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How to Efficiently Manage Your Money

|Includes: Vanguard Real Estate ETF (VNQ)

Tom Posey is a strong believer in efficient markets, keeping his clients in a mix of equity and bond funds. He tells about his view of using index funds tied to asset classes. He describes his philosophy of portfolio rebalancing, and offers his views on volatility and the euro.

Kate Stalter: Today, I’m on the phone with Tom Posey of Posey Capital Management. Tom, we have talked a couple of times in the past. The last time was early in the summer, and we discussed efficient markets and your view that indexing is the best way for individuals to take out the guesswork and eliminate attempts at market timing.

Of course, there has been a big sell-off since then, and a lot of volatility. Any adjustments to any of your client portfolios in light of all that?

Tom Posey: No, Kate, we still take the same view. You know, we do think that markets are efficient and unpredictable.

You saw, beginning in the fourth quarter…markets had been down substantially in the third quarter, and then surprising to everybody, they really dramatically picked up at the beginning of the fourth quarter.

I don’t think anybody predicted that, and I don’t think that general market movements can be predicted. So, it reinforces, really, my conviction that the best thing to do is just to have a well-diversified, intelligent portfolio and just stick with it.

Kate Stalter: Well you just brought up the idea of diversification. In previous market cycles, for example, emerging markets were a factor, but with so much market correlation lately, that has changed a bit. So it sounds like your thinking really hasn’t changed, but have you done any kind of portfolio rebalancing in that regard?

Tom Posey: Yes, we did review all portfolios at almost the end of the third quarter, just in our usual process. Just go through all portfolios and rebalance, which generated some trades in portfolios to sell bonds and buy stocks while the stocks were down.

Which proved to be a good thing, of course, when stocks turned around at the beginning of the fourth quarter and went back up. So we did do just standard rebalancing on accounts that were out of balance…just the process we do every quarter.

Kate Stalter: So tell us, what are some of the funds that you are turning to these days? I have written about you before, that you see indexing as more than just getting into the SPY, for example. What are some funds that you like currently?

Tom Posey: DFA Funds are one; they are basically an old standby, Dimensional Funds. Those are funds that are actually not available to retail investors. They are only available to institutional investors and advisors like us.

Essentially, they are an enhanced index fund. Fundamentally, they follow indexes, that is, asset classes that are defined from the portfolio. Examples might be the US Core Fund (DFQTX), or the US Large Cap Value Fund (DFLVX), US small, emerging markets, foreign core, real estate, etc.

They will essentially contain those asset classes, but they have some additional features in the fund, where DFA uses scientific research to enhance returns, so it is a little bit of a hybrid.

In some asset classes, we use Vanguard funds which are excellent funds and which are available to retail investors. In particular, we use Vanguard in the real estate or REIT space [Like Vanguard REIT ETF(VNQ)—Editor.] and in some of our bond funds.

Kate Stalter: What is your thinking on bond funds vs. equity funds in this particular market, Tom?

Tom Posey: My view, Kate, is that bond and equity funds are part of our asset allocation, and bonds ought to be part of almost anybody’s portfolio, as should equities. As I do with the equity portfolio, I view the overall asset allocation, the percentage of stocks and percentage of bonds to be an aspect of the portfolio that ought to be stable and ought to be targeted and then rebalanced.

An example is at the end of the third quarter, we discussed that stocks were down, so that was a good time to rebalance, which we do according to our process. We sold bonds, bought stocks, brought stocks up to their target percentage in the account, and of course, the fourth quarter comes along and stocks go up and you end up doing well. I’m glad I did that.

So it is not something we did because we are psychics of course, but it is just an example of how the process works.

Kate Stalter: What are some of the questions and concerns that your clients are coming to you with these days, Tom?

Tom Posey: You know, everybody is concerned about the markets, Kate. It is interesting to me that they are perceiving a ton of volatility in the markets, and yet, when you look at the markets historically on a monthly-returns basis, the fact is, the markets aren’t any more volatile than they have been in typical periods in the past.

On a daily basis, there is some argument that the markets are more volatile. We have seen a lot of days like this, when the market is down significantly, or up significantly. But looking at monthly returns, volatility is really very similar to the past.

I think what happens is that people remember 2003 to 2007, when markets—as people fantasize about it—they think that was normal. But in fact, that was an unusually calm period of time. So anyway, when you look at the volatility we are seeing in the market, it really is either not unusual, or it is not that unusual.

Kate Stalter: Good perspective there. Let me just wrap up today. What would be your advice for the retail investor who is managing his or her own account? What should that person be doing right now?

Tom Posey: I really think, Kate, that a retail investor needs to carefully consider the expenses in their funds, needs to carefully consider the amount of risk that they are willing to take.

If they don’t want stock risk, they need to be out of stocks and into bonds, and they need to keep on rebalancing. Even if markets look scary, I think they just need to establish a rebalancing pattern and then just stick with it.

I might toss in one more thing: Although I am such an efficient-market maven, I do have some thoughts that may be of interest on the subject of Europe. Everybody is concerned about Europe.

My own conviction is: I really think that the Eurozone probably is going to break up, and I have thought that for some time.

I really think the Eurozone should break up. I don’t see enough economic glue between the members of the Eurozone to justify the existence of the Eurozone.

I think it makes a lot of sense to have a free trade zone in Europe, as that existed before the euro and before the Eurozone did. I think the free trade zone, which is beneficial for everybody, can continue to exist after the Eurozone disappears.

But I don’t think that the end of the euro and the end of the Eurozone is necessarily the end of the world.