The Financial Philosopher

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

Where to Invest 2009: Stocks, Sectors & Structure

"The little reed, bending to the force of the wind, soon stood upright again when the storm had passed over." ~ Aesop

Living on the beautiful coast of South Carolina comes with similar risk/reward attributes as investing in stocks:  There is always risk of tropical storms and hurricanes, which are cyclical in nature, with a "major storm" occurrence approximately once every five to seven years and at least one "catastrophic" storm once per generation (every 20 to 30 years).  The "rewards," of course, of living on the southeastern coast are the mild temperatures, beautiful beaches and the comfortable, high quality of living.

After the big storms come and go, most of us do not reflect upon what we have lost but choose, instead, to focus on what we still possess -- all of which has nothing to do with money, material wealth or social status -- it is health, family, a tremendous sense of community and giving, colored with shades of hope -- all driving us forward.

In terms of our material loss, the big storms bring the opportunity, necessity and desire to "rebuild stronger than before."  Invariably, some homeowners will sell and move away; some will rebuild, hold on and stay; some will buy houses or land at depressed prices; and the few and unfortunate will have lost everything and have no capacity to do any of the above.

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

Today's installment of Where to Invest 2009 will focus on the spirit of "rebuilding a portfolio stronger than before," although with no extreme differences in strategy than any other calendar year or in any other given environment.

Of course, there is no "one-size fits all" investment portfolio; however, I am assuming here that investors will use their portfolios for what I believe stocks and bonds are best suited -- building wealth over a long period of time in a way that will provide returns that will significantly outpace inflation -- not necessarily to "beat the market" -- but to balance risk and returns.

We will achieve this balance by increasing exposure to areas that have been beaten down in the short-term but maintain a strong and positive long-term outlook.  Going forward, I will also assume that the prudent investor will have at least three years of short-term (less than three years) income needs and emergency funds allocated to money market accounts and certificates of deposit.

"If we will be quiet and ready enough, we shall find compensation in every disappointment." ~ Henry David Thoreau

As this Where to Invest 2009 series progresses over the next few weeks, I will provide more specifics on investment selection, but here are my general thoughts on asset allocation for the coming year and beyond:

• At present time I believe perceived risk is high and may remain that way for several months; but I believe "real risk" is falling.  This is a ripe environment for long-term investing.  In other words, I believe that the extreme levels of fear and pessimism are, at a minimum, slightly to moderately overdone at present time.
• Cash and short-term treasuries may provide "safety" but are yielding almost nothing now.  As the "flight to quality" mentality subsides, investors will be looking for higher yields and they will have compelling reasons to return to large-value stocks, which are currently yielding more than cash and short-term bonds.
• I will give more attention and allocation to small-cap stocks, which have historically done well following recessions.  For reference, according to Ibbotson & Associates, small-cap stocks had a cumulative return of 1,941.4% from 1932 to 1946, compared to large-cap stocks, which returned a total of 324.3% during the same period (a 6 to 1 margin of out-performance).
• For sectors, I still like Global Real Estate funds for defensive purposes, although 2009 may be a questionable period for the sector; I like Natural Resources (energy/big oil/gas refineries), which has arguably gone from extremely over-priced to moderately under-priced just in the last six months; and I still like the Health Care sector, especially active funds that invest in medical devices and biotechnology in addition to pharmaceuticals, for its perpetual defensive qualities.
• For bonds, I like high quality, intermediate to long-term corporate bond funds.  For the younger and/or more aggressive investor, there are a few well-managed multi-sector bond funds with higher yield/higher risk attributes. 
• I believe a gradual increase in exposure to foreign stocks and emerging markets is also wise for 2009.  The prudent investor will not expect the United States to lead the world out of this great recession but will look to foreign and emerging countries, such as India and China, to lead the way.
• As for my use of passive/active funds, I like Index Funds and ETF's for Large-cap stocks and Natural Resources and actively-managed funds for all other areas.  I never invest in (or recommend to clients) the use of individual stocks or bonds.  This would go against the idea of simplicity...

"In character, in manner, in style, in all things, the supreme excellence is simplicity." ~ Henry Wadsworth Longfellow

Believe it or not, these ideas can easily be put to use with very little skill or ongoing maintenance.  Personally, I don't see any reason or purpose to have more than eight to ten mutual funds, and I don't see any prudent reason for making more than an average of a dozen trades per year, if that.

For an early peek (and immediate gratification), that provides similarities to my balanced portfolio model, you may find some value in reading A Perfect Portfolio.

Above all, I will employ balance and the timeless virtues of simplicity, patience and moderation into the portfolio structure, while minimizing or eliminating the temptation to lead decisions with emotion... all strategies and attributes largely missing amongst the investor herd over the past several years...

Stay tuned for more on Where to Invest 2009...

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Related Post: The Wisdom of Asset Allocation

Investing in the 'Movement of Things'

"The investor's chief problem -- and even his worst enemy -- is likely to be him self." ~ Benjamin Graham

As the movement of stock prices heads lower and into Bear market territory, investors are naturally questioning their chosen vehicle for investment, often making changes to their own detriment.  Of course, media noise, with headlines screaming, "Worst Month for Stocks Since Depression" deafens the investor's ears to the sounds of their better judgment. 

Are we in a recession?  Where is the stock market heading?  Should I buy now, anticipating stock prices will turn higher, or should I sell in the event they will continue to go lower?  What type of investments should I hold now?  What am I to do?

"We do not, in fact step out of the movement of things, ask 'What am I to do' and, having obtained an answer, step in again.  All our actions, all our questionings and answerings, are part of the movement of things, and if we can work on things, things can work on us..." ~ John Anderson

The choice of investment vehicles is just as important, if not more so, than the vehicle itself.  The vehicle should suit your needs and personal preferences to get you to your destination safe and on time. 

The movement of things is beyond your control but choosing the means of navigating that movement is completely within your control. 

We may prudently choose the means of reaching a particular destination but we often question our choice when the movement of things shifts directions -- precisely the worst time for changing vehicles.

"Journeys, like artists, are born and not made.  A thousand differing circumstances contribute to them, few of them willed or determined by the will -- whatever we may think." ~ Lawrence Durrell

Consider a parallel scenario to the current investor dilemma regarding the choice of investment vehicles:

You are planning a long-distance journey and prudently select a vehicle that meets your travel objectives.  The vehicle of choice is a car and it is economical and comfortable and meets all of your personal and specific preferences, such as safety standards and cruise control. 

You begin your long journey and soon experience a traffic jam.  You look ahead and only see a long line of cars with no end in sight.  People are getting out of their vehicles and begin to speculate as to the cause of the traffic jam and how long it will last.  You begin to see people abandoning their cars in disgust and frustration. 

As the uncertainty mounts, you decide to sell your car for a rediculously low price and use the proceeds to buy a bicycle.  At least, now, you will be able to move forward again!  A few miles up the road, you see that the cause of the traffic jam is clearing and the long line of cars is beginning to move again. 

Soon, you see the person who bought your economical and comfortable car pass you on the road as they cheerfully wave and honk the horn... and you begin to question your latest choice of vehicle, the bicycle, as you realize that your first choice was best.

"Our patience will achieve more than our force." ~ Edmund Burke

If you are investing money in stocks and mutual funds for the traditional (and prudent) purpose of making your money work harder for a long-term objective, such as retirement, it is especially crucial to select your investment vehicle based upon the combination of your comfort level with investing (risk tolerance) and the length of time required to reach your financial destination (investment objective). 

What is happening around you at the moment of your investment decision, and any of the following moments that may challenge your decision along the way, will naturally enter your thoughts, but they should never gain influence over you and your journey.

Once you step into the movement of things, it is prudent to stay with that movement, regardless of its direction...

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Related Posts:

Quiet In The Storm

The Wisdom of Asset Allocation

The Essence of Understanding