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Jay Johannesen is a principal and investment strategist at Portfolio Research, LLC. Jay holds an MBA from the Haas School of Business at the University of California at Berkeley and a CPA certification in Washington state. Portfolio Research is the leader in building risk controlled portfolios... More
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  • IPE - Why TIPS Should Still Be Part Of Your Portfolio & How To Invest In TIPS Now
    TIPS-short for Treasury Inflation-Protected Securities-provide investors with an insurance against the risk of inflation. TIPS are backed by the U.S. government and provide investors with returns that will keep pace with future rates of inflation, as measured by the U.S. Consumer Price Index. You can buy TIPS directly from the government, but it's easier to buy low-fee investment funds that hold TIPS such as SPDR Barclay's IPE, iShares' TIP, or Vanguard's VIPSX.

    TIPS enjoyed a remarkably high return in 2011 with the benchmark TIPS index rising 13.56%. Investors have noticed this strong performance. Total assets in TIPS funds jumped 26 percent, or $27.1 billion, in the past year to $131.4 billion at the end of January, according to Lipper.

    But we are not advocating TIPS in hopes of soon repeating such unusually lofty returns. In fact the declining yields that drove the majority of the 2011 return are not likely to continue. Yields are currently so low that there is little room for substantial declines (in fact in recent days Treasury yields have suddenly started rising).

    We recommend TIPS for the same reason we recommend any asset class - as a single component of a diversified portfolio that will collectively generate the highest possible return for the desired level of risk. TIPS role is to mitigate inflation, while combining with equities, commodities, REITs, cash, and other bonds to maximize return in various market conditions. Allocation to TIPS in our asset allocation models ranges from 5.6% to 15.3% depending on the investor's appetite for risk.

    Several things to keep in mind when investing in TIPS:

    TIPS and Duration
    In this article on Diversifying Bond Duration we explained how all investors should be aware of the duration of their bond investments - and the risk that a rise in interest rates would cause the bond fund's share price to decline.

    IPE, the SPDR Barclays TIPS ETF has an average duration of 5.93 years, implying the value of IPE's securities would decline about 5.93% if interest rates rose 1%. The actual loss might be larger or smaller depending on how rates changed in different maturities.

    Other big TIPS funds have even longer durations. The $40.8 billion Vanguard VIPSX TIPS fund had an average duration of 8.4 years. The BlackRock Inflation Protected Bond Fund had a duration of 7.8 years at the end of January while the American Century Inflation-Adjusted Bond Fund reported seven years.

    As Reuters' Tim McLaughlin explains in yesterday's "Inflation-fighting funds see mounting rate risk": to some extent, longer duration is a feature of TIPS-oriented funds. Duration ultimately measures how long it takes an investor to get the balance of the cash they are owed on a bond including principal and interest. Because a large part of TIPS inflation kicker comes at maturity when the principal is returned, TIPS have a longer duration than the same maturity of ordinary Treasury bond. That helps boost the funds' returns when rates are falling but the advantage disappears if interest rates rise.

    TIPS and Fees

    SPDR Barclays IPE's annual expense ratio is 0.1845% making it a very efficient way to invest in TIPS. Vanguard's TIPS fund had a 0.22% expense ratio (0.11% for their Admiral Shares), while the average expense ratio for TIPS investment funds is 0.82%.

    Far and away the most certain way to control your investment performance is to reduce your investment expense ratios. Even just a 0.60% variation in returns can make a huge difference in your wealth accumulation over time.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: I am long VIPSX

    Mar 16 4:58 AM | Link | Comment!
  • Why Are Investors Paying So Much For Index Fund Selection?

    The financial service industry is shrinking - bankers, traders, and brokers are losing jobs en masse - but, remarkably, assets-under-management and fees for independent investment advisors have continued to grow steadily throughout the financial carnage of the past 5 years; as noted by the title of this article in last week's Wall Street Journal - "It's an RIA (Registered Investment Adviser) World, Everyone Else Just Lives in it"

    Why are investors increasingly relying on investment advisors?
    2011 was another dreadful year for actively managed funds (funds which seek to select individual winners and losers). Equity mutual funds had their worst year since 1997 relative to the Standard & Poor's 500 Index, as record-high correlation and price swings made it harder for money managers to pick stocks according to The 50-day correlation of S&P 500 stocks to gains or losses in the full index increased to a record 0.86 in October.

    What this means is that investors were better to put their money in broad index funds which track asset classes such as large-cap stocks, municipal bonds, or commodities. These asset classes soared and plummeted over the course of the year in tandem with the latest financial headlines, and with so much turmoil, most investors felt more comfortable going to bed at night knowing they were paying a professional to select and re-balance their portfolio of index funds.

    Dilbert Comic

    But isn't 1% still an awful lot to pay for asset allocation and a little hand-holding when markets are crashing?

    There is no question that experienced professional advice can be extraordinarily valuable for building a long-term financial plan and avoiding the behavioral finance pitfalls that plague the vast majority of individual investors. Most investors are likely to benefit from some form of outside financial assistance. But a fee based on 1% of your assets can add up to a staggering amount of your wealth over time (especially in today's low-yield environment).

    Asset allocation can be challenging (and those index funds aren't going to pick themselves). But in 2012, with asset allocation models (ours and others) available on the internet, it is a very, very do-able task for the average investor to manage their own portfolio. Investors can accomplish much of the fund management services provided by investment advisors by following the set-up and re-balancing instructions from these web-based models and then making the suggested low-cost index fund trades through an online brokerage account or mutual fund company like Vanguard. Investment Advisors can then be consulted on an hourly fee basis for periodic strategic planning and advice.

    Americans are zealously pursuing value in other areas of their lives from online coupons to do-it-yourself home repair. So it is surprising how well the traditional investment adviser business and fee structure is holding up.

    Jan 25 9:55 PM | Link | Comment!
  • Is it time to just put your money in the bank? Bond Funds versus Cash

    Portfolio Research utilizes both cash and bond funds in our risk-controlled model portfolios.  Whereas cash has returned nothing in nominal terms (and has lost value when adjusted for inflation), Treasury Bond Funds* have returned over 7% annualized over the past three years -- and longer-term bonds and high-yield bonds have done even better. Increasingly US Bonds have been a safe haven for global investors nervous about Europe.

    But as we described in this article on diversifying the bond portion of your portfolio, rising interest rates can diminish the value of your bond funds. If we do see rising interest rates, money market funds and certificate of deposits will eventually return more than bonds. Many longer term forecasts (such as GMO’s 7-year expected return forecast), are predicting negative returns on US Bonds. 

    So for your “satellite” portfolio, (at least the portion set aside for emergency needs), you may be prudent to stick with putting cash in the bank -- just be aware that the value is likely to erode over time. For your core portfolio we recommend a mix of bonds, cash and other asset classes based on objective factors such as volatility, correlation, and expected returns.  

    For example, look at our second lowest risk model - Risk-Target 5 Strategy - which is designed to preserve wealth while providing some capital appreciation, and for which we expect fluctuations less than plus or minus 10% per year, 95% of the time. The fixed income allocations are split among asset classes to generate a return and preserve wealth in any of the possible inflationary, deflationary, growth or recession scenarios we might encounter in the year ahead:

    US Bonds – 19.1%
    International Bonds – 16.1%
    TIPS – 15.2%
    Cash – 21.9%

    US Bonds funds would be low-cost broadly diversified funds or ETF such as iShares Barclays Aggregate Bond (AGG) or Vanguard Total Bond Fund (BND), while international bond funds include iShares S&P/Citi Intl. Treasury Bond Fund (IGOV), and SPDR Barclays Capital Short Term Intl. Bond (BWZ).  The remaining 27% of the portfolio is allocated to Equities, REITs and Commodities. 

    * Barclays U.S. Aggregate Bond Index



    l  Barclays U.S. Aggregate bond index

    Dec 20 8:36 AM | Link | Comment!
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