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Tales From The Future (tftf). I picked my nickname because many advisors and investors claim they can predict the future of the (stock) markets and somehow pick the winners. I don't. I usually do not engage in short-term trading and myopic analysis (quarter by quarter, without looking at the big... More
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  • Investing 101: Asset Class Returns Since 2000 (And A Refresher On Active Vs Passive Investing) 1 comment
    Aug 22, 2014 8:09 AM | about stocks: SPY, QQQ

    Since this is Instablog entry number 101, it feels like a good time to return to some investment basics. Investing 101.

    Below is a chart with various annual asset class returns since the year 2000:

    (click to enlarge)

    ( Chart Source: novelinvestor.com/asset-class-returns/ )

    There's also an Asset Allocation Portfolio (see white boxes, label AA) with a blended return for each year (the exact portfolio composition is shown on the lower right side of the chart).

    The only two classes missing in my opinion: I wish the authors added metals/currencies (like gold, a basket of foreign currencies) and commodities (like oil) as two separate classes, especially because they historically have a low correlation to stocks and bonds.

    Summary: It's very hard to get it even close to "right" in terms of asset allocation every year. A diversified portfolio is probably the safer choice for most long-term investors.

    The proposed AA portfolio (I would add some metals/foreign currencies and commodities to the mix as discussed above) can be constructed very easily nowadays using various low-cost ETFs.

    The nice thing about low-cost ETFs is that you don't have to be wealthy to create such a balanced portfolio over various asset classes - and for example slightly rebalance it every 6 or 12 months.

    As for the need/urge to "play" in the markets: A small (that's important) portion of assets can still be used to pick stocks you believe in - that is if you actually have...

    - the time to follow the news and SEC filings etc. from these companies closely

    - and/or feel like you can time the market cycles better than the average investor.

    Trust me, that is more difficult than it sounds over a long period of time*. A balanced portfolio constructed with low-cost ETFs is probably the better choice for most investors.

    Simply compare the returns of your "active" stock picks versus a balanced portfolio constructed with the proposed 40% stocks and 60% bonds/REITs/commodity portions after a few years (it is important to measure returns over more than just a single market cycle period).

    But make sure you don't just compare the net returns - include a value for your time hunting stocks and following the market, reading annual reports and use risk-reward, compare risk-adjusted ratios.**


    * A single winning stock pick doesn't count. I can recommend this good book once again on the subject:

    The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (Mauboussin, 2012)

    ** Search for Sharpe ratio or Sortino ratio and similar benchmarks and use them alongside the "pure" net returns to measure both risk and return. Explaining these ratios would be beyond the purpose of this short entry.

    Stocks: SPY, QQQ
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  • Tales From The Future
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    Author’s reply » A general discussion on Asset Allocation here:


    "From the highest level, asset allocation is simple. How much of your portfolio should be invested in stocks, and how much should be in more conservative investments such as cash, CDs and bonds. Rules of thumb abound here: 100 (or 110, or 120) minus your age is the figure that should be in stocks, etc. Personally I believe that this initial decision of asset allocation should be determined as a result of long term financial planning and a personal review of one’s need to take risk, ability to take risk and desire to take risk."




    "Now, there is ample evidence to suggest that some overweight (compared to the market portfolio) to small caps and value strategies will enhance long-term returns (although such allocations do increase risk). And we have terabytes of historical data to use to help with forward-looking guidance. And even still, we are faced with an unknown future."




    What strikes me again is the lack of foreign currencies (or a basket thereof), that's only indirectly touched with foreign stocks.


    I think adding metals (gold, silver...) and some foreign currencies (mainly as a hedge) is important - especially in countries with growing public debt and uncertain outlook covering social security obligations longer-term.


    PS: An interesting approch in forex asset allocation is GLOBAL from a well-known electronic broker IBKR:


    "As a result of our currency hedging strategy, in which we diversify our equity of nearly $5 billion across a basket of 16 currencies that we call the GLOBAL, we record a translation loss when we report our results in U.S. dollars, if the dollar has strengthened against the GLOBAL.


    This was again the case at the end of the quarter, as the U.S. dollar continued to rally, pulled up by rising rates in wake of the Fed chairman’s comments last month that the central bank could begin to pare back monetary stimulus."


    (Taken from one of their recent earnings calls, source: http://bit.ly/1l8a4Vf )


    A more general discussion of GLOBAL:


    "Interactive Brokers Group manages its global currency exposure by maintaining its equity in proportion to a defined basket of currencies, which it refers to as the "GLOBAL".


    Approximately half of the firm's equity is denominated in currencies other than U.S. dollars. The composition of the GLOBAL is based on the relative importance of the constituent currencies in the world economy and the company's businesses. As a result of a periodic assessment, the company has determined to expand the number of currencies in the GLOBAL and realign the relative weights of each component to better reflect the global diversification of its businesses.


    The new composition contains 16 currencies, up from 6 in the prior composition. The company currently transacts business and is required to manage balances in each of these 16 currencies."
    25 Aug 2014, 07:42 AM Reply Like
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