Where to Invest 2009: Funds & ETF's

"If a man is proud of his wealth, he should not be praised until it is known how he employs it." ~ Socrates

This post is the final entry in my "Where to Invest 2009" series.  I will end by making a similar point as I did when I began these posts:  In my humble opinion, resulting from years of observing investors and clients, the annual ritual of pursuing "where to invest" may be more prudently replaced with the idea of "how to invest."

This would further suggest that a portfolio of investments does not dramatically change with every change in calendar year or economic and market environment -- it evolves with the given investor's objective, which hopefully is motivated more by meaning than by money.

In other words, we won't be "timing the market" but managing risk in a manner that allows for less time and energy spent on finances and more time and energy spent on meaningful life pursuits.

"No wind serves him who addresses his voyage to no certain port." ~ Michel de Montaigne

Of course, "how to invest" is a personal endeavor, which first requires a given direction and objective that comes from the individual investor.  In this post, however, I'll assume the investor/reader wishes to achieve the following:

• Invest for a long period of time (more than three years but ideally more than ten years);
• Apply the virtues of simplicity, patience and moderation by investing in a small handful of diverse mutual funds and Exchange Traded Funds (ETFs) with little or no need to make changes for the next 12 months;
• And to minimize risk while maximizing returns in absence of the often perilous desire to "beat the market."

For a good visual with similarities to my portfolio structure and strategy, I recently stumbled over this nice pie chart that does a find job of illustrating the wisdom of asset allocation and risk management (click on the image for the BusinessWeek article and a larger image):

As you may see here, the returns are greater for all time periods with the diversified portfolio (at far right).  Even the 15-year period, where the conventional wisdom would say that the higher risk/higher return attributes of a 100% stock portfolio should pay off, the diverse mix of 50% stocks/30% bonds/10% Real Estate/10% Commodities has the highest cumulative return.

"Perception is strong and sight weak.  In strategy it is important to see distant things as if they were close and to take a distanced view of close things." ~  Miyamoto Musashi

The strategy for 2009, as I inferred previously, is not entirely different than a prudent strategy for any year -- maintaining a broad perspective of the long-term objective while attempting to simultaneously leverage current and short-term economic and market conditions:

• 30% Large-Cap Stock: This allocation does not change much for me over time.  I typically use an Index Fund for large-cap stocks because of their greater market efficiency (higher degree of difficulty in gaining an edge over other investors because of readily available information on large public companies); however, 2009 may prove to be a good year for Large Value because these companies' dividends are yielding (paying) more than money markets and short-term bonds.  For Index, I like Vanguard 500 Index (VFINX) or Fidelity Spartan 500 Index (FSMKX) and for Large Value, I like Dodge & Cox Stock (DODGX).
• 15% Foreign / Emerging Markets:  I've heard intelligent arguments both for and against the use of foreign stocks; however, the U.S. domination of capital markets has already begun to diminish and I suspect this trend will continue over time.  For Foreign Stock funds, I like Harbor International Value (HRINX) and for Emerging Markets, I like Lazard Emerging Markets (LZOEX).
• 10% Small-cap Stock:  This allocation has increased slightly from last year due to small caps' tendency to lead in performance coming out of recessions and in deflationary environments.  For funds, I like Keeley Small-cap Value (KSCVX) and almost anything that is managed by Royce Funds.
• 5% Global Real Estate:  I've always suggested exposure to Real Estate as a diversifier.  There is still great risk here but prices are attractive for the long-term.  For ETFs, I like iShares C&S Realty (ICF) and for actively-managed funds, I'm sticking with the deflated but well-managed Third Avenue Real Estate Value (TAREX) fund for broad global real estate exposure.
• 5% Commodities / Natural Resources:  Gold and Oil have also been hit hard, especially in the last half of 2008, which makes Commodities compelling now as well as for the long-term.  I also like Natural Resources (big oil, gas refineries) for the same reason, especially considering the logical expectation that the world economy will still depend on these traditional resources of energy for quite some time.  I like ETF's for this asset category.  I currently do not use a pure Commodities fund.  For Natural Resources, I use iShares S&P Natural Resources (IGE). Hat tip to David Shvartsman at Finance Trends Matter for providing added information in this area. 
• 5% Health Care:  This sector is also beaten down but it did hold up better than most sectors in 2008.  Big pharma has a few bright spots with stronger new drugs in the pipeline while medical devices and services will likely stay strong with the aging population.  To hit all of these areas, I like T. Rowe Price Health Sciences (PRHSX).
• 30% Bonds:  With U.S. Treasury yields at historic lows, the "spread," or gap, between the average high-yield bond and the rate on the 10-year Treasury is at an all-time high.  High default rates are also likely "priced in" now; therefore, an ambitious investor might consider a good multi-sector bond fund the dips into the high-yield (lower credit quality) bonds now.  For the less risk averse, a good intermediate-term bond fund that invests in higher quality corporate bonds would be good for 2009.  For the prior, I like Loomis Sayles Bond (LSBRX) and for the latter, I like Harbor Bond Inst (HABDX).  I never use index funds or ETF's with bonds, especially in weak environments where their passive nature requires matching the given index, which will require holding even the worst of issues. 

"Moderation, which consists in indifference about little things, and in a prudent and well-proportioned zeal about things of importance, can proceed from nothing but true knowledge, which has its foundation in self-acquaintance." ~ Plato

In summary, I will repeat that this portfolio structure is not one that needs to change much over time.  It also implements diversity and encompasses the powerful virtues (in life as well as investing) of simplicity, patience and moderation.

Above all, investors should remember that they are human beings and individual personalities; therefore, self-awareness is absolutely essential to successful investing.  The ultimate goal, unless the process of investing provides great value beyond monetary means, is to make money a tool for a life plan -- not to make one's life a tool for a money plan...

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Related Posts:

Where to Invest 2009: Back to the Basics

The Wisdom of Asset Allocation

Index Funds vs ETF's

Comments

[David]

Very interesting post, Kent, and thank you for the kind hat tip to Finance Trends.

I think you've honed in on a useful way of thinking when you stress the importance of "how to invest", rather than the more usual question of "where to invest".

I would agree that knowing yourself is a very important part of discovering which method of investing is right for you. At least based on what I've learned so far!