And of course, a plethora of explanations quickly followed. We heard about the “fat thumb” scenario describing a trader who, keying in the wrong trade, sold billions of shares instead of millions, triggered the collapse. One of the more interesting explanations is a truly bizarre account involving Nassim Taleb, trader and author of “The Black Swan,” a book that discusses high-impact, impossible-to-predict, and rare events that are beyond the realm of normal expectations.  According to this grand irony, Taleb’s fund placed a sizable S&P short that got the ball rolling for Thursday’s violent selling — creating his own “black swan.”  In the end, however, the 1000-point drop remains a mystery, and in the absence of any truly credible and complete explanation, market fear has been resurrected.

More important than understanding the cause of this event is understanding how you responded to it.  Did you yawn, or did you freak? For those who live by the market’s vicissitudes, May 6th was an apoplectic ride on a terrifying roller coaster. With each swing of the market, such investors sit glued to the ticker, at one moment thrilled, the next gripped by dread. For those of us who are MarketRiders, such days produce a yawn.

With our investments sheltered by a distant time horizon, low fees and smart diversification, we are free to go about the more important business of our lives. Some investors prefer drama. We prefer peace-of-mind.

But after 50 years old, we start waking up at night worrying, “Will I ever be able to stop working one day?”  Taking action without the benefit of 20-30 years of time on your side is like swearing off steaks as you’re being wheeled into the operating room for a triple bypass:  too little, too late.

Since April 15th was the deadline for making yearly IRA contribution, the finance writers were dolling out plenty of advice and ideas on retirement. Neil Weinberg of Forbes guides us how to figure out one’s asset allocation in his article Asset Allocation -The Key to Building A Big Nest Egg.  His advice is very useful and his guidelines are similar to how MarketRiders online portfolio manager software works.  Other articles worth reading are found in the Wall Street Journal and the Washington Post, they both feature articles on ways to figure out how much you’ll need to retire.

Saving is the first step.  Smart investing is the second.  A recent MarketRiders study on how fees can devastate an IRA portfolio has been generating a lot of interest.  The study reviews three scenarios showing how a 35 year old can diligently contribute $4000 per year to his IRA, but end up losing $1 – $1.5 million over 40 years, just because of fees.

After you read this week’s articles, please fund your IRA this year.  You’ll be glad you did!

Think of the conversations that occur behind closed doors at the White House, corporate boardrooms or U.S. Central Command. We all understand that there are elements of those conversations that are deemed, for whatever reason, unsuitable for public consumption. They are tucked into the classified file, sworn to secrecy and solemn oaths. But every now and again, some of the untold story leaks out – finds its way to the common person. Sometimes the information is so unbelievable, that it is marginalized as ridiculous. Other times it is corroborated with such credibility that all we are left with slack jaws and nodding heads.

Below are three brief but shocking behind-closed-doors accounts about Wall Street and investing that left me stunned.

CEO of a Top Publically Traded Tech Company: Having participated in the Silicon Valley for years and sat on the board of Baidu, I come into contact with a broad network of technology leaders and professionals. Recently, I became part of a stunning conversation with one of the top executives in The Valley.  This individual, while surprising humble, is also profoundly wealthy. For years he used the “top” wealth managers who have access to elite money managers who in turn “outperform” the market to justify their fees. After years of high cost and poor performance and tens of millions lost, this executive was seriously underwhelmed. He pulled his money out, embraced a simple indexing strategy and global diversifications. It takes him only a few hours a year to manage the money himself. He save hundreds of thousands if annual fees and achieves a much better result. Why don’t we ever see that ad during Wimbledon?

Former Banking Firm Top 500 Producer: Imagine being an investment advisor who has built a dream business – over $1B in assets under management (AUM) and a coveted Chairman’s Club member. Making just over 1% a year on AUM, this wealth manager was grossing over $10MM annually in fees. Unfortunately, he had a huge problem – he still had a conscious. The more he study active money management, the more he learned that it not only failed to add value to his customers, but was in fact deleterious.  When he approached management about this problem and sought an indexing approach, he was run out of town. After a legal battle and negotiations, the firm and the manager struck a settlement. He left his customers in the hands of the banking firm and he had to move on. I guess someone is now making money “the old fashion way – earning it.”

$750 An Hour Tax Attorney to the Uber-Wealthy: I was once invited into a private conversation with the uber-wealthy about tax management. The strategy was architected by top legal minds in the country. Profoundly expensive to set-up and maintain, this apparently legal and sophisticated offshore strategy would result in profound tax reduction. Imagine most of your wealth free to compound without tax consequence. These uber-wealthy could invest in the most sophisticated and elite products. When I asked the attorney what the majority of his clients were investing in, he just snickered. Over 60% of their dollars were dedicated to simple and diversified indexing strategies. There was no Wall Street, no active managers, or Jim Cramers – just hundreds of millions, even billions, going into a simple, proven approach used by those in the know.

I hope you are doing the same.

For years, my husband and I have been watching her on the TODAY Show and every time we feel as though we walk away more financially savvy than we were before watching her segment.  Oftentimes, it seems that financial experts speak in a different tongue as they make the subject so complicated and difficult to relate to.  But once again, a recent article Retirement Investing: Tips for Creating the Proper Asset Allocation by Jean Chatzky, hits the nail on the head about how best to tackle retirement planning.

“No matter what retirement savings vehicle you’re using – 401(k), Roth IRA, Traditional IRA, or some combination of the three – once you find the money to stash away, you can easily set up automatic contributions each month. By doing so, the money is whisked out of your bank account before you ever have a chance to spend it. But that doesn’t mean your role in the retirement savings game is over.”  This is where one’s role in their investing appears to be more daunting.  But as she comments, “you’ll need to weigh a few factors about yourself – including your age, your risk tolerance, and when you plan to retire – and then figure out how you are going to spread your money across the different investment categories. This is called an asset allocation.”    Whether you choose to hire an investment adviser to help you in this effort, or look to do-it-yourself portfolio management tools to assist you — such as one from MarketRiders Inc. – it is a step that must be taken for smart retirement investing.  Read her recent article and you too will feel more financially savvy, not to mention better armed to tackle your retirement investing strategy.

Well, of course it would. Fund companies, including PIMCO, Legg Mason, and Van Kampen, say they’ve got just the thing for you: They are called tactical asset allocation funds, and a new one seems to roll out daily. Don’t believe the pitch.  No manager can predict the future of one asset class let alone multiple ones. Yet terrible odds have not kept these new funds from becoming the trendy way to invest. So what is technical asset allocation and why is it dangerous?

How It Works

Tactical allocation requires managers to predict which asset classes will lead and which will lag, and then to own securities that will benefit. Needless to say, they don’t always get it right. But that doesn’t stop some of them from charging high expenses or keeping their investing strategies opaque or both.  This approach may sound like market timing, the discredited investment strategy of jumping in and out of a market to catch upswings and avoid downturns. But tactical fund managers prefer a more nuanced explanation of their approach. They typically hold a wide range of assets, overweighting classes they find most appealing and underweighting ones they consider overpriced or otherwise undesirable. Some choose allocations based on technical indicators, others on fundamentals. Sounds great, doesn’t it, but unfortunately it simply does not work over the long-haul. Portfolio diversification, however, is an investment strategy employed by leading institutions and endowments and is a great approach for retirement. Unlike tactical allocation, asset allocation focuses on using low-cost, tax-efficient index funds in specific target percentages that are rigorously maintained through rebalancing as markets shift.

Why It Is Dangerous

Research conclusively demonstrates that only a small percentage of managers will beat any one index in any given year. When you examine fund managers’ performance vs. the index out ten years, the winners drop into the low single digits. Now imagine asking a fund manager to not beat one, but four, five or six indexes all at the same time. Statistically, your likelihood of success drops into a fraction of one percent – probably not the best bet for your retirement.

In 2008 it turns out that asset allocation decisions have everything to do with a portfolio performance.

On MarketRiders, we use our own ETF portfolio builder to track some “Celebrity Portfolios” including the “Lazy Portfolios” (published by Paul B. Farrell at Marketwatch). These portfolios mimic allocations based upon Yale University’s David Swensen, Dr. William Bernstein, Ted Aronson, and Bill Schulthesis who wrote “The Coffeehouse Investor.” Community members also have posted many interesting portfolios with unique asset allocations that have held up well in the last few months.

These portfolios use ETFs without active management and we track weighted average portfolio fees. The component ETF fees range from .08% to .50% and the weighted average portfolio fees are between .12% and .21%.

Comparing and contrasting portfolios with similar asset allocations, shows a lot about how to build solid “all weather” allocations that have held up even in 2008. While some of the variance is surely explained by the allocation in non-equities (Bonds, Treasury Inflation Protected Bonds and Cash), a lot of it is explained by the level of diversification amongst the other asset classes.

There’s quite a variance between some of the portfolios – even when their equity exposures are similar. Two portfolios each with 60% equity exposure have dramatically different results.

For example, Bill Schulthesis, a ex-Salomon Smith Barney broker who wrote The Coffeehouse Investor, designed a portfolio with 40% in an intermediate bond index (BND) and 10% in each of 6 stock funds (Vanguad REIT ETF (VNQ), SPDR S&P 500 ETF (SPY), Vanguard Small-Cap ETF (VB), Vanguard Small-Cap Value ETF (VBR), Vanguard Value ETF (VTV), Vanguard FTSE All World ex-US ETF (VEU)). Dr. William Bernstein wrote the “Intelligent Asset Allocator” and “The Four Pillars of Investing” and proposed the same basic allocation. But high exposure to small cap value US stocks and REITs allowed Coffeehouse’s returns to trump Bernstein by over 2 times.

Here are the results as of last night’s close.  These portfolios and the ETFs in them are posted on MarketRiders.

The Best and the Worst Returns

To better understand where the variances lie, we drill down into each asset class to see where returns (or lack thereof) are coming from. Aronson’s portfolio, is the worst so far, down (16.65%) with 80% equity exposure. Unfortunately, Aronson had no REIT exposure and heavy exposure to Emerging Market (VWO) and Foreign Markets (European (VGK) and Pacific (VPL)) which have both been crushed this year. Aronson’s portfolio has performed very well for 5 years on the backs of these asset classes, but 2008 has been his come-uppance.

The MarketRiders “Low Risk” portfolio is doing the best so far this year – down only (1.83%) – but with 25% exposure to equity and Real Estate (RWR). A strong US allocation (iShares S&P SmallCap 600 Index  (IJR) and SPY) over Foreign Developed and Emerging Markets (VEU) helped dampen the losses.

It’s Time to Rebalance!

Today, we’re rebalancing a few of these portfolios where actual allocations now vary greater than 20% off our targets. The most out of balance portfolio is the one built by John Spense and Rick Ferri on MarketWatch. Emerging Markets, Foreign Markets, TIPs and Small Cap US stocks are all out of whack so this portfolio and others will be brought back to their targets.

Stay tuned.  At the end of the year, we’ll report back and show you how these portfolios did.

These are scary times for investors trying to shore up their retirement
portfolios. Stocks’ values are down, inflation is ticking up and home prices
are sliding. But as investors nervously eye all that, they may be overlooking
the biggest threat of all: themselves.

“How you react to negative news about the markets can do far more
damage to your retirement portfolio than temporary trends in the market,”
says Mark Cortazzo, an investment adviser at Macro Consulting Group in
Parsippany, N.J. “Investors can truly be their own worst enemies.”

While investors are prone to making mistakes no matter which direction the
market is headed, when stocks lose value — as they have for four consecutive
months — investor errors can have more exaggerated effects on wealth, Cortazzo
says.

So how much damage does the average investor inflict upon himself in real
numbers?

At the request of Barron’s, Christopher Cordaro, an investment
adviser in Chatham, N.J., with Regent Atlantic Capital, ran some
calculations to answer this question, and the answer isn’t pretty.

Bottom line: Simply by making three of the most common errors — failing to
diversify wisely, trying to time the market and overpaying on investment
expenses — you would have missed out on $375,000 of gains on a $1 million
portfolio invested for the 10 years through January 2008.

Cordaro found that a wisely constructed portfolio free of investor error
would have returned an average annual 6.86% during that period and grown to
about $1,942,000. But factor in the three errors, and the return shrinks to
4.59%, while the ending account balance drops to about $1,567,000. In general,
the smart portfolio was broadly diversified in terms of both asset class and country. It made no attempts to call tops and bottoms in the market, and it
steered clear of pointless but all-too-common fees.

The worst part, Cordaro says, is that investors often don’t even realize
they’re sabotaging their nest eggs — because the slippage in return isn’t
sudden or drastic. “It’s small enough that they don’t notice it, but it is
slowly eating away at their financial independence like a cancer,” he
says.

The good news? If you know what to look for, chances are you’ll be able to
avert disaster. Here is a rundown on the three most common and costliest
mistakes that investors make with their nest eggs.

Neglecting Asset Allocation

Practically all investors would agree that they want the best returns and
the lowest possible risk. But when it comes to setting up a portfolio to
deliver on that promise, many investors don’t go the distance — and they pay
dearly for it.

The best way for an average investor to achieve the highest risk-adjusted
rewards is to allocate investments broadly across different asset classes. Yet
few investors do so: According to a 2007 survey of 401(k) assets by the Profit
Sharing and 401(k) Council of America, the average investor holds
some 25% of 401(k) assets in his own company stock. Beyond that, at least a
third of assets are in domestic stocks. Less than 8% of retirement-plan assets
are in non-U.S. stocks, and fewer than 1% are in real estate.

In Cordaro’s example, you can see how an investor can buff up a return by
refining his asset allocation. A simple allocation of 60% in large U.S. growth and
value stocks and 40% in intermediate bonds would have delivered a 5.2% average
annual return in the 10-year period ending January 2008. Add a sprinkling of
small U.S.
growth and value stocks, and large foreign stocks, and you boost your return to
5.7%. Better yet, add some world bonds, emerging markets and real estate, and
the return plumps up to 6.4%.

That latter portfolio, Cordaro says, was invested 30% in large U.S. growth
and value stocks, 10% in small U.S. growth and value stocks, 10% in large
foreign growth and value stocks, 5% in emerging markets, 35% in intermediate
bonds, 5% in world bonds and 5% in real estate.

Juggling a number of asset classes isn’t always easy. Jay Berger, a partner
at Independent Wealth Management in Traverse City, Mich., said that in 2006,
clients panicked over the Pimco Commodity Real Return Fund’s 3% decline.
“We explained that we need a portfolio with assets moving in different
directions. The best analogy is: Look at it as a perennial garden. If
everything is in bloom at the same time, that probably means everything will
wilt at the same time.”

Timing the Market

Investors have such a dismal record of being able to time the market that
mutual-fund inflows and outflows appear to be contrary indicators of which way
the market is heading, says Meir Statman, a finance professor at Santa Clara University in California.

“It’s not the perfect-idiot forecast,” he says, but it’s close.
Ideally, of course, you would want to sell your holdings when prices are high
and poised to drop, and buy stocks on sale, right before a run-up in values.

But over the past decade, investors have done the exact opposite. The month
with the biggest-ever net inflows of assets into stock mutual funds occurred in
February of 2000, “which was the doorstep of one of the worst declines in
history,” says Ernie Ankrim, chief investment strategist at Russell Investments. The biggest outflows were also poorly timed: Some of
the biggest occurred in the months leading up to October 2002, when the market
hit bottom.

“This kind of behavior of getting excited after good news and scared
after bad news causes investors to give up between 2.5 and three percentage
points a year,” Ankrim says. “The whole reason investors put up with
the volatility of stocks is to gain about three or four percentage points over
bonds — if we give most of that back, that means we’re accepting all of the
volatility of the stock market for no good reason.”

In the 10-year period of Cordaro’s example, investors suffered more modestly
than Ankrim’s estimates, but losses were still significant. Using actual
mutual-fund flows over 10 years ending January 2008, Cordaro found that market
timing cost the average investor a half percentage point of
return each year. On his $1 million portfolio, that means missing out on
$93,000 in gains.

You don’t need to be near a long-term market top or bottom to do serious
damage. From 1980 through 2006, investors who missed out on just the five
best-performing days in the Standard & Poor’s 500
index would have ended up with 26% less than someone fully
invested in the index during that period, says Carolyn Clancy, executive vice
president of Personal Investments, a division of Fidelity Investments.
“Missing just 30 of the best-performing days would have reduced the value
by 73%,” she adds.

Another kind of market timing is more passive, yet still destructive: It is
simply to stop feeding more money into your investments in rockier times.

Consider this: According to a 2007 study by Dalbar’s, a mutual-fund research
firm, if you had invested $10,000 in the S&P 500 index over 20 years
through December 2006 in a sporadic pattern that matches actual behavior of mutual-fund
investors during that period, you would have ended up with a
total of $33,252.

If, however, you had systematically invested the $10,000 in equal increments
over 20 years — through good times and bad-you would have ended up with
$42,877. The study found that even if you chose a fund that captured only 75%
of the S&P 500’s return, by dollar-cost averaging you would still end up with more than if you had sporadically invested in the
S&P 500 fund.

Paying Too Much

Before you win cocktail-bragging rights for earning a robust return on an
investment, be sure to factor in how much you paid for your winnings through
expenses and fees.

While more investors than ever before are seeking out low-cost mutual funds,
there are still investors who believe that they need to pay higher expenses for
better performance, says Mercer Bullard, a securities-law professor at the University of Mississippi.
But, he adds, there is no evidence to support that. Higher fees simply do not
indicate better management.

Consider S&P 500 index funds. While the performance
of these funds is practically identical, given that they mirror the same index,
expenses are all over the map — some funds charge no load, some have no load
but do have a so-called 12b-1 fee, which is an operating expense, and
yet others have both a load and a 12b-1 fee.

A 2006 study by Zero Alpha Group, a network of advisory firms, and Fund
Democracy, a shareholder-advocacy group, looked at how much investors would pay
in fees if they invested $10,000 in these funds for 20 years and earned an
average annual 10% gain. It found that the average investor would have paid $2,582
in fees in the lowest-cost fund; $3,744 in the fund with only a 12b-1 fee, and
$7,600 in the load fund with the 12b-1 fee.

In Cordaro’s hypothetical $1 million portfolio invested 10 years ago, he
looked at the impact that half a percentage point in fees can make on a
portfolio. While his best-case portfolio earned an average annual return of
6.86%, he found that if higher fees knocked half a percentage point off of
returns, an investor would have ended up with $1,848,865 rather than
$1,941,837.

Taken altogether, Cordaro says, the impact of investor error — even
seemingly small ones — can be grievous over the long term. “We’re talking
about the difference in being able to retire in comfort or having to work many
more years to meet your goals.”

]]> http://www.marketriders.com/blog/barrons-online-3-ways-investors-ruin-their-nesteggs/feed/ 0 http://www.marketriders.com/blog/where-one-billionaire-has-allocated-his-assets/ http://www.marketriders.com/blog/where-one-billionaire-has-allocated-his-assets/#comments Sun, 06 Jan 2008 08:38:25 +0000 admin http://marketriders/weblog/?p=88 I
had lunch with T.S. at the end of 2007, who made his fortune founding and building technology companies.  T.S. is one of the smartest and most dynamic
entrepreneurs I’ve ever met who now approaches philanthropy with as
much drive as he did his business.  One hallmark of T.S.’s success is his ability to surround himself with the smartest people, polling them for information, and making accurate choices about what to do in a particular situation.

T.S. has a family office and also, he actively travels the world and polls the smartest investors about asset allocation so I asked him how
he was allocating his capital.  His answer was simple, and concise:

1.  Sold all commercial US real estate last year.

2.  Moving US Equities down from 40% to 10%. Thinks the Bush
administration has created policies over the last 7 years that will
dramatically impair our ability to compete globally for many years and
that the housing / subprime problem will take years to solve.

3.  Heavy into cash because of #2 — believes there will be huge opportunities in real estate in coming years.

4.  He is moving 40% of his capital into Asia — primarily China.
Recently spent 10 days in China where he visited Hong Kong, Shanghai,
and Beijing. Said that there is no way to believe what is happening
there until you visit China.  It is an experience that has changed his
life.  He is investing in private equity funds based in China, staying
away from stocks in the Shanghai exchange.  He is also buying stocks in
Australia that sell products to help China build their infrastructure.
“What the US did between 1870 and 2005, China is doing in 20 years.”

I thought these were interesting comments from an active and astute entrepreneur who is approaching the investment of his capital with the seriousness of running any business.