Category Archives: How to Build and Manage a Portfolio

Step by Step instructions, as well as FAQ’s (Frequently Asked Questions) on building and managing your portfolio using our tools and approach.

Sticking to the Cautious Plan

Hey everyone… I’ve been trying to take some time off this week, but have been watching the markets. I’m sticking to the cautious plan laid out over the last few weeks. We raised quite a bit of cash, then reinvested in bonds and real assets, keeping about 30% in cash. Today, we’re adding to the Facebook shares at a bargain price to get back to our 2% target. As the stock fluctuates up and down, we sell when it goes up and buy when it drops to keep the allocation at about 2% of the portfolio’s. In the long-term, I’m very comfortable ignoring the pundits. Let me know if you have any questions. I’ve also added a hedge against a sudden market drop using the inverse S&P500 fund (Symbol SH).

That may be more technical than many care to know, but I just wanted to you to know we’re holding steady and staying cautious.

Thanks!

This LIBOR Thing Bothers Me a Great Deal

I’m on vacation this week, but I spent the morning watching Ben Bernanke’s testimony on TV because I wanted to hear what he says about the LIBOR (London Interbank Offered Rate) manipulation by Barclays Bank (and others), ongoing since 2008. This thing reminds me of the initial news in 2007 that a couple of hedge funds in Europe had closed because they didn’t know what their holdings were worth. That news was apparently ignored by the markets, but was the first overt indication of the coming financial armageddon.

I don’t like what he said, and I don’t like the way he evaded questions from Congress about why he and the Fed did not expose this problem when they knew about it. I think this stinks. Essentially, it seems that big bankers lied about the true interest rate transactions occurring in order to under or overstate LIBOR interest rates to benefit trading positions held by, you guessed it, big banks. Our Fed and our regulators knew about this for years, but never blew the whistle, although they claim to have been working behind the scenes with European regulators to try fixing the problem. My personal opinion is that they cut the banks some slack because they did not want any more of them to fail, thus further damaging the flawed financial system. In other words, the ends justified the means.

The possible implications are far reaching and market reactions to this kind of thing are unpredictable. Markets might depart from normal behavior in some drastic move. So, for the second time this year I have raised a lot of cash in client accounts to wait and see how this all plays out. I’m not predicting a crash, but the risks of it happening in my view, are very real.

My primary job for you, as I see it, is managing risk and avoiding a big hit to your life savings. Sometimes I will appear to be too cautious, and miss opportunities when the market shrugs off my concerns. That’s OK with me.

If you, however, are still far from retirement and want me to be more aggressive with your accounts, please let me know directly. I can put your money back to work right away and let you ride things out.

As always, thanks so much for your trust.

Question from a PortfolioWisdom App Owner

Below is a question from someone who is using the PortfolioWisdom App along with my answer. I hope everyone finds it informative and useful.
Dale
On Jul 10, 2012, at 10:09 AM, AC wrote:
Dale,

I have become a recent fan of your investing philosophy and have recently subscribed to your excellent mobile app.  I have experimented quite a bit with entering different profiles into the app.  I realize that your methodology for asset allocation is your proprietary secret sauce, but would love a little more insight into what metrics you use to dynamically adjust the allocations over time, if you are willing to share it.  I also have a specific question about the app:

I have noticed there seem to be three different basic portfolios, based on portfolio size, consisting of either 6, 9 or 12 funds.  The charts that then appear when selecting a risk tolerance seem to indicate that the portfolio with only 6 funds has had better overall returns than those of 9 or 12 funds each.  Is this correct, or am I interpreting the charts wrong?

Thanks,
A

Dear A,

Thanks for the kind words. I’m really happy you are finding the PortfolioWisdom app helpful. You made my day!

Regarding your question, you may note that the 6 asset portfolio shows a better risk adjusted theoretical backtest return over the last 5 years than the 9 and 12 asset portfolios, but look at the components of the portfolio models. The six asset model has three different bond ETF’s (of 6 for 50%), while the 9 asset model has 4 (of 9) bond ETF’s and the 12 asset model has 5 (of 12) bond ETF’s. So, the six asset model is marginally more conservative (think about smaller investors with smaller portfolios) than the other models. Because it is more “bond weighted”, it has done better over the last 5 years, since bonds have generally been better than stocks. Obviously, in “good” times for stocks and real assets, the reverse would be true.
 
Regarding the “secret sauce”, I’m in the process of writing a book about my methodology and hope to publish it on Amazon later this Summer, along with a spreadsheet showing a simpler version more geared to 401k investors. The specific formulas I’ve developed will be “locked down”, but I intend for people to be able to try different assets and customize their portfolios somewhat.
 
In the meantime, here are a couple of nuggets. My underlying philosophy is that the markets are not inherently predictable or “time-able” in the short run of 2- 6 weeks (or maybe even for the next 1-3 months). So, my concept is based on the idea of developing a portfolio that allocates assets so the the inherent financial risk of each asset class is roughly equal to that of all the other asset classes in the portfolio. From the basis of that theoretical “equal risk” portfolio, I can then make intelligent decisions about over or underweighting the various asset classes, based on current asset class behavior and the risk tolerance of the investor, thus producing the different model portfolios. Implementation of that concept was tricky, and took me about two years of experimentation, because I needed to develop my own proprietary measure of “financial risk” for an asset class and another for a portfolio, and then my own algorithm for balancing that risk over time as asset behavior changes.
 
But, it works because it is based on some fundamental behaviors of multiple financial markets that have not appreciably changed over 300 years.
 
I hope this helps.
 
Dale

The Futility of Prediction Investing

If you had been asked to bet your portfolio on what would happen in the markets this last Monday, what would you have done? Listening to CNBC, Bloomberg, and everyone else on TV, most would have either bet the markets would collapse or just gone into cash to “wait it out”.

Today, there is a new announcement in Europe and there is a huge rally in stocks. Bonds are down, but not overly so. Real assets are up even more than stocks, presumably because the financial engineering in Europe is perceived to devalue paper currencies, especially the Euro.

If you had predicted a big rally, and bet the ranch, you would have been right and be making money. If you had predicted more trouble this week, you would be losing or sitting on the sidelines feeling lousy.

Because we stuck to our discipline, we weren’t scared out of the markets when Monday’s plunge occurred, and we are here to benefit by today’s rally. Very few people other than God really know what the future holds, and they are not talking on TV. The moral of this story is… don’t let the news push you into bad investment decisions based on predictions about what will happen. Find a proven investment discipline you can hold to, and turn off the news.

Diversification is a Beautiful Thing

Well, how about that?  I’m sitting here looking at the screen which shows our portfolios have gained over 1% since last Friday, when we went completely back into our portfolio models. Here’s the amazing part… the S&P500 is close to where it was a week ago, but just about all the other asset classes have gained.

The biggest contributors? Non-US government bonds! … followed by some holdings in real assets.

This development goes to show us at least three things:

  1. Prediction is a losing way to invest… we could never have predicted this even a week ago,
  2. Our methodology works … as volatility in those asset classes subsided, we were gradually increasing our positions in those asset classes … even as the news was calling for the end of the world, and
  3. Diversification is a beautiful thing!  If we had not been exposed to a broad array of asset classes, we would have missed out.

Have a great weekend.

Returning to Full Investment in the Models

Well, we have had a very good run vs. the markets since mid-April, when I said that “something doesn’t feel right” and raised a great deal of cash. At the time, I said we would gradually move the cash back into the models, which we have been doing. Today, I am putting the last 15%-20% cash back into the models. I am  not making a prediction the markets will now rally… I really don’t know. As I said in an earlier post “Wake Up and Smell the Coffee” , the investment professionals (and successful individual investors, for that matter) are people who have a discipline which keeps them out of the ditch of emotional investing. I have written at length about the other big trap of investing by prediction, which is fraught with peril. We don’t do that either.

We have a proven methodology, and since there is no overriding reason (as there was in April) to ignore it, I am going back to the methodology that has been successful for us in the past. The markets may go up and they may go down, but we are not going to be greedy or fearful. We will stick to our plan.

Have a great weekend.

Wake Up and Smell the Coffee! Please!

In September 2011, an acquaintance expressed concern that one of his smaller accounts was underperforming (losing money) and asked me if he should be more conservative,  just before the market bottomed and rose 25%. In March of 2012, another acquaintance informed me that he felt bullish and implied that he was going to be more aggressive with his account, weeks before the high for 2012. In May 2011, a relatively new acquaintance (who I was trying to gain as a client) expressed concern that my approach was calling for too many bonds and was concerned he would be hurt by interest rates that were sure to be rising soon. Within four weeks the market topped out and then dropped 20%. My clients, including this individual trusted my judgement and only saw a dip of 3-5% in their accounts during that period. These were all financially sophisticated, successful, level-headed people. If you honestly reflect on how you felt at those turning points in the market, you can remember people who were just as wrong about where the markets were going next. Perhaps, even you were wrong.

Investing for long term returns is NOT easy! Listening to the financial news on TV is hazardous to the health and welfare of your portfolio, plain and simple.

Only a few professional investors, and even fewer individual investors, succeed in reaching their goals in the financial markets. Everyone, even the professionals, make mistakes. What enables the professionals to succeed is having a discipline… a methodology that provides figurative guardrails to keep your portfolio on track. Individual investors have about the same odds of long-term success, as a good high school athlete does of succeeding in professional football.

What am I trying to say? Wake up! Smell the Coffee! Hire me to manage your money. At the very least, buy the PortfolioWisdom App and start comparing it’s recommendations to those of your current advisor. If you do, in six months or less, you will probably call me.

Look at your brokerage or 401k statements for the last two years… or for the last 5 years. Have you made any progress? Has the broker or advisor you use charted a wise course through the ups and downs of the markets? Did you experience an emotionally crippling portfolio loss that caused you to sell stocks at the bottom in 2008 or 2009?

We may be heading down into another crash. Please don’t go there again with your portfolio following the same strategy or advisor you did the last time.

Take care.

 

Dang! Wish I had better timing on Facebook!

Hello everyone, Boy was my timing off on Facebook! As a professional investor, you occasionally make judgement calls as you try to do your best for your clients. Some work out beautifully, and some, like this one, don’t work out the way you envisioned. Of course, the last chapter has not been written (this is a long-term holding), but the early returns are painful. I’m sorry this judgement call has been such a drag (approximately -0.5%) on the portfolios so far.

The good news is that I took a very small initial position (approximately 2%), so the temporary drag is very manageable relative to our long-term results. In fact, because I raised so much cash in April, 2012 (another judgement call that is going very well so far), our results for the year are still on track with the basic portfolio models, or slightly better, depending on the risk tolerance of your portfolio model. In summary, we’re still doing fine.

As of this writing, we still hold approximately 25% in cash, and I will be gradually moving that cash back into the portfolio models as previously discussed. The Facebook position will simply be part of the overall portfolio allocation to US stocks.

Hope you had a great Memorial Day…. thanks to all of those who gave their lives for our nation and our freedoms. Thanks also to the families who have born the heavy load of living with the loss of their loved ones.

We’re at a Fork in the Road

A look back, then a look forward…. As I write this post Friday morning before the market opens, 10 of 12 of the assets classes in our client portfolios are down for the Second Quarter and 4 of 12 are down for 2012. Remember when I said “I had to Laugh” back in February? People were predicting that we would see another 15% gain or more in the S&P500 from that point! This is a perfect example for my rule to pay little attention to CNBC and the financial news of the day. It often leads you in the wrong direction, my opinion. Our Balanced portfolio model has dipped approximately -2.7% from this year’s highs, while the S&P500 has dipped approximately -5.9%. Our actual client accounts have done somewhat better, because of the cash I raised back in April when I wrote that “Something Doesn’t Feel Right”.

Regarding FaceBook … I recommend you pay no attention to the media news on this subject either … it is pointing you in the wrong direction, I feel. I’ve noticed many  mainstream media stories that engender fear; fear of losing all your money; fear of missing out on the big move up. Fear sells, and the media is in the business of selling. The media is a lousy basis for forming your market opinions, unless you’ve learned to filter the news very carefully. We purchased a very small position in Facebook, and we intend to hold it for the long-term… possibly several years, so it is not a big deal in my view… certainly not as big a deal as the news stories.

Looking forward … I believe we’re at short-term fork in the road. I don’t know if we’re going to get a bounce off of the recent lows, or break through to some scary selling on wall street. Either could easily happen, based on the developments in Europe. In the big picture, we know we do not need to make predictions to make money over time. All we have to do is manage risk by responding to the behavior of asset classes according to my methodology. We are holding approximately 25% cash, and will continue moving back to full investment in the models over the next few weeks.

If anyone has questions or concerns, please give me a call. Thanks for being a part of our community!