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.
On Jul 10, 2012, at 10:09 AM, AC wrote:

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?


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.

A Negative Opinion Based on Economic Fundamentals

Hello Everyone, Here is an article I read today, written by Dan Amoss at , with which I agree. I think the downside risks in the stock market outweigh the risk of holding cash. The markets do not appear to be reacting to these risks yet, and our models have reduced stocks and real assets and now hold a very high percentage of bonds. It would seem that something has to give pretty quickly. If volatility begins to shrink, this will tell me that the risks I perceive are not that bad and we’ll move back to the full model allocations. Right now, though, I’m inclined to raise cash again.

The Daily Reckoning Presents
Seven Reasons to Sell Stocks Short

Dan Amoss

With all that’s going on, would you believe the market, as measured by the S&P 500 index, is only 4% off its high? Some folks interpret this fact as investors “shrugging off” bad developments, looking ahead to some unseen, glorious future that none of us individually can imagine.

But the “wisdom of crowds” is overrated. I see an epidemic of denial — denial at a level last seen near the 2007 market peak, when central bank policy was thought to be propping up stock prices. That denial didn’t end well.

Psychology and sentiment are important in markets, but not as important as overwhelming negative evidence, including the following seven reasons to remain bearish (the reasons to be bullish are well- known among institutional investors who have nervous clients’ money fully invested):
1. The market shrugged off the abysmal ISM report last week, but it shouldn’t have. This measure of US manufacturing activity dropped to 49.7 in June from 53.5 in May. This is the first time since July 2009 that we’ve seen a sub-50 ISM figure. Even more importantly, the index of new orders fell from 60.1 to 47.8 — its steepest month-to- month decline in a decade.

2. Central banks are panicking and easing policy, yet they’re still behind the curve in propping up stressed credit markets. Yesterday, the ECB, Bank of England and People’s Bank of China all eased policy. The Chinese in particular are starting to realize that easing credit policies would only worsen its overcapacity problems and are starting to think about the hard (and “growth”-depressing) work of restructuring a hugely imbalanced Chinese economy. At this point, the Federal Reserve is the only game in town. The Fed disappointed speculators in June by merely extending Operation Twist, and is unlikely to fire another volley of digital cash until the stock market and economy are in far more panicked states.

3. I didn’t address the so-called “plan” issued by the European Union a week ago because there was nothing to address: no details, no firm cash commitments and only vague promises to have another plan. Yet the stock market rallied anyway. The proof is in the pudding (and the “smart money” moves are reflected in the bond markets): Spanish government bond yields are soaring above 7% as I write. A real plan for Spanish banks will have to involve haircuts for shareholders and bondholders. There simply is not enough money — nor is there enough political capital — to bail out so many parties. We will see fewer month-long European vacations among the bailout crew this summer, and more emergency conference calls and meetings.

4. Leading economic indicators, including the ECRI Weekly Leading Index, rolled over in the spring and remain negative.

5. Nonresidential fixed-asset investment has peaked, as many companies go on an investment strike. Policy uncertainty is too great. The job market tends to follow the investment cycle; it has softened in recent months, including the data from this morning’s payroll report.

6. Forward earnings estimates for the major stock indexes are rolling over, starting from record levels and record-high profit margins. This is something we’ve discussed frequently in the past, but we’re seeing more and more earnings warnings related to squeezed profit margins. You can find more detail in the publicly accessible PDF chart book from Yardeni Research at this link.

7. Valuations are not low enough to compensate stock investors for all of these risks. You can see in the PDF document linked above that trailing earnings will likely turn out to be a good deal higher than forward earnings. This makes trailing PEs deceptively low and creates a strong head wind against future growth in dividends.
In summary, hold your short positions.


Dan Amoss
for The Daily Reckoning

What is the Goal of Investing?

Seems like a silly question to ask, but bear with me for a moment.

Any knucklehead mutual fund salesman or “advisor” can show you a hypothetical illustration with a better historical track record than the one you have (or the one his own clients have). All he has to do is go through the thousands of choices and pick one to show you that looks good. If you ever see an illustration like that from an “advisor”, ask if he recommended that investment to any of his clients five years ago. Then ask him to show you several proposals he made to clients several years ago. I’ll bet you the investment recommendations are very different than his current recommendation. I’ll further bet that both illustrations emphasize funds or asset classes that have been doing particularly well over the 3 years prior to the creation of the hypothetical illustration. That’s what “sells”.

At we believe the goal of investing is to use existing money to make more money in support of your life goals (such as retirement), as safely as possible. We strive to get from “point A” to “point B” steadily, without any big losses along the way. If, year over year, you see gains (or small losses in “bad years), then we are accomplishing our goal.

The goal is not “to beat the market” or “to beat a benchmark”. Because everyone follows the S&P500 or the Dow Jones Industrials or the Dow Jones Global Stock index, we compare our quarterly performance with those indexes. Since our portfolios are widely diversified, we also include a bond benchmark and a real asset benchmark so you can compare how your portfolio is doing in the context of the overall existing investment environment. It turns out that, over the last seven years, every one of the PortfolioWisdom models outperformed the S&P500 in our theoretical backtests, net of fees, but that is not the main point.

If the person who wants to be your advisor can show you that her past proposals and methodology are consistent with the ones she is showing you today, then you have probably found a true professional.

I wish you the best in reaching your goals.

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.


How Are the PortfolioWisdom App Users Doing?

Hey, App users? How are things going? I hope the “high” allocation to fixed income in the PortfolioWisdom App has been helping you this month! Have you noticed the way increasing equity and real asset volatility has decreased the allocation to those asset classes in the last four weeks? Please let me know if you have any questions.