Reconstructing Our Portfolio: Initial Thoughts

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Now that I have decided to stop spending time learning to trade individual stocks, I want to focus instead on optimizing our retirement portfolio. Right now we have almost $50,000 in retirement accounts, and if I liquidate my stock positions and start adding money regularly to a taxable brokerage account we can keeping building on that. That seems like enough money to split in between some different mutual funds to achieve a more specific asset allocation.

I intend to choose an asset allocation based on Modern Portfolio Theory, which tries to achieve the greatest return for a given amount of risk. Or the least risk for a given long-term expected return. There is lots of math and research behind it, but I’ll get more into that later. I’ve gone ahead and ordered a book dedicated to this, The Intelligent Asset Allocator by William Bernstein, to be my main resource. My overall goals are to (1) make my portfolio optimized with minimal expenses and (2) make it easy to maintain and continuously add money to.

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Comments

  1. I just invest in index funds that capture the preferred mix (S&P for domestic, international index funds, etc.)

    Low costs and they get you pretty close to the frontier.

  2. secretposter says

    I think you would be better off riding broad macro trends…China and India, bio-tech and high-tech, alternative energy, etc.

    Make a list of the broad macro trends in the last fifty years, and see how the well-known securities performed for ten year periods.

    Also, if you get an employee discount on your company’s stock, pick that up on the dips (only if you believe in it).

    That should work better than all the high-falutin’ math, which could have all its predictability wiped out by a single, simple, unforeseen event.

  3. krispytoast says

    Intelligent Asset Allocator — great choice. Probably the best investment book I ever read.

  4. Good idea. Indexing is best. I would take a look at CAPM models. You can do some very clever things without spending a lot of dough.
    Check out John Bogle for indexing. Do weighted averages for return with Risk Free CD’s and indexing.

  5. Recommend you read the following marketwatch.com article: link

    You may have to be registered with their website (would take less than five minutes).

    The gist of it: Gives you several combinations of index fund portfolios and historical performance. Portfolios range in name from “Yale Portfolio” to “Margaritaville Portfolio.” Don’t read much into these names. The names may help if you want to google them.

    Recommend looking to powershares.com if you want to research sector specific ETFs. Recommend using yahoo finance if you want to research the most common exchange traded funds (ETFs).

  6. I started reading IAA, but found it a bit dense for now (and I’m a technical person). His other book, “The Four Pillars of Investing”, is a more readable and covers mostly the same content, but without having standard deviation charts in chapter 1. And better jokes.

    Attempting to ride broad macro trends is really difficult for an individual investor. Theoretically, the future value of these trends is already reflected in the market prices of the assets (a la EMT). The question is not if they will do well. The question is if the reward is worth the increased risk they represent. They might be four times the risk for only twice the return. I think India and China, as countries, are going to do great in the next century. But, I don’t know if their markets are worth the risk, and I certainly don’t know if their assets are currently overpriced or not. They should be part of a diversified portfolio, but only as a tilt, not as a huge chunk.

    Finally, I ran across these yesterday. They’re videos of two of the smarted guys in asset allocation. Fama has a good comment about how, according to all know data, no one can pick better stocks than anyone else, you can only take more risk for more reward by picking different asset classes.

    Dimensional Thinkers: Kenneth R. French
    http://library.dfaus.com/videos/thinkers_french/

    Dimensional Thinkers: Eugene F. Fama
    http://library.dfaus.com/videos/thinkers_fama/

  7. Ah, and after I comment, I realize secretposter was joking.

  8. I have read Four Pillars as well, and reviewed in the ‘Book Reviews’ section. I think I’m ready for the math now 🙂

    I don’t think secretposter was joking…

  9. Speaking of trading stocks versus mutual funds, I found this opinion memorable. I am not a Forbe’s reader with $1.6 million in assets, but it is still a valid viewpoint.

    I Still Hate Funds
    http://www.forbes.com/markets/free_forbes/2006/0130/120.html

    Also, stocks are not so bad if one invest long term in a good dividend paying company:

    What makes a good dividend paying stock?
    http://www.financialsense.com/stormwatch/2005/0408.html
    From the article:
    “According to Mergent, superior dividend companies have several attributes in common. They are as follows:
    1) They are large and mature companies.
    2) They are past their growth phase with no major expenditures.
    3)They have strong cash flow and earnings growth.
    4)They have good management with solid corporate governance.”

  10. I highly recommend “Unconventional Success” by David Swensen. He examines most major types of investments in excruciating detail, and provides a lot of cautionary tales and gotchas to be aware of.

    It’s not a light read, and I thought his chapter on portfolio construction was too brief, but I still consider it the best investment book I’ve read to date.

    Amazon sells it at a reasonable price, and I’ve got a review on my site.

  11. Can’t wait for your review. I’ve read his other’s but haven’t had a need for IAA.

  12. I’ve read both the Four Pillars and Asset Allocation books by Bernstein, I’d highly recommended them.

    A couple of years back I pulled completely out of individual stocks and into a portfolio of Vanguard funds with an allocation model I created based on the ideas in the book. Since then all I do is my once a year rebalance back to my preferred asset allocations. That’s kind of interesting as it’s pretty hard to get it exactly as preferred as the assets are based in three different accounts – regular taxable, ROTH IRA and IRA (401k rollover).
    It works nicely for me in the end though

  13. I read IAA first, then Four Pillars, then went through IAA again to nail down a few things that seemed too technical the first time. Both are excellent books. The simplified metaphor in IAA of the Uncle’s “coin-toss” retirement plans is actually what got me started on working out my AAP and using index funds.

  14. secretposter says

    i wasn’t joking…

    i agree there is more risk in investing in foreign countries. but you don’t have to do that to ride their economic waves. there are plenty of companies in those markets that are publicly traded in well-regulated markets. and there are ADRs as well.

    but, if my idea is so ludicrous that someone thinks i was joking…then maybe i need to realign my thinking. i am certainly open to that suggestion.

    🙂

  15. Don:

    “I Still Hate Funds” – very interesting article!

    One detail that is I couldn’t overlook is that the average Forbes reader is worth 1.6 million in this article but was worth $2 million in the article’s prequel “I Hate Funds.”

    Also, Fisher admits in the article that most of his anti-fund arguments wouldn’t apply to low-cost index funds. Those average ER’s he quoted seem off the charts to any Vanguard customer!

    I’m not at the 1.6 to 2 million mark either, but even if I were, I think I’d keep the same strict AAP using mostly index funds.

  16. I agree with secretposter. following societal trends is a good way to make money. renewables are going to quadruple in 10 years. China and India are going to be huge developing economies and there is a lot of money to be made. Biotech and genomics is the wave of the future.

    secretposter was on the mark

  17. You are talking about two different things though. You want the bulk of your allocation capturing the proper Beta risk. That is in your index/etfs that track the general market moves. Making guesses or bets on industries and countries goes after the Alpha which is a measure of the skill of the stock picker. If you have 80-90% of your assets properly allocated catching the Beta of what you want, then you can spend 10% playing around chasing superior returns.

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