Nobody has the time or patience to wait 82 years to experience the long-term, but if they did (or if they wanted to bet on the future based on the long-term past), here is how a simple allocation between the S&P 500 index and the U.S. Aggregate Bond index worked out from 1926 through 2008.

Related proxy funds: SPY, IVV and VFINX for stocks; BND, AGG and VBMFX for bonds.

We have noticed that many investors, both sophisticated and small, don’t seem to understand the purpose of their investing. “Making money” is too simple an answer, as you can make money and still be worse off. The question is simply, “Why invest?” The answer to this question is philosophical and affects your pocket book in a deep way.

1) What is the purpose of investing?
The purpose of investing is not “making money.” That is the correct answer for investment advisors, as most make money off their clients’ ignorance and carelessness through layers of fat fees. A rational investor should do three things:

i) Preserve the after-inflation value of capital. This means an investor’s capital should buy the same amount, or more, of goods and services after a few years. An example:
-An investor has $100, which can buy 10 bread loaves and 2 massages.
-The $100 is invested and grows to $140 in 5 years.
-In year 5, the $140 can buy 10 bread loaves and 2 massages.
-The investor is on even ground – no losses and no gains. Despite “making money” she is no better off.
Any strategy that loses to inflation but beats its benchmarks, however numerous and glorious the benchmarks are, is bunk. Few equity mutual funds (less than 20%) have beaten their index benchmark in the last 5 and 10 years. Almost none have beaten inflation, which has averaged a little above 3% (no major US equity benchmark has beaten inflation in the last 5 years).

In addition, the Chinese and other foreign central banks, despite their complaints about U.S. monetary and fiscal policies, continue to reinvest their trade surpluses in U.S. government bonds. Notwithstanding the very bleak longer-term outlook for government bonds, the U.S. for the time being is having no trouble selling its debt. Yields on riskier classes of debt have generally fallen to unattractive levels. Corporate bonds, which were a relative bargain at the start of the year, have recovered so much that in many instances absolute borrowing costs have fallen to their lowest levels in 15-20 years. Similarly, municipal bonds no longer offer the attractive yields and spreads they had early in the year. TIPs, while still a better value than traditional Treasuries, do not offer the same level of protection from fiscal profligacy as they did early in the year. "Break even" inflation rates, derived from nominal versus inflation protected bond yields, have moved closer to long term averages, with the 10 year rate now pricing in around 2% inflation, up from a low of 0.5% in January.

Each new day seems to bring more downward pressure for the U.S. dollar, an unwelcome development for some investors who have seen the greenback slide near the $1.50 level against the euro in recent months. On Tuesday, two very powerful forces in the global economy expressed their doubts on the dollar’s future prospects: Warren Buffett and India’s central bank.

ETFs are intended for creating a low-cost and diverse portfolio regardless of which type of investor you may be. Here’s a breakdown of the various categories you can consider.

For every portfolio need, there is an ETF to fill it. Whether you’re looking in a niche area of the market or need an all-encompassing broad-based fund. Here is a simple breakdown from Aaron Levitt on Investopedia to help get you started.

On Thursday, Moody’s (MCO) cut the outlook for the sovereign debt of Portugal and put Greece on negative watch for a downgrade, signaling growing concern over spiraling debts. Just as with Spain and Ireland which I discussed earlier, Portugal and Greece are smaller countries within the Eurozone with large fiscal problems due to the recession. For example, the Wall Street Journal says that Greece expects a budget deficit of 12.5% of GDP this year – that’s more than 4 times larger than the limit set by the Maastricht treaty.

Bonds sold off on the news. The Wall Street Journal reports:

Former Morgan Stanley economist Andy Xie joins other famed prognosticators like Nouriel Roubini in worrying about an incipient asset bubble. The Rosetta Stone Advisors board member sees the huge increase in money supply created by central banks as fuel to an asset bubble fire. He even goes so far as to call the central banks ‘arsonists.’

The financial crisis exposed gross inefficiencies in the massive amounts of money financial institutions received from central banks. Supplying so much money to the same people who caused the crisis — and with the same incentives — does not feel right. The argument in favor of this policy is that, when the house is on fire, you have to do whatever to extinguish the fire and find the culprit later. The problem is that, in this case, the arsonists have been asked to put out the fire. How can we be sure they won’t start another fire?

The Burden of Proof
Tyler Durden had a fascinating report out over the weekend that generated plenty of interest. The title is as sensational as it gets:
An Overview Of The Fed's Intervention In Equity Markets Via The Primary Dealer Credit Facility
I will not go over the whole article, you would do well to read the entire thing.

After that title I was looking forward to some carbon paper copies of stock buy orders with Ben Bernanke's signature on them. Something like:

By Matt Hougan

Dave Nadig wants to fix bond ETFs? Here are a few simple ideas.

We don't know if the furor over climate, economic and sovereignty issues coming to a head over the impending December Copenhagen climate treaty is correct, incorrect, exaggerated or spot-on.

Obama on Cost Impact of Climate Policies (March 18, 2009):

By Dave Nadiq

Matt’s call for a better bond index is just the tip of the iceberg.

The 13 closed end fund (CEF) types on average were down 0.8% for the week ending 10/16/09. On an aggregate unweighted basis, the weekly average price change for 618 CEFs was down 1.6%.

The weighted 49 CEFs comprising the Claymore CEF Index registered an average advance of 1.0% for the week.

Who doesn’t appreciate a good analogy? State Street ETFs are to U.S. markets as Vanguard ETFs are to emerging markets. Put another way, iShares ETFs are to 30-year olds as Vanguard ETF are to teenagers.

Yep… Vanguard ETFs are rapidly growing. Recent ETF inflow/outflow data for the first three quarters show that Vanguard picked up nearly $18 billion in new assets, a startling 23% of its total under the Vanguard wrapper. iShares’ inflows over the same time frame corresponds to 8% of the firm’s total net, and State Street has experienced net outflows.

Last week we published a visual view of price range probability cones for several securities (SPY, FXI, TLT and UUP). This article builds on the concepts in that article and provides a tabular view of the same kind of data for twenty-seven asset categories.

The two tables below show the maximum and minimum price change that statistics would suggest are probable over the 21 trading days after October 9 (last Friday), based on 21 days (1 month) and on 63 days (3 months) of historical price volatility.

A previous post on bond ETFs elicited requests to explain why it is important to look at the yield-to-maturity instead of the yield quoted on financial portals like Yahoo Finance. Just why, for example, is it misleading to use Yahoo Finance’s quote of 4% on the iShares Canadian Short-Term Bond ETF [TSX:(XSB)] when iShares.ca’s website quotes the yield to maturity at 2.1%.

The challenge faced by investors seeking a respectable and reasonably secure stream of income from bonds is this: on one hand, you want to protect yourself against future inflation risk, which is accomplished by keeping the average maturity relatively short (i.e. under five years). On the other hand, you can't bring the average maturity in too far without damaging the income flow, due to the Fed's zero percent interest rate policy and the resulting steepness of the yield curve. Cash is unattractive, because you don't want to earn a negative real return. Meanwhile, yields on lower-quality bonds, such as high yield corporates, no longer seem to offer any margin of safety.

In "Goldman Sachs: The "Smart" Money?!" I called attention to the fact that the banks team at one of Wall Street's best known firms has not exactly been on target with its calls on the sector (e.g., they were negative when the stocks were trading at their lows).

However, one firm that has been ahead of the curve as far as financial sector realities are concerned is Institutional Risk Analytics (IRA), which specializes in providing "customized risk management solutions and advisory services to global enterprises."

Ten- and twenty-year average annual real returns on equities as a function of the ratio of price to a ten-year moving average of earnings: