Search Results for: swensen

Total Economy Portfolio: Adding Small Value Stock, REIT Exposure

In many investing books such as David Swensen’s Unconventional Success or Bill Schultheis’ The Coffeehouse Investor, you may see model portfolios that include an allocation to smaller companies and/or real estate investment trusts (REITs). Historically, adding these less-correlated asset classes have improved a portfolio’s overall return while reducing volatility. Author and portfolio manager Rick Ferri proposes another lens from which to view why such additions add value in his Forbes article called The Total Economy Portfolio.

Briefly, Ferri points out that the number of publicly traded companies has fallen by over 50% in the last 16 years, and those public companies together earn only about half of the U.S. economy’s profits. What is missing, and what should we do to replace them?

The two main areas of the economy that are underrepresented on the stock market are small businesses and commercial real estate. That means increasing small company and real estate exposure in your portfolio should help you track the economy better. [...] My “Economic Tilt Portfolio” is allocated 65% to the Wilshire 5000, 25% to the Russell 2000 small-cap value index and 10% to the Dow Jones U.S. Select Real Estate Investment Trust index.

The chart from the article below compares the total return of the Total US Stock Market (Wilshire 5000) vs. the Economic Tilt Portfolio:

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Motif Investing Adds New Passive, Index Fund Portfolios

Motif Investing is a new brokerage firm that is unique in that it lets you buy an entire basket of up to 30 stocks for only $9.95 per trade. I previously thought that this would be useful to creating your own “custom ETF” of whatever you want, for example dividend stocks.

This week, they rolled out a new set of “motif” baskets which are focused on passive, index fund strategies. I’m happy to see this, although in my opinion some are hits and others are misses. You can find them under the “Investing Classics” category:

  • Permanent Portfolio. Based on the Harry Browne Permanent Portfolio of 25% stocks, 25% long-term bonds, 25% cash (short-term bonds), and 25% gold. Their implementation seems a bit needlessly complex, however, as they use over 15 ETFs to replicate international stocks when they could have just used something like Vanguard Total International ETF (VXUS). But again, you can edit and customize the motifs to simplify down to 4-6 ETFs. Still, buying 5 ETFs of your choice in one go for $9.95 isn’t bad, and they will even rebalance for you as well.*
  • Target Date Motifs. Based on target-date retirement funds, you can choose for example “Retiring 2050″ or “Retiring 2030″. I’m not a big fan of this one, if you want to go this route I’d just stick with the Vanguard Target funds bought directly from Vanguard for no commission fees at all and the highest level of simplicity.
  • Ivy League. Based on the Yale Endowment manager David Swensen portfolio. Nice and simple, just the 6 ETFs matching each of the asset classes as described in his book Unconventional Success. I’m biased of course, as my own portfolio is very similar to this.
  • Index Fans. Supposedly based on the Boglehead philosophies of Jack Bogle, founder of Vanguard. I don’t know why they chose to use a combination of the Total World Stock ETF (VT) and Total US (VTI), when VT is already 50% US stocks and hold a lot less companies (and thus less diversification) as compared to holding US and non-US separately with VTI and VXUS. Or why they didn’t just use a single Total Bond ETF (BND) for bonds. I’m thinking they didn’t actually get official Bogle approval, nor did they read the Bogleheads book.

*Excerpted from a previous interview with Tariq Hilaly, Motif Investing’s Co-Founder & Chief Investment Officer:

MMB: Does the motif ever “rebalance” in the future back to the original weightings to prevent drift?
A: Yes, we rebalance most motifs on a quarterly basis. On rare occasions, with longer-term investing strategies that take longer to play out, we rebalance once a year.

$150 Sign-up Bonus.

Motif Investing is also offering a $150 cash bonus when you open a new brokerage account with $2,000+ and make 5 trades at $9.95 each. If you make 1 trade, you’ll get $50. 3 trades will get $75. The new funds must be posted to the account within 10 calendar days of account opening, and must remain in the account for 45 calendar days.

Index Fund vs. Top Hedge Funds: Buffett Bet Halfway Update

Halfway Update – 5 Years Later! Carol Loomis has posted the 5-year update in Fortune of the $1,000,000 index fund vs. hedge fund bet. Halfway through the 10-year bet (1/1/08 to 12/31/17), the Vanguard S&P 500 index fund backed by Buffett is up by 8.69%. The group of hedge funds hand-picked by Protégé Partners are up by 0.13%. Note that the index fund had been lagging just about ever year since this one, but that’s why we are looking at a longer period. Consider this halftime. :)

It will be very interesting to see how this turns out. Hedge funds charge fees of roughly 2% of assets annually + 20% of any gains. You may notice that five years of 2% fees would be 10% (ignoring the compounding effect for simplicity), and the hedge funds are lagging by about 9%. Costs matter!

You can read the terms of the bet and each side’s arguments at LongBets.org (also see original Fortune article below for backstory). This carefully-tracked bet was part of the inspiration for my transparent Beat the Market experiment. Too often, people are not honestly and accurately tracking the total performance of their portfolios. These ongoing updates help illustrate how hard it is to consistently beat a low-cost, diversified portfolio over the long run, and how it’s incorrect to declare yourself a winner even after several good years. Who knows, the hedge funds may still win.

Original blog post from 2008:
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Investment Portfolio Asset Allocation & Performance Update of 2012

It’s time for a end-of-year checkup on the ole’ portfolio, as I’m afraid that I’ll forget about it between Christmas and New Year’s. There isn’t much change to my investment portfolio itself, the target asset allocation is the same, and the specific fund holdings are pretty much the same. I’m closer to 70% stocks and 30% bonds now. With only about 7 trading days left, I wanted to see how the various asset classes that I own performed in 2011.

My portfolio is similar to the David Swensen model portfolio, which uses low-cost index funds to gain exposure to specific asset classes. Here is an implementation of the portfolio using actual ETFs in a recommended 70% stocks / 30% bonds breakdown.

30% Domestic US Equity (VTI)
15% Foreign Developed Equity (VEA)
10% Emerging Markets (VWO)
15% Real Estate (VNQ)
15% U.S. Treasury Bonds (IEF)
15% Inflation-Protected Securities (TIP)

The chart below shows the growth of $1,000 invested this way (eMAC) at the start of 2001 until the end of November 2011, as compiled by the financial advisory group ETF Portfolio Management for benchmark purposes.

I have also taken the liberty of updating their annual returns table to including 2011 year-to-date total returns (see highlighted) using Morningstar data as of 12/19/2011.

The weighted year-to-date return of the overall model portfolio is 0.35%, essentially zero for 2011. But from the table, you see that each individual asset class may have moved a lot. European and Emerging Market stocks performed quite poorly (in case you don’t read the news), the S&P 500 looks like it will more or less go nowhere for the year, REITs (Real Estate) did okay, and Treasury bonds did very, very well considering this low-yield environment. Inflation-Protected bonds (TIPS) were the superstar in my portfolio, they saved my bacon.

Another year, another reminder that predicting short-term market movements is way beyond me. :) I continue to be happy with owning various asset classes with long-term expected positive returns, but which tend not to move in sync and thus smooth out the ride.

Next year, I intend to learn more about an income-oriented portfolio as that may potentially work better – at least psychologically – for the early-retirement set. My secret crush, the Vanguard Wellesley Income Fund (VWINX) was up 7.91% in 2011 YTD. It’s a income-oriented actively-managed fund with about 35% in dividend stocks and 65% in corporate bonds – but with a tiny expense ratio of only 0.28% for investor shares, 0.21% for admiral shares.

U.S. Savings Bonds Have Outperformed Stocks Since 1998?

A reader recently told me that he was no longer investing in the stock market after seeing the chart below from the Savings Bond Advisor. It shows the total portfolio value after investing equal monthly amounts in either the S&P 500 stock market index or Series I US Savings Bonds. The time period is from September 1998 (when “I Bonds” started being sold) through August 1, 2011. My comments follow.

The past returns of savings bonds are indeed pretty good, but not likely to be repeated. Series I Savings Bonds (I Bonds) were the new thing in 1998, and the government offered some really enticing interest rates on them. I Bonds have a fixed component that lasts for the duration of that specific bond and an variable component that adjusts with inflation every 6 months. From 1998 to May 2001, the fixed component was always between 3% to 3.60% above inflation (source). However, since May 2008, the fixed rate has been between 0% and 0.7%. For the past year, the fixed rate has been a big fat zero. I would love to have a savings bond paying 3% plus inflation (currently 2.30%), as some current bondholders have, but I don’t expect that to ever happen again.

Now, that doesn’t mean that they aren’t still a competitive investment, especially for the short term. Since interest rates are so low, I still buy savings bonds even at a 0% fixed rate as part of my emergency fund cash reserves.

Savings Bonds are being slowly killed by the government. Even though savings bonds have historically encouraged people of all income levels to save, it appears that the US Treasury is slowly killing the savings bond. As recently as 2008, you could buy $30,000 worth of each type of savings bonds a year, per person. For a while, we were able to even use credit cards to buy them without a fee. Today, you can only buy $5,000 of paper I-bonds and $5,000 of electronic I-bonds a year, and even paper savings bonds are being phased out in 2012. (You can still overpay your taxes and buy paper bonds with a tax refund in 2012.) There was even a NY Times article last week entitled Save the Savings Bond. Basically, even if you wanted to create your retirement portfolio with savings bonds, you can’t.

Investing solely in inflation-linked bonds is actually recommended by some financial authors. The thing is, the government has so much debt that it greatly prefers US Treasury bonds which can be sold by the billions. Printing a $50 savings bonds is not even a drop in the bucket, it’s closer to a H2O molecule in the bucket. What you can invest in is Treasury Inflation Protected Securities (TIPS), which like I Bonds are backed by the government and pay an interest rate linked to inflation. Economics professor Kolitkoff in the book Spend ‘Til The End recommends your entire portfolio to be TIPS. The problem? You’re gonna have to save a lot. TIPS yields are very low, currently offering yields of negative 0.7% above inflation (!) for a 5-year bond to a meager 1.1% above inflation for a 30-year bond. If you’re okay with saving 50% of your income every year for 30 years, then this plan might work for you.

There is no easy answer as to the best place to invest right now. I am sticking with a diversified low-cost portfolio with both stocks and bonds (including a nice chunk of TIPS inside, which has done quite well recently), and you can see with this chart that it has also done pretty well the last decade.

Do You Believe In Your Asset Allocation?

asset allocation image from wikipedia

Mark Cuban recently had a post on his blog called Wall Street’s new lie to Main Street – Asset Allocation. In it, he quotes a recent newspaper article that presents this model asset allocation:

15% in an S&P 500 index fund
5% in a small-capitalization value fund
20% in a diversified international stock fund
5% in an emerging markets international fund
5% in Real Estate Investment Trusts
10% in stocks with a history of paying competitive and increasing dividends
10% in a diversified portfolio of convertible securities
5% in a U.S. Treasury inflation-indexed bonds and notes
15% in an international bond fund with traditional fixed coupon bonds
5% in an international bond fund for inflation-indexed bonds
5% in cash equivalents.

To which he translates as:

I want you to invest 5pct in cash and the rest in 10 different funds about which you know absolutely nothing. I want you to make this investment knowing that even if there were 128 hours in a day and you had a year long vacation, you could not possibly begin to understand all of these products. In fact, I don’t understand them either, but because I know it sounds good and everyone is making the same kind of recommendations, we all can pretend we are smart and going to make a lot of money. Until we don’t

Now, I don’t rely on Cuban for investing advice, but I do think he has a point. Over the past couple of years, I have to come value simplicity and also belief in investing. Now, I think asset allocation is important. To me, asset allocation is owning different assets that (1) all have good prospects for long-term returns above inflation, and (2) don’t necessarily move in the same direction. This allows you to reduce volatility when one things zigs while the other zags.

However, this also means you have to own said assets both when they are up and down. If the only reason you own something is because it’s in some financial newspaper article, then you’ll just sell it when the same newspaper starts touting the next new thing. This will likely lead to worse returns than just holding cash. You should only invest in asset classes that you understand and have strong reasons to hold in both good times and bad.

Here are the asset classes that I have strong beliefs in. This is of course my own personal opinion, but I’ll try to share my reasoning as well.
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Target Asset Allocation for Investment Portfolio

Asset allocation (AA) is an important part of portfolio design, and I like pinning down a target asset allocation for personal reference. This helps keep me focused as my portfolio shifts over time and makes it easy to re-balance back. For some educational posts on this topic, please refer to my asset allocation starter guide.

Below is my updated target asset allocation. Here is my target asset allocation from 2008. It’s not dramatically different, but I’ll try to explain the slight changes below. This is just my own AA, and I think everyone should develop their own based on their own beliefs and learning. If you just copy someone else’s without thinking, when things go awry you won’t have the foundation to stick to your guns. I have been strongly influenced by the writings of Jack Bogle, William Bernstein, David Swensen, Rick Ferri, and Larry Swedroe.

Stocks

I separate things out first into stocks and bonds, and then later it’s easy to go 60% stocks/40% bonds and so on. Here’s my stocks-only breakdown:

  • I now do a 50/50 split between US and International stocks. In general, I would like to mimic the overall world investment landscape. On a market cap basis, the US stock market is now about 45% of the world, while everyone else takes up 55%. 50/50 is just simpler, with a slight tilt towards domestic stocks.
  • I consider REITs a separate real estate asset class. I used to put Real Estate under US stocks since I only held US Real Estate Investment Trusts (REITs), but in the future I would be open to investing in foreign real estate as property laws improve and investing costs drop.
  • On the US side, I add some extra small-cap value companies. Historically, adding stocks of smaller companies with value characteristics (as opposed to growth) has improved the returns of portfolios while lowering volatility. There is debate amongst portfolio theories as to why this happened and if it will continue.

    If you buy a “total market” mutual fund or ETF, you’ll already own many of these types of companies (although many will not be held due to their small size relative to the big mega-corporations). I feel this adds a bit of diversification.

  • On the international side, I add a little extra exposure to emerging markets. You may be surprised to know that “emerging” countries like China, Brazil, Korea, India, Russia, and Taiwan already make up 26% of the world’s markets when you remove the US. These are countries that have a greater potential for growth, but also lots of ups and downs. I add a little bit more than market weight for these as well.

Bonds

I try to keep things simple for bonds, partially due to the fact that they are currently a smaller portion of my portfolio.

  • I like a 50/50 split between inflation-linked bonds and nominal bonds. Inflation-protected bonds provide a yield that is guaranteed to be a certain level above inflation. Nominal bonds pay a stated rate that is not adjusted for inflation. I like to balance the benefits of both.
  • Instead of only short-term US Treasuries for nominal bonds, I added some flexibility. I used to invest only in short-term US treasuries, as they provided the best buffer in my portfolio as they were of the highest quality and had a low sensitivity to interest rate fluctuations. Both TIPS and nominal Treasuries did great during the 2009 crash and the subsequent flight-to-quality, but now the yield on Treasuries is just too low in my opinion. There are trillions of dollars from countries and huge institutions around the world that are tucking their money away under the safe Treasury mattress. By venturing into other places they won’t with my tiny portfolio, I feel I can stay relatively safe yet increase my yield significantly. Possibilities include bank CDs, stable value funds, and high-quality municipal bonds.

Want more examples? Here are 8 model portfolios from respected sources, an updated Swensen portfolio, one from PIMCO’s El-Erian, and Ferri’s personal portfolio. Have fun!

Betterment.com Review: Investing Made Simple, But Is It Worth The Cost?

New start-up website Betterment.com wants to make investing more easy… imagine something as simple as your existing savings account but with higher returns. Too good to be true?

How does it work?

At it’s very core, Betterment is a standard brokerage account, like E*Trade or Scottrade, which holds stocks and bonds in the form of exchange-traded funds (ETFs). On top of this, Betterment provides a lot of automation and simplification so that a user’s required day-to-day involvement is minimized.

Using a short questionnaire or a simple slider bar, you can choose a basic asset allocation (AA) of, say, 80% stocks and 20% bonds. After that, you just link a checking account and transfer money in and out as you please. When you move money into Betterment, they’ll buy ETFs automatically for you according to your chose asset allocation. If you want to withdraw, they’ll make the needed sell trades for you. Dividends are reinvested automatically, and your portfolio is rebalanced quarterly if off by more than 5%.

Asset Allocation Tools

For me, the part I played with the most was the interactive demo that illustrated potential returns based on past results. The dark blue line shows the historical average, dark blue bands indicate where 80% of outcomes have fallen, and the light blue bands show where 95% of outcomes have fallen. Here are some screenshots for a $50,000 portfolio of 85% stocks/15% bonds over 1 year and 10 years (click to enlarge).

(Past performance does not guarantee future results…)

Replace your savings account?

Betterment.com has been getting some heat – in my opinion rightfully so – for some of it’s marketing slogans as a “savings account replacement” or “better than a bank”. This is not a bank. You are buying stocks and bonds. You can lose a lot of money. Even their most conservative option of inflation-linked bonds can lose money in the short-term due to interest rate fluctuations. Yes, they admit this all somewhere, but it should be clearer. You just can’t compare yourself even indirectly with a savings account when the risk levels are so different.

Another example is this quote in their “Safe and Secure” section on the front page:

We are a member of the Securities Investor Protection Corporation (SIPC), which means the securities in your account are protected up to $500,000.

SIPC-insured is not the same as FDIC-insured. SIPC only covers restoring assets to investors if your firm goes bankrupt. It does not insure the value of those assets. It does not cover investment fraud. Will people get confused? I think there is a good likelihood that some will.

Portfolio

So what are you actually buying? For the stock portion of your account, you are buying a basket of ETFs broken down as follows:

  • 10% SPDR Dow Jones Industrial Average ETF
  • 20% iShares S&P 500 Value Index ETF
  • 20% iShares S&P 1000 Value Index ETF
  • 15% iShares Russell 2000 Value Index ETF
  • 15% iShares Russell Midcap Value Index ETF
  • 20% Vanguard Total Stock Market ETF

In my opinion, there is a lot of unnecessary overlap here. Of course, they’re paying for the trades, so maybe that in itself doesn’t matter that much. But more importantly, where’s the international exposure? I’d rather be invested in something as simple as 50% Vanguard Total Stock Market (VTI) and 50% Vanguard FTSE All-World ex-US ETF (VEU). You’d own fewer ETFs but more different companies and be globally diversified.

As for the bond portion, that’s 100% Treasury Inflation-Protected bonds via the iShares Barclays TIPS Bond ETF (TIP). Here, I’d rather see a 50% split between TIP and some nominal Treasuries bonds like IEF or SHY. (As recommended by David Swensen.) More diversification, same high credit quality.

Fees

There are currently no minimum balances required to invest. You don’t pay commissions per trade, but instead are charged a flat 0.9% annual management fee on top of the ETF management fees of about 0.20%. Just for their fees, that’s $45 a year on a $5,000 account, and $450 a year on a $50,000 account. So what you have here is a really simple wrap account. (Compare with Fidelity Portfolio Advisory Services.) In exchange, you get a lot of automation. No manually placing trades or remembering to rebalance.

If you have a low-balance account, this works out to be a pretty good deal *if* you like their portfolio above. Even a discount brokerages range from $7/trade at Scottrade to $3.95/trade at OptionsHouse. If you have only a couple thousand dollars to invest, Betterment can be very economical. (Though I suspect that they will have to change their pricing structure at some point for small accounts that trade a lot.) If you have $25,000 or more in assets, you can do much better on your own, and it’s more likely to be worth your time to expand your investment mix.

Reinventing the wheel?

Time to compare this with existing alternatives. You can already buy a nice all-in-one mutual fund from Vanguard like the Vanguard 2045 Target Retirement Fund (VTIVX) with a $3,000 now $1,000 minimum investment. In a similar manner, you can choose your general asset allocation and they’ll maintain and rebalance for you as well, gradually becoming more conservative as time goes on. International stock exposure including emerging markets is included. They’ll let you transfer funds to/from a bank account in $100 increments. Those trades are also free when you hold them at Vanguard.com, and all this costs just 0.20% annually including all fees. Compare this to 1.1% in total expenses you’ll pay at Betterment.

Finally, a quick note about tax efficient placement of assets. When possible, it’s usually better to place less tax-efficient assets like bonds into tax-sheltered accounts like IRAs and 401k plans. You can’t do this easily with such all-in-one systems.

When Markets Collide: Book Review, Model Asset Allocation

The last book I reviewed was Financial Armageddon. Then I saw the title of this book: When Markets Collide. I almost stopped right there, as I was not at all in the mood for yet more doomsday talk.

However, I saw that the author, Mohamed El-Erian, ran the Harvard University Endowment for nearly two years, and is now the co-CEO of the huge bond investment company PIMCO. Throw in the fact that the tagline of this book is “Investment Strategies for the Age of Global Economic Change”, and perhaps this would be an insightful book about investing like David Swensen’s Unconventional Success. (Swensen ran the Yale University Endowment.)

Ease of Reading / Target Audience
The first I noticed about this book was that it was very difficult to read. The author tried to write this book for both experienced economic policymakers and the average investor. Not an easy feat. I felt that he came off as one of those guys who is just “too smart” and can’t simplify things for the rest of us. Here is an example of this high-level writing from the book:

The challenge of how to deal with consequential and volatile endogenous liquidity relates to another policy issue that I will discuss in Chapter 7: how to refine the traditional instruments of monetary control and ensure more meaningful and sophisticated supervision on a range of activities, with volatile leverage, that have been enabled by the ongoing structural transformations and yet are outside meaningful oversight.

Quick Summary: My Interpretation
The relationships between the economies of the world are changing. Emerging markets, which used to either be debtor nations or those who would only buy the safest thing available (US Treasuries), are growing fast and will start to invest their considerable wealth elsewhere, including equities. The U.S. can’t rely on other countries to buy our debt forever, just as the other countries can’t rely on U.S. consumers to prop up the world’s economy. This is where the “markets collide”. Throw in complicated structured investments like derivatives which nobody perfectly understands, and we are only in the beginning of a very bumpy road ahead.

Model Asset Allocation
So what is a U.S.-based individual investor to do? El-Erian states the three basic steps of portfolio management are: “choosing the right asset allocation, finding the best implementation vehicles, and conducting risk management.” Accordingly, here is his model asset allocation, with midrange percentages.

Equities (49% total)
15% United States
15% Other advanced economies
12% Emerging economies
7% Private

Bonds (14% total)
5% U.S.
9% International

Real Assets (27% total)
6% Real estate
11% Commodities
5% Inflation protected bonds
5% Infrastructure

Special Opportunities
8%

This adds up to 98%, but the way I read the book, the rest should be in cash. As a comparison, here is the asset allocation from Unconventional Success.

El-Erian doesn’t like home-bias and is believes strongly in being “globally-diversified”. You can see that only about 1/3rd of the equity allocation is to U.S. stocks. If an investor does have access to private equity, then you can redistribute that back into the other equities. In my opinion, he cops out in the active manager vs. passive index debate. He simply states that it’s really hard to find a good active manager, but if you can you should go with them. Of course, no further hints are given. :P

As for bonds, he believes that bonds are overall a good portfolio diversifier to manage volatility. He also advocates a big portion of international bonds, which he believes are mature enough to be considered right beside domestic bonds. (He was also was an emerging bonds analyst for many years.)

Inflation is another big concern due to huge global growth, and thus there is a sizable allocation to real assets – commodities, real estate, inflation-protected bonds, and infrastructure (publicly traded equity and debt securities of utilities, airports, ports, roads, hospitals, etc.). Special Opportunities could mean speculative plays such as distressed debt or long-term environmental gambles like carbon credits.

In general, this is pretty different mix from many other model asset allocations I’ve read about.

Summary
When Markets Collide is mainly a macro-economics book as opposed to a how-to-invest book, but it does give some interesting insights about the future that might influence my personal investing strategies. For example, I agree that activities from non-U.S. countries will be increasingly important and their equities should be a significant part of one’s portfolio. I am not so sure (or educated) about the rest. I could only give a very superficial review here, so if this perspective sounds interesting and you want more details than I have given, I would read the book. If futuristic projections aren’t your thing, then I’d probably skip it.

Asset Allocation: Investing In Real Estate Through REITs?

When deciding on your portfolio’s asset allocation, another option beyond broad stock funds in domestic or international markets is to invest in is real estate. Besides directly owning a home or office complex, an easy way to get exposure is to own Real Estate Investment Trusts, or REITs.

What is an REIT?
From the National Association of REITs website:

A REIT is a company that owns, and in most cases, operates income-producing real estate such as apartments, shopping centers, offices, hotels and warehouses. Some REITs also engage in financing real estate. The shares of many REITs are freely traded, usually on a major stock exchange.

To qualify as a REIT, a company must distribute at least 90 percent of its taxable income to its shareholders annually. A company that qualifies as a REIT is permitted to deduct dividends paid to its shareholders from its corporate taxable income. As a result, most REITs remit at least 100 percent of their taxable income to their shareholders and therefore owe no corporate tax.

Since the REIT income essentially “passes through” directly to the shareholders, you are getting relatively direct exposure to commercial real estate. You’re not investing in a builder, or some other funky derivative. There are both domestic and international REITs, but lots of the following is based on US REITs.

Characteristics of REITs
Long-term historical data for REITs are not directly available, as there was not necessarily a consistent index to track them, or actual broad mutual funds investing in them. I’ve read various estimates from varying companies and academic studies via different books for returns (annualized).

To generalize, the performance of REITs is a little less than that of broad stock indexes, but higher than the return from bonds.

However, the main reason why many investment professionals and institutions all invest in REITs is that they have a historically low correlation with the overall stock markets, and also the bond market. This diversification benefit allows you to incorporate Modern Portfolio Theory and try to construct a portfolio with a better return/risk ratio than you had previously.
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Interim Asset Allocation: History, Decision, and Changes

Over the last year or so, I’ve learned a lot of new things about investing and asset allocation. At the same time, I know that changing your asset allocation too frequently is often a response to recent market activity (aka performance chasing, or market timing). In addition, I’m a highly analytical person and I love for things to have a correct answer to 5 significant figures before committing… which is pretty much impossible here. But at some point I know I just need to take action if I truly believe it is an improvement.

Previous Asset Allocation
In April 2006, I moved from the all-in-one Vanguard Target Retirement 2045 Fund (VTIVX) to a portfolio with more asset classes in an attempt to better optimize risk/reward factors based on historical data. You can see the asset allocation breakdown here. This asset allocation is pretty much what I have right now, except that I added a Micro-Cap stock fund and we moved money into a 401k with limited investment options.

Interim Asset Allocation

altext

I’m still continuing my series on building my portfolio, so I won’t explain all my actions here, but here are some quick summaries:

  1. Stocks/bonds allocation. I am shifting to a age-based formula for my stocks percentage. Using 115 minus my age, I am at 86% stocks and 14% bonds.
  2. Domestic/international allocation. I am increasing my international allocation to better match the world market. It’s essentially 50/50 if you think REITs are a separate asset class.
  3. Small/Value/Emerging Markets. These sub-classes are riskier than their overall market, but have been shown to have diversification benefits. Even if they don’t in the future, I am okay with them simply being more risky along with higher returns. Essentially, I am taking the total markets, and increasing the portion of one additional asset class which I think has the highest diversification benefits. For example, Small Value is a subset of Total US market, and Emerging Markets is a subset of the Total International market.
  4. Real Estate. I’m still holding REITs, as they are a way to invest in commercial real estate, and have also been shown to provide diversification benefits. Will give more references later.
  5. Micro-Cap, International Value, and Large Value. I think all of these potentially good asset classes to hold, but I think they are of lesser overall importance than the others. So in an effort to simplify, I am dropping them as separate funds. I still continue to have exposure the asset classes within other funds.
  6. New Bonds Allocation. I’ve been meaning to this for a while. I’ve been holding an intermediate-term corporate bond fund because it used to have a lower expense ratio after various fees. Inflation-protected bonds are still pretty new, but I’ve been convinced of their utility. I’ve also been convinced that bond ratings agencies just aren’t that good at their jobs, so I’m sticking with the highest quality bonds (Treasuries). The book Unconventional Success was a big influence here.

I call this my interim asset allocation because while I’m very confident this new setup fits my needs and preferences better than my previous asset allocation, I know that I will continue to learn and read. But just like with football coaches, this interim asset allocation might just become my permanent one.

In addition to all the books that I have read (and am still reading), I’d also like to say thanks to the many smart and helpful folks over at the Diehards.org forums for all the indirect and direct help. (I post anonymously at both forums.) Even though they sometimes feed my tendency towards complexity, I love the wealth of information that is available.

Equity Asset Allocation: Comparison of 8 Model Portfolios

I’m still planning on reshaping my investments and continuing my choosing an asset allocation series, but Thanksgiving and work has thrown me off a bit.

To skip ahead a bit, here are several sample asset allocations from various sources for the equity (stock) side of your portfolio. I thought it would be helpful to see them all side by side and compare how different authorities might split things differently between domestic and international stocks, how they deviate from the “total” market indexes, and whether they choose to incorporate additional asset classes like real estate or commodities.

For more information about any specific portfolio and the source, just click on the pie chart.

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