Do You Pass the Investment Test?

Posted on January 6, 2012 at 12:15 PM PST by

Like a volcano, markets go through phases: they do very little and then suddenly they spit fiery lava. With new problems being introduced each day, be it Greek debt or the survival of the Euro, political bickering or Middle East uprisings, the markets are trying to figure out what stuff is worth.

Volatility was up in 2011, and brought out all of the “forecasters” in droves predicting which way the markets will blow. Most have been wrong. Bill Gross, who runs the largest bond fund in the world bet against US Treasuries, which was the top performer in 2011. Famed investor Meredith Whitney predicted the demise of municipal bonds. Following her advice would have been devastating as munis rallied after her “insights.” Hedge funds that focused on picking stocks were down 7% in 2011 with a Dow up 5%.

One of our members asked, why we recommended Vanguard’s Exchange Traded Fund VGK an index made up of the largest 482 stocks in 16 European countries when “everyone knows” that Europe is in trouble. VGK was down nearly 18% last year, while the S&P was flat.

First, think of the thousands of investors all around the world, who deeply understand the economic circumstances of every country in Europe, focused every second on figuring out what every one of those 482 companies are worth. Is your opinion on VGK’s price better than theirs? Second, VGK belongs in a globally diversified portfolio, because we care about the long term. Europe will recover. In 10 years, VGK’s price today will likely look cheap because those 482 companies will be more valuable. When CNBC says “Europe” remember these are real global businesses making money, employing millions of workers.

A year ago, when TIPS were selling at a high price, one of our members declined to include it in his recommended portfolio because in his opinion “it was over valued.” TIPs were up over 12% last year.

Trying to time and guess the market’s direction is futile for most mortals and investment professionals. It’s during times like these, that you can really appreciate the calming logic of a simple and disciplined asset allocation investment methodology. Since we never know how one particular asset class will perform –own them all at a very low cost, in proportion to our risk tolerance. Then rebalance them as the markets shift.

Sounds easy to “buy low and sell high” doesn’t it? Would you buy more Europe now if you were under-allocated? We certainly hope so. Is your asset allocation right? This market provides you with a litmus test. If you have been feeling panic lately, then perhaps your stomach lining isn’t strong enough for amount of equities in your portfolio. It may be time to consider whether you should increase your exposure to bonds and TIPs.

Markets like these test you. Stay the course and take a gut check. Keep rebalancing and make the market’s volatility your friend. If your allocation is right, you’ll be able to keep your mind off the stock market, keep CNBC off and focus on the rest of your life.