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  • The 6 Best Investing Ideas You've Never Heard Of 0 comments
    Nov 28, 2013 1:07 AM

    Sure, you want to keep your investing as simple as possible. So you invest steadily and hold fast to some simple but time-honored strategies: Keep your focus on the long term. Subtract your age from 110 (or maybe 100) and hold that percentage in stocks. Diversify as much as you can. Rebalance your portfolio on a regular basis.

    You might realize that the conventional strategy doesn't suit your situation or that you are missing out on a chance to do better. And even if you dismiss an idea as impractical, far-out, or just too chancy, it can teach you something important about what to expect from your investments or about weak points in your strategy.

    What follows are six surprising ideas that will make you see your portfolio in a new way. Not all are sure bets -- indeed, in some cases, one contradicts another. Nonetheless, you'll profit from understanding the logic behind them.

    Idea 1: Think having 100% in stocks is risky? How about 200%?

    You should hold more in stocks when you're young, and less when you're old. That's the conventional wisdom. After all, stocks tend to do well in the long run but are volatile in the short term. But when you're in your twenties or thirties and have the longest to run, you might have only a few thousand bucks in the market. By the time you're in your fifties and sixties, you'll have the most money but will want to risk less of it.

    In their book "Lifecycle Investing," Yale economists Ian Ayres and Barry Nalebuff propose an audacious solution: Increase your stock position with borrowed money when you're young. You can do that with a margin loan from a broker. Or, as Ayres and Nalebuff prefer, with LEAPS, which are options to buy an index like the S&P 500 in the future at a low price. (You win if stocks beat that price plus your cost.) Either way, your top allocation to stocks should be 200% of assets, meaning every $1 of your own money is effectively matched by another $1 borrowed.

    You may think such leverage is crazy speculation, as it amplifies both gains and losses. But hear Ayres and Nalebuff out. Many young people can afford to be hyperaggressive with stocks because they have another big asset: decades of future salary. A 27-year-old who saves $5,000 this year will earn enough to salt away hundreds of thousands over a lifetime. The question, the pair contends, isn't how much of $5,000 to risk on stocks, but how much of the hundreds of thousands. In that case, leverage looks less wild.

    Over time, Ayres and Nalebuff say, this strategy reduces the chance of falling short, since you rely less on good stock returns in later years. "It's safer to buy the S&P 500 than just five stocks," says Nalebuff.

    "Similarly, it's safer to spread your stock investments across 44 years." He and Ayres calculate that an investor starting at 200% stocks at 23 and tapering down to 32% at 67 can expect the same average return as a conservative investor who held 50% in stocks the whole way. Yet the range of lifetime outcomes is narrower in the leveraged portfolio the highs aren't as high, but, crucially, the lows aren't as low.

    HANG ON A SECOND ... This strategy has two big problems. First, it's tough to execute. Second, however it works on paper, it's psychologically taxing. People tend to be most excited about leverage when markets are high and then bail on stocks when they're low. Ride those mood swings on a margin account and you could destroy a lot of wealth. --Barbara Kiviat

    THE LESSONS: Ayres and Nalebuff are right that you should consider your assets beyond your portfolio, especially your earning power. Even without leverage, younger people with strong career prospects should seize the opportunity to be aggressive.

    This idea also highlights the fact that most savers rely a lot on good returns in a small set of years -- those closest to retirement. This should spur you to save and invest more early on.

    If the idea of leverage sounds nuts to you, consider this: A mortgage is leverage too. Sure, it gives you a place to live. But when home prices far outstrip the cost of renting -- as they did just a few years ago -- investment leverage might be a better alternative for young wealth builders.

    Idea 2: Then again, you may have too much in stocks already.

    Boston University economist Zvi Bodie thinks the problem for most investors is hardly that they're too timid to bet big on stocks. It's that they're far too optimistic. Remember, the standard view is that stocks aren't such a risky bet if you can hold on to them for a long time. Bodie says that's bunk.

    Risk, he says, isn't the probability of something bad happening. It's probability times the severity of the consequences. Granted, on average, stocks tend to make money over long periods of time. Just like, on average, you get heads half of the time when you flip a coin.

    But there is no guarantee that the general rule will work in your specific case. It's possible to have long runs of mostly tails in coin flips -- or to have an extended period over which stocks do very poorly. So when it comes to the money in your 401(k), long-term averages are meaningless; what's important is the market's performance in the years you're in it. If a bad run hits you soon before or after retirement, the damage could be irreparable.

    Similar to Ayres and Nalebuff, Bodie says you should consider your other income sources when deciding how much stock to hold. But Bodie says that this isn't strictly a matter of time. A tenured professor may expect enough solid lifetime earnings to take a flier on stocks, but not a young real estate agent. And anyone nearing the end of his career should be cautious, even though he still has two or three decades over which to invest.

    Bodie's advice: Instead of focusing on the time you'll be in the market, invest in stocks only when you know you have enough income and safe assets to weather any market condition. Bodie particularly likes Treasury Inflation-Protected Securities, or TIPS, bonds that protect your buying power.

    HANG ON A SECOND ... If you are saving 10% of your income every year, investing in low-returning TIPS may not get you to the retirement you want. Your savings target may be closer to a daunting 20%.

    You may also have to work well past 65. Bodie says he understands that many will resist such a big change to their portfolio -- or their lifestyle. Then they'll just have to live with the chance of a worst-case scenario. As Bodie puts it: "I'm not saying, 'Don't invest in equities.' I'm saying, 'Understand the risk.' " -- George Mannes

    THE LESSONS: There's no free lunch. The classic "stocks for the long run" argument has given many people the idea that stocks are volatile (they bounce up and down) but not really risky (they always come back in the end). That's not right -- big long-term losses are always possible, even if not likely. Just ask an investor in Japan.

    Even if you decide you can live with the risk of stocks, knowing that risk doesn't go away should be a spur to save more and consider working longer, if you can. The more you are able to put away, the less you'll have to wager on equities to have a shot at reaching your retirement dreams.

    Idea 3: There just might be a better kind of index fund.

    It's nearly impossible to come up with an investment that reliably beats the humble index fund. Simply by holding a mutual or exchange-traded fund that tracks a benchmark such as the Standard & Poor's 500, you can count on earning the market's return, minus a very low fee. Meanwhile, actively managed funds, which rack up higher costs and tax bills, typically lag behind their indexes over the long run.

    Yet some smart investing gurus say they've found a flaw in indexing and argue that there's a way to do it better. So what's the flaw? With a traditional index fund, you hold stocks in proportion to their market capitalization -- the stock prices multiplied by shares outstanding.

    This means that when a company's stock price goes up more than others in the index, you also end up owning more of it. So when an industry gets caught up in a bubble -- as tech stocks did back in the 1990s -- your index fund joins right in the party, giving you more exposure to those shares.

    "With traditional indexes, you overweight stocks that are overvalued and underweight undervalued stocks -- the reverse of what investors should do," says money manager Rob Arnott, head of Research Affiliates.

    To dodge those bubbles, Arnott came up with the notion of "fundamental" indexing. Instead of relying on market capitalizations, he weights stocks according to their economic strength using several financial measures, such as book value, dividends, and sales.

    Based on analysis of market data going back to 1962, this strategy would have outperformed the S&P, claims Arnott. The real-life test of his index dates back only to late 2005, when Power-Shares FTSE RAFI U.S. 1000 (NYSEARCA:PRF) was launched. So far the ETF has an annual average gain of 0.6%, vs. a 1.5% loss for the S&P.

    HANG ON A SECOND ... Sometimes an investment that seems to be revolutionary turns out to be kind of ... ordinary. Truth is, with its avoidance of highflying companies, fundamental indexing is really another way of investing in value -- that is, stocks that are cheap relative to their earnings or assets.

    Studies have shown that value has outperformed growth-style investing. But there's no guarantee this effect will continue. And there are other ways of tilting toward value, such as adding a traditional index fund that tracks a value index. Vanguard Value ETF (NYSEARCA:VTV) charges 0.14% a year, vs. 0.39% for the RAFI fund. --Penelope Wang

    THE LESSONS: Fundamental indexing highlights a truth many index fans miss. Although indexing is a simple strategy, it's not especially low risk. When the collective wisdom of the market becomes collective madness, you'll get carried along with the crowd in an index fund.

    Fundamental indexing should work pretty well because it shares two of indexing's basic advantages: It keeps trading low and expenses down. Both kinds of index funds will probably have an edge over active managers, who tend to trade a lot and charge more for their services.

    Idea 4: Don't invest in drips and drops. Go all in.

    There's something almost warm and fuzzy about the notion of dollar-cost averaging, or DCA. First, it's so simple: Some days the market is up; some days it's down. By investing in stocks in small amounts over time, instead of going all in on one specific day, you get to even out the good days and the bad, helping to tame some of the volatility of investing. Even better, you end up buying more shares at the cheaper prices, and fewer at the high prices. It seems like value investing on autopilot.

    Too bad that, according to a stack of studies, it doesn't actually improve your prospects. As business professors John Ross Knight and Lewis Mandell put it in the title of a paper, "Nobody Gains From Dollar-Cost Averaging." Why is this? Assume that your ideal allocation, given your risk tolerance, is 50% in stocks. If you go in slow, that means that you are invested too conservatively until you hit 50%. In a market that's down, you might be glad you did this. But in a market that goes up, you are missing much of the gain. And buying at steadily higher prices.

    If you think you can't predict when the market will go up or down -- and that's a smart call, there -- you should just figure out the optimal amount you want to hold in stocks (or any other asset) and buy in.

    If you assume that stocks go up over time, chances are you'll come out ahead. A study published in the Journal of Economics and Finance simulated DCA and lump-sum investment strategies using nearly 75 years of stock market data; lump-sum was the easy winner.

    HANG ON A SECOND ...This argument applies only to the decision of what to do with a lump sum you want to invest. But most people think of dollar-cost averaging as simply investing a little bit of their salary in the market every month. And that still makes perfect sense. In that case, you aren't purposely keeping any cash on the sidelines.

    Although the math shows DCA doesn't really work, it can still be very useful for psychological reasons. If you find the thought of making a big investment so scary that you can't pull the trigger, DCA is a decent second-best strategy that will eventually get your portfolio where you want it to be. Mandell suggests doing it over the course of a few days or weeks, not months. That way it won't really hurt you, but will mitigate the risk of buying moments before a market crash. -- David Futrelle

    THE LESSONS: Dollar-cost averaging appeals to the nervous Nellies in us all. But it's more of a psychological crutch than an investment strategy. Not that there's anything wrong with that.

    If you feel uneasy about the prospects for a given investment, the answer isn't to stretch out the process of buying in. Instead, just allocate less of your portfolio to it. Diversification is still the best tonic for uncertainty.

    Idea 5: Maybe you should chase performance.

    Chasing hot investments is generally a sucker's game. You read about a popular stock, mutual fund, or asset class -- micro caps! emerging markets! -- and you're tempted to buy what's on a tear and enjoy the ride.

    But as we've learned from bubbles in dotcoms and condos, people who invest in something just because the price is rising -- "momentum investors" is the standard label -- have a talent for jumping onto a winning horse just before it pulls up lame.

    But here's the wrinkle. While you can get killed with emotion-driven momentum investing (where, say, you fall in love with Apple after you watch it go up 90%), there's evidence that it works if you can be systematic and consistent about it.

    A landmark paper by Narasimhan Jegadeesh and Sheridan Titman found that top-performing stocks over three- to 12-month periods continued to outperform, on average, over the following three to 12 months (and that laggards over the same time period continued to underperform).

    Cliff Asness, managing principal of AQR Capital Management, says that momentum may be the result of different investors reacting to the same news at different times (the way some see a blockbuster the weekend it opens, while others wait a month to visit the multiplex). Plus, it's human nature to jump on bandwagons, whether the market is going up or down.

    Bear in mind that momentum works in general, not in every single case. That's what trips up many investors -- including many mutual fund managers -- who merely dabble in momentem to justify two or three bets.

    "Anytime a statistician tells you about a strategy, it means they're doing it in 10,000 places and hoping it works out on average," says Asness. "This doesn't mean you can say, 'Yeah, IBM's going up.' "

    Attempting a broad-brush approach, AQR last year launched AQR Momentum (MUTF:AMOMX), which takes the 1,000 largest U.S. stocks, ranks them by performance over roughly the prior year, and invests in the top third of performers. The track record for the fund (expense ratio: 0.49%) is too short to judge its success.

    HANG ON A SECOND ... Even Asness advises using momentum in conjunction with a more conservative value portfolio. Although momentum works in both bull and bear markets, when the market makes a U-turn, the results can be disastrous. --George Mannes

    THE LESSONS: There's a simple way to take advantage of momentum's effect: Don't trade too much. Be slow on the trigger to rebalance your portfolio. Think along the lines of once a year, not once a quarter. A Vanguard study found this boosts returns in markets with momentum, and doesn't really hurt when momentum fades.

    Understanding momentum can also prevent you from making costly mistakes. Don't be too eager to buy "on the dips." Stocks with falling prices can have downward momentum. If you are a stock picker hunting for bargains, look for beaten-down shares that have started to perk up. "If you consistently pursue value while fighting momentum, you've got a little bit of wind in your face," says Asness.

    Idea 6: Diversification is swell, but you don't need commodities.

    For decades, commodities futures have had the stigma of being little more than tools for gambling. But recently many advisers have been arguing that all savvy investors should own some commodities. Be skeptical.

    The vogue for these investments is partly driven by worries about inflation, which commodities are thought to protect against. But it's also because, as stocks around the world move more and more in sync with one another, investors are trying to find profitable ways to diversify. And recent studies have shown that commodities have provided stocklike long-term returns, while also often zigging when global stock and bond markets zag.

    When you buy a commodities future, you don't own the physical pork bellies or grain bushels, but instead a contract to pay a certain amount for them later on. If you look more closely at the way returns from these investments work, you may not be so eager to jump on the bandwagon.

    For starters, unlike stocks, where bull and bear markets tend to last only a few years at a time, "commodities go through long ups and downs that could last decades," says Fran Kinniry, a principal with the Vanguard Group. "You have to be willing to hold them for 30 or even 40 years." For a lot of that time, they could feel less like a diversifier and more like dead weight.

    What's more, with futures -- or the new funds and ETFs that track them -- part of your gain or loss comes from the "roll return." The details are messy, but here's what you need to know: When you buy a future, you're providing insurance for a producer who wants to lock in a price. In the past, producers' demand for this insurance outstripped the supply of investors willing to provide it, so you'd get a little extra premium that added to your return (or softened your loss).

    But lately commodities futures are so popular that this roll return has gone negative. That could be a sign that futures are overpriced and that total returns will be lower than in the past. "If you want diversification and inflation protection, just buy TIPS," says Michele Gambera, head of quantitative analysis at UBS.

    HANG ON A SECOND ... There may be legs in this market yet. Yale finance professor Gary Gorton says China and India are keeping their commodity inventories low. That could bring more producers into the market, pushing roll returns back up. "The truth is," he says, "we just don't know." --Paul J. Lim

    THE LESSONS: You can probably do just fine with a standard stocks-and-bonds portfolio. Even if market forces shift back in favor of commodities, "the evidence is by no means so clear that they're a must," says Thomas Idzorek, chief investment officer and director of research at Ibbotson Associates.

    Much of the current vogue for commodities is driven by the fact that they are still relatively complicated. Fund companies and brokers that can't charge much for boring old stock funds anymore would love to sell you a pricey commodities play.

    If you do decide to own commodities, don't put much faith in the record of past returns. Remember that when everyone in America realized that stocks provided a high return in the long run, prices went up and returns eventually fell. The same thing could happen as commodities become more popular.

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