Let me reiterate that this is simply a conceptual exploration and the building blocks here include being a diligent saver, having a proper asset allocation, not being likely to take defensive action in the manner I write about so frequently and of course that after a big bull market it would make any sense to entertain this with that portfolio size. If a portfolio quadruples to $200,000 after a bull market then no soup for you.
It might be interesting to think about a scenario where there has been a bull market in global equities and an investor in global equities has two and half times what he had five or six years ago. What next? In the context of totally reworking the asset allocation to do away with normal stock market volatility I would think about the following segments to own;
- Global Equities
- Commodities
- Absolute Return
- TIPS
- Foreign Sovereign Debt
- Domestic Fixed Income
- Cash (foreign or otherwise)
As I mentioned the other day I like the idea in commodities of gold, broad based agriculture and then some single commodity (maybe an industrial metal or soft commodity) for this part of the portfolio. If someone were to go to 10% commodities I think this sort of mix would cover a lot of ground but some may want to add a second single commodity so maybe one industrial metal and one soft.
Absolute Return may be the most difficult piece of the puzzle because there are a lot of funds in this space but not all of them work. My ownership universe includes RYMFX, DLSAX and NARFX. I have plenty of faith in them to be sure but the allocations are all quite small in case something goes wrong at the fund or I just turn out to be wrong with them. If 15% makes sense here I think it could entail four or five funds in case one does something unexpected. I think the IndexIQ ETFs could work in this regard, as opposed to really being like hedge funds but we are years away from wondering whether a bull market is long in the tooth or not giving the entire space time to prove itself one way or another.
TIPS, either the real thing or funds, are easy to buy but the weighting depends on where the investor is; 60, healthy and wanting to work probably has different income needs than 68 and unable to work. Someone not needing the portfolio income can go heavier with TIPS and anyone needing the income would probably want more in regular bonds.
Foreign sovereigns are important, IMO, but very difficult to access. For now I believe minimum order size is $100,000, it is at Schwab anyway. There are plenty of funds in the space but it would be nice to be able to go a little narrow than the entire planet ex-US. I do believe this will become a little friendlier to retail investors in the next few years.
One thing that this exploration is not calling for is lazy portfolio. IMO any sort of portfolio needs to actively followed meaning staying in reasonable contact with the basics of any countries where you own equities or debt. Additionally I think owning any sort of mutual fund that is "supposed' to do something needs to be watched. This exploration is about how much volatility to take on after a very narrow outcome and then whether anything about such a narrow outcome can be applied more generally. As I believe in defensive action and very active following of holdings the idea doesn't hold much real world appeal but perhaps reiterates the importance of knowing that at times it makes sense to take on more vol and at other times less vol. No one can be right all the time but being cognizant of the concept is the start to adding a risk adjusted dynamic to your portfolio.
10 comments:
"would an investor be wise to greatly reduce the volatility of their portfolio to avoid getting cut in half " = rebalancing
In many ways, what you're exploring here Roger also applies to retirees who have already made their nut, regardless of whether they enjoyed a triple along the way or not. Risk adjusted return is critical for us, which generally translates into a safe income stream with some growth to cover inflation.
I know you're not a big fan of REITs, but they can offset some volatility with a nice yield, as can MLPs. Within the global equities portion of the port, a tilt toward dividend payers and preferreds can help play defense as well.
Thanks for this thread. I continue to think that it's not as far out as you believe.
The problem with most types of funds, equity and debt alike, is that duration is unpredictable (portfolio turnover) and usually longer than desired as one approaches retirement. Yes, funds help the investor deal with non-systemic risk and/or difficult to access spaces but there are other risks and it never hurts to learn a bit more about and invest in individual issues in any case.
For example, those earlier in their investing careers might consider a few small, individual dividend reinvestment plan (DRiP) positions in the equity space. I fell into these more or less by accident back in the '80's because investing with a broker was expensive back then and that went double for small positions (gobsmacked if you didn't buy in round lots of 100): Companies with a steady history of dividend growth mostly do pretty well over time and letting the company or, more typically these days, its agent automatically reinvest dividends in additional shares can lead to a significant nest egg in 20-30 years even if a few do poorly or disappear in the interim (OTOH I have three that are more than 20 years old).
If I were starting out again I'd inspect the portfolio of a solid dividend growth fund like VDIGX, select some names that also have DRiPs and research them, then invest a few hundred bucks each in a half dozen or so with maybe a few additional bucks added over the next couple years ...then just go away and do something else for a couple decades, like build an emergency fund and a 'permanent' portfolio plus a T-bond ladder to control maturity and duration of future cash flows.*
*A TIP ladder might make sense too if inflation were picking up but since that usually means interest rates are rising floaters might make a lot more sense; why wait for bond adjustments based on CPI estimations when floaters react immediately and more strongly to the interest rate environment and market prices? JMO
I find diversification to be an extremely tricky issue. During the recent bull market, it seemed like EVERYTHING went up at the same time.
IMO, the biggest hurdle to this kind of portfolio adjustment is plain ol' hubris. A 40-50 year old who has just notched a triple is feeling pretty smug and probably thinks he or she is the world's greatest growth investor. How many of these folks were heeding Barton Biggs during the dotcom bubble? It's difficult to know when to fold 'em and, in my experience, even more difficult to do so. That's when a good FA can earn his or her keep.
A must read post by ZeroHedge from Mauldin regarding china.
http://zerohedge.blogspot.com/2009/07/some-weekend-thoughts-by-john-mauldin.html
I haven't had any trouble accessing foreign sovereigns, via fairly liquid CEFs such as FAX, MIN, GIM, JGT, etc.
I believe there are ETFs, as well.
Quick comment (before grilling some steaks but after genuflecting towards a semi-tall scotch so bear with me): What does your list category "Cash (foreign or otherwise)" mean? Foreign currency is a claim against the credit of a state other than a citizen's own and therefore "Foreign Sovereign Debt" by definition, not so?
at some point extending maturities will makes sense. at that point there could be a distinction between the two.
Conventional wisdom states that you adjust your portfolio to safer asset classes based upon your age. But what if instead its based upon your goal? Assuming that a person has specific goals and isnt just generating as much wealth as possible.
A person needs 1 million to comfortably retire and meet their needs. A 45 year old that still has 15-20 years of employment before retirement hits a triple and gets up to 800 thousand.
Keeping everything very simple at a starting working age of 20 and retire age of 65 we have 45 years of working income. If you have met 80% of you retirement goal then adding 80% of our working years onto 20 would give us 56.
The 45 year old would need to think like a 56 year old in terms of risk.
I'm sure a proper (and overly complex) formula could be invented by one of the experts.
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