of a $75 investment ends up being like a front-end load of 1.3%. Or given the target demographic of active smartphone users, you could just look at a buck a month as something you’d otherwise blow on some Candy Crush Saga app. I do think it is smart to let anyone 24 and under or a student use it for free.

Also, don’t call it a “piggy bank”. A piggy bank means you put in a quarter, and you can take out a quarter later on. A piggy bank is a bank savings account. Acorns on the other hand is a long-term investment account that you have to be ready not to touch for at least a decade. Sure the “expected” return is 4-9% but you have a good chance of a permanent loss of money if you withdraw within the next few years. If you start using this app, please remember this.

Bottom line: Neat idea, very nicely-designed app. Free for students or anyone age 24 and under. The Acorns app may not fund your entire retirement, but it can help those that need a nudge to invest. Automation helps you keep on track. I think there should an option for an FDIC-insured high-yield savings account.

Motif Investing Review – Be Your Own Fund Portfolio Manager, Even Get Paid By Others

motifnew0(Updated review, added new features. Motif is also offering a Free Trade Day on Friday, August 21st where all customers can get a free market order trade for a single stock/ETF.)

Ever wanted to manage your own mutual or ETF? A new brokerage company called Motif Investing will let you do just that. One of their pitches is that you can invest in a group of up to 30 individual stocks that fit into a motif or theme like “Housing Recovery” or “Lots of Likes” (companies that have the most Likes on Facebook). You can buy the entire basket of stocks with just one $9.95 commission, with no ongoing management fees. The minimum motif investment amount is $250.

My initial impression was that it felt a bit too trendy and gimmicky to recommend as a long-term investment. Indeed, I don’t really care how many Facebook Likes a company has, and I doubt I would buy stocks based on my love of pets or my political views. It’s just not my style.

Since they let you customize the basket, anyone could essentially make their own ETF or mutual fund with ZERO expense ratio. You can’t track a broad index like the S&P 500, but if you do have a basket of stocks that you buy regularly, this would be a very cost-efficient way of doing it. You can add or remove stocks, and adjust the relative weighting of each stock in the motif. Here’s a screenshot (click to enlarge):

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Horizon Motifs are preset “target date” motifs which are commision-free and with zero management fee. There are 9 different Horizon Motifs – you pick one of three time horizons (1 year, 5 year, or 15 year) and one of three risk levels (conservative, moderate, or aggressive). Kind of like a Target Date 20XX mutual fund, kind of like a roboadvisor. If you buy these specific portfolios, they waive their $9.95 commission. More information at this post: Horizon Motif Review: Commission-Free, No Advisory Fee, Index ETF Portfolios.

You can even make money when others use your Motif Portfolio with the Creator Royalty Program. Every time a client makes a $9.95 trade using your Motif, you’ll get a $1 royalty fee. For example, after reading an article about the Voya Corporate Leaders Trust Fund which bought 30 stocks in 1935 and then never sold them (but still charges a 0.52% management fee every year), I created the Depression Survivors Motif which does basically the same thing except it has zero management fees.

So far, I’ve made one entire dollar! :) Recent performance has been abysmal due to recent oil price drops, as Chevron and ExxonMobil are significant holdings.

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My plan is to someday create a custom basket of dividend-oriented stocks that hopefully will provide a long-term stream of growing income. For example, look at the SPDR S&P Dividend ETF (SDY) that holds 60 highest-yielding stocks of the S&P 1500 that have raised their dividends every year for the past 25 years. It’s a nice idea, but it leaves out some good companies and the 0.35% expense ratio eats up 10% of the original yield of the underlying companies. Why not hold most of these directly, remove some of the ones you don’t like, and keep the 0.35% as extra return for yourself?

Motif also uses dollar-based trades, which means every penny is invested, while they keep track of any fractional shares for you. No maintenance fees, no inactivity fees. In many ways, this is similar to the unlimited plan at Folio Investing, but Motif Investing has the potential to be a lot cheaper ($10 per motif trade with no minimum trade requirement vs. $29 every month for Folio) and is closer to a ETF in that they do real-time market trades. You can still do regular real-time trades of individual stocks for $4.95 per trade. Currently there is no automatic dividend reinvestment, the dividends go to cash and you reinvest yourself as desired.

Update: As of 8/13/15, Motif is adding the following features:

  • Dollar-based, real-time purchases of single stocks and ETFs (in addition to whole shares).
  • Stop loss orders by whole or fractional shares.
  • Create your own stock or ETF watch list.

New customer bonus. Right now, Motif Investing is offering new customers up to a $150 cash bonus when you open with $2,000+ and make 5 trades. If you make 1 trade, you’ll get $50. 3 trades will get $75.

Weight Management vs. Money Management Advice Similarities, Revisited

nodietI’ve written previously about the importance of permanent habit change in both managing your finances and your body weight. After finishing Smart People Don’t Diet by Charlotte Markey and then reviewing my Kindle highlights, please allow me to compare weight management and money management one more time.

I’m going to keep it simple; I’ll quote exact sentences from the book, and then tweak them ever-so-slightly to magically transform them into personal finance wisdom. Here’s a quote about her overall reason for writing this book:

Psychologists like me have been doing research about eating and weight loss for over a hundred years, and thousands of studies about these issues have been published. Scientists in related fields such as nutrition, medicine, and community health have also been studying and publishing about these issues for a very long time. And yet it seems that the most marketable and even outlandish ideas are what get the most attention when it comes to weight loss—not necessarily the ideas that are really going to work!

Here’s my Mad Libs version (all changes are bolded):

Finance academics like me have been doing research about investing for over a hundred years, and thousands of studies about these issues have been published. Scientists in related fields such as economics and behavioral psychology have also been studying and publishing about these issues for a very long time. And yet it seems that the most marketable and even outlandish ideas are what get the most attention when it comes to investing—not necessarily the ideas that are really going to work!

Sounds about right to me. Now, the recommended first step is to track your eating with a food diary:

Phase 1 is all about taking inventory and getting to know yourself—a critical first step. There should be no sense of deprivation when you follow the instructions for Phase 1. Phase 2 is when you’ll start to actually make changes to your eating behaviors.

In the same way, my recommended first step has been to track your spending with a daily log. There is virtually no change needed!

Phase 1 is all about taking inventory and getting to know yourself—a critical first step. There should be no sense of deprivation when you follow the instructions for Phase 1. Phase 2 is when you’ll start to actually make changes to your spending behaviors.

However, many successful people don’t need to keep up this daily tracking forever.

This is all common sense, but it is also supported by research: keeping a mental record of what you eat, or “counting” what you eat, is exhausting. This is one reason I don’t recommend constantly counting calories or counting anything as part of a long-term approach to weight management: food choices shouldn’t add to your mental fatigue.

The key is to measure your baseline and then make incremental but permanent changes. Nowadays, I still add up my expenses at the end of each month, but I don’t track anything on a day-to-day basis.

This is all common sense, but it is also supported by research: keeping a mental record of what you spend, or “counting” what you spend, is exhausting. This is one reason I don’t recommend constantly tracking every expense or counting anything as part of a long-term approach to money management: financial choices shouldn’t add to your mental fatigue.

Here are tips on creating better habits that won’t suck up all your willpower:

You don’t need to squeeze your own oranges to make juice; just eat an orange. You don’t need to make homemade bread; just buy whole-grain bread. It is okay to rely on frozen fruits or veggies to ensure that you eat enough each day. If you want to change your habits for the long-term, stick to a plan that is simple and create food routines. Simple is sustainable.

Simple is sustainable, I like that phrase!

You don’t need to analyze the balance sheets of individual companies; just buy an index fund. You don’t need to remember to manually save every month; make it automatic with scheduled online transfers to your IRA and/or 401k. It is okay to rely on Mint.com or PersonalCapital.com and credit/debit cards to track your overall spending. If you want to change your habits for the long-term, stick to a plan that is simple and create financial routines. Simple is sustainable.

Finally, a nice little summary. (The book has a lot of good advice, but it is a little repetitive.)

What I recommend to people to help them to lose weight is not always sexy, but it is what works. Weight-loss books change; most of them don’t stick around because they don’t work. To be healthy and lose weight, you have to change your habits. You also have to understand why you are eating. Convenience, habits, and our emotions are all an important part of our food choices.

What I recommend to people to help them to save and invest wisely is not always sexy, but it is what works. Personal finance and investing books change; most of them don’t stick around because they don’t work. To save prudently and achieve financial freedom, you have to change your habits. You also have to understand why you are earning and spending. Convenience, habits, and our emotions are all an important part of our financial choices.

Portfolio Charts Visualization Tool: Returns vs. Time (Holding Period)

When investing in stocks and bonds, it is important to take a long-term perspective. We’ve all heard that phrase. A new tool called PortfolioCharts.com lets you create charts that make it easier to visualize the relationship between returns and holding periods. Created by a fellow named Tyler, found via The Reformed Broker.

With the Pixel chart, you can customize any asset allocation and see that portfolio mix’s returns over a multitude of timeframes. Here’s the chart for The Swensen Portfolio, which is the closest “lazy portfolio” to my personal portfolio – 30% US Total, 15% Foreign Developed, 5% Emerging Market, 20 US REIT, 15% 5-Year Treasuries, 15% TIPS.

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You can see that depending on your starting year, the returns over the next 1-9 year period could be pretty rough. But as long as you held for 10 years or more, you always got a positive real return above inflation. You can also see that the often-promised 5% real returns aren’t always guaranteed, although historically if you held on for 20+ years your odds were pretty good.

You may recall a similar style of chart from the NYT and Crestmont Research which includes additional data going back to 1920:

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My favorite style is the Funnel chart:

The Funnel chart shows the changing uncertainty of compound annual growth rates over time. This demonstrates how long you may need to hold a portfolio to experience the average long-term returns it advertises. It also provides a nice snapshot of the range of 1-year volatility.

Here’s the Funnel for the same Swensen Portfolio:

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The funnel chart also supports the notion – in an even simpler way – that if you can take a long-term perspective, your risk of losing money should decrease. Here’s a similar chart from the classic investing book A Random Walk Down Wall Street that was one of my early blog posts:

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Finally, the Hurricane chart allows you to simulate what would have happened to your portfolio balance if you made annual withdrawals, such as in a retirement scenario.

Warren Buffett is another famous supporter of taking the long-term view. From a recent CNBC interview:

Buffett, who looks to buy stocks or business for their long-term prospects, said recent weakness in the market does not concern him.

“Stocks are going to be higher, and perhaps a lot higher 10 years from now, 20 years from now,” he said, adding that’s why he does not try to time the market.

Hopefully for those investors with a long runway ahead of them, this new tool will help you view your portfolio in a more patient manner. I’ll try to remember it when the next market panic arrives.

Maslow’s Hierarchy of Needs & The Portfolio Investment Pyramid

Yesterday, I looked back at extending the Maslow Hierarchy of Needs to Personal Finance. The basic idea of the triangle or pyramid is that lower needs must be satisfied before the higher needs can be addressed. For example, one must first obtain food and water before worrying about protecting my property. In terms of personal finance, you need to cover your food and shelter bills before worrying about homeowner’s insurance premiums.

Now let’s explore how investment professionals have extended this concept to portfolio investing. Again, the bottom level is the most important and forms the “base” of a solid portfolio. After that, you can move on the next concern. You can see that there is debate even amongst experts as to relative importance.

Here’s Christine Benz of Morningstar in How Do Your Financial Priorities Stack Up With Our Pyramid?

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Here’s Morgan Housel of Fool.com in The Hierarchy of Investor Needs:

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Here’s Cullen Roche of Pragmatic Capitalism in Thoughts on the Hierarchy of Investor Needs:

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The four common factors are:

  • Security Selection
  • Tax Efficiency
  • Investor Behavior
  • Asset Allocation

Two out of the three proposed pyramids above have Investor Behavior as the most important. I can see how this factor has the greatest impact on real-world returns, but it is also the hardest to really quantify ahead of time. You can write down on a piece of paper “I will not panic during the next crisis but will do XX instead” but that doesn’t mean you’ll actually do it (though it will probably help on average). In addition, it is also intertwined with asset allocation since the less your portfolio value drops in a bear market, the more likely you’ll stick with your plan. Meanwhile, you can quantify fees and transaction costs quite easily.

I think this debate makes for interesting conversation for investing geeks like myself, but in the end a good investor would address all of these factors. For example, I would never put off examining fees just because it is at the top of such a pyramid.

Owning a World Market-Cap Weighting of Gold

2015goldGold is an asset class that is part commodity, part currency, and part insurance policy. As I write this, gold prices are at a 5-year low. I own a little physical gold for cultural reasons, but I don’t consider it part of my asset allocation and I place it in the “too hard to stick with during prolonged underperformance” category.

In a recent WSJ article (paywall) by Jason Zweig, he shares his own opinion (everyone’s got one) while adding this interesting data point:

Laurens Swinkels, a senior researcher at Norges Bank Investment Management in Oslo, reckons that the total market value of the world’s financial assets at the end of 2014 was about $102.7 trillion. The World Gold Council estimates that the world’s total quantity of gold held for investment was about $1.4 trillion as of late 2014. So, if you held the same proportion of gold as the world’s investors as a whole, you would allocate 1.3% of your investment portfolio to it.

Many index funds are constructed by comparing their market-capitalizations, or the total value of all their shares. Apple is currently worth $760 billion dollars, which is 4% of the total value combined of all the companies in the S&P 500 combined. So if you own an S&P 500 Index fund, 4% of your money is in AAPL shares.

So what if you held a world market-cap weighting of gold? If you had a $100,000 portfolio, 1.3% would work out to $1,300, which you could round off to a single 1 oz. gold American Eagle. You could buy gold in another form, but don’t they look pretty? They also make 1/2 oz, 1/4 oz, and 1/10 oz versions. This fake gold coin tester is cool, but is rather expensive if you’re just buying a few coins.

If you had a $1,000,000 portfolio, 1.3% still only works out to 10 American Eagles, altogether weighing less than a pound and something you could still easily hide in your clothing as you escaped to the island nation of St. Kitts (you did buy a citizenship just in case, didn’t you?) just before the apocalypse.

But seriously, it could be that a 1.3% holding is just about the right amount. It’s something, a little exposure, a little insurance policy, something most people could keep in physical form if they preferred with no ongoing storage or management costs. You can justify it as part of the world’s investable market. But it’s not too much, not enough to worry about the price of gold.

Howard Marks on Assuming Less Risk and Lowering Expectations

greatmindsObserver has an interesting profile of respected investor Howard Marks, excerpted from the book The Great Minds of Investing (found via Abnormal Returns).

I enjoy the writings of Howard Marks because his observations are logical and rational, and he doesn’t mind putting out stuff that is boring and hard to do. It is much more popular to write about exciting things that are easy to do like “sell all your bonds!” or “buy oil stocks now!”. This quote from the profile is a good example. (Bolding is mine.)

“You can’t control the environment,” Mr. Marks adds. So the key is to recognize how it’s changing, accept it, and respond as wisely as possible. “The screwiest thing you can do is to think you’re a Master of the Universe. We’re all just little cogs, and the universe will go on without us. We have to fit into it and adapt to it.” For example, at the time of our interview in late 2014, he sees scant investment opportunity and excessive complacency: “What bigger mistake could there be than to think you can safely get high returns in a low-return world?” Investors should adjust by assuming less risk and lowering their expectations. He cites a favorite quote from Peter Bernstein: “The market’s not a very accommodating machine; it won’t provide high returns just because you need them.”

Assume less risk. Lower your expectations. I’ve been reading a lot of Dr. Seuss recently, and I think he would say “you may yawn and boo, but that is what you should do.”

For some reason, this book is out-of-stock at Amazon, unavailable at my library, and third-party copies are $70?! I believe this is because it contains high-quality photographs of the people profiled. Not to worry, Oaktree Capital has all of Marks’ famous memos online for free, or you can read a distillation of them in his book The Most Important Thing Illuminated (my review).

Global Asset Allocation Book Review: Comparing 12+ Expert Model Portfolios

gaafaberI am a regular reader of Meb Faber’s online writings, and volunteered to received a free review copy of his new book Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies. It is a rather short book and would probably be around 100 pages if printed, but it condensed a lot of information into that small package.

First off, you are shown how any individual asset class contains its own risks, from cash to stocks. The only “free lunch” out there is diversification, meaning that you should hold a portfolio of different, non-correlated asset classes. For the purposes of this book, the major asset classes are broken down into:

  • US Large Cap Stocks
  • US Small Cap Stocks
  • Foreign Developed Markets Stocks
  • Foreign Emerging Markets Stocks
  • US Corporate Bonds
  • US T-Bills
  • US 10-Year Treasury Bonds
  • US 30-Year Treasury Bonds
  • 10-Year Foreign Gov’t Bonds
  • TIPS (US Inflation-linked Treasuries)
  • Commodities (GSCI)
  • Gold (GFD)
  • REITs (NAREIT)

So, what mix of these “ingredients” is best? Faber discusses and compares model asset allocations from various experts and sources. I will only include the name and brief description below, but the book expands on the portfolios a little more. Don’t expect a comprehensive review of each model and its underpinnings, however.

  • Classic 60/40 – the benchmark portfolio, 60% stocks (S&P 500) and 40% bonds (10-year US Treasuries).
  • Global 60/40 – stocks split 50/50 US/foreign, bonds also split 50/50 US/foreign.
  • Ray Dalio All Seasons – proposed by well-known hedge fund manager in Master The Money Game book.
  • Harry Browne Permanent Portfolio – 25% stocks/25% cash/25% Long-term Treasuries/25% Gold.
  • Global Market Portfolio – Based on the estimated market-weighted composition of asset classes worldwide.
  • Rob Arnott Portfolio – Well-known proponent of fundamental indexing and “smart beta”.
  • Marc Faber Portfolio – Author of the “Gloom, Boom, and Doom” newsletter.
  • David Swensen Portfolio – Yale Endowment manager, from his book Unconventional Success.
  • Mohamad El-Erian Portfolio – Former Harvard Endowment manager, from his book When Markets Collide.
  • Warren Buffett Portfolio – As directed to Buffett’s trust for his wife’s benefit upon his passing.
  • Andrew Tobias Portfolio – 1/3rd each of: US Large, Foreign Developed, US 10-Year Treasuries.
  • Talmud Portfolio – “Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve.”
  • 7Twelve Portfolio – From the book 7Twelve by Craig Israelsen.
  • William Bernstein Portfolio – From his book The Intelligent Asset Allocator.
  • Larry Swedroe Portfolio – Specifically, his “Eliminate Fat Tails” portfolio.

Faber collected and calculated the average annualized returns, volatility, Sharpe ratio, and Max Drawdown percentage (peak-to-trough drop in value) of all these model asset allocations from 1973-2013. So what were his conclusions? Here some excerpts from the book:

If you exclude the Permanent Portfolio, all of the allocations are within one percentage point.

What if someone was able to predict the best-performing strategy in 1973 and then decided to implement it via the average mutual fund? We also looked at the effect if someone decided to use a financial advisor who then invested client assets in the average mutual fund. Predicting the best asset allocation, but implementing it via the average mutual fund would push returns down to roughly even with the Permanent Portfolio. If you added advisory fees on top of that, it had the effect of transforming the BEST performing asset allocation into lower than the WORST.

Think about that for a second. Fees are far more important than your asset allocation decision! Now what do you spend most of your time thinking about? Probably the asset allocation decision and not fees! This is the main point we are trying to drive home in this book – if you are going to allocate to a buy and hold portfolio you want to be paying as little as possible in total fees and costs.

So after collecting the best strategies from the smartest gurus out there, all with very different allocations, the difference in past performance between the 12+ portfolios was less than 1% a year (besides the permanent portfolio, which had performance roughly another 1% lower but also the smallest max drawdown). Now, there were some differences in Sharpe ratio, volatility, and max drawdown which was addressed a little but wasn’t explored in much detail. There was no “winner” that was crowned, but for the curious the Arnott portfolio had the highest Sharpe ratio by a little bit and the Permanent portfolio had the smallest max drawdown by a little bit.

Instead of trying to predict future performance, it would appear much more reliable to focus on fees and taxes. I would also add that all of these portfolio backtests looked pretty good, but they were all theoretical returns based on strict application of the model asset allocation. If you are going to use a buy-and-hold portfolio and get these sort of returns, you have to keep buying and keep holding through both the good times and bad.

Although I don’t believe it is explicitly mentioned in this book, Faber’s company has a new ETF that just happens to help you do these things. The Cambria Global Asset Allocation ETF (GAA) is an “all-in-one” ETF that includes 29 underlying funds with an approximate allocation of 40% stocks, 40% bonds, and 20% real assets. The total expense ratio is 0.29% which includes the expenses of the underlying funds with no separate management fee. The ETF holdings have a big chunk of various Vanguard index funds, but it also holds about 9% in Cambria ETFs managed by Faber.

Since it is an all-in-one fund, theoretically you can’t fiddle around with the asset allocation. That’s pretty much how automated advisors like Wealthfront and Betterment work as well. If you have more money to invest, you just hand it over and it will be invested for you, including regular rebalancing. The same idea has also been around for a while through the under-rated Vanguard Target Retirement Funds, which are also all-in-one but stick with simplicity rather than trying to capture possible higher returns though value, momentum, and real asset strategies. The Vanguard Target funds are cheaper though, at around 0.18% expense ratio.

Well, my portfolio already very low in costs. So my own takeaway is that I should… do nothing! :)

Alpha Architect also has a review of this book.

Why I Hold TIPS in My Portfolio (Treasury Inflation-Protected Securities)

EconompicData has a nice, relatively brief post about the relationship between US Treasury bonds, TIPS, and inflation. I would hold either Treasuries or TIPS (or both) because they have the highest credit quality available, and that is a big part of why you should own bonds in the first place. Read the whole thing, but the conclusion below pretty much sums up why I prefer to have TIPS in my investment portfolio.

In normal market environments when inflation is relatively stable, long-term returns tend to be similar for both Treasuries and TIPS. However, TIPS materially outperform in an inflationary environment, while Treasury outperformance is capped by a rate roughly equal to the break-even inflation rate in a deflationary environment. Thus, assuming a view that an inflationary and deflationary scenario are equally likely, the unlimited potential outperformance of TIPS vs. Treasuries in an inflationary environment and limited upside of Treasuries vs. TIPS in a deflation environment would sway an investor towards TIPS.