Saturday, May 30, 2009

How Should Households Invest? Sharing My Asset Allocation

Investing without an asset allocation in mind is more likely gambling than actual investing

A sound asset allocation is a key component in any investment portfolio. To put it bluntly investing without an asset allocation in mind is more likely gambling than actual investing.

Two weeks ago I wrote about my decision to gradually increase my exposure to the stock market as the low interest rate levels make it impossible to generate any real return on investment. Some may say low interest rates are a poor advisor. Still, I am quite confident in my decision to increase exposure to stocks in the long term using dollar cost averaging.

Having made up my mind on the question of when I turned to the question of what should I invest in or in other words: what would be a good asset allocation for me?

Asset allocation actually answers the very basic question of investing: What is the return I expect on my investment and, hand in hand, what is the risk I am willing to take?

A short introduction to asset allocation

I feel a short introduction is in order for those less familiar with the concept of asset allocation. I will avoid a deeper methodological discussion at this time.

Asset allocation is the strategy chosen by an investor to distribute his or her investment portfolio among various financial assets to achieve the investment goals. Asset allocation is the corner stone to investing.

Asset allocation has several goals the most important of which is to express the risk appetite of the investor in terms of allocation of funds to different financial assets through which the investment will achieve its goal taking into account the risk involved.

In finance theory, asset allocation is a means of minimizing the specific risk a certain financial asset has. Since various financial assets are not perfectly correlated diversification of the portfolio to several financial assets may (and perhaps should) result in a portfolio which is complete diversified with as little specific risk as possible (specific risk is the risk a certain stock has such as the death of a successful CEO). The diversified portfolio remains with the market risk only – the risk that characterizes the entire market.

Assets may and should be allocated according to several parameters for adequate diversification:

  • The level of risk of the financial asset – From derivatives to government bonds financial assets holds varying levels of risk. Through asset allocation one risky instrument may offset another.

  • Specific characteristics of the financial asset (usually associated with risk) – Stocks of different types vary immensely in risk and return. Large-caps are usually considered more conservative while small-cap or emerging markets are traditionally considered riskier. Risk levels in bonds vary as well with government bonds on the safer side (depends on government of course) and high-yield junk bonds are sometimes riskier than stocks.

  • Foreign currencies – Allocation across currencies is important as well to reduce exposure to a single currency and increase exposure to other powerful or promising currencies.

  • Other parameters such as industries, geographies, commodities, real estate and more.
    Asset allocation holds infinite possibilities. The guideline, as I mentioned, should be the risk appetite of the investor.

My asset allocation

If you've read my previous post on my decision to return to stocks you are aware of my choice to invest through ETF's and index funds. I believe that household investors with as little time on their hands to manage investments should not try to identify value investments in stocks simply because we don't have the time.

Chances of beating the market are slim to none so my recommendation to household investors, such as myself is to join the market (other than try and beat it).

Thus the allocation I will present will be achieved through investing in ETF's and index funds which track a certain index which suits my desired allocation.

It is important to remember that the following allocation is one I built for my own risk appetite and financial situation. Is may serve as an example but should be adapted for anyone else. The purpose of this post is to share my investment management with my readers.

The following is the asset allocation I have chosen for my investment portfolio:

I plan on reaching this asset allocation within 6 months of gradually increasing my exposure to ETF's and index funds in each category.

My considerations for choosing this asset allocation

My considerations for allocating my assets as such are comprised of the following:

I believe the US will emerge first from the current crisis with Europe lagging behind. I believe that the US economy is much more flexible and open to allow for rapid return to growth. The European economy is heavier and less flexible and will suffer more through the coming period. The level of money printed by the US government and the low interest rate environment are frightening as inflation my quickly be upon us. Still, I believe the US economy is resilient enough to withstand such impacts. Hopefully the situation would allow for rapid correction of interest rates to combat inflation after growth has been achieved.

Emerging markets present a long term opportunity which I would hate to miss. This is quite a risky investment but for the longer term (over 15 years) emerging markets such as China, India and others look very promising.

The financial sectors should rebound first if it survives. Banks are usually the first to capitalize on return to growth through credit issued and investments made.

As I mentioned I don't believe in beating the markets so I've decided to join them by investing the rest in ETF's and index funds which track country leading indices such as the S&P500, FTSE, DAX and others.

Monitoring my asset allocation

Setting up an asset allocation is not enough. As values of assets change the allocation shifts. Imagine a strong bullish period in stock markets. The percentage of investment in stock increases as stocks rise thus slowly shifting your asset allocation towards this instrument.
I've written a post in the past on how to monitor a portfolio which I strongly recommend as a supplement to this post.

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Sunday, May 17, 2009

Carnival of Financial Planning - May 16, 2009 Edition

Welcome to the May 16, 2009 edition of the Carnival of Financial Planning.

Today I'm having the pleasure of hosting the Carnival of Financial Planning on The Personal Financier. The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus on efficient and sustainable personal financial planning ractices that can lead to lifetime financial security.

If this is your first time here, at The Personal Financier, welcome! Please check out my Top Posts and consider subscribing to RSS Updates.

This edition is arranged by subject heading, so that you can browse efficiently.


This Edition of the Carnival was kindly edited by The Skilled Investor.


Barry presents Tips To Curb Impulse Buying posted at Associate Money.

Beth Dargis presents What to Do When Laid Off posted at My Simpler Life - Simple Living, saying, "What steps can you take to help your finances when you get laid off"

Silicon Valley Blogger presents The Dave Ramsey Budget: Budgeting Tips For Successful Savers posted at The Digerati Life

Pasadena Financial Advisor presents Financial Planning Reading List posted at Pasadena Financial Advisor, saying "When I work with clients to develop their customized lifetime
financial and investment plans, they often ask what they should read to improve their financial literacy. This article provides a list of recommended reading from among the many hundreds of articles that I have authored in the past several years."


Dana presents Is the Era of Rising Real Estate Prices Over? posted at Investoralist, saying, "Is this the end of rising real estate prices? Some demographic factors to consider."

Dorian Wales presents On Causality and Correlation in Economics posted at The Personal
, saying, "Causality is perhaps the most fundamental element of empirical evidence available to economists. However, it is also the source of many misconceptions due to its elusive nature."

PicktheBrain presents Gallows Humor: 21 Economy Inspired Cartoons posted at School Loans.

Estate Planning

Tushar Mathur presents Getting finances in order posted at Everything Finance,
saying, "Keeping organized records is a gift to your family and to yourself. It helps ensure that your wishes are followed, that your assets are accounted for, and that your money is available to meet your family's needs in a timely fashion."

Financial Planning

The Dough Roller presents Dave Ramsey Unleashed: How to Apply Ramsey’s ‘Baby Steps’ to Grown Up Finances posted at The Dough Roller, saying, "See how to apply Dave Ramsey's Baby Steps for those already on their way to retirement."

Todd presents FMyLife Financial Advice posted at Gloomberg News, saying, "Some of the most valuable lessons are learned when things hit rock bottom. FMyLife & Gloomberg present you with 3 Financial Mistakes and How to Prevent them!"

FMF presents Free eBook -- Everything You Ever Really Needed to Know About Personal Finance On Just One Page posted at Free Money Finance, saying, "The key's to financial success are very simple to detail and understand."

Tushar Mathur presents How to choose a financial planner posted at Everything Finance,
saying, "There's retirement to plan for and college tuition for the kids. Insurance. Estate planning. And, oh, don't forget a wedding for your daughter. If all this sounds familiar, it may be time for you to start shopping around for a financial planner."

Financing a Home

Dan Green presents Trends: Mortgage Rates Tend To Rise Between May And August posted at The Mortgage Reports, saying, "If history is an indicator, mortgage rates won't be this low again until after the summer."

Alex Fotopoulos presents When is it Smart to Refinance a Mortgage? posted at My Trader's
, saying, "Some key points to consider when refinancing your home."

Financing Education

Patrick @ Military Money presents Watch Out For Stimulus Check and Government Grant Fraud! posted at Military Finance Network, saying, "Tips on how to guard your identity and avoid online rip off scams like the infamous government grant scheme."

Ted presents Saving Money: 50 Tips for College Students posted at CampusGrotto, saying, "50 ideas on ways to save money as a college student."


KCLau presents The Most Common Habit of Rich People posted at KCLau's Money Tips, saying, "About the common habits of the rich".


ABC presents Commodities posted at ABCs of Investing, saying, "A brief explanation of commodities."

Manshu presents Value Traps posted at OneMint.

Zach Scheidt presents Synaptics Staying Ahead of Expectations posted at ZachStocks,
saying, "Synaptics Incorporated (SYNA) manufactures touchscreen and touch pad technology used on iPhones and laptop mouse applications. The company is beating estimates and the stock should offer an exceptional opportunity."

Frank Vertin presents Just Buy Index Funds Directly posted at No Load Index Funds, saying, "Buying an S&P 500 index fund through an investment counselor can substantially increase your initial purchasing costs and and drive up your annual management expense fees. Unfortunately, the vast majority of individual investors buy mutual funds and ETFs through
brokers and investment advisers. Rarely do financial advisors recommend that you buy index funds with low fees. This is because low cost, no load mutual funds do not pay them as well as loaded, high fee mutual funds.".

Four Pillars presents BMO InvestorLine Discount Brokerage Review posted at Quest For Four Pillars, saying, "Review of BMO InvestorLine discount brokerage."

Dividends4Life presents PepsiCo Sustains Its String Of Dividend Increases posted at Dividends Value, saying, "Dividend investors love companies that can sustain consistent
dividend growth through the good times and the bad. For three years in a row PepsiCo (PEP) has been named to the Dow Jones Sustainability Index in recognition of the company’s economic, environmental and social performance."

Four Pillars presents Asset Allocation - Include Future Contributions? posted at Quest For Four Pillars, saying, "Can a small investor ignore asset allocation?"

Alex Fotopoulos presents SPY Chart - Premarket posted at Chart Analysis, saying, "Chart of the large S&P 500 ETF, SPY. Alex analyzes the SPY chart using trend lines, moving averages and the Williams %R indicator."

Larry Russell presents 7 Ways to Pick the Best Noload Mutual Funds and ETFs posted at NoLoad Mutual Funds, saying, "Taken as a whole, the vast body of investment research studies show that there really are better approaches to buying and owning mutual funds and ETFs. You do not need to frantically chase fund performance. Performance chasing simply does not work."

Four Pillars presents Transfer In Kind posted at ABCs of Investing, saying, "An explanation of transfering your investments "in kind"."

Praveen presents Successful Trading is About More than Generating A Buy Signal.. posted at Stock Trading Riches, saying, "FINBLOGGER - When buying stocks, your initial purchase is the
least important part of successful investing. Your return is determined by how well you manage the trade - i.e. knowing when to add to your position and when to take profits."

ABC presents Warning - Not All Index Funds and ETFs Are Low Cost posted at ABCs of Investing, saying, "Some index funds and etfs are too expensive."

Wally Fouse presents 7 Ways to Pick the Best Noload Mutual Funds and ETFs posted at Best Index Funds, saying, "The vast body of investment research studies show that there really are better approaches to buying and owning mutual funds and ETFs. You do not need to frantically chase fund performance. Performance chasing simply does not work."

Praveen presents Options Basics posted at Stock Trading Riches, saying, "FINBLOGGER - A blog reader asked me this question: Can any one explain about options trading in a simple manner?"

Richard M. Rothschild presents Low Cost Taxable Bond Mutual Funds posted at Best Bond Index Funds, saying, "The top 14 low cost taxable US fixed income funds with a $10,000 or lower initial deposit. Low investment management fees are very important with fixed income funds. Simply put, if you pay higher bond mutual fund fees, then these bond management expenses tend just to be a deadweight loss to you. When you pay more in bond mutual fund
fees, you are just wasting your money."

Zach Scheidt presents IntercontinentalExchange (ICE) Sharply Higher on Earnings posted at ZachStocks, saying, "IntercontinentalExchange, Inc. (ICE) reported earnings and investors bid the stock higher. Futures clearing and Credit Derivatives Swaps accounted for much of the strength. Management has an excellent track record with acquisitions."

MoneyNing presents TradeKing Review posted at Money Ning, saying, "TradeKing is quickly becoming one of the best stock brokers out there. Find out why."

Alex Fotopoulos presents DIA 3 Month Chart - April 29, 2009 posted at Chart Analysis,
saying, "Alex charted the Dow Jones tracking ETF, DIA, this week and highlights where near term resistance could surface."

Alex Fotopoulos presents RSP Chart - May 7, 2009 posted at Chart Analysis, saying, "Alex analyzes the RSP chart for the past three months to attempt to pick an entry point."

Zach Scheidt presents Bankruptcies, M&A, and Playing Defense posted at ZachStocks,
saying, "A discussion on current economic reports and their effect on the markets, Bank stress tests as a catalyst for selling, and defensive strategies to protect your portfolio from losses."

Managing Debt

Madison presents Making Home Affordable Q & A posted at My Dollar Plan.

Pinyo presents 7 Steps Debt Reduction Illustrated posted at Moolanomy, saying, "Illustrative guide to help you effectively manage and pay down your credit card debt"

KCLau presents Do You Have a Wedding Debt? posted at KCLau's Money Tips, saying, "Most couples want to begin their married life auspiciously and free from the problems. However, it is not uncommon to hear about married couples who go into debt just to get married. Article explores the reasons."


GrrlScientist presents Tough Love for City's Homeless: Pay Rent or Get Out! posted at Living the Scientific Life, saying, "Sounding like a story that is fresh out of the satirical newspaper, The Onion, the eighth richest person in America tells thousands of homeless families in NYC to pay rent to live in a shelter or GET OUT!"

Retirement Planning

Darwin presents Start Investing Today: An Amazing Comparison of 25 vs 35 Year Old Starters posted at Darwin's Finance, saying, "This article shares some poignant numerical and graphical
representations of the stark differences between an investor/saver starting at 25 vs 35 years old."

Risk Management and Insurance

nickel presents How to Save Money on Car Insurance posted at, saying, "Six surefire tips for reducing your car insurance premiums."

puneetkapoor presents UNDERSTANDING RISK posted at KuberKhana -Indian Stock Fundamental Analysis, saying, "If we understand risk, we prosper."

Silicon Valley Blogger presents Lower Your Car Insurance Rates! How To Cut Insurance Premiums In Half posted at The Digerati Life, saying, "I offer some suggestions and tips for lowering your car insurance and keeping your car related costs (and budget) to a minimum."

KCLau presents Bad Experience of Car Insurance Claim posted at KCLau's Money Tips,
saying, "a story of bad experience with vehicle insurance claim"

MoneyNing presents 20 Different Areas to Think About for a Cheaper Auto Insurance Policy
posted at Money Ning, saying, "Insurance is something we usually forget, yet we pay quite a
bit for it regularly. If you can spend a few minutes and save big, why not?"


The Skilled Investor presents Most Individual Investors Are Poor Personal Portfolio Managers Personal Investment Management posted at Personal Investment Manager,
saying, "Investors more easily understand investment costs that are directly measurable, such as fees deducted on investment statements. However, many investors ignore or are unaware of the opportunity costs of their sub-optimal investment behaviors. Opportunity costs are usually much more difficult to measure directly, but these investment costs can be even higher than more visible investment fees."



Barb A. Ryan presents Asset Allocation, Investment Asset Tax Location, and Emergency Cash Management posted at Independent Financial Planner, saying As you move your cash, bond, and stock financial assets into lower cost, more broadly diversified investment mutual funds and/or ETFs, you should also consider how to locate your investment asset allocation with respect to more optimal taxation. This article will discusses some ideas about where and how to hold your cash assets and how to make emergency cash available."

That concludes this edition. Submit your blog article to the next edition of Carnival of Financial Planning using our carnival submission form. Past posts and future hosts can be found on our blog carnival index page.

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Saturday, May 16, 2009

What is the Recommended Investment Strategy for Household Investors?

I've promised to update you, my readers, on my investment decisions. I've decided.

After months of deliberation I've finally decided on getting my feet wet again and bought some stocks on Monday. As readers of The Personal Financier know I am a big fan of investment vehicles that track certain indices such as index funds or ETF's so I've decided on gradually increasing my exposure to the markets via these financial instruments.

Needless to say I have a gift for timing the market, the other way around. Since my recent purchase leading indicators, such as the S&P500 had shed over 5%. That was rather expected as the markets rallied these past couple of months.

In this post I'll share my personal considerations behind my recent decision to increase exposure to stocks. If I breakdown my decision into three main lines of consideration they would be:

  • My considerations regarding my desired investment style.

  • My considerations regarding the market environment.

  • My decision to use index funds and ETF's and invest gradually using dollar cost averaging (Investing a certain sum each period).

My considerations regarding my desired investment style

So why did I decide to reinvest in stocks again? The reasons behind my newly discovered enthusiasm about the markets and why I decided on gradually increasing my exposure to stocks has a lot to do with what I consider a desired or suitable investment style for me and many other household investors (in my opinion, of course).

During the past couple of years I've been fortunate enough (ironically) to not have to worry about my savings and investments as I had none. I'd bought an apartment and literally invested my funds there releasing me of my need to consider alternative investments. Luckily enough the apartment I had bought has yet to suffer the impact of the housing crisis.

Now, two years later I've managed to save up a sum which necessitates more serious consideration regarding where to invest it and how to both preserve it and grow it, if possible.
Naturally, the state of the markets was enough cause of concern for me to seriously consider my investment plans. Losing my hard earned money is not an option.

The more I thought of it I understood I was failing to obey my view on investments, a view that I had learned after paying "tuition" in investment losses in my early investment years.

#1 I decided sitting on the fence won't get me far
I find out I was literally sitting on the fence. Avoiding decision allowed me to remain unscathed during the recent plummet but I did not earn anything either. I've written a post titled "Who Dares Wins" but failed to follow it.

There is no need to take huge risks for huge profits, just thought out risk for a better chance of meeting my personal financial goals.
Sitting on the fence is not a solution to anything. It's a very easy way out. Usually when I avoid deciding I know something is wrong. So I decided to slowly climb down from the fence.

It does feel much better to have decided and to have the feeling of taking a path and having a purpose. My savings were idling in a short term deposit which barely covers the bank's fees with the low interest rate environment. I had to do something and feel like I'm doing something.

#2 I was guilty of timing the market
I just can't help it. I don't think many can. I always try and time the market. Since one does not usually keep objective score of one's efforts of timing the market we never know whether we are any good at it. I most certainly am not.

No one thought the market would rally 50% after Citi's March earning release. Missing out on such a rally is very costly in terms of investment. And now, having raced 50% up the more probable scenario is a downward technical correction in prices… and then? Timing the market almost never works so I've decide to stop and just invest a portion at a time thus averaging these corrections out and enjoying the long trend in prices which will hopefully be a bullish one.

#3 I finally remembered I am a long term investor
It took some time but I've finally remembered I'm actually a long term investor. I think it's hard on humans to invest for the long term. We are programmed to be impatient and impatience is a bane for investors.

I think the birth of my baby boy had something to do with it. I've decided on treating my investments as his. An 18 year investment term should be enough to be considered long term (some may argue).

My considerations regarding the market environment

In my recent posts I've written about a correction in prices which is probable to follow the recent rally. I had thought the stress tests will give enough reason for sophisticated investors to realize profits and change the trend. This hasn't happed, yet. Markets have shed 5% but this can be considered only profit taking on an uptrend.

I still believe a correction is in order but since I've decided on quitting my market timing efforts I've decided to ignore this belief. This is actually a great relief. No one seems to really know what's going on anyway.

It certainly wasn't short-term considerations regarding the economy which got me to reinvest. There seem to be fundamental reasons to believe the global economy will get better in the near future (2-3 years).

#1 Very low interest rate environment leaves little choice
There is money out there looking for reasonable returns. With interest rates this low this money has little choice of investment and will turn, eventually, to the stock market. Interest rates on deposits are so ridicules many investors will find it very hard to accept.

This low interest rate environment will hopefully serve to set the markets back in motion with cheaper credit more motivation to capitalize on this opportunity.

There are risks to such a low interest rate environment, together with increasing influx of money into the markets. Inflation will follow and will have to be controlled but hopefully we'll be on a correct course by then.

#2 Risk appetite seems to be returning to the markets
One of the effects of the recent crisis has been a dramatic impact on risk appetite. When risks seem to be that high no return is justifiable. Risk appetite is perhaps the most important thing for the stock market which is, in essence, a risk-return tradeoff.

Recently there seems to have been a shift in trend and the risk appetite is reappearing. The public's share in the stock markets is increasing through institutional investors and, hopefully, it won't be long before the mass market will find stocks appealing again.

#3 Cyclicality
As my market timing days are over I am better equipped to use one of the characteristics of financial markets in my advantage. Cyclicality is a common trait of financial markets. Though it never seems so in times of prosperity or times of depressions, the tide will turn and the markets will change.

Keeping a presence in the market is vital for long term success and profiting of cyclicality.

My decision to use index funds and dollar cost averaging

My considerations should be clear by now in light of my investment style and market beliefs.

#1 Beating the market is as hard as timing it
Chances are you or the institutional investor you've chosen though a fund or IRA cannot beat the market. For this reason buying the market is the way to go. Fees and commissions paid are often unjustified and hurt portfolio performance with no real abnormal returns over the market.

Index funds are cheap in fees, are simple to follow I believe serve best the needs of household investors.

#2 Dollar cost averaging is a good way to gradually increase exposure
Uncertainty rules the markets, especially today. I would be very nervous had I invested my entire savings in one period. The market is still very fickle and dangerous. Naturally the risk – return equations dictates that averaging investments over time will yield lower returns, and it does, but it is important for sleeping at night.

Dollar cost averaging enables me to remain content even when markets correct themselves downwards. I'll just buy more, cheaply. When markets are bullish again I'll profit on the average investment.

I believe the outlines I've described to be the optimal solution for independent household investors under the current market conditions. I am not recommending anything to anyone. I'm simply describing my strategy as I've promised to do in the past.

I would not like to expose the size of my investments but rather the portion. I've invested 10% of my portfolio in stocks (US Index) and will continue to do so on a monthly basis.

I will update my readers on how my portfolio progresses. By next week I will hopefully have finalized my planned asset allocation and will share it as well.

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