What Should I Do If I Am Holding Cash?

What should I do if I am holding cash?  Is it time to move back into the market, and if so, how should I proceed?  Those are difficult questions considering the S&P 500 (VFINX) increased in value by 87.4% since January 20, 2009.  If one were to follow the Louis Rukeyser analysis, moving immediately into the market is the correct decision.  However, Rukeyser was using data that included one of the greatest bull market of the 20th century.  In a raging bull market it is always time to jump in as soon as possible.  Moving immediately into this market may not be the best advice as we close out August of 2012.

What would I do if I were holding a large percentage of a portfolio in cash or cash equivalents?

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Return and Risk Relationship

What is the relationship between return of a portfolio and the associated risk involved?

Quoting from an “Active vs. Passive” paper I found in my files.

“High potential returns always involve high potential risks. There are no low-risk/high-return investments. Investment risk comes in many forms but, to most investors, risk means the potential for losing investment capital and the duration or permanency of that loss. Through analyzing the best available long-term data, researchers have carefully defined the risk/return ratios of all major asset classes and identified the correlation or interdependence of different types of investments. These findings provide our best approximation of future risk and return for any given asset class or mix of asset classes, and clearly show that there are no high return, low risk asset classes.”

Let me raise the questions I asked several months ago.

1. Do you have an accurate method for tracking the internal rate of return of your investments?

2. Do you have any means to track the risk measurement of your investments? By your investment decisions, are you adding value or alpha to your portfolio?

Unfortunately, few software programs are set up to accurately measure portfolio risk. It is possible to find programs that do a good job calculating the Internal Rate of Return (IRR) of the portfolio but not portfolio risk. The spreadsheet used to track ITA portfolios does an excellent job of making this calculation, and with proper data entry, it also does an excellent job of tracking the performance of an index such as the VFINX or VTSMX.

When I first discussed the Return/Risk ratio issue, the TLH Spreadsheet did not have a way to calculate portfolio risk.  That problem is now solved and we have a superior method (semi-variance) to calculate portfolio risk and work it into the Sortino Ratio.

Simplified “Holy Grail” Portfolio: A 12-ETF Approach

12-ETF Portfolio

Following up on yesterday's blog post, here is a simplified revision of the "Holy Grail" portfolio.  Any time one can reduce the number of holdings and improve the return and volatility projections, give the new portfolio high marks.  The following group of twelve (12) ETFs provides a higher Return/Risk ratio than the portfolio discussed yesterday. 

Platinum membership is available for $5.00 per month.

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Five Investing Tips to Launch a Successful Retirement Program

Five money hints below will put you on the road to financial success.

  • Follow "The Golden Rule of Investing." Save as much as you can as early as you can.
  • Live below your means.  Learn self-discipline and stop spending on trivial material goods.
    • Avoid Credit Card debt as it will kill your chances of success.
  • Invest in index funds or index ETFs.  Many examples of how to do this are provided throughout this blog.
    • Keep expenses low.
  • Diversify your portfolio across the world market. 
    • Learn what is meant by asset allocation.  This blog will teach you.
  • Keep It Simple.  Avoid stock picking unless you are skilled in stock analysis and read a few of the Top Ten Investment Books.
    • Follow the advice of William Bernstein and Richard Ferri.


Platinum membership is available for $5.00 per month.  Learn how to invest for the price of an inexpensive breakfast.

Holy Grail Portfolio Revised

Revising the "Holy Grail" portfolio is an extension of the blog entry posted earlier today.  The following QPP analysis is somewhat constrained by two new corporate bond ETFs (VCIT and VCLT) that have not been in existence three years.  Nevertheless, Platinum members will find this portfolio of interest.  The broad guidelines for putting this portfolio together is as follows.  Invest 30% of the portfolio in U.S. Equities, 20% in international equities, 15% in real estate (domestic and international), 5% in commodities, and the remaining 30% in bonds.  As readers will see in a moment, the 30% bond exposure tempers potential growth.

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Basic Financial Principles To Consider When Building A Portfolio

Basic financial principles to consider when building a portfolio include the following.

  • Diversity across global markets
  • Orientation toward equity or growth
  • Inflation protection
  • Low correlated assets

Diversity across global markets will include both developed international markets and emerging markets.  To provide the necessary growth for retirement, the portfolio will need exposure to equity assets.  A portfolio filled with bond ETFs will not suffice.  Inflation protection will require holding U.S. Treasury Inflation-Protected Securities.  A second line of defense is to hold real estate, both domestic and international, as a guard against inflation.  Domestic equity holdings will also provide some protection against inflation.  The last guideline, finding low correlated assets, is one of the most difficult to accomplish successfully.  We frequently look to commodities for a solution to this problem.

Slicing the diversification problem further, one needs to decide how many asset classes to use when building a portfolio.  The answer to this question depends on how one defines an asset class.  For example, U.S. Equities can be considered to be one asset class or it can be divided into as many as nine asset classes.  Definitions such as this are up to each investor.  I favor breaking U.S. Equities into multiple asset classes in order to tilt the portfolio toward value, growth, large-cap or small-cap.

It is important not to slice the asset classes so thin that the percentage in a particular asset class is not able to contribute to portfolio movement.  Asset classes such as bonds, domestic real estate, commodities, etc., should hold at least 5% of the total portfolio.  One might go as low as 2% or 3% for one of the "Big Nine" asset classes within U.S. Equities.

Depending on the risk an investor is willing to take, a 70% allocation to equity orientated investments is reasonable.  The remaining 30% is allocated to bonds or high yield generators.  A very common stock/bond ratio is 60/40.  Even a 60/40 portfolio, while conservative at first glance, carries a 90% risk associated with the 60% allocated to equities.

The general guidelines listed above are put into action when specific stocks, ETFs, or mutual funds are selected to build the portfolio.  Numerous examples are described throughout this blog.  Many of the portfolios are limited to Platinum members.

Response to “The Trend is Your Fickle Friend” Article

If you have been reading the Comments on this blog you saw the reference to the Hussman Funds article, "The Trend is Your Fickle Friend."  After reading the article I concluded that my response would be too long for another comment, so I decided to give attention to the article with a full blog post.

In the early part of Hussman's article, he points out the problems associated with trend following models using the S&P 500.  While this post is not a defense of the ITA Risk Reduction model, there are differences in Hussman's criticism and the ITARR model.  Here are a few points of separation.

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“Delta Factor” Projections for Bond ETFs

"Delta Factor" projections for bond ETFs are grim for the next few months.  All but BWX are negative in the Delta column.  SHV only rounds to zero as it is also negative.  While a number of bonds are showing a "Delta Factor" of Hold, the bias or tilt is definitely down as shown by the Delta column.  The general prediction is to hold these ETFs with great care till the end of the year or until the next examination period.

The reference or benchmark used for bonds is AGG, a broad based bond index ETF.

Portfolio Construction: The Most Important Decisions

William J. Bernstein, in his most recent book, “The Investor’s Manifesto” writes, “Before diving into the most important issue faced by any investor–the asset allocation decision–you will need to understand four things: save as much as you can, make sure you have enough liquid taxable assets for emergencies, diversify widely, and do so with passive or index funds.“

 If you are not a saver, it is questionable how much useful information you will derive from this blog, ITA Wealth Management. Perhaps I can persuade or scare you into saving more than you ever thought possible. This blog is also about diversification and using index funds or index ETFs as the primary investment vehicles.  My preference is to use index funds for smaller portfolios and ETFs for larger portfolios. If one can hold commissions to something below 50 basis points per transaction, then I favor ETFs.  It is now possible, through TDAmeritrade, to populate a well-diversified portfolio with commission free ETFs.  Drive costs lower as it works to the bottom line. And now to that most important investment decision — one of asset allocation.

The first decision, and the most important according to available research, is to determine the stock/bond ratio. Will it be a 50/50 or a 90/10 ratio? This decision is unique for each investor, and to help with this determination, once more I direct investors over to http://www.ifa.com for the Risk Capacity Survey.  If you have not already done so, take this survey to see where you fit on the stock/bond continuum. The next asset allocation step is even more difficult as one now needs to decide what asset classes will make up the equity portion of the portfolio and what bonds to use for the bond portion. A lot of attention is given to these decisions here on the Platinum level of ITA Wealth Management.  Once the different asset classes are identified, investors are ready for the last decision and that is — what percentage should be allocated to each asset class?  For example, if 40% is allocated to bonds do you place all 40% in BND or is it better to divide bonds into several different bond ETFs such as TIP, HYG, TLT, JNK, PCY, BIV, and BND, or some other combination of different ETFs? This is were we rely on some correlation analysis, particularly when it comes to the different stock or equity asset classes. Again, this analysis requires a little more effort using Quantext Portfolio Planner (QPP) and other resources.

Platinum members have access to several portfolios on this blog and this includes all the trades, few though they are, and the asset allocation plans.  New members can watch the development of the Gauss and Kenilworth, young portfolios just beginning to grow.

Platinum membership is available for $5.00 per month.  You will make this back by following the examples shown here at ITA.

“Delta Factor” Projections For Next Several Months

Every few weeks I post the market outlook for equity holdings (ETFs and/or stocks) we use in many of the portfolios.  The table below shows the probability projections based on what I call the "Delta Factor."

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