High Returns, Low Risk! (or Financial Porn?)

On the cover of a recent issue of a major national financial magazine, written in big block letters was: HIGH RETURNS – LOW RISK. This is a blatant example of what many financial authors refer to as financial pornography. I already discussed my disdain for most financial news in my February 2010 post Financial News: Worse than Useless!, but this headline was so appallingly ridiculous that I couldn’t resist commenting on it.

Stock Basics

In this post, I’ll cover some of the basics of stocks, illustrating some of the concepts by using real examples for a specific company: Google. I chose Google because it’s well known and is a relatively new company. I’ll discuss shares, stock, IPOs, market capitalization, growth/value, etc.

Portfolio 6 Update

In my May 8 post, Implementing Portfolio 5: A Current Example, I discussed a plan for a particular investor to migrate from a simple portfolio to a more complex portfolio (more asset classes). This is an update on the execution of that plan (you may want to scan the May 8 post before reading this post). Since the allocation is slightly different than Portfolio 5, I’m renaming this portfolio Portfolio 6. If you need a refresher on stock asset classes (e.g., large-cap, small-cap, growth, blend, value, international, etc.), please read my January 2010 post, Asset Allocation: Part 2.

Keep in mind that this is a fairly complex portfolio, and that the investor is taking a very active approach to building the portfolio. This approach probably is not suitable for most investors, but is being presented for those who might be interested in dealing with the additional complexity. The most important point is that the investor has made decisions on how to proceed, and is taking action to execute her plan.

Lumpers vs. Splitters

Among investors who agree that using low-cost index funds is the winning investment strategy, there is an ongoing and unresolved debate. On one side the lumpers believe that since markets are very efficient, the best approach is to use a few total market index funds; e.g., a total US stock market fund, a total bond market fund, and perhaps a total international stock fund. On the other side, the splitters believe that the academic research justifies slicing and dicing the stock portion of your portfolio into more asset classes; e.g., large-cap, small-cap, value, growth, developed (foreign) markets, emerging markets, REITs, etc. Depending on which book you read or which web site you visit, you can find compelling evidence for each point of view. Let’s briefly explore the debate.

Your Retirement Goal

Setting goals and targets is part of the investment process. Retirement is a goal for most people. How do you determine your target for your retirement savings? This isn’t something that can be fully answered in a short blog post, but it’s something that most people probably should think more about. Here are some guidelines that may help.

US Corporate Bonds Are Holding Up

The US stock market is down about 10% in the last month, and before today’s bounce, non-US stocks were down about 15%. This is nothing compared to the 50%-60% drop in 2008-2009, but another difference is that US corporate bonds have not dropped along with stocks. This is one indicator that the fears of today are nothing like the panic of the 2008-2009 financial crisis.

Winning The Loser’s Game

Winning The Loser’s Game, by Charles D. Ellis, is one of the books on my recommended reading list. It’s not the first book I’d recommend for a novice investor, but it’s definitely worth a read if you’re serious about learning about investing. I don’t own it, but recently checked it out of the library to re-read, and thought I’d share a few key points from the book.

Implementing Portfolio 5: A Current Example

The investor who currently is invested in Portfolio 1 [about 50% Vanguard Total Stock Market Index (US) and 50% in Vanguard Total International Stock Index (non-US)] has decided to diversify into a more complex asset allocation, along the lines of Portfolio 5 (see my April 25 post, Some Real Portfolios). Here are my thoughts on how to implement this change.

Every Now and Then …

Today was a reminder that every now and then the financial markets go nuts. In case you missed it, there was a major panic in the global stock market today. At one point the US stock market was down about 10% from its high of the day, but recovered to end the day down a bit over 3%. There were price swings (down, then up) of more than 5% within 5-10 minutes.

A Vanguard ETF (VEU) that tracks the non-US market had prices ranging from 40 to 34 within a 5 minute period (that’s almost a 20% difference!), ending the day down about 4.8%. There were even crazier swings in individual stocks, but you can read about that elsewhere if you’re interested.

It’s natural to feel fear when things like this happen. The parts of our brain that react emotionally and physiologically to perceived threats evolved long before the rational parts. It takes discipline to bring your rational mind to bear when your emotional mind doing the thing it evolved to do. With investing, it helps to put things in perspective, and remind yourself that investing in stocks is a long-term proposition.

Vanguard Offers Commission-Free ETF Trades

As of May 4, Vanguard is offering commission-free trades of its 46 Exchange Traded Funds (ETFs), and has lowered brokerage commissions on purchases of other stock and ETFs to $7 per trade (and even less if you have $50,000 or more with Vanguard). I’m thrilled to see this, as it makes them competitive with Schwab and Fidelity in terms of ETF trading costs. It’s now feasible for a small investor to create a low cost, highly diversified portfolio using Vanguard ETFs.

A Conservative Approach to Investing

Not everyone agrees that you should invest in stocks to meet critical financial goals. It’s probably a good idea to at least consider this viewpoint, and familiarize yourself with a conservative alternative investment strategy. In the end, you must decide for yourself how much risk is appropriate for you, and make your investment decisions accordingly.

Portfolio 2: The rest of the story

In this post I conclude the story of portfolio 2. I review how the portfolio has performed, discuss some aspects of managing the portfolio, and talk a bit more about the asset allocation.

Portfolio 2: Genesis

In this post, we look at the genesis of Portfolio 2. This may be of interest to those of you who are currently relying on an investment firm or broker to manage your investments, and who are interested in moving to a lower cost, more efficient solution.

Portfolio 2 (simple, moderately conservative): the fixed-income story

In this post we start digging into Portfolio 2 (from my post Some Real Portfolios). There are several interesting aspects to this portfolio, so I'll use more than one post to discuss the portfolio. In this post, we focus primarily on the fixed-income portion of the portfolio. This is likely to be of more interest to retired investors, or investors who are investing for shorter term goals (less than 10 years).

Portfolio 1: Simple, aggressive, global equity

In this post, we explore Portfolio 1 from my post, Some Real Portfolios. This portfolio is extremely simple, consisting of only two Vanguard index funds:

• 50% Total Stock Market Index (US stocks)
• 50% Total International Stock Index (non-US stocks)

We might call this as an aggressive, global equity (stock) portfolio because it is 100% invested in stocks (no bonds -- very aggressive), and has a relatively high allocation to international (non-US) stocks (hence, global).  First, let's consider the investor's willingness, ability and need to take risk, and see how this portfolio fits.

Risk Tolerance

Before I get into details of the portfolios presented in the previous post, it will be useful to discuss risk tolerance, since it's so fundamental to making investment decisions.

In his book, The Only Guide to a Winning Investment Strategy You'll Ever Need, Larry Swedroe breaks down risk tolerance into three components:

1. The willingness to take risk
2. The ability to take risk
3. The need to take risk

Some Real Portfolios

I thought it might be helpful to discuss some real portfolios that I've been involved in developing. I'll start with the simplest portfolios, and then move to the more complex. The idea is to expose you to a variety of asset allocations, each having been designed based on the willingness, ability and need of the investor to take risk, along with ability and willingness to handle portfolio complexity.

What Do You Want to Learn More About?

I'm often thinking about different investing topics I'd like to write about, but want to write something that is most likely to benefit someone (which of course means someone has to at least read it!).  Here are some topics I've been thinking about:

Time, Inflation, and Uncertainty

This article discusses a little of the theory behind why investors expect to make money on investments, and why they expect to make more money on some investments than others.  This post is a bit more theoretical than most so far.

Tax Reporting Basics for Taxable and Tax Privileged Accounts

As an investor, you should understand the difference between your taxable and tax privileged accounts with respect to tax reporting.  I've noticed that novice investors sometimes get confused about this, especially when they have both taxable and tax privileged accounts at the same financial institution (e.g., Vanguard, Fidelity, Schwab, etc.).  For example, they may hold the same mutual fund in both a tax privileged and taxable account, and they wonder why they got a 1099 tax form for one and not the other.  This article doesn't get into details about tax reporting for earnings from taxable accounts, but just tries to distinguish between tax reporting for taxable and tax privileged accounts at a high level.