Difu Wu

Deep value, long-term horizon, dividend growth investing, portfolio strategy
Difu Wu
Deep value, long-term horizon, dividend growth investing, portfolio strategy
Contributor since: 2011
thanks for commenting! No, do not use any advisers, robot or person, especially person, because they charge way too much. Just buy the lowest fee diversified ETF for each asset class. For example, I would use VTI for US stocks, VEA for foreign developed stocks, VWO for emerging markets, and BND for bonds. Given your sample SIP, you seem extremely risk averse. I wonder if that is really necessary. If you are 66 and expect to work 1-2 more years, you will probably qualify for social security which is essentially a bond. How much investable asset do you have? If you expect to receive $1000/mo in social security benefits, that is $12,000/yr, which is equivalent to $300,000 in bond holding at 4% interest rate. For your age, an even 50/50 split between stocks and bonds is usually appropriate, so if say you have $700,000 liquid assets, you want to put $200,000 into BND (which combined with the social security equates $500,000 in bonds) and the rest ($500,000) into stocks, which can be split evenly among VTI, VEA, and VWO. Don't touch commodities, which are speculative instruments and not investments.
Mike: Thanks for commenting. Yes, cash can provide some stability, but we must weigh the cost versus the benefits, and here the former overwhelmingly outweighs the latter. A 6% cash allocation means the portfolio is 94% correlated with stocks, so for all essential purposes it behaves no differently than an all stock portfolio. As for the cost, the seemingly small cost of cash drag compounds over the years to cost an investor almost a third of his assets and potentially millions of dollars in 50 years, an average lifetime of investing, as my graph showed. That is too much, way too much.
Cash has zero role in a long term investment portfolio. Let's go back to the definition of what an investment is. According to Ben Graham, "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." Since cash is a depreciating asset whose value is continually corroded by inflation, it not only fails to promise an adequate return, but in fact guarantees a poor return.
To be fair, I agree with you that Betterment and Wealthfront as well as other advisors all charge too much. But at least they are being transparent with their fees, while the true cost of Schwab Intelligent Portfolios is cloaked under the hidden cost of cash drag. I am not recommending the use of other advisors instead. My recommendation would be to simply buy and hold a low cost index fund like SCHX or VTI, or better yet, invest in individual stocks for rock bottom investment costs. Please see http://seekingalpha.co....
expatom: The Schwab fundamental index ETFs have too short an existence for return data to be meaningful. But if you go to morningstar, you can see for yourself that they too have underperformed.
Mike: An average yield on cash of 1.82% not only significantly underperform stocks, but won't even keep up with inflation. Even if we be generous and assume a long term cash yield of 3%, that still underperforms stocks by 7%, which means a cost of 0.42% of assets annually on 6% cash allocation. Historically, cash will not keep pace with inflation, while long term bonds will at least keep up. Cash is a short term investment, NOT a long term investment. Yes, anyone should hold some cash... in a saving account, not in an investment account meant to last 25+ years. There is no liquidity for cash deposits placed with Schwab robo advisor, because the account has to maintain at least 6% cash at all times.
Greater diversification is a good thing, but this benefit is far outweighed by the significantly greater costs of fundamental index ETFs, which charge 3-8 times as much as the market cap ETFs. That is a tough hurdle to overcome.
A little more stability and diversification is never a good tradeoff for much lower expected returns. The Schwab portfolio would be very stable and diversified already without the cash allocation and high cost fundamental index ETFs.
Dave Ross: I agree. Advisors are charging too much. This article is needed, however, to further raise awareness of the importance of costs on investment returns, and also to examine a striking example of ingenious marketing strategy to disguise a high cost service as "no fee", which may not be apparent to the novice at first glance.
epjepson: how is 10% long term return on stocks too optimistic, given that is the long-term average? CAGR for the S&P 500 is 9.11% from 1871 to 2014, 10.14% from 1926-2014, and 10.15% from 1957-2014. See http://bit.ly/vFOfUm.
Regarding cash in lieu of fixed income instead of more equity, that may be true, but since equity is the best vehicle for long term (20 years or more), equity return is the true opportunity cost here. Also, bonds and commodities have significantly greater expected returns than cash, which is not negated by higher transaction costs in trading fixed income investments.
Good point, vinyl1. Arbitrage profits are another revenue source, though it is not as significant as cash drag and ETF fund expenses. Thanks for commenting.
My number are straight from LendingClub's prospectus. You need to calculate market cap on a fully diluted basis under GAAP, otherwise you are deceiving yourself.
@ GI:
Perhaps, but you could have said the same thing about eToy, Lucent, Palm, CMGI, Linux, Red Hat, etc. I can go on an on. You can project growth to Heaven if you wish, but I'd rather get my money's worth. Plus I get better sleep at night.
No recession coming? You can't be serious. How much do you want to bet there will be recession? Do you really believe this time it's different and the Fed somehow cured the business cycle that has operated ever since there was a stock market?
Did you know that 30 year treasury bond was paying >20% back in the early 1980s? The current extremely low interest rates are a rare anomaly and it will revert to the mean. Then LC will lose its glitters.
@LS: Agreed. The tax laws definitely favor stocks over bonds and growth stocks over income stocks. We can't change the laws, but we can change our investing strategies to make the most use of them.
Are you kidding? Using FIFO, you owe $3240.45 in short term capital gains on the 285 shares you bought at $15 and sold at $26.37. Check your math, or the tax man will come get you. IRS laws don't allow you to reallocate cost basis like that.
There is no such thing as house money. That is a mental accounting trap. Money is money. Period.
Competition can be good... for the consumer. For the company, though, it will drive down margins and profits. 250 shares may not be a lot for you, but at $26.50 per share, that represents a little over 1% of my total net worth, and about 6-7 months of expenses, too much to bet on a rank speculation like LC stock.
Your links do not include Berkshire's foreign holdings, which the SEC does not require discloure. Check out these links below:
Thanks Peter for commenting. I agree Gazprom and Sberbank are not for everyone. They could easily drop another 50-80% from here. But the best opportunity is found at times of crisis, and the value proposition offered here is too great to ignore.
VISA actually happens to have the best current ratio among all 30 issues, at 3.46, so that is the least of problems with VISA (its poor earnings and dividend record and very high price are why it failed as a defensive investment). I wonder sometimes too if the requirement for at least 2:1 current ratio is a little too stringent/outdated today, given most companies fail this test. But then you almost always find companies improve their balance sheets dramatically and become financially conservative after a major market correction of previous speculative excesses, such as in 2003 and 2009. I think requiring 2:1 current ratio at a minimum is important to help provide sizable cushion of working capital to sustain a company through hard times that will inevitably come. People tend to forget that a bear market is even possible after 5 years of a bull market.
Also, I would not put too much stock on S&P ratings. XOM's AAA rating is mainly based on high IC and low D/E. S&P is facing lawsuits from the Justice Dept for giving high ratings for mortgage securities that turned out to be junk and ignited the 2008 financial crisis.
Thanks for the correction! I meant to write "will not ONLY hurt bonds", but somehow the word "only" got lost. Unfortunately, this type of typo doesn't get picked up by spell check, so I have to be more careful proofreading next time. I glad you know what I meant to say though.
Thanks for your comment. Sorry the color coding failed to work. I'll try something else next time. You are right, meeting Graham's criteria doesn't guarantee survival, but it tends to increase chance of satisfactory return on investment when purchased at the time all criteria are met, as Graham's investment record has shown. Value stocks tend to get bought out, usually at a premium, and you can then reinvest the proceeds. On the other hand, survival does not guarantee satisfactory return. GE is the oldest component of the DJIA, but if you bought it at $60 in 2000, you are still looking at a 60% loss today, 14 years later, even though the company has survived.
Hi rr76012:
Thanks for commenting. I agree today's market is on the high side, but valuations are not ridiculous so I would remain invested. I would overweight foreign stocks, especially emerging markets, which are still cheap.
Hi muscat:
Residual value, or terminal value, is how much the company is worth at the end of time period for which discounted cash flows are calculated, assuming a terminal growth rate of future cash flows and a discount rate.
My math for calculating discount rate is correct. 0.02 + 0.35 * 0.06 = 0.0416, or 4.16%.
Calculation for intrinsic value using DCF will vary greatly depending on the discount rate used. Feel free to use a higher discount rate if that suits you.
Thanks for commenting.
Managing: No one can predict future returns with any certainty. If so, he would soon have all the money in the world. You can't expect any list of stocks to outperform in any given year.
Thank you all very much for commenting and adding valuable insights to the article. I agree that most of these stocks are cheap because they have been facing headwinds lately. How else will you be able to buy stocks cheaply? You will overpay if you buy only when all lights are flashing green. These are solid, large and prominent companies that are likely to survive the current difficulties and thrive. That said, don't necessary expect them to outperform in 2014, as catalysts can take time to happen, but it is worth the wait. Most of these will do ok, a few may disappoint, but some will turn out great, and the overall performance should be better than buying an overpriced P&G or Coke.
If you don't trust the dollar, doesn't it make sense to diversify into foreign stocks?
Thanks for your kind sentiments. I appreciate it.
Thanks Lallemand for your insightful comments. With the current valuations, may I humbly suggest that much of risks you mentioned has been baked into the price already. Also, reversion of the mean suggests that natural gas prices will recover eventually. Dividend cut is a risk for E.on, though dividends are not as sacred for foreign stocks as they are for US stocks. More bad news when market expectations are low will drop the stock price but a little, but a positive surprise given low expectations will cause a big run.
Thanks for your comment and adding valuable insight to this article. All stocks are shorted by one guru or another. Accounting in emerging market companies can be problematic, and share dilution is a concern, though almost all banks partake in constant capital raising/dilution. Dilution is more concerning for some major US banks trading at higher price to book value.
Your argument is fallacious. Fundamental indexes are true indices: they are indexed to the fundamental businesses, as opposed to the stock prices as for cap weighted indexes. And of course everyone can invest in fundamental index funds. The prices will simply adjust to the shift in demand and those invested early in fundamental index funds will enjoy a one time boost to performance, then the cap weighted index will be the same as the fundamental index. If you argue that an index must reflect the current investment opportunity set, then nothing is an index fund, because the current investment opportunity set includes not only all stocks around the globe, but also private equity, restricted non-float shares, commodities, preferred stocks, bonds, etc.
Thanks kenleezle for reading my article and your reply. With respect to market timing, if you don't invest all at once, then you are holding cash and thereby defeating the purpose of leveraging to 200% stock that A&N recommends. With respect to costs, 5% is way too high considering that total stock returns average about 10% per annum, so 5% effectively eats away half of your expected return. Even if the "borrowing cost" were lower, say 3%, it would still be too costly when the risks of leveraging is taken into account. Finally, with respect to rebalancing, there is no way to overcome this, naming buying high and selling low with every rebalancing act. That is the nature of the beast (leveraging that is). And that is exactly why leveraged ETFs are so toxic. Hope this helps.
Thanks for your comment, kolpin. Some picks from 2012 did not make it onto my 2013 list because they appear more fully valued now, such as HRS and HAS you cited, and are less attractive than my new picks for 2013. However, as I emphasize in this article, I believe all my 2012 picks are still suitable for holding and my 2013 recommendations are for new money only. If there is no new money, I would just recommend holding onto the old stock picks because of taxes and commissions. After paying 15% capital gains tax, reinvestment into a new pick would have to outperform the old by a huge margin just to break even (it is a good exercise to do the math yourself to make sure you understand this critical point), which is why I recommend a buy and hold strategy.
Cheese Head: Exactly, to calculate normalized PE, I simply divide the current price by the median EPS over the past 10 years.
Jack Rice: If Warren Buffett, with most of his wealth in Berkshire stock that he has held for decades, is "not making money", I am quite content "not making money" also.
@giorgiolb: True, you can't spend paper gains. When investing in stocks for the long term, however, growth is far more important than income, and unrealized gains more efficient as they compound without taxes taking a huge bite out of them.
@Jack Rice: By your reckoning, Warren Buffett is not so much so a great investor after all, but merely someone good at keeping scores, for much of his gains remain unrealized in long term holdings such as Coca Cola and Washington Post. What are you going to tell me next? That losses don't count unless you realize them??