Category Archives: Asset Allocation

Different Perspectives on Home Ownership

The question of whether to buy or rent a home is of enormous economic significance for most families. Home equity represents the vast majority of American families’ net worth (see chart below). In a post in mid-2011, I discussed some of the major economic variables in the decision to buy a home. My conclusion was that buying a home made sense, but not because housing generates attractive long-term investment gains. The long-term data suggests houses have historically increased in value at a rate only slightly higher than inflation. The best arguments for owning a home, I argued, were historically-low interest rates, the mortgage interest tax deduction, and the inflation hedge provided by locking in your costs for shelter for the long-term. Since that time, housing prices and rents have risen dramatically. In the past week I read two thoughtful and interesting articles on the economics of owning a home that motivated me to revisit this topic for 2014.

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A ‘New Era’ for Bonds?

The Wall Street Journal recently published an article titled How You Can Survive a New Era in the Bond Market.  The article suggests that investors adjust their bond allocations to tilt more towards high-yield (aka junk) bonds (both corporate and municipal) and global bonds, which tend to yield more than U.S. bonds.  This advice resonates with an Op Ed by Burton Malkiel, famed author of A Random Walk Down Wall Street, at the end of 2013.

The case against bonds is straightforward.  The best estimate for the expected future return from bonds is their current yield.  If you hold a bond until maturity, your total return will be very close to the current yield.  There are nuances to this rule.  With high-yield bonds, you should expect a total return that is a bit less than the current yield due to the fact that some of these bonds will probably end in default.  With bond funds, you don’t necessarily end up holding individual bonds until maturity, so the correspondence between current yield and expected return is a bit weaker.  Nonetheless, with current yields as low as they are, bond investors should not expect attractive returns from most bond classes.

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60-Second Retirement Savings and Income Checkup

I think that the American public has largely tuned out the myriad studies showing that most households are woefully under-saving for retirement.  Even if we’d prefer not to think about this issue, however, it is crucial to regularly check on how we are doing.  There are two major questions.  First, during your working years, are you saving enough?  Second, during retirement, how much income can you sustainably plan to draw from your savings each year?  The good news is that there are some simple tools that you can use to do a fast estimate of how you are doing, how much you need to save to stay on track, or how to get on track. Continue reading

Planning for College Costs, Part II

In part 1 of this article, I explored how you can estimate how much college will cost and how much you need to save, going forward, to accumulate enough savings to cover the amount that you plan to contribute towards your child’s college costs.  One of the major variables in this calculation is what you assume about how you will invest the money that you save.  While you can design a portfolio yourself, it is also worth looking at funds that combine the major asset classes into portfolios at various risk levels.  Continue reading

Review of The Affluent Investor by Phil DeMuth

I have known Phil DeMuth for a number of years and I admire his common sense and views on many topics.  Phil authored the recently-published book The Affluent Investor that fills a need in the crowded shelves of investment books.  As a financial advisor to high-net-worth families, Phil brings valuable perspective to investors who have built substantial portfolios and seek to protect and grow their wealth effectively. Continue reading

The Great Rotation?

The financial media loves a catch phrase and, with the apparent emotional hook of the ‘fiscal cliff’ diminished, we needed a new one.  The current best candidate is the so-called ‘Great Rotation.’  The idea here is that investors, finally and completely fed up with the dismal returns from bonds, are going to move heavily back into equities.  This is the ‘Great Rotation.’  When I Google the term, there are 820,000 search results.  Not bad for a phrase that was invented in October 2012 (in a research note from Bank of America, apparently).  Continue reading

The Yield Paradox

I have been struggling to understand a problem that I am going to refer to as the ‘yield paradox.’  Yields for individual asset classes look low.  The 10-year Treasury bond is yielding about 1.9%, and 30-year Treasury bonds are yielding a similarly paltry 3%.  The S&P 500 is yielding 2.1%, which is very low by comparison to historical levels.  Investment-grade corporate bond indexes are yielding less than 4% (see LQD, for example, at 3.8%).  Given that the official rate of inflation for 2012 was 1.7%, these yields mean that investors are getting very little yield net of inflation.  The very low yields on bonds and on stock indexes is a direct result of the Fed’s actions in holding interest rates at historical lows via Quantitative Easing.  We have not yet gotten to the paradox. Continue reading

Target Date Strategies Over The Last Five Years

The intent of target date strategies is to provide investors with fully-diversified portfolios that evolve appropriately as investors age.  Target date funds have enjoyed enormous growth over recent years, not least because the Pension Protection Act of 2006 allows employers to direct retirement plan participants into these funds as the default investment option.  Consultancy Casey Quirk projects that target date funds will hold almost half of all assets in 401(k) plans by 2020.

Target Date Folios are an alternative to traditional target date funds, launched on the Folio Investing platform in December of 2007.  These portfolios now have more than five years of performance history.  Prior to the design of the Folios, a detailed analysis of target date funds suggested that they could be considerably improved.  The Folios were designed to provide investors with an enhanced target date solution.  In this article, I will discuss the design and performance of the Folios and target date mutual funds over this tumultuous period.  The risk and return characteristics of these funds and Folios provides insight into the effectiveness of different approaches to portfolio design and diversification.  Continue reading

Perpetually Out of Step

There is increasing evidence of big flows of money into equities and leaving bonds.  This is being seen at all levels in the market, including among institutional investors such as pension plans.  The Wall Street Journal just published an article discussing this shift called Are Mom and Pop Heading for Wall Street?   Mutual fund flows suggest that investors are finally returning to equities, after selling in droves over the past several years.  This article summarizes the issue:

From April 2009 through now, mutual-fund investors sold a quarter trillion dollars in stock funds, according to recent data from the Investment Company Institute.

Ironically, that selloff coincided with a period of stellar performance in stocks—when the Dow Jones Industrial Average jumped more than 60%. Continue reading

Falling ETF Fees and What They Mean

Vanguard has just reduced the expense ratios of 24 of its ETFs.  The reductions are fairly substantial.  What I noticed, in particular, is that the reductions include sector-specific ETFs.

The Vanguard Energy ETF (VDE), the Vanguard Information Technology ETF (VGT), the Vanguard Telecom ETF (VOX), and the Vanguard Utility ETF (VPU) each now have 0.14% expense ratios vs. 0.19% previously.  While the expense ratios of these funds were already low, the new expenses are 26% lower than before. Continue reading