2009 May

Survey says…

Thank you to everybody who took the time to answer the survey this weekend. The results were quite enlightening.

Regarding complexity

The biggest takeaway was that literally nobody said that they felt the articles/topics were too technical or complex, and 64% of respondents indicated that they’d like to see it taken up a level. Sounds fun. I’ll see what I can do.

Granted, that doesn’t mean I intend to start spending a lot of time on complex/arcane investment strategies. I’m a firm believer that most investors stand to gain very little from strategies more complex than a simple buy & hold plan using low-cost, diversified funds.

Regarding asset allocation suggestions

Several readers indicated that they’d appreciate some guidelines for suggested asset allocations at various points throughout life. In that vein, I’ve updated my “asset allocation pyramid” article to include what I think are two very reasonable asset allocation glide paths.

Unfortunately, guidelines/suggestions are really the best I can do. There are simply too many other variables to pinpoint a precise “you should have X% in bonds, and Y% in stocks” type of answer based purely on age.

Regarding requests for historical return data

Also, a handful of readers requested that I share more facts about historical returns– “how did strategy A do against strategy B over period X?” type-of-stuff.

Strange as it may sound, I often go out of my way to avoid quoting historical return data to prove a point. I’m extremely wary of the seductive nature of data. As we’ve seen lately, our tendency to place too great a degree of trust in data has lead to some very sad scenarios for investors nearing (or in) retirement.

Of course, that’s not to say that I don’t see any value in analyzing historical investment returns. Quite the opposite in fact. I simply try (not always successfully) to avoid coming to conclusions too quickly.

Also, for any of you who are interested, I have a spreadsheet that’s a pretty good collection of data for returns provided by stocks, bonds, and gold going back to 1928. (More on this later though, it needs to be cleaned up a bit so that it’s fit for outside consumption.)

Thanks again!

So thanks again to everybody who took the time to fill out the survey. I really appreciate your feedback, and I’ll be doing my best to give you what you’ve asked for.

And that’s enough about that.

Tomorrow we’ll be back to our regular investment-related discussion.

May 18, 2009

A few questions for you…

In an effort to help improve the blog and determine its future direction, I’ve put together a short survey to help me see exactly what it is that you’d like to read about/discuss.

It’s 5 questions in total, so it won’t take more than a couple minutes. (Also, it doesn’t ask for any identifying information.)

Click here to take the survey.

Thanks for your time. I really do appreciate it.

May 15, 2009

Weekend Reading Book Reviews Edition

Oblivious Investing has been out for a couple weeks now, and the reviews are coming in. Thanks to Bad Money Advice, Yielding Wealth, Smart Family Tips, A Rich Life, and Amateur Asset Allocator for taking the time to review it.

I read an abundance of articles in the personal finance realm this week that I thought were worth pointing out:

Investing

Psy-Fi discusses overconfidence and over-optimism.

Bargaineering compares fixed annuities to CDs.

Monevator explains how to rebalance your portfolio.

Moolanomy explains that penny stocks are not cheap stocks.

BadMoneyAdvice explains why we shouldn’t listen to Dave Ramsey when it comes to investing.

Amateur Asset Allocator has some thoughts on how to fix the 401k system.

The Dividend Guy Blog shares a whole list of tips on how to avoid getting roped in by a shoddy (or shady) financial advisor.

From ETFDB: Top 50 buy & hold investing blogs.

Taxes

TaxGirl tells the story of what is being called the largest fraud scheme ever perpetrated by a DC government official.

From my tax blog: How do I deduct a loss from employee theft or embezzlement?

Other Personal Finance

From Allan Roth: My dog is America’s top financial planner.

Wealth Pilgrim provides an essential tip for how to find a competent estate attorney.

FiveCentNickel walks us through the question, “how much life insurance do I need?”

Weakonomics shares 6 money lessons from Star Trek.

GetRichSlowly’s new redesign is looking pretty fancy. I like the handy “shop for CD rates” widget.

Yielding Wealth shares 3 ideas for additional income during retirement.

Enjoy! And thanks again for reading.

May 15, 2009

How does rebalancing affect return?

I recently came across an article from William Bernstein explaining how periodic rebalancing is likely to affect the return in your portfolio.

The language in the article is a bit technical, but the message is important. The following is my attempt to put it in everyday terms (with some of my own explanations/interpretations mixed in).

What we’d expect: weighted-average returns

Imagine a portfolio made up of a 75/25 allocation between a stock index fund and a bond index fund.

If, over the next 10 years, the stock market were to earn an 8% return, and the bond market were to earn a 4% return, we might expect the portfolio (with its 75/25 allocation) to earn a return equal to the weighted average of the two–a 7% return.

Weighted Average Return = .75 (8%) + .25 (4%) = 7%

If the portfolio is rebalanced regularly throughout the 10-year period, however, the results are different. In fact, in most cases, the portfolio ends up earning a return that’s slightly greater than the weighted-average return of its components. (Bernstein refers to this additional return as the “rebalancing bonus.”)

Why does this happen?

In short, it’s because regular rebalancing is a way to force yourself to buy low and sell high.

The idea is that decreasing your exposure to the portion of your portfolio that’s just performed best, while increasing your exposure to the portion of your portfolio that’s underperformed should improve your performance. It doesn’t always work, but apparently it works more often than not.

How much additional return can we get?

Well, that depends on a couple variables. Specifically, it depends upon:

The volatility of each of the asset classes, and
The correlation between the two asset classes.

In order to maximize the rebalancing bonus, we want the volatility of each asset class to be high, and we want the correlation between the two to be low.

How we can profit from this information

It’s common sense that we can reduce portfolio volatility by adding an asset class that has little correlation to the rest of the portfolio. What’s fascinating to learn is that if the asset has an expected return equal to the rest of the portfolio, including it in the portfolio would not only decrease volatility but probably increase return as well.

Alternatively, if the asset has an expected return that’s less than the rest of the portfolio (as would be the case with adding a bond component to a stock portfolio), including it in the portfolio is unlikely to decrease expected return as much as we’d intuitively expect.

In other words, some of the return we sacrifice by including an asset class with a lower expected return than the rest of the portfolio is made up for in the form of a rebalancing bonus.

Takeaway #1: When constructing a portfolio, the correlation of the asset classes involved will affect not just your portfolio volatility, but your overall return as well.

Takeaway #2: Any asset that’s both highly volatile and uncorrelated to the stock market (gold, for instance) can make a lot of sense as a small portion of a portfolio due to the fact that it’s likely to contribute a greater return for the portfolio than would be indicated by the asset’s stand-alone return.

May 14, 2009

Fooled by Wall Street

Wall Street tells us that the ways to build wealth are to:

Unfortunately, each of these things has a less than 50% probability of increasing your returns.

But I’m starting to think that an even bigger problem than the ineffectiveness of those strategies is the fact that the focus on them is a distraction from the few things that really do matter when developing an investment strategy.

For example…

I’ve met several investors who have no difficulty spouting off several folk-wisdom tidbits about how to pick stocks, but who aren’t familiar with the concept of asset allocation.

I’ve met several investors who can tell you the 10-year return for the fund they just switched their 401k contributions to, but who never bothered to check the fund’s expenses.

I’ve met several investors who can list a whole host of reasons that the market is sure to go up (or down) over the next X months, but who don’t know (and haven’t bothered to research) whether they should be maxing out their Roth IRA or 401k first.

Why is that?

We’ve been duped!

The financial services industry makes money when we trade stocks (or when we subscribe to newsletters promising to show us how to pick stocks).

They make money when we invest in their actively-managed funds.

They make money when we jump in and out of the market (or subscribe to their services telling us when to do so).

They don’t make money when we demand low-cost investment options.

They don’t make money when we hold stocks for decades at a time.

Is it any surprise then that they’re engaged in an ongoing media blitz to obfuscate the handful of things that really do matter when it comes to investing?

Discouraging investors

Not only are investors confused, I have little doubt that many would-be investors have given up without even trying. They’ve decided not to bother learning about investing at all.

After all, it’s extremely complicated and math-intensive, right? You have to calculate financial ratios, check your stocks online, and watch CNBC all day so you can figure out where the market’s going next, right?

Better to pay someone a small fortune to do all that for you.

May 13, 2009

Improving Your Quality of Life through Investing

When we talk about saving/investing, we tend to think of it as something that will benefit us at some point down the road.

One of my favorite things about the investing principles I generally advocate is that they can actually improve your quality of life now. No need to wait 30 years to start seeing benefits.

Immediate benefits of diversification

If you’re investing in individual stocks, you’re stuck constantly monitoring them. Not only is that a giant time-suck, but it’s stressful as well.

Invest instead in an extremely diversified portfolio, and free yourself (immediately) from having to worry about what happens to any given company.

Immediate benefits of passive investing

If you’re investing in actively-managed funds, there’s always the possibility that the fund manager will make some terrible mistake. Any time you hand your money over to somebody else to invest, there’s risk involved. And–at least in my experience–with risk comes worry.

Opt for a diversified portfolio of passively-managed funds and free yourself (immediately) from the worry that a fund manager is going to make a costly mistake with your money.

Immediate benefits of automation

We all know the feeling of having some big “to-do” hanging over our head. There’s a part of human nature that prevents us from fully enjoying anything until we’ve taken care of whatever responsibilities we’ve been putting off.

If you haven’t gotten started investing yet, you’ll be surprised at how much better you’ll feel as soon as you get the ball rolling with an automatic savings plan–automated 401k contributions, for instance.

Knowing that you’re on the way to building wealth gives you a (well-deserved) sense of accomplishment and goes a long way toward eliminating worries/stress about the future.

What benefits have you noticed?

Aside from the obvious financial benefits, have you found yourself enjoying any quality of life improvements as a result of implementing a prudent investing strategy?

May 12, 2009