What many investors don’t know, however, is the Federal Reserve’s dirty little inflation secret. When the Fed reports on inflation, it reports on core inflation, a calculation that excludes food and energy costs.

The Fed has not always calculated inflation in this way. In February of 2000, the Federal Reserve rejected its old method of calculating inflation, which included food and energy, in favor of this new core inflation method, claiming that highly volatile food and energy prices made their influence impractical in determining monetary policy.

When you hear of the inflation rates of the late ’70s for instance, you are hearing about a number that included food and energy, whereas today’s number is skewed lower. Similar to how unemployment calculations have been skewed lower, using the 1970s method, both inflation and unemployment are higher today than most people realize.

The Fed has clearly revealed it wants inflation that is high enough to globally weaken the U.S. dollar, promote exports, and debase U.S. debt, but also low enough to keep investor confidence high and the economy moving forward. Fed chair Ben Bernanke has stated that the Fed is looking to stoke inflation to a rate of around 2 percent a year.

Unfortunately, inflation is not so easy to control. Inflation has a history of suddenly lurching out of control. Like a careening car that unexpectedly fishtails to one side, driver overcorrection will suddenly send the car dramatically sliding in the opposite direction and potentially out of control. Knowing this, the Fed wants to keep investors calm regarding the inflation story. Just last week, Bernanke suggested that inflation is not a threat and that the U.S. base interest rate will stay close to zero for an “extended period.”

What does this mean for you? Historically, developed economies have maintained an inflation rate of around 2 percent, while emerging economies have maintained a blended rate of around 6 percent. Strangely, these same economies tend to grow at similar rates as well.

People who live in emerging economies spend approximately 50 percent of their income on food and energy. In developed economies like the U.S., that drops to around 20 percent. Essentially, the poorer you are, the more your dollars must go to basic needs like food and energy. For the poor, their inflation tax goes up. Sadly, recent inflation of food, energy, and other basic commodities coupled with the deflation of the U.S. dollar is hitting many Americans harder than they may realize.

To respond to the inflation threat, every retirement portfolio needs to be inflation proofed. Start by allocating a part of your portfolio to Treasury Inflation-Protected Securities (TIPS). TIPS pay a stated dividend and also add the Consumer Price Index rate—a common measure of inflation—to the underlying value (PAR value) of the bond bi-annually.

Additionally, by adding exchange-traded funds like iShares S&P Global Energy (symbol IXC), iShares Dow Jones US Oil & Gas Ex Index (IEO), and iShares Dow Jones US Oil Equipment Index (IEZ) to your portfolio, you gain diversification to more than 300 companies impacted by the price of oil and gas.

Finally, add some precious metal exposure to your portfolio though ETFs like SPDR Gold Shares (GLD) or iShares Silver Trust (SLV), both of which will give you low-cost exposure to gold and silver. Beware of farming and food related ETFs because they involve futures contracts and are unpredictable.

But before you run out and turn your entire portfolio into an inflation hedge, remember that like inflation, deflation is also an ever-present risk. Just as quickly as the economy can careen toward inflation, a sudden overcorrection by the Fed can send the economy sliding wildly towards deflation.

Through global diversification and disciplined rebalancing, you can get the inflation pickpocket out of your wallet and rest assured that no matter which way the economy slides, you stand prepared to emerge a winner.

Minimizing Risk

One of the difficulties male investors face is the testosterone factor-an innate urge to beat the other guy, and then, of course, brag about it. This may explain why men trade in their accounts 45 percent more than women. While many men may feel that getting one’s panties all wadded up over a little bit of risk is for sissies, research shows that sober risk analysis is essential to constructing a well-diversified portfolio and achieving long-term performance.

Minimizing risk, for whatever reason, doesn’t seem to come naturally for men. A recent New York City Department of Transportation study revealed that men are 40 percent more likely to speed through a yellow light than women. More tragically, a 2007 TrafficSTATS report revealed that men have a 77 percent higher risk of dying in a car accident.

Men can be found running red lights in other areas of life as well. A study by anthropologist Kate Fox revealed that women view gambling negatively, while men hold a slightly positive view. The study goes on to state that women are more likely to avoid smoking, wear a seat belt, and even brush their teeth.

Men’s willingness to take risk in an effort to beat the market, however, is sadly misplaced. Academic research reveals that a mere 1 out of 3 professional managers beat their benchmark over five years, with the odds dramatically decreasing over a 10-year time span. Women seem more able to grok this reality, and invest accordingly by taking a longer-term approach.

A Wee Bit Impatient

During the financial collapse of 2008, one nationwide survey revealed that 1 in 8 men-as opposed to 1 in 40 women-made trades during the collapse in an effort to reevaluate, change paths, and find a new strategy for future growth. Such switches in investment approach were also confirmed in Fox’s research revealing that women are more patient and less impulsive with their investing. This results in a less active approach with fewer transaction fees, lower tax friction, and, as the science confirms, better returns.

Why Ask for Directions?

Most everyone seems to have a tale of a male driver being lost and unwilling to stop and ask for directions. Whether myth or fact, Fox’s research revealed that when it comes to finances, women are more apt to admit ignorance and reach out for help. While both men and women lacked knowledge when it came to certain financial products, women had a higher likelihood to ask for more information and clarification. More facts resulted in better investment decision and performance.

By stepping out of the testosterone-laden sandbox of active money management and resisting the impulse to compete to win, men can take a page out of the playbook of their gender counterparts. Simple global diversification, low-cost and tax-efficient indexing, and staying committed to maintaining allocations over the long haul are great building blocks for portfolio success.

Portfolio rebalancing suffers the same disdain amongst many investors as does eating vegetables amongst children. Why would an investor want to sell those equities that are outperforming and buy more of those that are underperforming?  But just like a parent who will not allow her child to live on dessert alone, a smart retirement investor accepts rebalancing as an irreplaceable discipline that results in portfolio health.

Portfolio rebalancing is the process of bringing the different asset classes back into proper relationship following a significant change in one or more. More simply stated, it is returning your portfolio to the proper mix of stocks, bonds and cash when they no longer conform to your plan.

Reams of research have demonstrated that disciplined portfolio rebalancing adds to returns over time. In additional to enhancing performance, rebalancing also provides the added benefit of reducing your portfolio’s risk profile. Like healthy eaters who learn to cherish fresh vegetables, healthy investors also learn to celebrate each rebalancing.

Below are a few articles that reinforce the power of rebalancing.

Webcast:  Commodities and Asset Allocation- Roger Gibson’s research reveals the compelling truth surrounding portfolio rebalancing. His math shows that an investment of $1 in the S&P 500 in 1971 would by this year have grown to $32.07.  An identical investment in commodities would have increased to $36.26.  A 50/50 portfolio, however, built of both asset classes and rebalanced annually returned a shocking $52. As Roger puts it in the webcast, “The whole outperformed the components.”

Buy & Hold, Asset Allocation And Rebalancing- This article in iStockanalyst provides a simple review of the value of asset allocation and disciplined rebalancing. The author notes, “there’s also the challenge of deciding when to rebalance . . . it pays to monitor the major asset classes for signals that enhance the odds of rebalancing at timely moments.” With MarketRiders, you don’t have to stare at your portfolio wondering when the right rebalancing moment will come. Our algorithms monitor your portfolio 24×7 and will alert you to ideal moments to bring your portfolio into focus.

The joy of portfolio cooking, now easier and less expensive- In this article, Scott Burns celebrates the low-cost ETF revolution that is afoot at Schwab, Fidelity and Vanguard. Why pay ten times more for mutual fund management when it underperforms a diversified ETF portfolio and can easily be managed through a service like MarketRiders?

Similarly with such market volatility in recent weeks, a few MarketRiders members have been asked to make some tough calls when, depending upon the portfolio, our rebalancing algorithms have alerted them to add to positions like, of all things, Europe. “Are you serious?” one member moaned. “Everyone knows Europe is blowing up. Why buy more now?”

Just like the man from the quote above, this member was having a tough time sticking with the plan. Sorry, but “buy low sell high” is tough to do. Successful investors must continually bet against the crowd, always with deep conviction, coupled with a tug of “unbelief.”

The MarketRiders system of buy, hold, rebalance is an investment approach, based upon solid research and unshakable facts. We can never remove all doubt, but we’ve harnessed the most scientifically verifiable investment approach known today. Rebalancing adds to returns and helps manage risk. You maintain your target allocations, and the risk level you set for yourself when you built your portfolio. Riding winners if fun, but what goes up, certainly comes down. Moving from religion to the casino: rebalancing forces you to “take money off the table” and add to losing bets that will be tomorrow’s winning ones.

It’s tough to maintain your allocations, and trimming a gold position or buying Europe while it is apparently swirling down the toilet is not easy. At moments like these, lean into the facts of the scientific research, push back your emotions and then rebalance your portfolio. You will be glad you did.

Investors who have decided to enter this tournament via day trading, market timing, technical analysis or even tactical asset allocation, need to pay close attention. You are playing a game that is very difficult to win, especially if you have fewer resources, knowledge and technology than your competition. Oh, sure, you might be lucky enough to win a few early hands but the long-term outcome is fairly predictable. Such investors live with a prevailing sense of unrest knowing that they have shown up to a shotgun duel carrying a pocketknife.

Wealthy families, endowments and elite institutions practice a different investment approach. These investors are wise enough to avoid, paying fees to managers trying to “beat” the averages in public stock markets. Sure, they may invest in private equity and venture capital where they enjoy an advantage via access to the best deals and terms. But when it comes to public markets, these investors commit a large portion of their portfolio to passive indexed strategies – the MarketRiders approach. The only bet such investors are making is that the world is in fact not coming to an end any time soon and that its markets, companies and their portfolio will continue to grow over long periods of time.

This approach provides amazing freedom from having to stare at your portfolio several times a day. Unconcerned about the daily gyrations of Jim Cramer and the rest of the bobble-headed finance media, long-term and disciplined MarketRiders can go about their daily lives with peace of mind. Sure, the market is down May and your portfolio probably dropped with it, but with a retirement time-horizon that is years away, your portfolio will not only recover, but grow quite nicely.  And by rebalancing you are taking advantage of these swings.  This knowledge frees you from staring at a computer monitor and gives you time to go about the real business of living your life.  In the end, isn’t that what the money is actually for?

Sadly, it was no surprise to learn the Goldman Sachs threw their clients “under the bus” by deceitfully selling them mortgage securities while at the same time making a killing on shorting the housing market.  Their slogan, “Helping clients build and preserve their financial wealth” needs a minor adjustment. “Helping clients build and preserve OUR financial wealth.” This is a paragon of the Wall Street ethic – make money (hmmm – a lot of money) even if you must trample your client under foot. When you manage your own diversified portfolio of ETFs through a MarketRiders account, you truly get Wall Street out of your pocketbook by removing the intermediaries.

The Wall Street gurus seem to have a closet full of tricks to help investors outperform the market. Unfortunately, most of this advice is unproven and ineffective. In this MoneyWatch article, James Picerno points out one of the ONLY scientifically proven secrets to boost portfolio returns year-upon-year – disciplined rebalancing. Mr. Picerno underscores that rebalancing can deliver a 0.5 to 1.0 percentage point annual bonus compared to what you’d earn on the same portfolio that’s left alone. Our research shows that by using MarketRiders’ advanced rebalancing algorithms rather than a simple calendar based approach, investors add up to 2% additional growth in some portfolios and market conditions. We have more on this topic here: “How Often Do I Need to Rebalance?”.

When it comes to retirement investing, remember that you don’t have as many friends in the financial services industry as you think. By taking the time to learn the virtues of low cost indexing, global diversification and disciplined rebalancing, you will truly build and preserve YOUR wealth.

Most retirement investors rebalance via calender alerts on a quarterly basis. This method, however, is trumped by the deeply researched practices of large endowments that rigorously perform event based rebalancing. These large institutions have hundreds of millions if not billions at work in and understand that by setting pre-defined bans by asset class or index, they are able to have thier technology keep a watchful eye on market dynamics and harvest gains at the exact moment the portfolio moves outside of rules for the portfolio. This contrarian discipline allows these endowments and large institutions to add as much as 2% a year to their returns, not including taxes and trading fees.

At MarketRiders, we have created an retirement platform that empowers everyday retirement investor with rebalancing technology enjoyed by wealthy endowments. In our MarketRiders engine, you too  can set the rebalancing bands for your retirement portfolio. If it is in a tax free account and you have low brokerage fees, you may go under your dashboard and choose Set Alert Levels to increase your rebalancing sensitivity to a setting of 4 or 5. If you are in a taxable account, we recommend a setting of 3. Whether you are a MarketRiders member or not, what matter most is that you follow the examples of the pros through disciplined event based rebalancing.  For more information about this strategy, download our free report by clicking here.

He first suggests ”setting an asset allocation for your portfolio and dollar-cost-average your investment dollars into low-cost, broad index funds.”  One can do this by either deciding to use the service of an investment adviser to create a customized asset allocation, our by using a ‘do-it-yourself’ tool offered by companies like MarketRiders, AmeriTrade or Fidelity to manage your own portfolio. 

He then goes on to state the importance of ‘rebalancing your portfolio when your asset tilt gets out of whack because the markets surprise you, as they surely will. This means forcing yourself to buy stocks when they’re down and selling when they’re up. Doing so allows you to take advantage of irrational investor behavior rather than being a victim of it.”  Investment rebalancing can be quick and easy with the ‘do-it-yourself’ tools on the market today, enabling one to realize even greater returns. 

What made me smile most when I read his article was: “Don’t buy into the hype that asset allocation is dead and that now is the time for active investing. Arithmetic works every bit as well in bad financial markets as it does in good markets. If you see ugly returns on the indexes in the next decade, just smile and realize how much better you are actually doing.”  For ones like me that take great comfort in seeing things in black and white, is there any other choice than going with an asset allocation and rebalancing as needed.  The numbers speak for themselves.

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.