My Saving Plan Is In Place: What Is The Next Step?

Is it safe to assume you have read one or more of the following sources?

1) Chapter 1 of The Elements of Investing by Malkiel and Ellis

2) Pages 143 – 144 and 152 – 154 of The Investor's Manifesto by William J. Bernstein

3) Pages 179 – 184 of The Power of Passive Investing by Richard Ferri

4) Rule 1 (Chapter 1) of Millionaire Teacher by Andrew Hallam

Using these resources, and armed with $1,000 in hand, locate a discount broker so you have a conduit into what we call the Stock Market.  For a number of reasons I prefer TDAmeritrade as my discount broker.  Their monthly reporting forms are well laid out and understandable.  TDA has 101 commission free ETFs, cutting costs to the consumer.  There are other good discount brokers, so Google "discount brokers" and make a choice.

After you opened up an account and signed all the papers, be sure you have instructions as to how to access your account electronically.  You will need to know the name of the account as well as the password.  TDAmeritrade will ask you to fill out the answers to five questions such as what is the name of your first dog.  You can select the questions and the answers.  That is about all there is to setting up an account.

So my account is open and set up to purchase shares of something.  What is the next step as I don't have a clue what to purchase with my $1,000?  To keep it very simple, I suggest investing 35% in the U.S. Equities market with a purchase of VTI.  Place another 35% in the international market with shares of VEU.  Put the last 30% in bonds.  I would likely go with an intermediate bond ETF such as BIV.

This is a "get-your-feet-wet" type of portfolio.  You now hold three baskets of stocks giving you worldwide exposure with only three investments.  Now wait a month before making your next purchase.

Sharpe Ratio: Why I Prefer the Sortino and Retirement Ratios

The Sharpe Ratio is a measure of return-risk for a portfolio or individual investment.  Like many concepts that lend themselves to mathematics, it is easier to understand what the Sharpe Ratio means if written in the form of an equation.

S = (R – T)/Sigma    (My editor does not have the correct symbol for Sigma.)

Developed by Stanford Professor, William F. Sharpe, the return of the portfolio or investment is represented by R.  T is a T-bill (90-Day for example) or risk-free cash investment and Sigma is the uncertainty or volatility of the investment.

To help understand the Sharpe Ratio, Faber and Richardson, in their The Ivy Portfolio  book write,

"A good rule of thumb for Sharpe Ratios is that asset classes, over the long term, have Sharpes around 0.2 to 0.3.  A "dummy" 60/40 allocation of stocks/bonds is around 0.4.  The Ivy Portfolio allocation is around 0.6.  However, over shorter periods, the numbers can bounce all over the place.  From 1900-2008, the S&P 500 has had Sharpe Ratios per decade ranging from negative 0.8 (0.8) (the 1970s) to 1.4 (the 1950s)."

The reason for not using the Sharpe Ratio is that it penalizes the money manager for upside volatility.  That is the nature of the Sigma calculation.  Both the Sortino and Retirement Ratios circumvent this problem as both employ a semi-variance calculation in the denominator.

The reason for using a "downside risk" calculation in the denominator is that the purpose of investing is to make money and this requires volatility to the upside.  It makes no sense to downgrade the investor for gaining an upside advantage.

Both the Sortino and Retirement Ratios are slight modifications of the Sharpe Ratio, and for that reason we need to give Dr. Sharpe the credit he richly deserves for his research.


Photograph: Buddhist Monastery – Lhasa, Tibet

Bohr Portfolio Update: 30 January 2012

Today I added shares of VWO and RWX as emerging markets and international REITs were both under target.  Even though the Bohr Portfolio is not part of the ITA Risk Reduction experiment, there is an incentive to fill up asset classes where the current price of the the ETF is above its 195-Day Exponential Moving Average (EMA).

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Quotes From “Millionaire Teacher”

The following five quotes come from Andrew Hallam's book, Millionaire Teacher.

1) Index fund investing will provide the highest statistical chance of success, compared with actively managed mutual fund investing.

2) Nobody yet has devised a system of choosing which actively managed mutual fund will consistently beat stock market indexes.  Ignore people who suggest otherwise.

3) Don't be impressed by the historical returns of any actively managed mutual fund.  Choosing to invest in a fund based on its past performance is one of the silliest things an investor can do.

4) Index funds extend their superiority over actively managed funds when the invested money is in a taxable account.

5) Remember the conflict of interest that most advisers face.  They don't want you to buy index funds because they (the brokers) make far more money in commissions and trailer fees when they convince you to buy actively managed funds..

Portfolio Construction

There are many different schools of thought when it comes to creating a portfolio, but how you proceed will depend on several different factors. Attitude to risk, targeted returns and available length of time to invest are all aspects that need to be built into any plan.

Strategic asset allocation is one way of managing a portfolio that can accommodate different attitudes to risk, which in turn inevitably impacts on the return. However, it is less suitable for short-term investors who are hoping for significant and rapid returns on any trades.

Strategic asset allocation is primarily for investors who are looking to create a diverse portfolio but are able to leave their money invested for longer periods and don`t require an immediate return on their funds. This is the pole opposite of tactical asset allocation, which is concerned with short-term gains, combined with a high-risk approach. Tactical planning is unsuitable for medium to long-term investments.

Before looking at the individual components to incorporate into the strategic asset plan, it is first necessary to ascertain the attitude towards risk. Unlike tactical asset allocation, a strategic asset plan can be adapted to include higher risk ventures, should it be desired. If this were the case, the investor would select assets with a greater level of volatility, perhaps using the Standard Deviance measure, which would undoubtedly be a high risk but would potentially have a greater yield.

However, just because strategic asset allocation is fundamentally based around longer term investment returns, it does not mean it cannot also include an element of shorter term trades. The balance of the portfolio is of prime importance throughout and setting aside funds to allocate on short-term, higher risk investments can help to boost returns. Providing sufficient money is left for the longer term projects and the integrity of the portfolio is not compromised by the riskier nature of short-term trades, it is possible to incorporate both into a strategic asset plan. Foreign currency trading, or forex, as it is more commonly known, is a popular inclusion because of the rapid swings in the market and potential for large gains.

To maximize the profits on a strategic asset allocation plan, it is necessary to combine a number of different asset classes. Typical components include stocks and bonds as well as commodities and real estate. Jewelry is another option that could be considered for long-term appreciation. For a slightly more diverse portfolio, investors could include business ventures or antiques, where the assets are likely to increase in value over time. In these cases, the investor effectively becomes a silent or `sleeping` partner.

Adopting a strategic approach to asset management should enable a solid foundation for investment that increases the net value of the portfolio year on year. To enable the portfolio to perform to its fullest, the individual components should be continually reviewed to make sure they remain at the desired level of risk and are on track to achieve their projected returns. Whether the subject of the investment is a long-term project or a short-term asset such as forex information should be readily accessible in order to monitor performance satisfactorily.


Ottorino Respighi: Ancient Airs and Dances

In the process of looking through the music played in the Oscar nominated film, "The Tree of Life," I came across Respighi Ancient Airs and Dances, compositions included in the film.  While there are numerous recordings available, I selected the Orchestra of Ireland as that is what was used in the film.  The CD is also reasonably priced.

Here is one positive review that I found quite accurate.

"Respighi's transcriptions of old lute pieces and ancient manuscripts has been one of his favored works. Many times we only get to hear the third suite, or the first and third. On this nicely priced CD, Ricco Saccani conducts all three. The sound quality is quite good, and the performances are sprightly and lively. The lyrical moments are relaxed but do not drag. The warm sound is a big plus also, although some might find the sound too close-up, but I find it invigorating. These perfomances are not too rowdy, however, and give pleasure, and for the price, why not try it?"

I strongly agree – try it.


Photograph:  ITA editor on the Greek island of Delos.

Five Wiley Investment Books

There are five Wiley investment books that should be on every bookshelf.  Consider these five volumes to be your key references for successful investing.  Actively use them.  Here are my recommendations, in no particular order.

  1. The Investor's Manifesto by William J. Bernstein
  2. The Power of Passive Investing by Richard A. Ferri
  3. Millionaire Teacher by Andrew Hallam
  4. The Elements of Investing by Burton G. Malkiel and Charles D. Ellis
  5. The Bogleheads' Guide to Investing by Taylor Larimore, Mel Lindauer, and Michael LeBoeuf

Number 3, Andrew Hallam's book is new, having just arrive this week.  His writing style is entertaining and he has the fundamentals of investing down pat.  The book is well researched and there are plenty of references at the end of each chapter.  Hallam hammers the actively managed mutual fund industry as does Ferri.

The Bogleheads' Guide to Investing is another book I don't recall recommending.  While cutting a wider swath through the investing world, Larimore et. al. cut to the heart of investing with their obsession to index investing.

Photograph:  Istanbul, Turkey – Standing in Europe looking over to Asia across the bridge.

ITA Portfolio Performance: 28 January 2012

What a great week for the eleven ITA Wealth Management portfolios!  All showed both absolute and relative positive performance returns.  Every portfolio gained ground on the VTSMX benchmark.  The simple reason is due to rising prices in developed international markets (VEU), emerging markets (VWO), and international REITs (RWX).  In other words, our globally diversified portfolios showed unusual life this week.

The unusually high ITA Index for the Kenilworth (36.3%) is due to a recent purchases in commodities as DBC is up an annualized 549.5%.  That exaggerated IRR value will begin to come back to earth over the next few weeks.  A treasury, TLT, is up 972.1%.  Once more, this is due to the short holding period and needs to be discounted until several months pass.

Click on title to clear sidebar.

Portfolio Performance - 01/28/2012

Portfolio Last Update Launch Date Tracking Tool Port. IRR ITA Index Diff Port. vs. ITA Index VTSMX IRR Diff. Port. vs. VTSMX Index IR SR RR
Curie 01/27/2012 12/26/2007 TLH SS 4.6% 2.3% 2.3% 1.5% 3.1% 10.7 0.9 0.1
Newton 01/27/2012 06/02/2008 TLH SS 7.5% 6.1% 1.4% 6.8% 0.7% 0.4 0.1 0.1
Schrodinger 01/27/2012 12/01/2000 TLH SS 4.8% 3.1% 1.7% 3.1% 1.7% NA 10.6 2.5
Einstein 01/27/2012 06/30/2008 TLH SS 10.6% 8.8% 1.8% 10.4% 0.2% 0.1 0.2 0.2
Kepler 01/27/2012 11/01/2008 TLH SS 14.4% 13.9% 0.5% 15.6% -1.2% 0.06 0.01 0.01
Bohr 01/27/2012 08/14/2008 TLH SS 9.6% 9.8% -0.2% 5.3% 4.3% -0.02 -0.02 -0.02
Kenilworth 01/27/2012 08/18/2010 TLH SS 9.3% 36.3% -27.0% 11.7% -2.4% 1.04 -0.26 -0.26
Maxwell 01/27/2012 12/25/2000 TLH SS 1.2% 6.4% -5.2% 4.4% -3.3% NA -0.10 -0.10
Euclid 01/27/2012 06/30/1999 TLH SS 2.4% 5.2% -2.8% 4.5% -2.1% NA -0.08 -0.08
Madison 01/27/2012 03/13/2008 TLH SS 5.5% 7.9% -2.4% 7.7% -2.2% -0.31 -0.92 -0.92
Gauss 01/27/2012 12/27/2011 TLH SS 32.6% 81.2% -48.6% 73.3% -40.7% -2.25* -0.20* -0.16*

The Asset Allocation Decision

What asset classes should be included in a portfolio?  Global diversification is highly recommended.  A well-diversified portfolio will contain, at a minimum, the following asset classes.

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Commodities: Second Thoughts On DBC

ITA Wealth Management readers know I am highly aware of costs and do everything to keep them low.  This includes seeking out commission free ETFs and one example is DBC, a commission free ETF available through TDAmeritrade.  However, the expense ratio of DBC is a very high 0.85% or 85 basis points.  Yes, it costs more to run a commodity ETF, but is this reaching the breaking point.

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