I have previously written about worry-free investing (my first blog post!). I have more or less being following that approach (i.e. mostly fixed-income investments). However, the monetary policy of the last few years in the US has made me start to rethink that approach. Historically low interest rates (typically < 1% on a savings account) coupled with stocks going sky high (a nearly 200% gain since the low of March 2009) makes me feel like I'm "missing out." In all likelihood, I will never actually implement any of these portfolios, but the primary reason for this, as with my post about ways to own gold, is to consolidate my learnings on this subject. I will continue to add to this as I learn more about the subject.
The basic asset classes
Most simple portfolios comprise a weighting of 2 or more of the following asset classes.
The following are are of the simple portfolios that are supposed to weather all economic times. They are supposed to work on auto-pilot using a fixed allocation of various asset classes and so they require minimal maintenance. These simple portfolios also tend to have better returns than many actively managed funds when measured over longer periods of time.
All of the above simple portfolios are of the set-and-forget type. At most, the only maintenance that may be recommended would be rebalancing at the end of each quarter or at the end of the year to make sure the asset allocation hasn't moved too much off target. The effect of rebalancing is widely debated.
Is it possible to time the market? I'm not sure if it can be done reliably. In the short term the answer is a definite "no." In the long term, it may be possible by careful observation and interpretation of macroeconomic data. I have been following several economic blogs since 2005, and only one of those blogs -- CalculatedRisk -- has made several correct predictions about the economy, including recession calls, and the bottom of the real-estate market in terms of home prices and inventory (see the "economic predictions" section towards the end of this post). However, the author of that blog refuses to offer investing advice. If he is actually able to call the next recession correctly, I think I will have to assume that timing the market is possible!
I recently came across this article from Doug Short (he updates this at the end of each month) which explains a market timing strategy based on moving averages as described in the Ivy Portfolio. Doug's page is updated monthly with the signal that indicates whether to remain invested in the fund or stay in cash for each of 5 funds - VTI (total US stock market), VEU (world, ex-US), IEF (7-10 year treasuries), VNQ (US REIT), DBC (commodities). Scott's Investments has a nice spreadsheet for the Ivy Portfolio that is updated in real-time. The moving average strategy for various durations can be backtested here.
Finally, someone in the bogleheads.org community suggested this method which takes into account both market trends and the unemployment rate. Apparently using two indicators avoids some of the whipsaws that the Ivy Portfolio method is subject to.
Market valuation indicators
The following are some of the indicators used for measuring the valuation of the stock market (i.e. to determine whether stocks are over- or under-valued). Because periods of over- and under-valuation can persist for long periods of time, they are perhaps only useful in terms of what to expect in the long term. Additionally, there are other factors such as interest rates that affect the valuation at any given time. But here are the indicators:
The basic asset classes
Most simple portfolios comprise a weighting of 2 or more of the following asset classes.
- Stocks (small cap, mid cap, large cap, ...)
- Bonds (short term, mid term, long term, ...)
- Real-estate
- Precious metals
- Cash
The following are are of the simple portfolios that are supposed to weather all economic times. They are supposed to work on auto-pilot using a fixed allocation of various asset classes and so they require minimal maintenance. These simple portfolios also tend to have better returns than many actively managed funds when measured over longer periods of time.
- Couch-potato portfolio (50% stock, 50% bonds)
- Coffee house portfolio (10% in various stock funds, 40% fixed income)
- Permanent portfolio fund (25% stocks, 25% bonds, 25% gold, 25% cash)
- Using age to determine what percent of assets should be in stocks (110 - age)
- Ms. Cheat Sheet sample portfolio for recessions (100 - age in low volatility stocks [USMV], age/2 in bonds [BSV], age/2 in cash)
I should note that none of these portfolios was able to successfully dodge the financial crisis of 2008-2009. In particular, here's an excellent article by Doug Short on the pros and cons of the Permanent Portfolio Fund, and another one about diversification.
There are variations of these to try to bring in more diversification, but I think that unnecessarily takes away from the simplicity. If I ever decided to try something different than the worry-free investing approach, it would probably be one of these or a very minor modification of it, e.g. 20% in an S&P500 index fund and the rest in US treasuries or cash.
Several "lazy" portfolios are described here.
Several "lazy" portfolios are described here.
Timing the market
All of the above simple portfolios are of the set-and-forget type. At most, the only maintenance that may be recommended would be rebalancing at the end of each quarter or at the end of the year to make sure the asset allocation hasn't moved too much off target. The effect of rebalancing is widely debated.
Is it possible to time the market? I'm not sure if it can be done reliably. In the short term the answer is a definite "no." In the long term, it may be possible by careful observation and interpretation of macroeconomic data. I have been following several economic blogs since 2005, and only one of those blogs -- CalculatedRisk -- has made several correct predictions about the economy, including recession calls, and the bottom of the real-estate market in terms of home prices and inventory (see the "economic predictions" section towards the end of this post). However, the author of that blog refuses to offer investing advice. If he is actually able to call the next recession correctly, I think I will have to assume that timing the market is possible!
I recently came across this article from Doug Short (he updates this at the end of each month) which explains a market timing strategy based on moving averages as described in the Ivy Portfolio. Doug's page is updated monthly with the signal that indicates whether to remain invested in the fund or stay in cash for each of 5 funds - VTI (total US stock market), VEU (world, ex-US), IEF (7-10 year treasuries), VNQ (US REIT), DBC (commodities). Scott's Investments has a nice spreadsheet for the Ivy Portfolio that is updated in real-time. The moving average strategy for various durations can be backtested here.
Finally, someone in the bogleheads.org community suggested this method which takes into account both market trends and the unemployment rate. Apparently using two indicators avoids some of the whipsaws that the Ivy Portfolio method is subject to.
Market valuation indicators
The following are some of the indicators used for measuring the valuation of the stock market (i.e. to determine whether stocks are over- or under-valued). Because periods of over- and under-valuation can persist for long periods of time, they are perhaps only useful in terms of what to expect in the long term. Additionally, there are other factors such as interest rates that affect the valuation at any given time. But here are the indicators:
- Price-to-earnings or P/E
- Price-to-dividend or P/D -- the dividend for the S&P 500 can be obtained here
- Tobin's Q
- Market Cap to GDP
- Price/earnings growth ratio or PEG ratio
- FINRA margin debt (formerly NYSE margin debt) (@yardeni.com)
- Greg Mannarino's MMRI (DXY * 10Y yield) / 1.61
Some useful tools and references
- stockchoker.com
- portfoliocharts.com - Provides charts showing how any portfolio would have performed using data going back to 1972. Here is the data for one of the sample portfolios called the "Golden Butterfly, but users can design their own portfolio to generate each of those plots (although it is a somewhat slow process).
- Morningstar Investing Classroom
- finviz.com - Stock screener.
- World's most ethical companies by Ethisphere
- A list of S&P 500 companies with no debt
