Post-Modern Portfolio Theory

Serious investors interested in digging deeper into the issue of portfolio risk management will find the article titled, Post-Modern Portfolio Theory of great interest. Any link is bound to produce different references over time so here is a clue to finding the article. Google the term, “Post-Modern Portfolio Theory” and then look for the PDF article by the same name. The article is authored by Pete Swisher and Gregory W. Kasten. Download the PDF file and open.

Post-Modern Portfolio Theory is the study of moving a 60 year-old theory forward. One issue that needs transformation is portfolio risk management. Mean-variance or standard deviation is an inadequate method for measuring portfolio risk. I learned this many years ago when I first started using the Windows version of Captool. Later, I read in Harold Evensky’s book, Wealth Management, the advantage of using semi-variance instead of mean-variance to measure portfolio risk. Verbiage from many sources did not translate into actual measurement until a few months ago when I was able to convert these ideas into a workable Excel worksheet within the TLH portfolio monitoring spreadsheet. [Read more…]

Can You Beat The Market?

As an investor, ask yourself the following questions.

  • Am I selecting individual stocks as the primary building blocks for my portfolio?
  • Do I use actively managed mutual funds as my investing vehicles?
  • Do I even know what active management means?
  • Have I turned my investments over to an investment manager?
  • What are the total management fees charged by the investment manager?
  • If the funds are managed by an investment manager, how well is the portfolio performing with respect to an appropriate benchmark?
  • What is an appropriate benchmark?
  • Does my investment manager provide detailed information of portfolio performance with respect to an appropriate benchmark?
  • What risk (portfolio volatility) is involved in my portfolio?
  • Can I live with that risk and is it explained carefully?
  • How can I reduce expenses?
  • Is my portfolio beating the market and how do I define the market?

The Financial Express article points out that 100 billion a year is spent on trying to beat the market.  Check it out as it is a real eye opener, particularly since the majority of investors are throwing their money away.  Is it possible to both reduce expenses and enhance returns?  The simple answer is yes, although it does take discipline and some effort to learn a new way of investing.  Platinum members are walked through a process of using index funds (primarily index ETFs) as the core portfolio building blocks.  A spreadsheet (TLH) is provided, including on going instructions how to track the portfolio performance, the performance of a customized benchmark, and portfolio uncertainty using a semi-variance calculation.

Platinum membership is available for a mere $5.00 per month.  Become your own financial advisor by building a portfolio using index ETFs.

Photograph: Zion National Park – Utah – USA

Newton Portfolio Review: June 29, 2011

It is time to update the Newton Portfolio and I am posting the results using 11:00 a.m. data from June 29th.  Two new stocks were added this month.  I purchased CVR and AEY, two relatively unknown stocks that showed up in one of my tight screens.  Since the Newton is one of the larger portfolios I track, the owner permits a higher percentage to be investing in individual stocks.  The core of the portfolio continues to be held in tax advantage ETFs.

New members need to know the following screen shot comes out of the TLH Spreadsheet.  It is the Dashboard worksheet and this is where the Strategic Asset Allocation plan for the portfolio is displayed.  This page is the key to forming an investment philosophy.  Note how the portfolio is skewed toward the left side or value ETFs.

The Newton, as currently constructed, is totally out of balance.  Limit orders are in place, but they will not be triggered so long as the market marches forward.  I do not plan to chase this market.


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Bohr Portfolio Review: 29 June 2011

Bohr Portfolio Update

Reviewing a portfolio this close to the end of a quarter almost assures one that dividends will be missed.  Most of the ETFs report second quarter dividends on one of the last two days of the quarter.  Expect the IRR for the portfolio will be a little lower than the actual value.  This morning I did enter dividends for IDV, EIDO, and BKF.

The following dashboard indicates the Bohr is closely following the asset allocation plan.  I did make a Tactical Asset Allocation (TAA) move by lowering the percentage allocated to bonds and income.  Limit orders to see have yet to be triggered.


The following screen shot shows the performance of the Bohr, a portfolio launched on 08/14/2008, a period when the market was still in free-fall.

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Ten Best Investment Books

Education is a step toward financial success.

Where does one begin when trying to come up with the top ten investment books? Here is my list, but be forewarned, this is not a list of books that focus on either fundamental analysis of stocks, nor is it a list of books explaining technical analysis. In fact, the list below is the antithesis of stock picking. My list of the top ten investment books focus on index investing and a passive approach to portfolio management. When I use the term passive, I do not mean that in the tightest definition of that term.


Here is my recommended list.

  1. Four Pillars of Investing – William J. Bernstein
  2. Index Funds: The 12-Step Program for the Active Investors – Mark T. Hebner (Available online for free.)
  3. The Little Book of Common Sense Investing – John C. Bogle
  4. All About Asset Allocation – Richard A. Ferri
  5. The Intelligent Asset Allocator – William J. Bernstein
  6. The Power of Passive Investing* – Richard A. Ferri
  7. Asset Allocation – Roger C. Gibson
  8. What Wall Street Doesn’t Want You to Know – Larry E. Swedroe
  9. Unconventional Success – David F. Swensen
  10. The Investor's Manifesto – William J. Bernstein

It was not easy to pick which of Bogle’s books to recommend. His First 50 Years is definitely one to substitute for my number 3. In this blog post I replaced Rob Arnott’s book with Bernstein's third investment book, The Investor's Manifesto. Arnott's book advocates actively managed index funds and that philosophy runs counter to the investment strategy laid out in the other recommended books. I figure if you read the ten listed books, you can handle Arnott's book. There are several ways to read these books. 1) Read them from start to finish as one reads most books. This looks like a daunting task if one is going to commit to reading all ten. 2) An alternative approach is to have, say the first seven or eight on your book shelf and you pick themes to read. For example, you might check the index of each and read all about asset allocation or rebalancing. Use them as reference books. If you take this approach, I highly recommend you read Bernstein’s second book, “Four Pillars” from start to finish so you have a sound base from which to begin developing your portfolio plan and eventually a strategy for portfolio management and tracking.  Another excellent starter is The Investor's Manifesto.  It may be a little easier to read, so take that into consideration. Make the investment in a number of these books and it will reward you over the course of your investing life.

* Number six (6) is a new addition as of 12/8/2010.

The Golden Rule of Investing

The Golden Rule of Investing is simply, “Save as much as you can as early as you can.” The operative word is early. William J. Bernstein lays it out in stark language in his book, “The Investor’s Manifesto“ where he writes, “Each dollar you do not save at 25 will mean two inflation-adjusted dollars that you will need to save if you start at age 35, four if you begin at 45, and eight if you start at 55. In practice, if you lack substantial savings at 45, you are in serious trouble. Since a 25-year-old should be saving at least 10 percent of his or her salary, this means that a 45-year-old will need to save nearly half of his or her salary. Most 45-year-olds will find this nearly impossible, if for no other reason than the necessity of paying living expenses, payroll taxes, and income taxes.” 

Malkiel and Ellis devote the first chapter of their little book, “The Elements of Investing” to the subject of saving. M & E point out that one of the first steps in saving is to stop dissaving. This means one needs to begin to live below their income. Save instead of spend.

Stop burning up your retirement and kick the tobacco habit is one step. Whether it is smoking or chewing, both are harmful to your body health and financial health. Kick the habit of drinking bottled water. Why pay for water that is drawn out of the tap or from wells and sold in plastic bottles. Save the environment and build up your saving. Never, never, never incur credit card debt. This is the worst kind of debt and it will choke your financial health until you clean up the mess. These are some of the first steps in applying The Golden Rule of Investing. It is difficult to help anyone build and monitor a portfolio if they do not have the discipline to save.

Photograph: Northern Norway

Einstein Portfolio Review – 27 June 2011

It is again time to review the Einstein Portfolio and below is the Dashboard worksheet from the TLH spreadsheet.  This screen shot lays out the Strategic Asset Allocation plan for the Einstein.  Note how the percentages are skewed toward value and small-cap asset classes.  We do not hold international bonds in this portfolio as it is not a very large portfolio. 

The Dark Red background indicates the asset class is over 25% above the threshold target range and the Purplish background indicates the asset class is more than 25% below the threshold target.  The Blue-Green coding indicates the asset class is in balance.

Limit orders were placed many weeks ago for the out-of-balance asset classes and we are patiently waiting for the market to readjust and pick up the orders.


Part of the Dashboard worksheet includes a rebalancing data table.  Below we see what is required to bring every asset class into balance.


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Benchmarking The Portfolio

Establishing an appropriate benchmark for a portfolio is essential if one is serious about investing.  Avoiding portfolio benchmarking is an act of self-deception, but all too common with the average investor.  Exactly what is the purpose of a benchmark and what are the requirements for a fair and reasonable benchmark.  Here is one definition of benchmarking.

In the investing world, the S&P 500 is frequently used as a benchmark for portfolios made up of U.S. equity holdings.  Even though the S&P 500 is a common benchmark, it is not the most appropriate standard and it does not satisfy all the benchmark requirements listed below.  Here are six standards for benchmarking.

1. The benchmark must be investable.  If one is using the S&P 500 as the benchmark, then an investable vehicle is the VFINX index fund as it closely tracks the performance of the S& P 500.

2. The benchmark must be identified in advance.  It is unfair to set up a benchmark after the fact so the portfolio shows up better with respect to the benchmark. Establish the benchmark along with the Strategic Asset Allocation (SAA) plan.

3. The benchmark must be objectively constructed. Many investors will use a simple benchmark such as Vanguard's Total Market Index ETF, VTI, or the index fund, VTSMX. These are certainly objective benchmarks as one can easily understand their construction. It becomes more difficult to meet this requirement when one begins to put together a customized benchmark.

4. A good performance benchmark has an unambiguous composition. This is why the S&P 500 is frequently used. Once more, it is difficult to establish a benchmark that is customized to a portfolio that holds an array of asset classes such as emerging markets, international REITs, commodities, etc.

5. A good performance benchmark is easily measured. 

6. The benchmark will also include a risk measuring metric. A strong portfolio tracking tool provides the user with a means for measuring portfolio risk. While risk, or portfolio uncertainty, is not frequently thought of as part of the benchmarking process, due to the intimate relationship between return and risk, an added calculation should be available for both the user and an outside evaluator. 

Why do investors avoid portfolio benchmarking? 1) It takes time to learn, understand, and implement. Most investors do not have the time or inclination to set up portfolio benchmarks. 2) There are few affordable tools available for the small investor to adequately benchmark their portfolio. Even the affordable commercial programs have gaps when it comes to meeting the above standards, particularly when it comes to accurately measuring portfolio volatility or uncertainty. 3) Investors are unsure whether they really want to know the truth about the performance of their portfolio. 4) Investors insist in setting up their own standards of portfolio evaluation, well outside the accepted standards of the industry.

What is needed to increase portfolio benchmarking? While there are a few quality software programs that do a good job of measuring the Internal Rate of Return (IRR) for the portfolio, missing is the capability of setting up a customized benchmark that matches the asset allocation makeup of the portfolio.  In addition, it is rare to find a program that will measure portfolio volatility or uncertainty using a semi-variance calculation rather than the standard mean-variation.  The investor also needs a visual picture to see if the portfolio is meeting the Strategic Asset Allocation plan.

What Does It Take To Retire?

Retirement Requirements

What does it take in savings to live during retirement? Here is data that readers may find of interest as they think about portfolio development and eventual retirement.

Assume a couple, nearing retirement, anticipate they will need $80,000 after taxes per year to live during their first year without employment. Between them they will receive a pension of $2,000 per month or $24,000 per year. These are all after tax dollars used in this example. Social security will provide another $2,500 per month or $30,000 per year. Eighty thousand minus $54,000 leaves them $26,000 short and this money needs to come from a savings plan. The question then comes down to what will it take to generate $26,000 in after tax dollars each year. I tend to be quite conservative when it comes to thinking through these numbers. Many advisors will tell clients they can withdrawal 5% per year from their retirement funds. My preference is to lower it to 2% so the portfolio has a greater chance to grow and fight off inflation should it raise its ugly head during the anticipated 30 years of retirement. $26,000 = X * 0.02 or X = $1,300,000.

To some, this is a shocking figure. This simple calculation helps one think of the value of a $24,000 pension or a $30,000 social security benefit. There is a considerable amount of money sitting behind those payouts, even if one uses a 6% figure. William Bernstein writes about this in his “Four Pillars” book. If withdrawing only 2% seems too conservative, then move up to 3% or 4%, but my recommendation is to not plan on withdrawing a higher percentage. If one pulls out 4% of the savings, then the required amount of savings is $650,000, still a substantial amount. If one does not have a pension, it places a greater burden on the individual to save more during a lifetime or cut down their living style, or both. The next issue facing this couple is to lay out an asset allocation and savings plan that will put them in a position to withdrawal the equivalent of $26,000 to $30,000 in today’s money sometime in the future. Planning for retirement becomes very complex when one adds in inflation and taxes as both are going to vary a great deal. This is why I tell couples to plan on saving between 1.2 million and 1.5 million in today's dollars. That seems like a very high bar to meet, but it can be done with discipline and frugal living.

Photograph:  The Arches National Park in Utah, USA

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The Five Best Asset Allocation Books

Investors interested in digging deeper into the nuances of asset allocation will find the following five books of interest. Here is my list of the five best books on asset allocation.  In a later post, I will add another five books to this group, making up my top ten list of investment books.

  • The Four Pillars of Investing: Lessons for Building a Winning Portfolio – William J. Bernstein
  • Asset Allocation: Balancing Financial Risk – Roger C. Gibson
  • The Investor's Manifesto – William J. Bernstein
  • All About Asset Allocation: The Easy Way To Get Started – Richard A. Ferri
  • What Wall Street Doesn't Want You To Know – Larry E. Swedroe

William Bernstein, of Oregon, is the author of my number one and number three picks. Actually, The Intelligent Asset Allocator, his first book is my favorite (not on this list), but I would not recommend it as the first to read as the above suggestions are easier to read.  If you are unfamiliar with the language of asset allocation the Top Five will get you started.  Begin your journey with The Four Pillars. Roger C. Gibson, in his Asset Allocation (number two pick) book does a remarkable job of showing why one should build a diversified portfolio. However, I am still waiting for an author who will provide compelling data for using over ten different asset classes. Since I first wrote up this list of five books, Bernstein came out with his third book, Investor's Manifesto, and that book replaced Mark T. Hebner's book.  Hebner provides one of the best overviews for passive or index investing. In his Index Funds book, Hebner goes into the history and research for this approach to investing. If cost is an issue, this book is a best buy. I also recommend visiting the IFA web site as it is one of the very best available. I provide a link off to the right under “Links.” Larry Swedroe fills out this list of outstanding Asset Allocation books.  My one complaint about Swedroe's book is that it does not have an index. If anyone has a favorite book on asset allocation, please add it to this list under the comments section. Your contributions are most welcome. Lowell Herr Photograph: Lima, Peru students taking a snack break.